Assetz® News - A major part of the credit crunch is over

A major part of the credit crunch is over - LIBOR near enough back to normal

13th January 2008 |

Is the credit crunch over? No, not fully by any means but one of the main indicators of problems in the credit market has almost totally recovered to pre-summer normal levels. LIBOR, the rate at which banks lend to each other had shot up well above bank base rate in the middle of last year in a sign that banks did not trust each other to have declared their true exposure to American sub prime debt risk. With some disclosure now having taken place by banks, the year-end having passed without complete carnage to profits in the banking sector and the Bank of England's liquidity injection pre-Christmas we've seen an almost complete normalisation of interbank lending rates very suddenly in the last two or three weeks. Certain rather misguided commentators who weren't close to the finance markets, including the regular Moneyweek property bear James Ferguson, stated that most mortgages were based on LIBOR and because LIBOR would stay stratospherically high for years to come, mortgages would become ridiculously expensive. Wrong on both counts James - perhaps you should stick to the stock market. The same goes for many other property bears that have been let out of their cages in the last few months but are probably going to look pretty foolish a little later this year when their repetitive negative predictions again fail to transpire.

All of this means that mortgages from lenders who do not receive money from savings accounts by depositors and who have to borrow money on the money markets in order to lend it out as mortgages have seen a dramatic lowering of their borrowing costs. Mid-December LIBOR was nearly 6.7%, nearly 1.2% over base rate - late last week it was 0.13% over base rate, lower than the long-term average but reflecting the fact the markets are pricing in a reduction in bank base rates in the near future. We still think rates are going below 5% this year and all the evidence points to this being sooner rather than later. Apart from tracker mortgages which we think are the best product at present, banks are being a little slow passing on base rate reductions but they need to make their profits back somewhere that they have lost to the bad credit mortgage derivative investments - competition will ensure this extra profit is trimmed soon enough.

There is a reasonable chance that inflation will end of 2007 below 2% when it is announced later this month - certain key elements of the inflation calculation including furniture and other retail sectors could well help inflation come in at 1.8 to 1.9% in the year, below the 2% target according to my calculations. If this is the case it supports short-term interest rate reductions that the bank must carry out even though in theory the bank is trying to manage long-term inflation. As per my previous comments all the evidence suggests the bank is overcompensating (just like it did in raising rates to 5.75%) and reacting to shorter term data rather than taking a long-term inflation view - this short-term thinking can increase volatility and problems rather than reduce them in a less stable environment and it will probably be the undoing of Mervyn King in him losing his position soon. Whilst he probably won't suffer the savaging of his reputation that Greenspan will over the pond, his reputation for having managed a long period of low inflation through effective bank base rates may be called into question somewhat if he can't continue to do it this year.

The Bank of England didn't drop base rates last week as we strongly felt they would, but February is looking a near certainty now. Mervyn King, or King Canute as I still call him, is still attempting to hold back the tide of inevitability after we thought he had learnt his lesson from several embarrassing U-turns late last year. The reason this time however could well be the attempt at political interference in base rate setting by Alistair Darling who is still a little wet behind the ears in his role as Chancellor. We go 10 years without politicians attempting to influence the Bank of England and then Darling suggests there is room for an imminent reduction last week - a red rag to a bull for the MPC committee I'm sure and pretty likely to be a factor in their decision to leave things until February I suspect just for the principle of the thing.

Overall my views remain that bank base rates are heading to around 4.75% by the end of this year, inflation is still looking to be under control and on target (although under some pressure), buy to let mortgages are now cheaper than homebuyer mortgages on average and will continue to be so and there will be a substantial increase in mortgage lending to people with reasonably good credit or better to be seen in the first quarter this year. When people look back I think it's pretty likely that they will state that the credit crunch bottomed in terms of mortgage availability and mortgage pricing in the first half of December 2007 - things will get significantly better going forwards and already almost weekly we are seeing better and better mortgage rates coming into the market. One key buy to let lender who is very aggressive in the market has dropped their key products from 5.8% to 5.4% in two steps just over the last few weeks and another drop is due in the next few days we hear.

All very comforting for those reaching the end of some particularly cheap mortgage deals from two or three years ago - there will be some pretty good deals available to move into in 2008 and although those who took out mortgages at the very bottom of the rate cycle will still have a bit more to pay we expect people to be pleasantly surprised compared to any mortgages they tried to get in November or so. It's the beginning of the end of the credit crunch and another financial crisis gets consigned to history.

Stuart Law

This news story has come from the property investment blog by Stuart Law, CEO Assetz plc.