Page last updated at 17:35 GMT, Sunday, 11 January 2009

Bank bosses discuss mortgage plan

By Joe Lynam
Business correspondent, BBC News

For sale signs
A stronger housing market would bolster the ailing economy

The government could be set to step in and guarantee mortgage lending under a plan being discussed this weekend.

Some of Britain's top bankers are meeting at the prime minister's country residence Chequers.

On the agenda is the possible implementation of the Crosby Report, which was published last November.

Among recommendations was a plan for the government to provide guarantees on mortgage securities.

This is along the lines of the so-called "bad bank" solution, which US Treasury Secretary Hank Paulson envisaged last September when he persuaded the US Congress to provide $700bn in funding to buy tainted assets from banks in order to free up lending again.

The Treasury would guarantee bank bonds that used home loans as collateral.

Roughly 100bn in mortgages were provided using these types of investments in 2007 before the market imploded.

'Exorbitant fees'

It is technically known as securitisation, and it is the collapse in this market that has dried up mortgage lending and overall confidence in the housing market.

Major players in this market have all but disappeared over the past 18 months, including a few major US banks, hedge funds and some sovereign wealth funds - state-owned investment trusts usually controlled by oil-rich Asian countries.

The Crosby report, by the former HBOS chief executive Sir James Crosby, envisaged that the government would auction mortgage guarantees to the highest bidder and charge a fee to the eventual winner, on the condition that they would provide home loans to first-time buyers and not to remortgaging customers.

The problem up to now has been that any guarantees that the government has offered to banks have come with major strings and exorbitant fees attached.

Speaking to the BBC, a senior bank executive described fees up to this as "usury" and "a disincentive to lend".

So one of the discussion points this weekend will no doubt be how much the government will charge banks for these precious guarantees.

Too little and the banks would make too much money, which would be politically unacceptable. Too much and the banks won't take up the scheme and lending will remain available to the very rich.

There's also talk of extending these guarantees to small businesses, though that was not mentioned in the Crosby report.

The issue of mortgage guarantees needs to get sorted out soon though, as the housing market tanks and the economy weakens substantially.

"We need to move quickly - even within the next fortnight so that banks can start increasing the flow of money to potential mortgage holders", the senior banking executive told the BBC.

"January and February are slow anyway for housing activity. Easter is the usual start of housing period."

Worthless bonds

Up to 2000 the banks were self funding, which means they only lent out money they had on their books.

That changed with the arrival of wholesale funding, including securitisation, and this reached 650bn in lending by 2007.

When poor or subprime homeowners in the US started defaulting on their mortgages, this meant that the bonds which were linked to these home loans were worth almost nothing.

Thus the birth of the credit crunch and the looming recession worldwide.

The BBC has learned that neither the banks nor the government are aiming for a return to the levels of lending seen in 2007 - described by a senior banker as "heady" - nor do they want to see a return to banks relying solely on the money they get in from savers. That would lead to a collapse in house prices.

This mortgage guarantee plan is distinct from the 50bn Special Liquidity Scheme offered by the Bank of England, which allows banks to swap toxic bonds for high quality Treasury bonds on a short-term basis.

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