The Bank of England (BoE) reported last week on six potential factors that could slow down Great Britain's macroeconomy. Following the subprime problems in the U.S., the bank highlighted its concerns on similar loans going unpaid as one of those factors, which could threaten the economy's overall growth.
"Those arranging [similar] loans may be less inclined to assess credit quality at origination if they bear little of the ultimate risk," the BoE wrote. "While market mechanisms exist to ensure that originators distributing risk remain exposed to some of the potential credit loss, the high levels of arrears in recent vintages of U.S. subprime mortgage lending raise questions about the effectiveness of those mechanisms."
Despite these questions, real estate in Wales and England, and London in particular, continues to grow unabated. Morgan Stanley analysts reported that the rise in immigrant and student populations is leading to more applicants in the buy-to-let market and the prevalence of self-employed borrowers. Meanwhile, the greater abundance of self-certified forms was pushing competition, enticing lenders into riskier and riskier dealings, despite the recent BoE warnings.
The BoE stresses that financial institutions may become more dependent on "sustained market liquidity" in order to distribute risks they wish to securitize and that these institutions may allow for greater portfolio adjustment and take on a greater, more unpredictable risk. Lenders continue to offer multimillion-pound loans to people with inadequate salaries to properly cover these massive mortgages, and they have begun lending to people with poor credit histories, even considering people that have just come out of bankruptcy. Some lenders even continue to offer mortgages to buy-to-let landlords without requiring any minimum rental cover or proof of income, Morgan Stanley said, and have lowered the ratio of gross rent-to-mortgage interest payments from 130% to 100%.
This claim runs opposite to BoE perceptions that lenders are, in fact, tightening credit terms in the face of rising insolvencies and heightened uncertainty about potential future losses. "If it becomes impossible or expensive to find counterparties," the BoE said, "financial institutions could be left holding unplanned credit risk exposures in their warehouses' awaiting distribution or find it difficult to close out positions, as was apparent in synthetic U.S. subprime mortgage markets in February."
Nonetheless, Britain is trying to learn from the U.S. in an effort to avoid such an event becoming widespread. But a solution is not yet at hand, and the BoE said last week that further work is needed to strengthen arrangements for managing cross-border problems, which could emerge in the event of severe difficulties at a global financial institution.
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