The interest rate dilemma

The International Herald Tribune pointed out one of the most important contradictions in UK economic policy. It concerns the epicentre of our problems, the housing market:

"Britain needs to reinvigorate its mortgage markets to save its economy and its banks. The problem is, few want to borrow and there is precious little money to lend.

British property prices are down about 15 percent in a year and mortgage approvals are down 52 percent. Given the freeze in the securitization market and the scarcity of savings in Britain, new net mortgage lending may even fall below zero in 2009."

The problem boils down to interest rates. If lending rates come down, then so will deposit rates. This will, of course, discourage savers from putting their money into banks.

If lending rates go up, banks have more room to increase deposit rates. This might encourage more saving, but with higher mortgage rates, the housing market is likely to fall further.

In the past, banks squared this circle by relying on the wholesale money market. With mortgage backed securities, banks could obtain funding from non-deposit sources. That option has now disappeared; too many investors lost too much money. It will take a long time before investors are ready to go down that road again.

What can Brown, Darling and the rest of the New Labour crew do? If anyone has an answer, please let us know.