Financial markets: King insists he won't prop up home loan market

Financial markets: King insists he won't prop up home loan market

The Bank of England governor, Mervyn King, yesterday warned the government not to try to artificially support the mortgage market as that could further prolong the year-long credit crunch. He also held out little immediate prospect of interest rate cuts to boost the flagging economy.

Appearing before parliament's cross-party Treasury committee, King said the Bank did not have the resources to underpin lending across the entire financial system and thereby boost mortgage lending.

The Treasury has commissioned Sir James Crosby to report on steps that could be taken to encourage more mortgage lending which could help prevent house prices from tumbling further.

King said there were only two choices for the government - either to let the Bank's special liquidity scheme (SLS) help the financial system gradually return to health, or to fund the mortgage market through a state-run bank.

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"It is not the purpose of central bank liquidity insurance to provide a source of long-term funding to the financial system - indeed it cannot do that. Only private savers or taxpayers, via the government, can provide such funds."

But he made clear he did not favour a state-run mortgage bank offering cheap loans, saying it would impede the commercial banks' incentive to improve their balance sheets and find fresh capital so they can resume lending.

"That would be throwing out the baby with the bathwater," he said, adding he had come under no pressure whatever from the chancellor, Alistair Darling, to increase lending to the mortgage market.

He said that next week the Bank would publish plans for a permanent scheme to provide liquidity to the banking system. The new scheme would provide short-term liquidity finance to banks but would not seek to replace or expand the SLS, which was launched in April and which closes its doors to new activity in October. Under the SLS, banks can swap high-grade, but illiquid, mortgage assets for more liquid Treasury bills for up to three years.

King has been under pressure from commercial banks to extend the SLS beyond October 21 but he ruled that out, saying the scheme was, in any case, a "one-off, a breathing space" and the most generous of any central bank in the world.

It had successfully provided "significant" liquidity to the banking system though the actual amount will not be revealed until after October 21. Banks, he said, were sophisticated operators for whom six months should easily be enough in which to work out their medium-term liquidity needs. He also said the Bank will next week announce arrangements under which banks can access short-term liquidity facilities from October 22 until the permanent arrangement is in place.

"The facility will be an important part of the contribution which the Bank can make to enhance the stability of the banking system," King said, adding there were signs of loan rates being reduced in the mortgage market for loan-to-value ratios of up to 70%.

The Bank's executive director for markets, Paul Tucker, said some banks were strong again and competition was gradually increasing in the mortgage market. "Conditions are difficult but not absolutely dire," he said, but warned that it was impossible to know how long it would be until the credit crunch was over.

King said he hoped Darling would provide details in next month's pre-budget report about how the public finances would be returned to a sustainable position in the medium term, since the economic slowdown had pushed up the budget deficit.

The economy was deteriorating more quickly than expected but, with inflation having picked up strongly and likely to rise to around 5% in the next month or two, he was concerned that wages could pick up in the new-year pay round. He stressed the Bank had to focus on bringing inflation back to its 2% target.

But David Blanchflower, an external member of the Bank's monetary policy committee who has repeatedly voted to cut interest rates, said he was worried about unemployment shooting up and the economy slowing sharply as a result of the credit crunch and falling house prices.

The pound fell to a two-and-a-half-year low against the dollar on his words, dropping below $1.75.

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