I just saw this story in the Times.. I would like to say more, but I am rather busy right now. Perhaps, others might like to take up the story with some comments. (Asteve, Nick, Vado, traderboy, I am thinking of you here).
Britons are facing more months of rising mortgage costs after the rate at which banks lend to each other unexpectedly spiked and lenders rushed to borrow £78.3 billion from the Bank of England, which had £13.7 billion on offer.
The three-month London inter bank offer rate (Libor), which is the cost of borrowing in the wholesale funding market, rose from 5.70 per cent to 5.84 per cent as banks reacted to yesterday's Bank of England quarterly Inflation Report that ruled out more interest rate cuts to curb inflation which now 3 per cent - above the Government's 2 per cent target.
Libor is now nearly a whole percentage point above the 5 per cent base rate, and today's surge sent sterling down against the dollar from $1.9446 to $1.9438.
Inflation going up, market interest rates rising, I am shocked!!
10 comments:
Two words - predictable and inevitable.
well, aside from the rubbish statement in The Times saying "today's surge sent sterling down against the dollar from $1.9446 to $1.9438", which is the smallest "surge" i've ever seen...
mortgage rates will be going up for the foreseeable future, and not just because banks borrowing is more expensive...banks now know they have the upper hand in forcing rates higher, which will help their profits, and also they are finally coming to the realisation that the collateral backing their lending is going down considerably.
With LIBOR approaching 6%, and banks borrowing in the wholesale market at anything from LIBOR + 75 to 150bps or even higher, that means the banks are ~7% or more for funds...now, if memory serves me right, their interest margin on mortgages used to be about 200bps, so looks to me like mortgage rates need to get up to 9% or so. Not far away from double digits then...that'll really start to bite.
Have been watching property in my area of London pretty closely for the last couple of months, lots of asking prices being SLASHED and have seen a number of properties go from Sold or Under Offer to Available...market is not clearing at current prices, I suspect the real clearing level at the moment is considerably lower than current prices, like 20-40%.
I agree with most of what you say, TB... especially about the irrelevance of the GBP/USD move... I've a slightly different take on mortgages.
Over the short term, mortgages can't go up much... especially not the high risk ones... the defaults would likely prove devastating. LIBOR is merely reflecting that banks with cash are calling the shots today. It makes perfect sense. With securitisation dead, there's no competition to speak of.
What is relevant at the moment is that there is absolutely no desire to write new mortgage business. The rates of interest are all-but irrelevant. There's Northern Rock's entire book to exploit... there's no need to find new customers.
Over the medium to long term (thinking from 2 to 3 years into the future) I can imagine lenders wanting to write new business - all be it at much smaller income multiples. I think it will be unusual to have a new mortgage of over £100K issued for the best part of a decade... but that lenders will want to lend to those with good income and no debt. The interest rate will be all-but irrelevant as the mortgage principles will be dramatically smaller.
This story, of course, is not the biggie right now. The big story is that ~£90bn is planned to be swapped in the BoE SLS scheme. This is just another indication that the scale of the problems in the UK mortgage markets are at least twice as bad as the current worst case scenario estimates. Those haircuts are going to smart like a samurai beheading! No wonder we've seen a rash of rights issues...
I think this means that the probability of a long, drawn-out recession (a-la Japan post 1990) is looking ever more credible.
The FT reports on this as "Banks eye £90bn in mortgage asset swaps" (google for it - then you can read for free... unless, like me, you've over-run your freeloading limit. ;) )
The most interesting part of the article is that the ECB, in light of this news, thinks that it (the ECB) is being taken for a ride... where its own schemes are being exploited to offload rubbish. I'm interested to discover more about the ECB schemes.
P.S. "Inflation going up, market interest rates rising, I am shocked!!"
Why?
Stagflation took the economic mainstream by surprise in the 1970s... their models said that it was impossible. Their models were wrong. Today, we know stagflation can arise... but what we see happening still seems impossible by conventional wisdom. Our models are wrong again - but in a different way to in the 1970s.
Blflation it is today... it's new - and the consequences are yet to be established experimentally. It's fun to live in interesting times, isn't it?
I agree with asteves LIBOR post. My tuppence:
In bank crisis the solution is always the same - steepen the yield curve. Banks make their profits on the spread between what they pay to borrow (depositors, wholesale) and what they lend at (mortgages, other loans).
To rehabilitate banks the BoE has to keep the BoE rate as low as possible while allowing LIBOR to rise (not that they can actually stop it rising). The spread increases and thus banks gradually recapitalise. So the current increase in LIBOR is exactly what is supposed to be happening.
It's compounded further by the very reason you get a bank crisis in the first place - too much lending leading to too many bad loans leading to too low reserves leading to restricted future lending.
Basically banks don't want to lend at ANY price, yet if they shut up shop completely they go out of business. So they retrench to very safe loans with very good collateral and high rates. So LIBOR goes up.
The problem is this usualy prescription isn't working very well and that's because the solution is based on a liquidity problem when the reality is its a solvency problem. Therefore we see a further strategy: zombification
Put simply, the BoE pretends not to notice banks are insolvent. It swaps them enough rubbish to keep a trickle of banking activity in place, to maintain the illusion we still have a functioning banking system. And then, over a VERY LONG TIME the banks can mature or write off loans and stealth recapitalise from the yield curve. But as Japan found out, it can take over a decade.
As if that's not bad enough, we then have it happening in a deflationary environment. As loans are cancelled or repaid the commerical money evaporates from the system and is not replaced by new loans. Investment slows. Spending slows. A deflationary spiral ensues. No matter how much the BoE prints it just gets trapped on banks balance sheets because nobody wants to borrow and nobody wants to lend. Again, see Japan 1990-2004.
That's why I probably disagree with asteves post on stagflation in a strict sense. We have a deflation now, despite some commodities going up. Because we have a net contraction in money supply (i.e. bank-created money, or credit, evaporating) an increase in the amount of it going on food and oil means less going on other things (like apparel, entertainment).
Cash is still king.
Nick
BTW, to clarify the above post:
Mortagage and other loan rates charged by banks to customers goes up => steepening yield curve
LIBOR goes up because banks need to keep what cash they have if they are to weather write downs and issue new loans to take advantage of the steeper yield curve.
Rising LIBOR is interfering with the rehabilitation.
Nick
I think we're in for something like a rerun of the early 70s.
The only positive thing I can see coming from it is that most people will blame Labour and give them the push for a few years.
What are people's ideas for how to try and repair or at least sooth this situation?
Why do otherwise credible people expect a repeat of a previous economic circumstance? (I was guilty, to some extent... talking about the 70s oil crisis; 90s Japanese crash and early 90s recession in the UK... but I use these just to illustrate the public being taken by surprise by dramatic turns of events.)
There's a lot of similarity between now and the early 1970s, I think - but the outcome will be different because:
1. There's spectacularly more debt today.
2. The workforce competes in a global market - unionisation is all but dead.
3. Our economic models have already been adjusted after the shock realisation that stagflation was possible...
This time, securitisation of debt is the monster elephant in the room. It eclipses almost everything else. This strategy had not even been invented in the 70s. I think that securitisation will define revelations about economies this time.
I take your point. I think it was Mark Twain who said 'History doesn't repeat itself, but it does rhyme'
I'm waiting to see to what degree unemployment takes off.
Yes, unemployment will be crucial over the coming years. It is important to note, however, that employment/unemployment will lag leading indicators by a year or more in today's consumer-driven, deficit-financed economy.
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