Great news for homebuyers

At last, housing bear Cliff D'Arcy has something positive to say about the property market....

Frequent readers of lovemoney.com will know that I'm something of a housing 'bear'. For several years, I've been very pessimistic about the outlook for residential property. Indeed, 4½ years ago, I sold my family home in order to sit out the inevitable housing crash.

In my first two years as a tenant, UK house prices continued their relentless climb, peaking in August 2007. Two now-familiar words explain why house prices started to fall steeply after the summer of 2007: credit crunch.

When credit collapsed

The seeds of the credit crunch were sown in the US housing boom that began in the second half of the Nineties. As US house prices reached their peak towards the end of 2006, more and more American homeowners began defaulting on their mortgages. These bad debts, combined with huge leverage and derivatives which magnified losses, began producing hefty write-downs for US lenders.

Even worse, these lenders had packaged up their home loans into bundles of residential mortgage-backed securities (RMBS). These bonds -- plus other loan derivatives such as CDOs (collateralized debt obligations) -- were chopped up and sold to investors across the world. Thus, as the US housing market started to crash, the effects were felt around the globe.

In early 2007, hedge funds and big US banks started to report losses on RMBS and other securities linked to US home loans. As the underlying loans turned bad in their millions, financial firms all over the world stopped buying mortgage-backed bonds.

Eventually, in early August 2007, the cost of borrowing became so high -- and banks became so frightened and risk-averse -- that credit markets around the world effectively shut down. Of course, this delivered a massive blow to the UK housing market, sending prices into a 1½-year slump.

No RMBS = No Northern Rock

The first UK victim of the credit crunch was Northern Rock. In the first half of 2007, Northern Rock lent almost a fifth of all the money advanced to homebuyers. Alas, three-quarters of its mortgage funding came from loans raised in the wholesale money markets.

Hence, when the credit markets shut up shop, the Rock sought emergency funding from the Bank of England. This news caused a run on the Newcastle-based bank in mid-September 2007 and, eventually, Northern Rock was nationalised in February 2008.

Just over a year ago, credit markets suffered another serious setback when US investment bank Lehman Brothers went bankrupt. This caused banks to cut back even more sharply on their lending, which sent credit spreads soaring once again.

From big freeze to thaw

In short, the period from 2007 to 2009 saw the worst crisis in financial markets since the Wall Street Crash of 1929 and the Great Depression which followed it in the Thirties. However, since this spring, things have started to improve. Stock markets have soared, the Bank of England slashed its base rate to an all-time low of 0.5% a year, and the cost of credit has tumbled.

Of course, after The Rock became The Wreck, UK lenders found it impossible to sell mortgage bonds, as there were no buyers. Then again, it looks as if the UK market for residential mortgage-backed securities is starting to re-open, albeit cautiously.

In September, Lloyds Banking Group sold £4 billion of bonds created from a bundle of Halifax mortgages. These came with the top credit rating of AAA, and demand from investors was so high that Lloyds was able to expand this offer while securing an attractive price.

Lloyds' deal was the first RMBS transaction since the summer of 2007. However, last month, Nationwide BS followed suit, selling £3.5 billion of mortgage-backed bonds to investors. What's more, as financial markets return to normal, bankers expect more and more RMBS deals to hit the market.

Cheaper, easier credit

Just as one swallow doesn't make a summer, two RMBS trades doesn't make a market. Nevertheless, the residential mortgage-backed securities (RMBS) market is showing the first signs of life since its collapse in summer 2007. Although this may seem a bit esoteric, it has major implications for lenders' ability to lend.

At their peak, RMBS and other mortgage securitisations were a key source of funding for UK banks. Indeed, before the credit crunch, the UK accounted for around half of the entire European market for RMBS. At the peak in 2006, UK lenders issued almost £90 billion of mortgage-backed securities.

If this market does gather momentum, then it will ease access to credit, enabling lenders to lend to a broader range of homebuyers. In addition, more RMBS transactions could mean a reduction in mortgage rates as healthy competition returns to the UK mortgage market.

While the rebirth of RMBS is good news for homebuyers and homeowners, I don't expect it to fuel another housing boom. Although the RMBS market should eventually gather pace, it will never again see its previous heights. In future, RMBS must become just another fund-raising tool for lenders -- and not a bubble made of mortgage bonds!

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