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April 10, 2008



What ever happened to the global savings glut? Hard to use banks as a barrier against that.

How do countercyclical capital requirements work on off balance sheet SIVs and unregulated hedge funds?

In good times banks pile on capital and are not constrained by it so intervention would have to be brutal if it is to have any effect.

So, to implement such an idea, politicians will have to know what stage of the cycle they are at, be prepared to take steps that are unpopular and in the short term actually damaging, use measures more extreme than they are used to and to radically extend the range of regulation.

Apart from that it's a great idea. Do you know who thought of it originally? Are there numbers?

Bob B

Many thanks.

For starters, I think we should exonerate George Osborne from belatedly leading a misguided charge here.

Roger Bootle, of Capital Economics, was trying to worry us about the house price bubble and its likely downstream consequences five years ago in his book: Money for Nothing (2003):

Besides Roger Bootle, I've only just learned of a book by Charles Goodhart, which I've yet to get and read: House Prices and the Macroeconomy: Implications for Banking and Price Stability (OUP, 2006)

Gordon Brown seemed to be almost bragging about the bubble a few days back and, of course, it has to be admitted that the bubble is popular with existing house owners. In a BBC interview, he said: "We've seen house prices rise by about 180% over the last 10 years and they have risen by about 18% over the last three years, so a 2.5% fall is something that is containable."

We can comprehend the electoral consequences of a feel-good factor but surely, he must have realised that a rise of 180% in average house prices over the last 10 years means serious challenges for first-time house buyers, especially for public service employees, and especially with the miserable record of house building during New Labour governance:

And GB must surely have been briefed that several "informed" commentators have been saying for years that houses in Britain are overvalued by about 20% rising to 30%. He could have seen from the latest chart in The Economist (3 April): High-rise Living, that the house-price bubble in America is modest compared with the bubble here.

Btw I'm not persuaded by the comparison with the bursting of the dot.com bubble of 2000/1 and its light consequences. After all, many millions more own houses than owned dot.com equity and about half home-owners have outstanding mortgages.

Bob B


With the scale of growing consumer indebtedness, I'll grant there is a problem of deciding precisely the moment when enough is enough but, as with many macroeconomic stability issues, the appropriate policy is more a case of "leaning against the wind" for reasons of prudence. The media were reporting that outstanding consumer debt had reached £1 trillion four years ago:

Even Alistair Darling, as Chancellor, was last year urging British banks to "take a more cautious approach to lending":

It doesn't take much nous to appreciate that the proliferation of 100% and 125% mortgages are likely to have advesre consequences downstream.

The big question is what, if anything, is the appropriate policy response to excessive and imprudent bank lending?

Bob B

Yet another reason why GB can't dodge the blame for fuelling the UK credit boom and an additional boost to the house price bubble.

In December 2003, the government set a new inflation target for the Bank of England when the Monetary Policy Committee makes decisions about setting interest rates:

"From May 1997 the target was 2 ½% for RPIX inflation. But in December the Chancellor gave the Monetary Policy Committee a new target for inflation. It is 2% as measured by the Consumer Prices Index or CPI, formerly known as the Harmonised Index of Consumer Prices."

The consequence of that shift in the measures of inflation was that the two measures, the CPI and RPI, diverged thereafter according to the ONS:

By February 2008, the annual rate of inflation by the CPI was running at 2.5%, compared with the old RPIX (Retail Prices Minus Mortgage Interest) at 3.7%. Had the old inflation target applied then interest rates would be significantly higher than they are now.


I'd be interested to see if the recent behaviour by banks and non bank mortgage lenders will have a real impact on their Basel 2 capital requirements. One of the matters to be considered is pro-cyclicality - the tendency of banks to ease lending criteria in a boom and then tighten them in a recession. Banks are supposed to be able to demonstrate they have controls in place to avoid, or mitigate the effects of, procyclicality.

Recent events have demonstrated just how much reliance one should place on banks controls or intentions. I hope the FSA will mark their cards accordingly when reviewing the banks' Basel 2 applications.

It might be nice to read something in the press on this and other capital and risk related issues.

Bob B

The headline report in Thursday's FT includes this:

"The Institute of International Finance . . representing more than 375 of the world's largest financial companies acknowledged 'major points of weakness in business practices', including bankers' pay and management of risk."

Banks seem acutely anxious about the possibility of unwelcome new regulations to prevent a repetition of the present looming crisis in the credit cycle. It seems to be widely accepted now that prevailing performance pay schemes which reward bank staff for taking successful investment or trading decisions but impose no personal penalties for unsuccessful decisions or losses are bound to create an upward bias favouring risk regardless of eventual downstream consequences.

Of course, paying staff bonuses for signing up 100% and 125% mortgages looked altogether more sensible if house price inflation was set to continue indefinitely and there were no concerted signs from government ministers of wanting to rein it back until very recently.

There were warnings enough years ago from independent, informed commentators that the ratio of average house prices to average earnings was increasingly unsustainable but ministers with responsibility for housing took no action. I suspect the calculation was that booming house prices were good for New Labour's re-election prospects in 2005 and then came the hiatus over when Blair was to step down.

Bob B

News update:

"April 10 (Bloomberg) -- UK banks asked to increase sharply their borrowing facilities at the Bank of England yesterday over concern the current instability may leave them short of cash, the Financial Times reported.

"Banks have asked to be able to keep total reserves of 23.54 billion pounds on deposit at the central bank, up from the almost 20 billion pounds on deposit yesterday.

"Banks can borrow from the deposit if interbank lending is too expensive, the FT said."

Bob B

New update 2:

See the time series graph of the ratio of house prices to average earnings in: The Bubble Bursts, in latest issue of The Economist out today:

The government isn't in any position to deny that, from years back, the housing market was predictably heading into an unsustainable boom.

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