MortgagesMay 22 2013

More than one can chew

Search sponsored by
ByGeoffrey Wood

The economic outlook was so gloomy that the deal no longer seemed worthwhile, a bank spokesman said. This seemed odd even at the time. No firm undertakes a takeover that would greatly affect the size and structure of its business for years to come on the basis of the next couple of years’ prospects. Now it has become clear that other factors were at play. Not only has recent data shown that the economic outlook is brighter than the statement implied – which, to be fair, the Co-op could not have foreseen – but, as Moody’s has made clear, there is quite a lot that needs attention at the Co-op itself before it starts taking over new businesses.


The lesson is: statements made immediately after a takeover is called off do not always give a complete explanation of what went wrong.

But, there are two much more important lessons. Both have implications for current and future discussions of the shape and structure of the banking industry, and for its regulation. These relate to how the risks of certain types of lending should be viewed, and to the appropriate corporate form for banks.

Conventionally, lending on property (especially residential property) has been viewed as safe. This has led to its being given a very low risk weighting by the Basel Committee. In the US shortly before the banking crisis, Ben Bernanke, chairman of the US Federal Reserve, stated that he was unconcerned about the mortgage market because there had never been a nationwide house price crash in the US. And, of course in Britain, building societies are conventionally viewed as stable, safe places for small savers.

The first lesson to be learned – although it could have been learned before, from the failure of Northern Rock, for example – is that property lending, even on residential mortgages, is not absolutely safe. How safe it is depends on many things, but most basic is the standard of the lending. What proportion of the house price has been lent? Who did the valuation, and how conservatively? What multiple of income was advanced? Was the declared income confirmed by an independent party?

All these have been neglected in recent years, but despite that it has been generally believed that a mortgage is just a mortgage – all are the same, and all are secure. I doubt if Ben Bernanke made that elementary error, but he made another more sophisticated one, and one that matters in the UK. He neglected to note the importance of a major change in the US banking system that had made it more like the UK one.