The credit crunch is not a symptom; it is the cure

Yesterday, the Council of Mortgage Lenders had their annual lunch. Their Chairman - Steven Crawshaw - entertained the guests with a speech, where he shamelessly demanded help from the Bank of England, the FSA and the government to counter the effects of the credit crunch.

Crawshaw warned that there was "a real possibility that net lending in 2008 could reach only half last year’s level unless additional funds become available". There is now a "funding gap" in the UK mortgage market and that "potential borrowing still significantly exceeds the industry’s collective capacity to supply funds."

The CML chairman had some answers to these problems. Unfortunately, all his answers were directed towards the public sector.

First, he wants more of the Bank of England's balance sheet to be transferred to troubled banks - "deeper and longer term repo facilities – extending beyond the 3-month facility to 12 months or perhaps even 24 months – would definitely begin to help."

He also wants the Bank of England to kick start "the market for new issuance of mortgage-backed securities – perhaps by incentivising the kind of stable, domestic investors such as pension funds."

Crawshaw also had a message for the FSA. He pleaded for the FSA to "regulate us in a proportionate and focused way". He added "With the FSA hugely concerned with monitoring individual institutions’ liquidity on a regular basis, and driven by meeting its business plan commitments, there seems to be little “flex” in the regulator’s approach."

Finally, he wanted to tell the Chancellor that "it would be good for the Government to continue to remind people that the UK mortgage industry has been and remains a major asset to UK plc and our economy."

Lets examine Crawshaw's suggestions, starting with the helpful advice to the Bank of England. Why should mortgage lenders receive publicly-owned assets to bolster their balance sheets? If asked, Crawshaw would answer that if the BoE failed to support the mortgage sector, the UK could see a systemic banking crisis, which might cause real economic pain. Crawshaw is right about the danger, however, he is unwilling to shoulder any of the cost of this dreadful state of affairs.

Larger and longer repo operations are fine so long as banks using these facilities pay penal rates. Obviously, the banks may not have the cash to pay for these facilities right now. So why don't they pay in the form of equity. Banks can access long term repos from the BoE but must pay a 5 percent premium over market interest rates payable in bank equity. Persistent users would see their equity diluted, share prices would fall and in extreme cases, banks would be nationalized. The pain of these operations would be transferred to shareholders, bank management while the public sector would gain.

His ideas on mortgage backed securities is yet another example of banks shifting the consequences of their excessive risk-taking onto others. Not content with transferring under performing assets to our central bank, Crawshaw also wants our pension funds to take up some of these high dubious mortgage backed securities.

Meanwhile his plea for more flexible FSA supervison is totally inappropriate. The FSA needs to tighten things up. This is likely to happen. The FSA received a pasting after the Northern Rock collapse, and the request for more flexibility is unlikely to get much of a hearing.

Turning finally to the Mr. Darling. The Chancellor only needs to look at government debt numbers to understand the contribution of the mortgage industry. One of the CML members - Northern Rock - has just added about 7 percent of GDP to public sector debt.

Unfortunately, Crawshaw simply does not understand that has just happened. The housing bubble has burst, and the balance sheets of his members are now deeply compromised. There is only one way out of this crisis. Asset quality must improve. A further increase in lending volumes, which Crawshaw craves, would only make balances sheets deteriorate further. Crawshaw has to understand that the collapse in mortgage volumes is not a symptom of the problem, it is part of the cure.

Rather than pleading for public sector assistance, Crawshaw would serve his membership better if he helped introduce tighter and more prudent lending standards . He should help them prepare for higher default rates and lower profitability. Above all, he should tell his members that the bubble has crashed; it will not return any time soon; and that mortgage lenders need to adjust to that new reality.