In a report published this week, Sir James Crosby - named in April this year as government advisor on the mortgage finance market - noted the UK RMBS market has all but disappeared. Few new deals are being structured, and of those, almost none are placed on the public market. Instead, he said, banks are holding on to their RMBSs in order to exchange them for Treasury bonds through the Bank of England's Special Liquidity Scheme (SLS).
The SLS was set up in April to provide respite to banks with large amounts of illiquid and unsaleable RMBSs on their books - it allows them to exchange AAA-rated RMBSs for Treasury notes. However, the scheme has not helped the mortgage market, Crosby says. The absence of a flourishing securitisation market is limiting banks' ability to make new loans, which risks causing house prices to undershoot, with serious consequences for the economy in general.
Crosby believes the Treasury should auction off guarantees on up to £100 billion of AAA-rated RMBSs over the next two years. Only RMBSs collateralised by mortgages that involved "a genuine change of ownership, i.e. house moves, buy-to-let purchases and first time purchases, but not remortgages" would be eligible, in order to ensure a stimulus to the housing market.
The UK market is very different from the US market, Crosby pointed out: there is no subprime crisis in the UK, with the main cause of the problem being the evaporation of investment in mortgage securitisation. In particular, no AAA-rated UK RMBSs have yet defaulted or been downgraded, and "according to industry estimates, for [credit losses] to happen... house prices would have to fall more than twice as much as was the case in the 1989 to 1996 period".
This could make the guarantee business "highly likely to be profitable for the Government," Crosby added.
The recommendation represents a significant turnaround. In his interim report in July, Crosby advised against guarantees for MBSs on the grounds that while it could lead to increased market activity in the near term, "the extent of the impact on net new mortgage lending is less clear". He warned that "a transfer of risk to the government might distort incentives and create moral hazard, rather than help investors and issuers price that risk more accurately". Any intervention would have to be matched by industry reform, he added.
However, he said this week, "Coupled with now much lower base rates, I believe such intervention would be effective in improving the availability of mortgage finance to consumers and in directly stimulating activity in the housing market, averting the risk of a protracted fall in house prices. It would therefore be of huge benefit to the economy and the public finances whilst affording significant relief to homeowners and would be homeowners."
He also praised the UK tendency for banks to retain some of the first-loss risk in a securitisation - this prevented the incentives for poor-quality origination that existed in the US system, he said, though it "may not be well understood by investors".
The government should also act to improve transparency and standardisation in the RMBS market, Crosby added, and to revise the mark-to-market rule that some claim have caused illiquid assets such as RMBS to enter "the downward asset spirals that have so undermined confidence in bank balance sheets and therefore caused inter-bank lending markets to seize up".