As most of you will be aware, the government has today announced a further series of measures to try and get the banks lending again, and ensure that what is likely to be a recession doesn’t tip over into a depression.

One of the fundamental problems when entering a slow-down/recession, is changes to behaviour. In times of uncertainty a common and natural behavioural reaction is to spend less. However the danger with this particular recession is that lack of spending is being driven in large part by the lack of available credit. This is impacting, very severely, the housing market, but is also having major implications in other areas, notably car manufacturing, where nearly 50% of new cars are bought (or rather were) with finance (Honda has today announced that its UK plants will shut for 4 months from March!).

Whilst the credit bubble that we have all witnessed since 2000 (the point at which banks effectively ceased to be funded entirely by matched deposits) has now clearly burst, the government’s actions are clearly aimed at ensuring a gradual return to normal lending conditions rather than simply going the equivalent of ‘cold turkey’.  There is over £700bn of debt owed to British banks, which was funded in some way or other through the wholesale markets. With the wholesale markets still remaining effectively closed, the only way to avoid a massive contraction of lending, with disastrous consequences for both consumers and businesses, is for the government to step in. With this is mind, 5 key announcements were made today:

Extending the time period of the special liquidity scheme and extending the maturity date for the Bank of England’s Discount Window Facility which provides liquidity to the banking sector by allowing them to swap less liquid assets.

Establishing  a new Bank of England facility for purchasing high quality assets: In effect this means the government buying up, by the issuance of liquid treasury notes (initially up to £50bn), a range of AAA type assets including such things as corporate bonds, commercial paper and a limited range of ABS in paper format. The buying of assets (rather than simply a temporary ‘parking ‘of assets to date) represents an important departure here not only in allowing banks to remove certain assets from their balance sheets and free up capital for lending, but also in the widening scope of acceptable securities. The buying of assets also potentially marks the start of quantative easing (click here for more details).

An asset protection scheme:  This is effectively insurance for the banks (after the banks take an agreed first loss piece) on assets they hold. One of the biggest issues for banks is provisioning and effectively holding back cash in case of future losses (which may or may not occur). The very real issue here is that the effective hoarding of liquidity actually makes future losses more likely by starving business of the funding they need. So, for a price, the government will provide insurance on agreed assets, reducing provisioning required and freeing cash for the banks to lend. As the government is keen to emphasise, all the help offered is on the proviso that banks agree to lend more.

Adoption of the Crosby report: As covered in our blog on 25th November 2008 (click here), the government will be pressing ahead by offering full or partial guarantees for AAA mortgage backed securities, corporate and consumer debt. As over 30% of the UK mortgage market was funded through the issuance of mortgage bonds pre-crunch, its disappearance had a major impact.

Allowing NR to become a net lender again: as we covered in our blog before Christmas, the Rock has been sorely missed both in terms of its attitude and approach and also its contribution to net lending. Running its mortgage book down by circa £20bn a year has had a major impact in terms of mortgage availability and the announcement that it now (subject to EU approval) intends to recommence lending in a more substantive way is very welcome (click here for more details).

Checkmate’s view

The above moves are very welcome given the extra liquidity that should be injected into the lending markets. Whilst there is focus quite naturally on the UK’s largest banks, a concern does exist that the proposal to date focuses purely on tier one deposit-taking institutions. Relying on a handful of major banks for mortgage lending should be a market concern, particularly as I would argue that with one or two exceptions, mortgage lending is not their forte. As many intermediaries will testify, service from several of the big 6 has regularly suffered from delays and processing issues even with current low volumes. The aim or hope must surely be that liquidity trickles down to the smaller lenders who are more responsive and capable of delivering the right products to consumers.

Whilst adoption of the Crosby report will undoubtedly have a benefit, the guarantee on AAA paper only will mean a continued focus on lower risk, lower LTV loans, an area where you can get loans currently. It is higher LTVs and help to FTBs where we feel there needs to be greater focus and none of the above appears to address this important area. An insurance scheme, backed by the government whereby lenders were offered (at a price) insurance on lending above 75% LTV is the area where help was really needed. As we have pointed out in earlier blogs, house prices are largely a function of liquidity. The more difficult it remains for anyone, other than those with a substantial deposit, to buy, the longer house prices will decline and the more painful this recession is going to be. Getting lending moving again is partly about creating liquidity but also about removing some of the perceived risk. Addressing the risk of new lending has to be a priority and concentrating Government support on the deposit-taking banks only will not help the market as much as a more widely drawn set of initiatives.