FSA screw it up again

The FSA is irredeemably compromised. It has been captured by the financial services industry. As such, taxpayers can not rely on it to properly supervise banks. It must be abolished, with all its powers returned to the Bank of England.

This story from the FT, which highlights the government's disapointment with the FSA's so called crackdown on bonuses, further emphasises the need to abolish this pathetic institution as soon as possible.

Senior cabinet ministers are so disappointed with the Financial Services Authority’s new pay rules, released this week, they are considering whether legislation may be needed to crack down on bankers’ bonuses.

A number of ministers, including Lord Mandelson, the business secretary, are understood to be unhappy with the City regulator’s remuneration code, which toned down some earlier suggested measures.

Lord Mandelson thinks the guidelines, intended to reduce reckless risk-taking, have failed to reflect public concerns that the City is returning to “business as usual” after receiving billions in state support.

“Excessive risk taking had the results that we saw. Ordinary businesses are paying the price,” he said in an interview. “We have not heard the last word on this subject.”

His views are shared by other senior ministers, who suggest legislation may be needed to control short-term incentives for bankers unless the FSA shows it can pursue a tougher line.

B&B - huge losses for the taxpayer

I feel nauseous every time I hear the name "Bradford & Bingley". It is state-owned and it is, financially speaking, a stinking heap of toxic crap. It is not something that I can easily ignore since this mess now firmly belongs to UK taxpayers.

It has just announced a further £160 million of losses. Moreover, 40 percent of its mortgage book is now mired in negative equity. That is what you get when 60 percent of your loans were extended to buy-to-let and 20 per cent were self-certified loans.

However, I suspect that the B&B isn't something that can be safely filed away. It is not something that can be explained away as a past mistake. It As we move away from the terrifying events of September 2008, those commitments to tighten up banking sector supervision are being quietly watered down. Furthermore,We have yet to see a major overhaul of the FSA.

In short, five or ten years down the line, we could easily see another B&B turn up at the doorstep of her majesty's treasury, demanding a bailout.

Government considers guaranteeing mortgages

Is there no end to this madness? Why should a renter have her tax receipts used to subsidize a first time buyer who wants to buy a home?

Why doesn't the government consider subsidizing rents? Why not offer guarantees for any renter unable to pay their rent? That way, I could find the big house somewhere in Hampstead, which I can't afford, rent it, default on my payments and then hand the bill over the Her Majesty's Treasury.

This proposal to guarantee mortgages would be so unfair. In fact, it is inequitable. I wonder whether Ms. Harman's new equality legislation could be used to outlaw this kind of guarantee?

From today's Guardian....

First time home buyers could be thrown a lifeline under plans being considered by the Treasury to underwrite 'risky' mortgages, allowing people with only small deposits to buy homes.

Since the credit crunch took hold, banks have demanded far tougher criteria for lending, asking buyers to provide between 25% and 30% of the price of a home as a deposit.

There were 30,000 loans to first time buyers in the first three months of 2009 against an average of more than 100,000 a quarter in the previous decade.

Decision time on quantitative easing

The Bank of England have almost exhausted their authorization to print cash to buy up assets. As of July 23, the Bank of England had purchased ₤121 billion of government bonds, commercial paper, and corporate bonds. The government had authorized purchases up to ₤125 billion under the asset purchase scheme.

Of course, the Bank of England can go back to the government and ask for an increase in the amount of cash it can print. However, ₤125 billion is a huge number. Asking for more would only further increase the risk of an explosion in inflation two or so years down the line.

In terms of kick-starting the economy quantitative easing has yielded dismal results. The economy continues to decline. GDP has now contracted for five straight quarters. Since the recession began, the UK economy has shrunk by almost 6 percent.

Quantitative easing hasn't done much to boost credit; at least not so far. Lending to the corporate sector continues to decline, while consumer credit is flat. It is only the housing sector where we have seen any tangible results. Mortgage approvals are up and credit conditions are improving.

However, the policy of printing money and buying government debt has had one notable success. The Bank of England has used its QE authorization to buy up over ₤118 billion of gilts, allowing the UK government to run up the largest fiscal deficit in history.

David Miles on house prices

David Miles, prospective member of the Monetary policy committee thinks the housing market is over the worst. Here is his answer to the Treasury Select Committee:

What are your views on the prospects for the UK housing market?

Before house prices started falling I - like many others - believed that prices were over-valued. I said that in 2005 and 2006 (and was ridiculed by many in the mortgage industry for so saying).

The economic modelling I did then suggested prices might be 20-25% too high – relative to sustainable levels. Since then there have been many offsetting developments: Incomes are weaker; unemployment is up sharply, and is expected to rise further. But interest rates are down a lot (and there has been a reasonable amount of pass-through to the cost of mortgages since the significant cuts in Bank
Rate).

High loan-to-value mortgage products have dried up. Ultimately that is not a disaster; people will wait a bit longer to buy and rent a bit longer. The owner occupation rate would be lower, but the rented sector bigger. It does not clearly reduce substantially the long run demand for housing.

The short run issues are more difficult. Now 20-25% deposits are typically required. The flow of first time buyers will be reduced as they accumulate higher deposits. This means that the volume of house purchases on a transition to a new equilibrium, where people buy later and with higher deposits, will be reduced. That is part of what we have been going through over the past 18 months. But it is a transition.
Expectations are crucial in the housing market and they look a bit better now than a few months ago.

My hunch – and I put it no stronger than that – is that we have seen most of the overall aggregate house price falls. But no-one knows.

Mortgage approvals increase in May

Is the glass half empty or half full.

According to seasonally adjusted data from the British Bankers Association, mortgage approvals reached 31,000; 74 percent up from the November peak. However, approvals are down 50 percent from a typical pre-crash month.

For what it is worth, I think there is a recovery taking place. Moreover, I fear that it will gather pace on the coming months.

What? More bitterness?

My recent post on inflation upset a minority of readers. The criticisms took three forms:

Inflation – its not going to happen

Despite the huge increase in monetary growth, some are profoundly skeptical that inflation is going to pick out. Of course, no one can know what the future will bring. I could be wrong when I say that inflation will rise. Furthermore, I would be happy to be wrong. A 5 percent by the middle of next year inflation rate is the last thing I want to see.

In the short term, I expect inflation to keep on falling. By the late summer, it could be as low as 1.5 percent. The short period deflation last winter did knock the wind out of rising prices.

However, that stopped in February, and since then the monthly inflation rate has been painfully high. By next winter, I expect inflation to rise, and within two years, it could be a serious problem. By that, I mean a rate somewhere between 5-10 percent. If the MPC raise rates, then this prediction is nothing more than a gloomy alternative scenario that an appropriate policy tightening successfully avoided.

With each passing month, we will pick up more information about the likely path of inflation. The following simple rule will help enormously. If the monthly inflation rate is 0.15 or lower, then the Bank of England can rest easy. It will easily meet its inflation target. If the monthly inflation rate is about 0.3 percent, then it is in trouble. We can be fairly confident that inflation will hit 4 percent by December. Of course, if the monthly inflation rate is consistently negative, we have deflation.

How dare you suggest an interest rate rise!

Some people become extremely agitated by the idea that the price of money should increase. Some think that rates should remain low in order to help homeowners pay down their ridiculously large mortgages. This amounts to an argument that savers should subsidize borrowers. Personally, I don't see any compelling reasons why this should be so.

Others seemed to think that low interest rates will sustain the economy and keep unemployment at bay. I have a lot more sympathy for this argument. Recessions are nasty and miserable.

However, historical experience suggests that a surge in monetary growth can only have a temporary effect on output and employment. In the long run, more money means higher prices. I wish that wasn't so, but it is, and denial helps no one.

You are just a bitter renter

Well, I've never tried to hide that fact. It says it on my profile in proud letters. If you don't like the bitterness, then this isn't a blog for you. Move on, find your happiness six elsewhere, because I'm not going to provide it for you.

Besides, bitterness is something that the Brits do very well. Personally, I don't feel the least bit isolated. This is the country full of anger and despair, and this blog in part, reflects that fact.

So, returning to the inflation question, who knows? Maybe everything will be all right in the end, and people can read this blog and tell me that I was wrong. I'm ready for that.

Where did the high street banks go

Over the last twenty years, UK bank balance sheets exploded, but bank branch networks contracted. The reason was increased automation of banking services. It wasn't just ATMS and cash-handling, loans approvals were increasingly delegated to computers.

To what extent did this over-reliance on technology contribute to the banking crisis?

April is the cruellest month

This is the core of the problem; the government has lost control of the public purse.

This chart compares just one month's fiscal deficit - April - over the four previous years. During the good times, the government ran up a surplus in April. Revenues were always higher than expenditures.

Things began to go pear-shaped in 2008, but even then, the situation was under control. However, in April 2009, the government ran up a deficit of almost ₤7 billion. As the chart so amply illustrates, this monthly deficit is unprecedented.

Finally, the credit rating agencies have woken up to this unfolding disaster. At last, they have realised that the truck is rolling down the mountain track, and there is no one in the driving seat.

UK mortgage approvals down again

The entire UK real estate industry is waiting, desperately hoping for the first signs of a pick up in housing activity. Once the first positive number comes through, we will be smothered in an avalanche of hype.

"The crash is over", they will declare. The UK will be back to normal. Property, and how fast it is appreciating, will again become the main topic of conversation.

However, the mortgage approvals data isn't being terribly obliging. April data was rather disappointing. Maybe next month, we will see some improvement.

Least we forget.....

...the UK is still mired in the greatest financial crisis in a century.

It is one of the intended benefits of a corrupt legislature. While voters are distracted by MPs expenses, the financial system continues to throw up huge liabilities that will end up on the public sector balance sheet.

So, the bailout continues; this time it is the turn of the building societies. From today's Times...

A RESCUE operation to save one of Britain’s biggest building societies is under way in the first of a new series of expected bailouts in the sector.

West Bromwich building society, which celebrated its 160th anniversary this year, has a loan book worth almost £10 billion. It is being secretly offered to potential white-knight bidders by the Financial Services Authority (FSA), the City regulator.

Coventry and Yorkshire building societies are both in talks with the regulator on a possible takeover of their struggling rival. If no deal can be agreed the worst parts of its loan book are likely to be nationalised, with its 47 branches and 530,000 customers passed to another society. The move follows stringent new stress tests being imposed on the sector by the FSA.

Housing market recovery on hold....

...at least for another month. According to the British Bankers Association, loan approvals for house purchases fell in March. Never mind, there is always next's months number. Perhaps, the April figure will show a modest recovery, and which can be used to declare the housing crash over.

UK mortgage market improves slightly

Here is some tentative evidence that mortgage lending conditins might be improving slightly. The number of mortgage applications increased sharply in March, while the mortgage acceptance rate increased marginally (from 73.1 percent to 74.2 percent).

Nevertheless, there are no signs of an early return to 100 percent mortgages with income ratios of 5 or more. I am not sure that the improving lending conditions signal a return to the crazy days of 2006.

Credit rating agencies sow more havoc

Its those credit rating agencies again; with their recent downgrades of UK buildings socieites, they have thrown a spanner into the Bank of England's Special Liquidity Scheme. From today's Times:

THE Bank of England is locked in talks with seven British building societies to renegotiate crisis funding measures introduced at the height of the credit crunch. A slew of credit-rating downgrades for building societies last week threatens to breach the terms of the government’s Special Liquidity Scheme and force the societies to hand back cash to the Bank of England.

Such a move would reduce the amount of new lending they could make, dealing a blow to Whitehall plans to kick-start the housing market. Chelsea, Yorkshire, Skipton, Coventry, Newcastle, Norwich & Peterborough and Principality are the societies affected. All have recently passed stress tests imposed by the Financial Services Authority (FSA) and are not considered in danger of collapse. Nonetheless, they will now be charged more to use the emergency funding.

Maybe its because I'm a Londoner.....

...that I can't buy a house.

True, the house price to income ratio has come down a smidgen. However, it is still almost 5. Back in the mid-1990s, it was under 3.

Halifax or Nationwide - who do you believe?

We have a slight difference of opinion; the Nationwide say that UK house prices rose in March; the Halifax say prices fell.

From their peak, the Halifax estimates that prices have fallen 22 percent; while the Nationwide put the decline at 19 percent.

(just to clarify, both series in the above chart use non-seasonally adjusted data).

What happened to my shares?

A question from the Bradford and Bingley post-nationalisation Q&A website:

What's happened to my shares?

All shares in Bradford & Bingley were transferred to the Treasury at 8am on 29 September 2008.

The site should have added "and you are not getting them back!"

The Dunfermline - What happened?

We are becoming numb to financial scandals. We have seen far too many. So when a mid-sized regional bank fails, it barely registers.

However, the failure of the Dunfermline building society is scandalous. Yet again, the FSA failed to properly supervise an institution that was taking unacceptably dangerous risks. It was also an institution that had a highly paid but basically incompetent management team. The FSA missed it all. Yet again, the taxpayer has been lumbered with a huge bill to clean up yet another FSA supervisory disaster.

The FSA had a opportunity to step in when the Dunfermline building society prepared their Basel II Pillar 3 Disclosures 2007 document. This submission is supposed to outline the institution's exposure to various kinds of risk. This is what the Dunfermline management said about their commercial property risk profile.

Our commercial risk appetite is confined to loans secured on property where the Society is able to achieve an adequate return for that risk, where the commercial investment is in lower risk areas, and where the Society is able to take advantage of risk mitigation such as guarantees to limit its risk.

The Society seeks to limit its risk to any one area of commercial lending by imposing sector limits.

This wasn't a terribly accurate representation of the magnitude of their commercial property exposure. The Chancellor - Alistair Darling - picked up on this point on Monday when he was forced to explain why the Dunfermline failed.

"This is a building society that, unfortunately, took out over £650million in loans in commercial property. In the last couple of years, it bought some mortgages from an American company that had gone bad. It's had to write off some of its IT systems because of difficulties it's had and it needed between £60 million and £100 million to keep it going. When you bear in mind that the society has never made more than about £5 million or £6 million a year in the recent past, it couldn't even service that sort of loan, let alone repay it.”

Presumably, someone at the FSA took a look at the Basel II document and concluded that everything was fine. Yet if someone had bothered to look at the loan portfolio, they would have quickly realized that the Dunfermline was far too exposed to a commercial property downturn.

After all, as the 2007 annual report pointed out, the institution had assets amounting to ₤3.3 billion. It had ₤117 million in capital, giving it a leverage ratio of 28. Holding a £650million exposure to commercial property was a very precarious position for a bank like the Dunfermline. The FSA should have picked this up.

The Dunfermline debacle sadly reveals that the FSA continues to incompetently supervise the financial sector. In fact, it is worse than that. The institution is dangerous. With each bank failure, it pushes huge clean up costs onto the taxpayer. In summary, it has wrecked the financial viability of UK public finances. It has to be stopped before it does any more damage.

Do you think there might be a connection?

What determines house prices? Demographics, immigration, a lack of land, or planning restrictions? The chart above tracks the money supply (M4) and house prices from 1963-2008. They do seem to move together.

For those who have dabbled in statistics, the correlation is 0.97.

Over a third of UK mortgages have an income multiple of 3 or more

Limiting mortgages to income multiples of three or less would have a dramatic effect on house prices. Currently, well over a third of new mortgages have income multiples of greater than three. At least 10 percent have multiples of four or more (mostly to single buyers).

The FSA's plans to limit income multiples would make it much harder for housing bubbles to form in the future. Since mortgage availability would be linked to incomes, house prices would also be anchored by borrower's capacity to repay.

Limiting income multiples could be the first good idea that the FSA has produced.