Why this crisis will hit all home owners

Should you have thought that the credit crunch was over and the greater threat to our prosperity was high oil prices, think again.

The collapse of confidence in Bradford & Bingley suggests that Britain's financial system is still not out of the woods.

The crisis which began last year in the trailer-park mortgage market in the U.S. has landed on these shores with a vengeance.

Despite all the assurances that the UK's mortgage lenders had been far more careful than their American counterparts, the evidence is growing that we have a home-grown problem of accelerating arrears in home loans to add to those imported from overseas.

At Bradford & Bingley the peculiar difficulty is that it has been lending heavily to one of the most exposed parts of the housing market  -  buy-to-let.

When property values were rising and home loans were easy to come by, buy-to-let looked a sure way to make money and a far more secure investment than a pension for many consumers.

But conditions have changed rapidly. The surge in house prices has come to an abrupt halt and some of the hardest-hit properties are the inner-city apartments loved by the buy-to-let lender.

From Liverpool to Bradford, price drops of up to 40 per cent have been seen on these new-build properties.

This at a time when the cost of borrowing has been rising sharply  -  despite three, quarter-point cuts in the official bank rate to 5 per cent since August.

As a result, Bradford & Bingley has seen the arrears on its lending soar to £1.1billion in the first four months of 2008 against £828million in the same period last year.

The current crisis could hit all home-owners

Even more worrying, the bank didn't see this coming because its reporting system was so inadequate and at least a month behind events.

B&B has also revealed that it made a loss of £8million in the first four months of this year, against a profit of £107million in the same period of 2007.

No other lender in the British mortgage market has devoted as much of its resources to the incendiary buy-to-let market.

Analysis of the bank's latest lending figures show that 57 per cent of the home loans it makes have been for this purpose.

Inevitably, though, it is not just buy-to-let customers who will now pay for B&B's focus on this group.

The weakness of the bank's position means that the cost of all its funding will rise.

Existing and new borrowers can expect to face higher interest charges for their home loans in a market where mortgages are becoming increasingly scarce.

It was the sudden and sharp deterioration in Bradford & Bingley's business which caused the bank last month to go cap in hand to its shareholders  -  including 800,000 private investors  -  in an attempt to repair its balance sheet with a £300million injection of new capital.

The City was not convinced this was enough and also lost faith in the company's chief executive Steve Crawshaw, who has stepped down having fallen seriously ill six days ago.

Now the banks backing the new share issue  -  the American giant Citigroup and the Swiss bankers UBS  -  have been forced to bring in the cavalry to shore up the group's capital.

The investment bankers Goldman Sachs  -  employed by the Government at the time of the Northern Rock crisis last autumn  -  were charged with finding a new strategic investor.

They hauled in the private equity firm Texas Pacific Group (TPG) which jumped to prominence in Britain when it bought up shares in the department stores chain Debenhams only to bring the company back on an unsuspecting stock market 18 months later, having made a quick profit.

The only consolation for Bradford & Bingley shareholders  -  who now find 23 per cent of their company will be owned by Texas Pacific  -  is that the private-equity firm has an instinctive feel for a bargain and must believe that there is some value to B&B.

The bank and the authorities have been at pains to point out that the lender's problems, unlike those of Northern Rock, are down to 'trading not funding'.

This means that it is the business which has temporarily gone sour, because the fall in property prices and the cost of raising finance has risen sharply, and not a problem with deposits or the fundamental viability of the company.

It believes that unlike Northern Rock, which borrowed most of its own money short-term in the money markets (where banks lend to each other), it has secure finance in place.

So far B&B claims to have seen no unusual withdrawal of deposits in the wholesale market, through the internet or its branch network since the problems erupted.

Last year, under the tutelage of the City regulator the Financial Services Authority, B&B sold its housing association loans to another lender and secured £4billion of extra cash  -  enough to see its borrowing needs through until 2009.

What has caught the attention of the stock market is the deterioration in B&B's underlying businesses.

Investors reckon that if conditions have become so much worse for the Bradford & Bingley  -  which is expecting increased arrears and rising repossessions through to the year end  -  then the same will be true of other banks.

This is why the shares of many tumbled, led by Halifax Bank of Scotland and Alliance and Leicester.

The 'tripartite' authorities the FSA, Bank of England and Treasury monitored events closely from the sidelines-over the weekend as the final arrangements for injecting £400million of new capital into B&B were put in place.

The authorities hope that the bail-out by TPG and stock market investors will be enough to prevent savers panicking as they did at the time of Northern Rock last September.

It is also noted that now £35,000 of savings are fully covered by the Government's banking insurance scheme, when previously only 90 per cent beyond the first £2,000 was covered.

Some consideration may have been given to guaranteeing all of Bradford & Bingley's savings  -  as occurred at Northern Rock  -  but it was decided that premature action on this front might have been 'counter-productive' and scared savers.

For the moment the situation appears to have been stabilised. But we should not underestimate the impact which rising mortgage arrears and repossessions will have on the future value of all our homes, attitudes to borrowing and consumer confidence.

The squeeze on incomes is now biting hard, threatening growth and living standards.