Tuesday, 14 October 2008

Banking on Change - Can we build a sane future?

The action of governments and central banks across Europe and in the U.S to save the financial system from complete collapse is without a doubt one of the most significant economic and political events since the second world war. But it would be foolish to think that this crisis is anywhere near over. In fact, we may simply be entering a third phase in which we witness the impacts start to spill over into the real economy - resulting in more lost homes and rising unemployment.

The primary reason for continuing alarm? The causes of the credit crisis have not been addressed. We perhaps need to remind ourselves that neither the mass movement of bank deposits or the loss of liquidity in the banking system was the initial cause. Both of these were second order problems. They only arose because of falling values in the U.S - and by extension uncertainty in other national - housing markets. This 'trigger' remains in place, creating a prisoner's dilemma for banks.

Simply put the prisoner's dilemma is this - with so many people now in need of remortgaging at cheaper rates in the U.S, which one of the banks will be the first to take the risk on by offering them loans? The answer, clearly is none will do so for fear of attracting the most risky customers - after all just as the market knows that those banks accepting loans from government are in the worst problems, the banks know that those customers most desperate to reschedule home loans are likely to have the most problem repaying. This 'adverse selection' in credit markets was recognised long ago.

Two immediate actions need to be taken to resolve this. Firstly, households in the most difficulties need helping and fast. Secondly, central banks have to break the prisoner's dilemma by placing 'strings' on their assistance.

How can households be helped? - Debt on our Doorstep calls on government to consider introducing a 'housing interest credit' for low income families, which provides interest relief at source on mortgages and is paid on a sliding scale according to income. That will provide instant assistance to households struggling with increased fuel prices, and rising inflation but will ensure that it reaches mortgage repayments and reduces the risk of arrears. The Obama campaign has something similar in its economic proposals in the U.S at the moment.

Government should also legislate to amend S.36 of the Administration of Justice Act 1970 and S.8 of the Administration of Justice Act 1970 - the legislation which currently provides court's with powers to help borrowers facing repossession proceedings. The current law does not allow judges to reschedule mortgage agreements to ensure that people can retain their homes. They should be provided with the discretion to do so. Again, these measures are being supported by Democrats and community groups in the U.S.

But fundamentally the prisoner's dilemma in banking needs to be broken. To do this, banks must be forced to put out greater amounts of capital on loan to support mortgage and consumer credit restructuring for households over the next five years. Long term loans need to be made available to the banking industry from central banks to support this but banks must pass on this funding at fixed rates and terms established by the central banks to consumers. In effect the central bank will be setting the terms on which loans are to be provided to consumers, with banks simply acting as the intermediaries. Such is the lack of trust which can be afforded to Britain's banks.

Over time, such a direct mechanism can be relaxed provided the regulatory framework under which credit is provided in future is revamped and ensures that incentives are in place for responsible lending to take place and long term, ethical, relationships between consumers and lenders fostered.

That regulatory framework now needs to be constructed with the active participation of consumer agencies and representatives in partnership with banks and government. Our conference, which will take place on 13th and 14th November in London provides a seminal opportunity to begin those discussions. Further details can be found at

Please note that we have also secured up to 50 half price places for not for profit agencies to attend these discussions.

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