Mortgage News - 3rd Feb 2008

David Miles, chief economist at Morgan Stanley and a Treasury advisor on the mortgage market, has reported that UK banks need to refinance £250bn worth of mortgage loans. He argues that if the markets remained frozen, the Bank of England - or another agency - will need to lend £60bn to £80bn to the banks this year to prevent mortgage finance totally freezing up. Without such help, banks will be severely limited in their ability to issue new mortgages, and will have no choice but to charge higher rates in order to attract additional funding required.

These higher mortgage costs could then well lead to a steeper decline in house prices, which would make the UK economic slowdown much deeper.

The good news is that the UK banking sector is not as exposed as banks in the US to the problems in the credit markets, nevertheless, Morgan Stanley estimates that 28% of mortgages issued in the UK were financed by banks selling them to other investors (as opposed to around 70% to 80% in the US). As around one-third of these mortgage packages will need to be refinanced this year, there could be problems ahead as investors are fearful of "buying" bad mortgage debts.

As stated above, the result of this "fear" could be that UK mortgage lenders will have to either pay very high interest rates to borrow money from other wholesale investors, or pay higher interest rates to retail savers to attract more deposits. As the banks have already been squeezed (because their profit margins on mortgage lending has dropped substantially in the last few years) they will have no choice but to raise mortgage rates sharply in order to cover the higher costs of borrowing - regardless of what the Bank of England does with base rates.

The Council of Mortgage Lenders acknowledges that "there is a potential shortfall" in the wholesale funding and says it has urged the authorities "to intervene more aggressively" in money markets to restore normal market conditions.