I am disappointed to note that, as the FT reports:
There is no quick fix for Britain's mortgage crisis and the long-term funding of mortgages should be left to the market, a report to Alistair Darling will conclude on Tuesday.
The interim report from Sir James Crosby, the former HBOS chairman asked by the Treasury to lead a review into improving wholesale mortgage financing in April, is likely to receive a cool response from lenders who have been lobbying the government for rapid action to break the logjam in the mortgage market.
The Crosby report will also say that Britain should avoid US-style government-backed agencies to tackle the funding crisis.
I am profoundly disappointed by this. Such an approach is indicative of callous indifference to the plight of a great many people inside the United Kingdom whom it is obvious that Sir James would wish to carry the burden of obligation for the problems that banks have created. To believe that the market can provide a solution for a problem which the market so obviously created is not just na?Øve, it flies in the face of all evidence from history, and is indicative of a belief in dogma over practical reality. I sincerely hope that Sir James' report is dismissed out of hand as a consequence.
But let me also take this as an opportunity to present an alternative, because I am extraordinarily worried about the current state of the housing market in the UK and the consequences of that for ordinary people, which I rate an issue of considerably greater significance than the preservation of the free market.
I do think that there is a need for strong and positive government intervention in the housing market at present. All the evidence is that the credit crunch will continue for some time to come. If that is true then the policy that Sir James proposes is reckless in the extreme. Banks will face continued stress but will be unable to raise additional capital to strengthen their balance sheets simply because that capital will not exist elsewhere. Failures will follow. More mortgage foreclosures will result. House prices will fall further. Social turmoil will increase and the opportunity for Keynesian intervention without substantial inflationary pressure will also reduce because the capacity for further government borrowing will be limited. Economic recession is guaranteed as a result.
This makes clear that an alternative proposal is essential to stabilise the housing market, to prevent the social disruption arising from forcing people from their homes, to stabilise banks and to provide a new structure for use in the future that prevents recurrence of the problem and a deepening recession. In that case I offer the following as a possible solution for those banks and individuals faced with the risk of mortgage foreclosure.
First, when any bank reaches the point where foreclosure appears necessary the homeowner will automatically be offered a price by the government for the property on which foreclosure is to take place. The bank would have to accept this unless it could guarantee to better it. That price would be calculated in accordance with a formula.
The basic price to be offered would be determined by the market price for the property in August 2007 less an indexed reduction calculated on a regional basis, with that index updated quarterly (to prevent the creation of too intense a feedback cycle). So, for example, if the market price in August 2007 (when prices could be determined in a liquid environment) was £200,000 and the regional fall in value in the meantime was 10% then the basic offer price at the time foreclosure was threatened would be £180,000.
This basic offer price would not, however, be the sum paid. The price paid would depend upon whether the basic offer price would, if paid, clear the whole mortgage on the property, or not. If it would not clear the whole mortgage it is clear that home owner has lost all their equity in the property. If they are to remain in occupation of it (assuming they can afford the payments noted below) then they will do so as tenant, not as owner. In that case the government will acquire full title to the property upon redemption of the bank's mortgage. That redemption would, in this case, be paid at the basic offer price less a further 50% of the fall in value since August 2007. If the 50% increase was less than 10% of the mortgage value then that sum would be deducted instead to create comparability with the situation where there was residual equity in the property, noted below. This additional effective charge to the bank would be compensation to the government for three things. The first is saving the bank the cost of foreclosing and having to sell the property. The second is for providing the bank with a viable income stream sooner than it could have done if it had relied on a market solution for sale. The third is to compensate the government for the tax relief that will be given upon the mortgage loss to the bank and from which it should not secure a double benefit.
So, to extend the example noted above, in this case the bank would either be offered £170,000 as a redemption price for the mortgage and the government would in exchange secure full title to the property, to which the owner could not object (£170,000 being calculated as the basic offer price of £180,000 less 50% of the £20,000 fall in value since August 2007) or alternatively, if the mortgage was for £210,000 (and this is plausible) then the bank would be paid £180,000 less 10% of the value of the mortgage, or £159,000. It is stressed, the bank would not have the choice either of the price paid or whether to take part in the scheme or not. If the tenant were to ask that the scheme apply then it would (subject to evidence that they were not deliberately defaulting).
In practice, the government would not actually pay anything to the bank for redeeming the mortgage. The bank would instead be required to lend the funds previously advanced against the security of the property to the government and would in exchange be paid at an officially set rate of mortgage interest, which would be a balanced index of prevailing mortgage interest rates, less a discount for the value of the government guarantee. Average gilt rate would be paid, if lower. The advantage to the bank is, however, obvious. It has swapped a non-performing asset for a government backed security. Its balance sheet has immediately been straightened and its income stream secured.
If instead of the above the current formula calculated value of the property would allow, in principle, a full mortgage redemption because of the equity the owner had in the property then the bank must, if it has really reached the stage where foreclosure is necessary, have this consideration recognised but once again only through substitution of a loan to the government at the interest rate noted above for the original mortgage. In this case though to allow for the fact that there would, inevitably, have been a cost to the bank if it had been forced to foreclose a consideration of 10% of the mortgage value would be deducted from the redeemed loan to allow for those costs. To continue with the example already noted, and assuming the mortgage were for £140,000 the nominal mortgage redemption to be paid would be the mortgage value of £140,000 less 10% of that sum i.e. £126,000. In exchange for redeeming this sum (albeit, as above, by simply guaranteeing payment of the sum in question to the mortgage lender) the government would become co-owner of the property with the former sole owner.
But of course in this case the former sole owner still has equity in this property. £126,000 has been paid to redeem the mortgage on a property notionally worth £180,000 in the market place on which there had been a mortgage of £140,000. This equity now has to be split fairly, taking into consideration fairness for the taxpayer at large who has now helped secure the former sole owner's right to stay in this property as well as fairness for that former sole owner.
My suggestion is simple: the former sole owner had accepted liability for £140,000 of mortgage. They must continue to do so. The government will therefore have equity of £140,000 in the property, the former sole owner has equity of £40,000. But that is not the end of the issue. The former sole owner has a duty to pay for being allowed to stay in their property. That must be done in three ways. The first way is to ensure that they pay the government what will now be rent for the stake in the property that the government now owns. Since it was almost certainly the case that they could afford their former mortgage at some point during their ownership, probably because lower rate mortgage deals were available in the past, their capacity to make appropriate payments probably still exists. They should therefore be required to pay either the last fixed rate they had enjoyed on the property (so long as they had paid it for at least a year before foreclosure became an issue) or 1% above the government set mortgage rate to be paid to their former lender, if higher. If base rates fall the fixed price rate should fall by 90% of any cut in bank base rate. In this way the government should be able to service the debt assumed which will be 10% less than that which the now joint owner will, in any event, be servicing, so adding another margin for the sake of security.
Two additional protections should be available for the government. First, all falls in value should be charged against the equity stake of the original sole owner so that if they wish to leave the property and it is sold they bear in full the cost of sale and any fall in value until their equity is fully utilised. This would have been the case with a mortgage as well. Second, any increase in value should be shared equally between the government and the co-owner. This should compensate for any situations where the government suffers an absolute loss on sale of properties.
Do the economics of this stack? Well, I'm not promising every suggested percentage is correct. Clearly those would need to be worked through in detail, but they feel about right to me. But what we have got here is a situation where if a mortgage is to default a bank does not have to foreclose and force a person from their home, or dump a property on the market, so depressing prices further. The downward spiral of house prices is therefore broken. The owners are not forced into social housing. They can even keep an equity stake in some cases, and have an affordable mortgage in most cases. If it is not affordable on the formula shown then orderly rehousing to a property they can afford will be necessary, and enforceable. Given that the government will, inevitably, increase its social housing stock using this scheme the likelihood of such rehousing is much increased under this scheme. .
Former sole owners are protected under this scheme in that they can still live in their properties at what is likely to be reduced current cost , but will pay a long term cost for what has happened. That is appropriate.
Banks have their balance sheets effectively underpinned, and their losses limited. That stops the spiralling descents in the valuations we have seen.
No new money is required to make this work: existing mortgages are recycled into the arrangement. I admit that appeals to me, a lot.
There is a cash margin in the scheme for the government to cover its risk and cost of letting, and equity stakes are provided to it to cover market risks and risks of default and damage from former sole owners. Again, that is necessary insurance.
None of this happens unless foreclosure is the only real option for going forward, and it has sufficient cost for all parties to not make it an option of choice.
A deepening recession may be avoided though as a result.
So why not do it? It's hard to imagine why not. Unless of course you're Sir James Crosby and you seek to avoid government intervention in a bank made crisis at any cost, however big the social and economic disruption that might result from your failure to act.
Any comments and suggestions would be appreciated.
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It’s difficult to see how any rational person could do anything other than applaud a serious alternative, albeit one that needs working through in detail, for addressing impending disaster in the housing market to the standard “robber” response of the financial world, ie extract massive rewards while engaging in activity that causes a catastrophic position but leave every one else to fund the resolution of that position. Your proposal seems at first read just such an alternative and worthy of very serious consideration.
However, the cynic in me sees a government that is frozen in the headlights of the of the monolith confronting it and, until it can find the courage to propose radical solutions that will be fought tooth and nail by vested financial interests, won’t even give itself the chance of receiving popular support. Please Mr Brown, or any other politician of any party for that matter, at least show some evidence of what you say you are doing, listening, and allow the electorate to understand how they are being ripped off.
In summary, a very good idea to pursue….but which of our political elite has the balls to even consider it, much less take on those few who view their own collossal profit as more important than the cost of that profit to the rest of society?
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Hi Richard
Its a few weeks since I tried to post a rather long contribution to your blog suggesting a comprehensive and well-thought out modification to international trade that would release some of the currency advantage or purchasing power of the Western currencies while they are still high for a just investment against climate change. We need to boost those investments urgently. You asked for a briefer submission, this is about half the length. Since then banking plcs have further unravelled and a rescue plan announced to avert disaster.
Very recently shares have gone up (temporarily I believe as there is speculation and profit-taking still going on). The profit motive still exists and stocks could easily go down again (a “saw-tooth effect” where the big operators are continually manipulating the share and currency prices to the disadvantage of the smaller investors). Should big players be allowed these extra advantages and profits?
There have been no announcements that I have heard as yet (except a few months freeze on short selling). Nothing along the lines of your suggestions in June of reining in off-shore tax haven investments or serious adjustments to profiteering as yet.
Banking as a profession became over-rewarded because of the serious additional profits they enjoyed via credit money creation. That is a very large root of the excess wealth that grew unsustainably. This is without question, proven by recent events. Serious amounts of credit money were literally CREATED over many years, adding to the cost of everything without direct payment to the public purse (except corporation tax after some avoidance) by those banks.
Instead, payment (or at least part of it) on ANY money creation should, we suggest, have been to the Treasuries — that is the public purse – in each of the countries of the world where the loans arose and therefore where the money which then came into circulation was created. It should be distributed where the interest burden arises at least partly against climate change. The non-payment now on what were previously vast sums is evidenced by the crisis — what was too much money and not evenly enough spread has become too little to allow government investment without further massive loans.
The tap was turned off in the US/UK as borrowing tailed off and money ceased to be created via the credit means. The sheer extent of what was free money until 2006 is revealed by the extent of the freeze – money is not being created which formerly distorted the economy in favour of the banks and finance sector before that freeze. The outlook was uncertain for several reasons and should still be so until a correction of the underlying flaws is announced. However, now as proposed even if half of the UK banks were nationalised permanently, this might still not solve the problem as inefficiencies could creep in under government control. INSTEAD WE NEED A FREE AND FAIR MONEY SUPPLY IN AN ANTI-INFLATIONARY and EFFICIENT WAY. HERE IS THE MEANS TO DO IT.
An orderly descent of inflated property prices compared to incomes is urgently needed to ensure stability in the long term. It would be foolhardy to return to the old system of money creation as another boom/bust would result. In recent years until 2006 in the UK alone at least £50 billion of new money was created as credit by the banks in addition to their income from charges, interest mark-up on deposits. fees, investments and penalties. It would be healthy to return to a system whereby about half of the boom figure was created, some of which could, as we propose, be for investments instead of property speculation, especially into renewable energy and energy efficiency i.e. super-insulation. These investments can mow easily be justified – a Keynesian-type stimulus to avoid too sudden a slowdown in the economy. This money can be created – £25 billion in the housing market – as a construction stimulus for those efficiencies and investments by issuing loans in the normal way to be paid back by householders who have the means to pay but a new incentive to do so. This would require a generous incentive — additional subsidy. For example if subsidies were increased to improve the payback on super-insulation and renewables there would be more rapid uptake as well as less waste of energy almost immediately (see our Every Town an Eco Town paper). This would help to achieve EU sustainability of energy targets. The vulnerable can then be protected via an offset from the old revenue stream that was part of banking profits. For example for every interest bearing loan created to pay half of the new efficiency investment, a bank will create a large proportion of that credit money in the same way that existed before the credit freeze and have a revenue stream from the repayments. Banks would at the same time however, pay a proportion of the interest on any money created to the Treasury which in turn offsets the cost to the vulnerable sections of the public of the newly structured environmental tax. The reduced costs from banking alone might not only reduce inflation, but also engender a healthy spiral down of costs overall.
This new tax would operate similarly to the Environmental Tax proposal described as “interesting” by the UK Cabinet Office and published by STEERglobal in the UK’s Stern Review (2006) on Climate Change. A similar paper was requested from us by the Treasury expert and issued with the UK Treasury Select Committee Report No 14 on “Globalisation and the Real Economy” (2007).
James Robertson has suggested in line with media reports that the banks that have been so far nationalised should be returned to ordinary commercial ownership over time. He says this along with the proposal of abolition of all future credit money creation by commercial banks. The STEERglobal alternative should have value as less bureaucracy would be necessary. A charge for new money could made to the public purse at the level of the base rate of interest achieving about half of what was previously “free”revenue – “balanced economics” is the term we have coined. This would avoid the need for further nationalisations – a proper road map and direction out of the “credit mess” but maintaining the free market. This could be a permanent part of the revenue flow for environmental and other purposes (that way the UK and other countries could be saved from sinking). See the paper describing the Credit Money Banking Adjustment (CMBA) on our website: http://www.STEERglobal.org.
Any of the changes proposed will require registration of existing money held in bank accounts: “100% Registered Money as recommended by Bill Davies from the Border regions of UK/Scotland or “100% Legal Tender” as recommended by the Money Reform Party. As an additional measure a floor could be created on savings rates/deposited money and current account balances to encourage small savers, improving the currently almost non-existent incentive to save because of the current inflationary nature of money, especially in property terms. Inflation lowering of value of money is understood by most people and very low rates on small deposits, especially for low income earners, just do not encourage small savers – the very people who need to save something to get out of the poverty trap.. That way the poorer people would have a chance begin to learn the advantages of saving in a stable low-inflation economy, possibly building a cushion against unexpected events or a fund to pay their share of the sustainability investment costs (described elsewhere) that we in the UK sorely need given the proven global threats we face.
THE GLOBAL CLIMATE THREAT
As climate continues to change, it has been shown that “groupthink” has held back IPCC forecasts of the rate of sea level soon to rise. Floating ice needs to be protected from melting, as it acts as a cushion against the more severe effect of land ice melt but is fast disappearing. The UK should be announcing support for global measures to avoid inundation, rather than only planning managed retreat. UK must keep its leading role in the nations of Europe and the G8 to achieve these changes and not lose sight of them.
What do you and your readers think? Is this an adequate response to your June post in which you ask for ideas?
SUMMARISING: Divert base rate interest on new money to the public purse initially to offset any effects on the vulnerable from a new Environmental Tax.
The Environmental Tax would ideally be on imports (or greater on imports to reflect the greater environmental harm) and be VAT-style with the proviso that half of the dollar value should be returned to the producer nation for the self-same projects against climate change.
POSITIVE FEEDBACK
Note: Bill Powell who you probably know of has suggested that this is “by far the simplest way to amend bank/credit money. Credit should be returning a fair proportion to the public purse”.
He also says “A credit creation charge has some of the features of a land value tax which is long overdue”.
The present Governor of the Bank of England has alluded to the need for a more level playing field for businesses. The “free ” money created by banks as credit money should not be entirely to the banks so as not to create unfairness or disparity between rewards for the different sectors.
Another global researcher has referred to CMBA/ credit creation charge/ET as “pragmatic, relatively easily bolted on”. (JW 2008).
The Author of the Money as Debt DVD has agreed CMBA is “a plan for orderly transition”.
Others have referred to the “inefficiency” of the existing money creation system and the innovative nature of the proposals.
Kind regards, Ian
PS What is the next step – a small TV series to show all this and how the credit money grew out of control between 1946 (2X multiple of currency each year) and 2006 (20X multiple)? Our proposal is, quite simply to reduce the bank proportion back to half – a total multiple of about 10X, so the public also get 5X times the currency from credit money issued by commercial banks eventually reducing tax and inflation. If desired this could be phased in over a few years, by only applying it to new money each year ~ £3 bn extra p.a?
Do we need to put this money creation illustration in a separate post to the blog? Feel free to shorten, edit and send back for checking if you wish as I sincerely believe this could save the situation – for keeps, and for global benefit “everyone gets all of the benefit from all of the Tax/reform.
[Otherwise the danger is, as Malcolm Howard, Lecturer in Management finance at Surrey has pointed out, (Independent letter a few weeks ago) that Banks can show higher levels of losses by using revalued asset figures downwards and create a more severe impression than should really be the case on assets held for long enough. Nothing changed except the numbers and the degree of panic in the public used to manipulate opinion and increase profit from negotiations. I hope all the above is some help.]
Sorry small clarifying change to the former post: should say £50 billion (in the UK) EACH YEAR.
and after EU targets “help to keep the costs of energy down”
[of “free” credit money which adds up to about £ 1.5 TRILLION sum under a straight line from 1946 values to 2006 values – the same as that held offshore in tax havens etc?]