I just don't get it. The UK is awash with debt it can't shift, yet the UK government thinks it's a great idea to ensure that people get £130bn of mortgages they can't otherwise afford.
A Treasury spokesperson is quoted in today's FT as saying that "there are rules ensuring that people can pay the mortgage that they have taken on." But if they couldn't have got the mortgage in the first place, how is that so?
It would be fair enough if someone were able to point to specific, unreasonably restrictive bank lending practices and get them changed. Yet neither the Treasury nor the Bank of England has been able to bring the banks to heel, so putting the taxpayer on the hook for 15% of a bunch of new high loan-to-value mortgages seems a little careless to say the least.
But maybe it's too late. Maybe we're just seeing the inevitable consequence of the fact that the UK state is already standing behind £491bn of UK mortgage debt, or 42%. The state simply has to be back even more. The US introduced this nonsense as a 'temporary measure' 70 years ago and, as Gillian Tett recently pointed out, is now behind 90% of the US mortgage market. How's that working out for them? You be the judge.
Great to see the MoveYourMoney campaign up and running - certainly a step up from the calls for futile mass withdrawals in 2010. But there are two significant gaps in the message.
Firstly: why should we move our money?
We don't need to 'save'. That's not really an activitiy in itself. And it's only one side of a much bigger story. Where do our deposits go?
As a society, our financial challenge is to get surplus cash from those who have it to creditworthy people and businesses who need it. Quickly and cheaply. At the rate that's right for both parties.
Our financial institutions don't enable this right now. They pay very little to interest to savers. They keep too much of the interest that borrowers pay. They use this 'margin' to cover losses from their own poor investments.
So we've had to invent direct finance services that cut the cost of connecting savers and borrowers - meaning higher returns on savings and cheaper borrowing costs. As each borrower repays, you can re-lend your money to others. Think of it as financial recycling. The banks still play a role - the operators of these new services recycle the money through segregated business bank accounts - but they don't get to use your money the same way as if you opened your own personal savings account.
But this brings us to the second gap in the MoveYourMoney campaign. We shouldn't move our money to just one place. We need to put our eggs in lots of baskets - we need to diversify more. There are many other baskets for your eggs than those listed.
Yet we are incentivised by government not to diversify. Most of us only get basic tax breaks (e.g. ISAs) for putting our small amounts of savings in the bank or building society (or in regulated stocks and shares). This not only discourages us from using more efficient services, but also protects banks and building societies (and managed investment funds) from competition. Worse, it encourages us to put all our eggs in a few baskets, so our holdings of surplus funds are not diversified. We're told this is 'safe' to do because at least some of our money is protected by the Financial Services Compensation Scheme. But such insurance does not ultimately make these baskets 'safe' for all of us as a society. It makes these baskets expensive - because as consumers we all pay for the compensation scheme in the end. And we pay again as taxpayers when the highly concentrated risks in the financial system bring it grinding to a halt.
MoveYourMoney may not yet explain the need to get your money quickly and cheaply to creditworthy people and businesses who need funding. Nor adequately explain the need to diversify. But the government is now aware that the regulations and incentives are wrong. And organisations like MoveYourMoney should be helping us to keep the pressure on government so that these problems are actually addressed.
Some might say that the alternative finance market is small beer at this point, and it's not worth accommodating them in the regulatory framework. But it's unrealistic to expect alternative business models to thrive amidst the dominance of the banks and while the entire financial system is hard-wired to suit them and other traditional investment vehicles (see the series of articles by Vince Heaney, David Potter and Adriana Nilsson in February's Financial World).
Others might also say that we should wait until the 'winning' business models emerge before figuring out what regulation may need to change. Yet picking winning business ideas is impossible, as Peter Urwin explains in "Self-employment, Small Firms and Enterprise". He has found that, while
"entrepreneurship is crucial for economic growth... we have no idea
where it will come from - not even in the most general terms."
As a
result, the best that we - and government - can do is to ensure "a
climate in which enterpreneurship can thrive".
I'm off to Number 10 today, to talk about red tape that's constraining disruptive business models in financial services. In the interests of transparency, I've summarised my thoughts for both the legal community here, as well as below. I'll be submitting a more detailed paper in the coming weeks, both to the Red Tape Challenge and the BIS Taskforce on alternative business finance. I'm interested in any comments you may have.
Financial regulation similarly fails to deal with a range of
non-bank finance platforms that share some of the key characteristics of Zopa’s
person-to-person lending platform. Accordingly, financial regulation is failing
to enable the cost efficient flow of surplus funds from ordinary people savers
and investors to creditworthy people and businesses who need finance. In
particular, the current framework:
generates confusion amongst ordinary people as to the basis on which they may lawfully participate on alternative finance
platforms (even though some are licensed by the Office of Fair Trading);
does not make alternative finance products eligible for the usual mechanisms through which ordinary people save and invest,
exposing lenders to higher ‘effective tax rates’;
discourages ordinary savers and investors from adequately diversifying their investments;
incentivises ordinary savers and investors to concentrate their money in bank cash deposits, and regulated stocks and shares;
inhibits ordinary savers’ and investors’ from accessing fixed income returns that exceed long term savings rates;
inhibits the development of peer-to-peer funding of other fixed term finance (e.g.mortgages and project/asset finance, and even short term funding of invoices); and
protects ‘traditional’ regulated financial services providers from competition.
These
regulatory failings could be resolved by creating a new regulated activity of
operating a direct finance platform, for which the best-equipped regulatory authority
would be the Financial Services Authority (as replaced by the Financial Conduct
Authority). Regulation of the platform would be independent of any regulation
that may apply to the type of product offered to participants on the platform
(e.g. loans, trade invoices, debentures to finance renewable energy and lending
for social projects). Proportionate regulation that
obliges platform operators to address operational risks common to all products
would also enable
economies of scale and sharing of consistent best practice, and leave product
providers and other competent regulators to focus solely on product-specific
issues (e.g. consumer credit, charitable purposes).
Similarly,
there is no reason why products distributed via these platforms should not also
be eligible for the usual mechanisms through which ordinary people save and
invest, such as ISAs, pensions and enterprise investment schemes.
The FSA's aims are to ensure the mortgage market is sustainable for all participants, and works better for consumers - and taxpayers.
The credit crunch has shown that consumer lending and related securitisation programmes have become a high risk, low/no data process. That has to change.
So, the immediate challenge to the FSA's approach is the decision (thinly explained on page 67) to focus only on the 'mortgage market', rather than the role of mortgages in the 'credit market' or indeed the overall investment market of which the credit market is an integral part. Of course, the FSA's remit and resources don't even extend to unsecured credit, let alone the entire investment market. This silo mentality renders the investment markets a fool's paradise.
Secondly, lenders and their investors (including the Treasury) will only get better at risk management if all the data systems in the lending/investment process are up to the job of collecting and processing enough credit data. That includes using the data gleaned in the underwriting process to help inform the loan collections/enforcement process, then 'closing the loop' by feeding the lessons learned back into the underwriting and investment processes. It would be interesting to see how much work the FSA has done to understand and encourage the level of investment in systems used for underwriting, collections and investment decisions.
Thirdly, the FSA is right to avoid 'blunt' caps on loan-to-value and debt-to-income ratios. Adding a more detailed calculation of 'free disposable income' is a good way to introduce more data that might help lenders and investors predict the likelihood of default. But that will only work if borrowers are willing to contribute accurate data, rather than try to 'game' the system - which lenders/investors will end up tolerating. So far, the FSA seems to be generating consumer resistance to providing extra information to lenders (making it harder for lenders to ask) by not explaining that extra data is critical to lenders improving their credit risk management systems, which ultimately protects the entire financial system.
A scuba instructor once told me the tragic story of a diver who tried to salvage an outboard motor at the bottom of a lake. Struggling to raise the motor, our man decided to fully inflate his buoyancy jacket for extra lift. All went well until he lost his grip on the motor, transforming himself into the human version of a Polaris missile. A fatal case of the bends ensued.
Of course, Messrs Bernanke, King et al. are also struggling manfully to lift something heavy that is deep underwater. For extra lift, they are also pumping lots and lots of air into the economic buoyancy control devices, and even appearing on TV to talk things up. The obvious concerns are (a) the amount of air being pumped in, (b) when to stop pumping and (c) how fast they can get the air out again when the economy turns to prevent it going ballistic.
The AIG saga seems instructive on this last concern. The $170bn in government aid is said to have been used to boost the "collateral" (or reserves) that secured AIG's insurance obligations on dodgy credit-default swaps (CDS's). And about $105bn has since been paid out to insured banks (on the full face value of the CDS's - hey presto, no loss!). In turn, the banks have used the money to shore up their own "reserves" rather than lend it - much as they're doing with the bailout money they receive directly, more of which is being printed as we speak.
There is no single definition of the term "reserves". To a large extent, what's prudent or required today may be deemed overkill next quarter and released to revenue and used in the ordinary course again. Given the care they took on the way into this mess, my bet is that as the economy turns the banks and insurers will release the reserves and provisions they made in a panic over the lack of liquidity way too quickly for central bankers to get the surplus air out of the economic buoyancy jacket. See picture for the consequences...
That's not to say there's any practicable solution at the global level, or that individually any of those banks or insurers will be wrong to release the reserves in question. It's just the system we have. It ain't perfect, as Lord Turner has just explained [stable door creaks and slams shut].
So, on a personal basis, one might at least consider that a tracker mortgage with an interest rate cap, or even a fixed rate mortgage, is a prudent option right now.
PS: Earlier in May, I went with a fixed rate mortgage, as the tracker with cap options started getting too expensive at the level of the cap.
PS: 28 May '09, FT Alphaville notes: "Wednesday saw a frantic steepening of the Treasuries curve... The fact is there is a growing perception in the market that further down the line, a messy quantitative easing-exit strategy might see the Fed forced to raise rates quite fiercely." I guess John Kay would say there is an opportunity to bet against the market, here. However, perception seems to be everything, so if the Fed is persuaded the market is looking for a rate hike, it may well deliver, and other central banks may have no alternative but to follow.
PPS: 10 June 09: Interactive Investor summarises the "flamewar" between Keynesian and Monetarist economists over the implications of rising bond yields.
