One might have expected at least some political debate about the financial time bomb depicted in James Crosby’s “Interim Analysis of Mortgage Finance”—a report commissioned by the treasury into the mortgage market crisis—published in July. Instead, it was quickly tagged as something too difficult to contemplate.

The hope is that markets will be able to ride out what will turn out to be short-term turbulence. But a year after the credit crunch began, some of the problems seem to be intensifying. Privately, business and householders alike are preparing for the worst—while everyone colludes in the fiction that no useful public action is possible.

Yet Crosby’s review demands a proper response. It is one of the most sobering documents released by a British government in recent years. Crosby, the former head of HBOS, believes that the collapse of the markets for residential mortgage-backed securities (RMBS) and covered bonds—fixed-income bonds backed by home loans—which together provided an amazing two thirds of the finance for new mortgage lending in 2006, will lead to a mortgage famine lasting until the end of 2010, with only a gentle recovery thereafter. Crosby believes that even forecasts that mortgage lending will merely halve over the next few years are too optimistic. Net new mortgage lending for all but the most creditworthy borrowers could virtually end.

This collapse in demand will, of course, mean a further downward pressure on house prices. The most pessimistic forecasters expect prices to fall by 40 per cent by 2010 from their 2007 peak. But if Crosby’s fears are realised, even that could prove optimistic. Confronted by a sharp fall in the value of their main asset, consumers will spend significantly less.   Meanwhile, banks and building societies will have to acknowledge greater loan losses as house prices fall, encouraging further deleveraging by banks, squeezing the supply of credit to an already hard-pressed economy (this process was described in “A perfect financial storm,” Prospect, March 2008). This could turn a slowdown into a recession, with big implications for government finances—let alone for employment and investment. Worst-case projections, I have been told, are for a government deficit in this financial year approaching £70bn—more than twice last year’s £34.2bn—translating into a peak deficit of £100bn in 2010-11.

The problem is that between 2003 and the first half of 2007, the City, indulged by regulators and the government, exploited its role as a global magnet…

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