Turning back the clock to ‘Hovis banking’

Interest rates in Britain more than doubled between mid-1988 and the end of 1989. The Bank of England’s base rate rose to within a whisker of 15 per cent and remained above 10 per cent for more than two years. House prices fell steadily in that period, and then stayed flat. By the time they edged upwards in 1995, they were in real terms almost 40 per cent below their peak.

Following the bursting of the credit bubble in 2007, British house prices also fell for two years, but have since recovered somewhat. They now stand at around the levels they reached in 2006, about 10 per cent below the peak of a year later, having more than doubled in the decade before 2007.

This rise not only followed the actual price crash of the early 1990s; it was accompanied, and largely caused, by a sharp fall in real and nominal interest rates. Most of the gains have been retained. There has been no house price crash in Britain.

Some commentators predict such a crash is imminent, as some have predicted for 10 years. If there was a bubble in the UK housing market the only conclusive evidence of it – that it bursts – has yet to emerge. The British experience in this respect is very different from that of Ireland or the United States.

The UK housing market crisis of the early 1990s was therefore much more serious than the one following the 2007 credit crunch. In 1991, 76,000 houses were repossessed: in 2009, 46,000. But in the earlier period, the principal mortgage lenders sailed comfortably through. The largest – Halifax – increased loss provisions but nevertheless reported year-on-year increases in profits.

Some of the costs were assumed by insurance companies, which had issued mortgage indemnity guarantees, a primitive form of credit default swap. They had little knowledge or understanding of the risks they were underwriting – a familiar story – but these companies had successfully limited their exposure to this line of business. No major institution recorded an overall loss, or encountered significant funding problems. Mortgages, much the largest part of external lending by banks, remained readily available.

In the recent crisis, however, three major lenders failed. Northern Rock and Bradford & Bingley were nationalised, and HBOS – successor to Halifax – was rescued by Lloyds. The fate of Alliance & Leicester would have been in doubt if it had not been taken over by Santander. Few independent building societies remain, but one of these – Dunfermline – collapsed and more than one other was on the brink of failure. Since the crisis, mortgage availability has contracted sharply and margins have widened.

The recent problems of British lenders have been much more severe than those of 20 years ago, but not because the economic fundamentals have deteriorated. What has changed is the structure and behaviour of the financial services industry, which is far less robust to external shocks. Although Northern Rock and Bradford & Bingley did undertake poor quality lending, no large institution failed because of losses on UK residential mortgages. They failed either because they had pursued more complex funding structures that ceased to be viable, or because of losses outside their own mainstream activities, or a combination of these factors.

Regulatory changes, which dismantled structural restrictions, encouraged mistaken business decisions that new, more complex controls on capital adequacy failed to check. Financial innovation ostensibly designed to control risk in fact magnified it. Diversification aimed at reducing business risk increased it. Changes in the structure of mortgage funding turned out to raise the price of mortgages and make their supply less reliable.

The suggestion that we might partially turn back the clock has been described as a call for “Hovis banking”, referring to an advertisement that plays on nostalgia. The commercial succeeds because we believe the bread our grandparents ate, before innovations in technology and marketing, was nicer and more wholesome. Perhaps that is true in banking as in baking.