Government feeling 'gilty'

Posted on 17 April 2008 by Katie Tucker

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The government is finalising a plan with the UK's major banks to swap the old pre-December mortgage backed securities (that are proving impossible to sell to raise money for lending) for 1 - 3 year government bonds (Gilts). Lenders have been strapped up for the last few months by the complete lack of liquidity in the market- there has been no cash for them to access, and (by the rules of supply and demand) the little cash there has been in high demand, so commanding a high interest rate. This rate is then passed on to the consumer when they take their mortgage, and is the reason for the high new mortgage rates we've been seeing.

How the gilt plan works:

The lenders can then trade these government issued bonds (gilts) with each other, and more importantly, to 3rd party investors, for a negotiated price. There is a strong market for these government bonds, it is a lot more liquid. Pension funds like to buy them, so do private equity firms. This means that the lenders will have an asset to sell in exchange for cash, cash which they can then lend to borrowers. As there will be a lot more cash suddenly available, the cost of obtaining it won't be so high, and the new borrower rates that we are seeing around the 6% mark at the moment, should come back down to normal levels.  The bulk of gilts is extimated to worth around £50bn.

Isn't this nationalisation of the existing mortgage debts then?

The tax payer should be at minimal risk here because the government with firstly be very carefully risk-rating the mortgage books before taking them on, but also, the Bank of England will structure the deal in a way that leaves the laibility of any loss with the lenders.  Details are yet to be verified by the Bank of England but this may require an indemnity insurance (like you taking out buildings insurance on the property you offer as security on a mortgage, in case it falls down).  Most noteably, a financial 'haircut' is expected: which means that the swap of gilt for mortgage-backed-asset, won't be pound for pound. For every £100m of old mortgages the Bank of England takes from a lender, it might only give £90m worth of gilts.  This is a bail-out from the government, and they have every right, plus a duty to the tax-payer, to make a profit from it.

 

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