High and dry

"The credit environment remains difficult, impacting the workings of the money, banking and capital markets."

That is how Paragon Finance director Nicholas Keen described the financial markets today. The situation is difficult; there is no doubt about that. Paragon's lending volumes are down fifty percent. However, Keen goes on to explain:

"If anything they (the credit markets) look like they're getting a bit worse so it could be a long wait until the capital and bank markets are back to a normal level of functional operation."

Keen's comments point to an interesting question: what is the normal and functional operation of the capital and bank markets? Here is my attempt to answer that question.

Last August, UK interbank lending fell off a climb, and it has not recovered since. Presumably, this is what Mr. Keen means when he talks about a difficult credit environment.


(click on the chart for a sharper image)

However, the outstanding volume of interrbank lending back in August was about 50 percent of GDP. Moreover, it had grown by 325 percent since December 2001. In fact, interbank lending had grown far faster than house prices. Interbank lending was one of those bubbles that went undetected. We didn't know about it until it had burst.

Returning to the question; what would be a normal and functional level of interbank lending? The data seems to suggest that we could be close to it right now. Between January 2000 and December 2002, outstanding balances of interbank lending averaged about £183 billion. In January 2008, the balance was £198 billion.

This points to a terrifying and unresolved problem for Paragon and other similar buy-to-let specialists. Volumes in the interbank market will never return to the levels we saw back in July 2007. The market was abnormal back then, and it has gone forever. To use the words of Mr. Keen, today, the market has returned to its "normal and functional" level. Unfortunately for Paragon, it has left the BTL lender high and dry and unable to fund any increase in business.