UK mortgage plan won't end credit famine: James Saft

-- James Saft is a Reuters columnist. The opinions expressed are his own --

By James Saft

LONDON (Reuters) - Britain's banks will be happy to swap their hard to sell assets for trusty government debt, but don't look for them to increase their exposure to the teetering housing market.

The Bank of England has agreed to swap at least 50 billion pounds of banks' risky mortgage and other assets for easy to liquidate government debt, its latest and most radical attempt to break the back of the credit crunch.

The plan has its uses; it makes another Northern Rock or Bear Stearns far less likely and it may well bring down interbank lending rates, though this is far from clear on the early evidence.

What it is, in short, is liquidity. What it isn't is capital, which is the true constraint on British mortgage lending.

While banks theoretically could take the government bonds, turn them into cash and lend the money out to homeowners, gearing up their already very big exposure to British housing, it would be a risky move by an industry now rediscovering risk controls.

"I don't think it gives the banks a green light to go through an enormous lending program," said Mike Amey, the fund manager at PIMCO in London responsible for sterling portfolios. "While it will free up some liquidity, how much we would see in mortgage rates coming down is less clear cut."

To be sure, the plan does reduce the chances of a blowup in interbank lending and the damage that would do to the mortgage market, but it will not end what amounts to a credit famine in Britain.

Approvals for British mortgages hit a record low in March, according to data from the Council of Mortgage Lenders, falling by almost half compared with a year ago.

The reasons for this are straightforward and not fundamentally changed by the Bank of England plan. In recent years the amounts Britons could borrow to buy houses, and the costs, were turbo charged by a hot market for loan securitizations.

That market accounted for something in the order of 35 percent of all loans in the year to July 2007, when the storm broke and the market shut.

BANKS TO BORROWERS: PAY UP

The competition from the securitization market forced all lenders to cut their prices and standards. According to Bank of England data, the effective mortgage spread, essentially the extra interest above their funding costs banks charge mortgage borrowers, fell steadily and precipitously in recent years, from about 100-120 basis points in 2003 to about 40 basis points last year.

In retrospect, given that some loans go bad and it costs money to run a bank, it wasn't much of a business model.

That spread is now rising and can be expected to go back to its traditional peaks, if not beyond. At least half of all mortgage deals available earlier this year are gone, and it is now all but impossible to borrow the full amount of a house purchase.