To be published as HC 1895-i




Treasury CommitteE

Mortgage Market Review

Wednesday 14 March 2012

Lord Turner and Martin Wheatley

Evidence heard in Public Questions 1 - 92



This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.


Any public use of, or reference to, the contents should make clear that neither witnesses nor Members have had the opportunity to correct the record. The transcript is not yet an approved formal record of these proceedings.


Members who receive this for the purpose of correcting questions addressed by them to witnesses are asked to send corrections to the Committee Assistant.


Prospective witnesses may receive this in preparation for any written or oral evidence they may in due course give to the Committee.

Oral Evidence

Taken before the Treasury Committee

on Wednesday 14 March 2012

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Stewart Hosie

Mr Andrew Love

Mr Pat McFadden

Mr George Mudie

Jesse Norman

Teresa Pearce


Examination of Witnesses

Witnesses: Lord Turner, Chairman, Financial Services Authority, and Martin Wheatley, Managing Director, Conduct Business Unit, Financial Services Authority, gave evidence.

Q1 Chair: Lord Turner, you made a speech or at least what is described as a broadside against the City, which is reported in the papers this morning. Perhaps I could summarise at least one of the points you made as being that complexity should not get in the way of innovation. Do you accept that regulation gets in the way of innovation?

Lord Turner: Can I just be clear? The speech is going to be delivered this evening, and it is a rather technical, theoretical speech about shadow banking and what we mean by shadow banking and how we regulate it. The actual interview that is there, which was linked to the speech, was that I was asked to respond to some things that the journalist said that the Governor of the Bank of England had said, which were somewhat critical of the City, and did I think that industry had yet learned the lessons of 2008. I said that I thought many of them had, but that we still saw in the financial industry a tendency of some parts of it to continually try to create complex products both in the retail space and in the wholesale space, and that we had to continue to keep our eyes on that. I think it would be possible for regulation to prevent useful innovation. I think that would clearly be possible, and that is why it is very important that we get regulation right.

I think the bigger problem in the industry is that innovation has often meant over-complexity rather than things that are really designed on making life better for customers. That is the bigger problem over the last 20 years or so in terms of financial innovation in the financial services industry.

Q2 Chair: Have you not more or less just said what I just tried to say in a sentence?

Lord Turner: Possibly, but I was trying to provide the context so you understood what exactly that speech is and what it is not.

Q3 Chair: Given that complexity-or "over-complexity" is the word that you are quoted as using-can get in the way of good quality innovation, my question was, do you think regulation gets in the way of innovation?

Lord Turner: Yes, I think it theoretically can.

Q4 Chair: But it never has in practice?

Lord Turner: I think there are fewer examples of it getting in the way in the financial services industry than there are of the industry creating unnecessary innovation outside the scope of innovation. I do not think it has been the biggest problem in the financial services industry. Maybe it has in other industries.

Q5 Chair: Maybe it would be helpful to us if you could set out on a piece of paper for us afterwards a list of the main areas in which you think regulation has got in the way of innovation. You said that there were fewer but there are some, and I think it would be helpful for us to have a look.

Lord Turner: I will try to do that, but I think what I said was I could theoretically accept the case that there was, but I honestly do not believe that a fundamental problem in the financial services industry has been regulation preventing useful innovation. I am not starting from the point of view that that has been a major problem in respect to the dynamics of the financial services industry.

Q6 Chair: You have said also-at least it is reported that you have said-that the fine on HBOS could have been as much as £100 million. That is quite a large fine. The cost would have been borne by the shareholders, would it not?

Lord Turner: Yes, of whom 40% are the taxpayers and therefore your constituents.

Q7 Chair: Therefore, what you have done in fact is make a transfer to the private shareholders, who are 60%, from the taxpayer. They have gained, have they not, because they would have been hit by a fine that you have decided not to impose?

Lord Turner: The way that we thought about it-and I would defend this completely-is we have prevented your constituents paying a fine that would have been to the benefit of a reduction on the levy, for instance on investment bankers and other people whom they might think caused the problems, so I am a little bit surprised.

Chair: Leave the politics to us, Lord Turner. I am just trying to concentrate on what has happened here. There has been a transfer, has there not, from the private shareholders, among others, to-

Lord Turner: If we had imposed a fine, it would have been to the disadvantage of both the private and the taxpayer shareholders of Lloyds, and it would have been to the benefit of the rest of the financial services industry through a rebate of their levy.

Q8 Chair: Was it not the private shareholders who were stupid enough to vote for this deal and who are now getting a free ride? They are not even having to pay a fine, Lord Turner.

Lord Turner: There is a difficulty that this is half owned by the taxpayer and half owned by others. We took the point of view-and I am fairly confident that, if we had gone ahead and imposed a fine, we would be getting from this table exactly the inverse of the implied criticism that you are now putting forward-that by imposing a large fine we were hitting the taxpayers twice. I would agree with you that the fundamental responsibility for going ahead with the HBOS merger was the then board of Lloyds Bank and the shareholders who voted for it. That is, ultimately the responsibility for going ahead with a merger, if you subsequently regret, resides with the board and shareholders of the company who do it.

Q9 Chair: Had you levied the fine, it would have reduced your levy pro rata and therefore been a transfer from the narrow class of private shareholders to the broader levy payers in the financial services industry.

Lord Turner: Yes, it would. If we had imposed the fine, we would have taken money out of the pockets of taxpayers and given it as a levy.

Chair: You are talking like a politician. I am asking you-

Lord Turner: I think you are asking the question to me like a politician. I am trying to explain it in the most obvious way that I can.

Q10 Chair: With respect, 60% of this company is owned by private shareholders, and I have been asking you about them, and each time I ask you about them you tell me about the 40% taxpayers, which I am sure you are right we would have asked about, had you taken the decision, but that is not the decision that has been taken. So, quite reasonably, I am asking you about the decision you have.

Lord Turner: I think you are clearly right that the failure to impose a fine benefits not only the taxpayer as a shareholder, but also the private shareholders of Lloyds Bank as they exist at the moment. Of course, the offences that occurred were committed by the management, or the firm in total, of the previously existing HBOS. We felt that this was a special case. From our point of view, I can tell you enforcement would love to be able to say that they imposed a large fine. We rather like large rebates to the industry because it reduces criticism of the level of our fees. That would have been an easy course of action for us, but we simply did not think it was the right thing to do in these circumstances.

Q11 Jesse Norman: Of course, it was not just the Lloyds directors; it was also the political context in which they were being bounced into a merger with HBOS that fulfilled a certain desire for them-so there is a degree of political responsibility for that as well. Isn’t the FSA under a duty to impose fines as it sees fit, and not-as it were-under a duty to impose fines where they are required? Why have you abrogated that duty, if there is one?

Lord Turner: No, I think we are able to decide what the appropriate approach is in a circumstance to achieve the effect that is required, and what we wanted to do was give very clear publicity to the failures that had occurred in the appropriate controls at HBOS. I think that has been very clearly achieved by the issuance of this report. There are some circumstances where a censure is as effective as a fine, and a fine would simply be, as I say, something that at one level would have put us in a favourable light in terms of our economics. I think that to have gone ahead with a fine would have been doing something that made us look good but disadvantaged the taxpayer. That is honestly the point of view that I had.

Q12 Jesse Norman: You do not think it is a political decision as much as an economic one?

Lord Turner: It is a decision as to what is appropriate. I am honestly slightly surprised by this discussion because I think you are asking for an economic hit to be imposed upon your constituents, which I find slightly odd.

Jesse Norman: No. With respect, we are just asking first to understand what the basis in fact of your thinking was, not drawing any conclusions about that.

Lord Turner: I will tell you exactly what the basis of the thinking was. At the time when we decided to bring a case against the firm-as well as some other enforcement proceedings that are still ongoing and that I cannot talk about-we did debate, "What is the point of bringing it against a firm, HBOS, which no longer exists and was rescued by the taxpayer?" We said, "No, it is very important if we think the firm did a set of things wrong and if, in the normal course of events, we would have charged the firm that we do so, and therefore we are going to go ahead and bring a proceeding against the firm, but it will look odd to some people and seem unreasonable if we then, as it were, hit the taxpayer twice. Therefore there is a reasonable balance here, which is to bring a proceeding against the firm, but if it ends up finding that there were problems, to use the sanction of a censure rather than a fine". That literally was the thinking that we went through.

Q13 Jesse Norman: Thank you, Lord Turner. I described accruing capitalism as a state of affairs where the public interest is separated from the activity of corporates and banks, and business merit is separated from business reward within institutions. Do you think that that is the culture we have in the City at the moment, from your remarks today?

Lord Turner: I just want the precise words you used again, sorry.

Jesse Norman: The first part is that any connection between business activity or financial activity and the wider public purpose is lost, which mirrors comments you have made about socially unproductive activities in the past. The second is that business merit is separated from business reward.

Lord Turner: I think there are problems with that. Those problems were severe before the crisis. Some of them have gone away, and it is important to say that there are many people working in banks and the insurance industry who do a good job and deliver good products and services to the end consumer. But I think there is a particular problem about financial services, because the difficulty that the consumer has in understanding whether this is the product that they want, which is a difficulty that does not exist when they are buying a car or going to a retailer, means that there is a far greater opportunity for precisely the two problems that you have suggested, and therefore, in those circumstances, the desire simply to maximise profit has to be balanced by a sense of responsibility.

Q14 Jesse Norman: I have two quick questions on that. Given the time, I would be grateful if you could answer briefly. Do you think some banks or financial institutions are making products needlessly complex in order to create more revenue?

Lord Turner: Yes, I think they are, sometimes.

Q15 Jesse Norman: Thank you for the boldness of that reply: I agree with you. Do you think that there should be a duty on the boards of financial institutions to review products to ensure that they are not detrimental to consumers?

Lord Turner: What I said in the interview today is that I certainly think that boards should-at least in a moral sense, or whether we turn this into a rule sense-ask searching questions about, particularly where there are big product lines, whether those are in the good interest of consumers.

Let me give you an example. We all know that there has been a very major problem with the effective mis-selling of payment protection insurance. This was a product which produced very high product margins. There must have been situations in the boardrooms of some of our retail banks about three or four years ago where it was obvious, because it was so big, that the retail division was delivering very large profits on that particular line. Very high profits can sometimes mean that you have created something that is really great and valuable but can also be a giveaway that something has gone wrong.

I fear that, if we went through the board room minutes or the management committee minutes of those companies at that time, you will find the retail division being congratulated on those large profit flows, rather than somebody asking the question, "Hang on, we are making such high margins on this product. Can it possibly be to the benefit of the customer? Can we do a "drains up" on that?" This might be difficult to write into rules, although we clearly have to debate that, but-as I am sure you appreciate and would agree-good business conduct is partially driven by rules, but it is also driven by norms of behaviour and values. I think it is important for the industry to have a sense of values that push them to go beyond what the letter of the law says.

Q16 Chair: Why don’t we turn to MMR? Although I think you have to understand that if you make a speech or at least trail a speech as important as this, you are likely to get the odd question about it.

Lord Turner: Yes, of course.

Chair: But I am sure you had that in mind.

Lord Turner: I anticipated you might ask me a question about it, yes. I did not trail it with you in mind.

Q17 Chair: I am pleased to hear that too. Do you think that MMR raises issues of prudential importance and, if so, how important, as well as conduct of business?

Lord Turner: The approach of the Mortgage Market Review as we have issued it for consultation is focused entirely on the conduct side, and it is therefore-and that is why Martin is here rather than Hector-something that will belong to the FCA in the future. The way that we have approached it is essentially looking at the appropriate relationship between providers of mortgages and the customers and the appropriate degree of customer protection, and that is the entire focus of this document.

Clearly, the mortgage market in general is a crucial prudential issue because it is not merely a part of lending by banks, it is a very large part of their balance sheets-though the prudential rules that relate to mortgage lending are very important. That is why, within the deliberations that the Financial Policy Committee is now involved in about the macroprudential tools that could exist, two of them that were flagged back in the discussion paper put back in December were either rules that directly relate to borrowers, such as loan-to-value or loan-to-income ratio limit, or new approaches to prudential rules that would enable us to vary the capital requirement in line with the LTV or the LTI or some other measure of riskiness, but I would not like to say more about that because the FPC is going through the process of coming out fairly shortly with which of those we think are appropriate, and it is an FPC issue rather than an FCA issue.

Q18 Chair: The reason that I raise this is that you had responsibility for both.

Lord Turner: At the moment, yes.

Chair: We do not want to find ourselves with a gap between two stools created by legislation-

Lord Turner: No, I do not think there will be a gap.

Chair: -or the one that is dependent on one individual to breach.

Lord Turner: I do not think there will be a gap between these. I do not think there is anything in the rules that are being put forward here on a conduct side that constrain the necessary degrees of freedom, if it asks for it from Parliament. It is up to Parliament to decide what tools the FPC has. I do not think this constrains the appropriate design of the FPC rules. Clearly, in the future, if the FPC does decide first of all to ask for and then to pull any of those levers, there could be a process of how they are implemented, because if they are borrower limits, that will involve the implementation arm of the FCA, and obviously there will be, to a degree, some overlap. It will have consequences at the level of individual customers, particularly if they are borrower limits, and that of course is one of the reasons why the Chief Executive of the FCA will be, from the point that the legislation is passed, a member of the FPC.

Chair: We will take an interest in that.

Lord Turner: No, I think that is the important issue.

Q19 Chair: I would be grateful if, in a short note, you could let us have a look at what thought has gone into making sure that the institutional relationship is working well rather than wasting time and exploring it now.

Lord Turner: I will send you that. If I could do that after the FPC has produced its statement on the macroprudential rules-

Q20 Chair: Which will be?

Lord Turner: Within the next few weeks.

Chair: Okay, that is fine.

Q21 Stewart Hosie: Lord Turner, you said that the post-crisis impact has so far been more favourable than feared, but that was due in part to lower than expected interest rates and unemployment. Since the start of 2009, we have seen unemployment rise and we have seen tightening in the interbank lending system, which has affected mortgage rates. You do not appear, though, to have estimated the impact of the changes in those variables-interbank lending and unemployment-in your recommendations. Was there a reason why you did not do that?

Lord Turner: I do not think that is quite right. Just one thing on the impact of the financial crisis: what is striking is that, compared with what we thought back in 2008, the impact in the residential mortgage market has been less dramatic than we feared and the impact on the commercial real estate market has been even worse than we feared. There has been that interesting pattern, but if we focus on the residential mortgage market, broadly speaking, arrears and repossessions and write-offs have been nothing like as big as they are, for instance, in the US, where there was a major subprime problem, and they have been less than in the early 1990s.

We all recognise, however, that crucial to that has been the low rate of bank rate, 0.5%, which, although not fully reflected in the rates of mortgages, has been to a significant extent. For instance, average standard variable rates came down from around 6% to 3.5%. Since then, they have remained reasonably stable. I know that there are some signs recently of SVRs going up, but if you look at the latest figures for up until the end of last year, the Quarter 4 2011 figures, which were in the figures that we put out just yesterday, at that stage standard variable rates on average were the lowest they had ever been.

The overall pattern from 2009 to Quarter 4 2011 was a slight further drift down of the level of SVRs. They are now beginning to go up, and in a sense we were a little bit surprised in the autumn that they did not go up a bit earlier. Because of the eurozone partly, there were pressures on the wholesale funding market that were reflected in the cost of wholesale funds, and we thought it likely that at some stage they would be reflected in an increase in mortgage rates, and we are beginning to see that.

In our assessment of the impact of the Mortgage Market Review, we very much have allowed for that. Let us be clear that one of the most important impacts, the biggest impact in terms of how it might change whether you can get a loan or not, is the requirement for an interest rate stress, i.e. that the lender has to think not only about whether somebody could afford the mortgage now, but whether they could afford the mortgage if interest rates went up a bit. We have certainly tried to take into account the fact that we cannot assume that interest rates will stay at these low levels forever.

Q22 Stewart Hosie: I am sure one of us will be asking about the interest rate level upon which the stress is based later. I think what you are saying is that you believe that the reforms will be sufficient if the economic outlook of circumstances change. Can you see any circumstance or any change in a variable that would lead you to want to review the reforms?

Lord Turner: One should always keep reviewing the situation and seeing whether there is something that we have not thought about in advance. But, broadly speaking, what our cost/benefit analysis suggested-and it is one of these things where you do a lot of complicated figure work but it confirms what intuition tells you in the first place-is that the application of these rules applied today will make really only a trivial difference to the amount of mortgage loans put forward, but that if they had been applied in, say, 2006 or 2007 they could have had appreciable-not massive, but appreciable-impact, say 7% or 8%, in cutting down mortgage lending at that time. That is the best analysis that we have, and that is an analysis that therefore tries to think about the impact now and the impact on the future circumstances.

Obviously, it will be important to track it over time and to see whether that turns out to be the case, and one of the things that we are putting in place is much more effective mechanisms to track what is going on in terms of the characters of loans given and the arrears that result.

Q23 Stewart Hosie: That is important because, given the current weakness in the mortgage market, the other side of the question is, is this the right time to be intervening with new regulation at all? You seem to be suggesting that it would be absolutely marginal in the current climate in terms of the impact on mortgage availability, but the circumstances change, or, as you say, had this been done some time ago there could have been an appreciable, measurable impact on mortgage availability. That sums that up, I think, does it?

Lord Turner: Yes, that is correct.

Q24 Stewart Hosie: Just one final question on the process. The review began in 2009. The current consultation runs until 30 March, with final rules to be published in summer. Why did it take so long?

Lord Turner: It took long because it is a very complicated issue and it is very important to get right, so I am not at all defensive about the length of time it took. I think this was a model of the FSA board interfacing with the executive in a completely appropriate way. I can assure you that what happened was there were a series of proposals put forward and then reviewed by the board, who then wanted to look at it more or make sure that it had been consulted on.

One of the reasons why we were willing for it to take long was precisely the point we have just been talking about: because we were in a very subdued period of the mortgage market, we did not think at the moment there was a lot of bad practice going on, and therefore we thought that delaying to get it right did not have a big disadvantage in terms of people entering into bad contracts now. We thought the very fact of the depression, as it were, gave us the opportunity to take the time to get it right. I think the proposals that have come forward have been hugely improved by that process of setting out things and then listening to the industry, and intensive debates on many occasions, as I said, by the FSA board.

For instance, I think we did initially put forward a set of proposals about how you would work out whether a mortgage was affordable, which, while theoretically desirable, were just too complicated to put into place. They required a degree of asking questions about somebody’s expenditure that was too detailed. We put that forward because we wanted to test it and the board said, "Okay, put that forward, but we are not endorsing it now. We want to go through a process of debate". I think we have ended up with a very good balanced approach, and I think the industry has broadly accepted that.

Q25 Teresa Pearce: Mr Wheatley, you are relatively new to the FSA but certainly part of going forward. Given this report clearly indicates that self certification and fast-track mortgages were a problem, that arrears were 3 or 4 times higher among that sector, and that the FSA has a responsibility to protect the consumer, do you think they have failed to do that?

Martin Wheatley: What we had in the past were principles of good lending. We had principles in place that should have applied and should have meant that the excesses that existed in the period around 2007 should not have happened. The banks moved away from those principles. Frankly, they forgot good practice. They moved away from what we would consider to be proper verification of income. They had a responsibility to assess affordability in the past and they did not do it. The fact is that the rules in the past, which did exist, were not followed, so we are coming forward with some clearer rules that will protect consumers better in the future. That is in practice what happened.

Q26 Teresa Pearce: What you are saying is the policy was good but the practice was bad?

Martin Wheatley: I think the rules, if they had been followed, would have prevented the excesses that we saw.

Q27 Teresa Pearce: You are confident, going forward with the new regulations, that that will be spotted at an earlier stage?

Martin Wheatley: I hope so. We will spend more time in our supervisory systems looking at the extent to which these new rules are embedded into firms’ processes. As Adair said earlier, we cannot micromanage the banks and building societies that provide these services. A lot of it has to come from the governance within those organisations, from the boards, from the ethical standards that the firms set, but we will certainly be doing more to check compliance with these rules in the future.

Q28 Teresa Pearce: Statistics show that there is about £1 billion worth of mortgage fraud carried out each year. How much do you think your recommendations will reduce that fraud? Do you think there is a percentage it will reduce it by?

Martin Wheatley: I do not think I could give you a specific number.

Q29 Teresa Pearce: Do you think it will reduce it?

Martin Wheatley: I think it should reduce it because the lenders themselves will have the responsibility. In the past they relied to a large degree on agents and third parties to carry this out. We are now putting the obligation back on to the lenders, and that should allow them to do better checking against potential fraud.

Q30 Teresa Pearce: How many enforcement actions have been enacted this year? How does that compare to previous years?

Martin Wheatley: In broad terms, our enforcement actions are fairly consistently the same as in previous years. Specifically, I cannot tell you, particularly in this area, so I would have to come back to you with more detail on that.

Q31 Teresa Pearce: In some of the recommendations about self-certified income in the MMR, information sharing is something that has been brought up. How are you, as the FSA, going to ensure that information will be shared between, for instance, lenders and HMRC?

Martin Wheatley: I do not think that is our responsibility. What we have-

Teresa Pearce: But it is one of your recommendations.

Martin Wheatley: We have required that the banks do their own verification and do proper verification of income. The extent to which they share that with HMRC is, I think, an issue for HMRC to pursue with the banks. I do not think our remit extends to tax collection.

Q32 Teresa Pearce: Not for tax collection but for information sharing, where you are trying to verify someone’s income. If insurance companies share information about claimants, it is obviously a way forward that could help protect that risk. As a regulator, do you not think that you should be insisting that the banks do that information sharing?

Martin Wheatley: Again, it comes back to what, as a regulator, is within our remit and what is good practice. Clearly, there is a concern in the self certification, particularly in the self employed space, that the banks could be told a different story from HMRC, so I think they are-

Teresa Pearce: Quite often.

Martin Wheatley: Quite often, possibly. There ought to be closer collaboration there, but the tax collection component is outside of our remit.

Q33 Teresa Pearce: So is this something that you would wish to see?

Martin Wheatley: I think it would be good practice, yes.

Q34 Teresa Pearce: Talking about self-employed people, quite often business owners are required to use their homes as collateral for business ventures. Is that something you think is appropriate?

Martin Wheatley: Obviously, small businesses, entrepreneurs, are very important to the economy and it is very important that they have adequate access to capital. Traditionally, one of the assets that they secured loans against has been a personal home, and we just recognise that that is a fact, that is how the industry has worked. So, in our consultation we have made it clear that we need to get a little bit more feedback as to how our proposals might affect the ability of small businesses to raise capital. It is an area that we have not been prescriptive on but we are very much looking to get some more information back on.

Q35 Teresa Pearce: Lord Turner, do you want to add anything to any of those responses?

Lord Turner: Just to say that I think this issue of small business lending is very important. It is set out on page 255 to 256, and as Martin has said, it is an area where we would want to consult on, and indeed we have asked for feedback on something that would effectively be a form of deregulation. It would be providing a wider ability for people who have nominated themselves as doing this lending for business purposes to be outside the protections.

You have to be very careful of that, because that can be abused by people simply doing that and then saying that they were encouraged into an unaffordable loan, but if you look at the proposals we have set out there, we are asking for feedback as to whether the business borrower should be able to choose to forego the protections of the mortgage rules. It would have to be on a very clearly defined process where somebody said, "I am consciously running a small business. I am raising the money for this small business and I consider myself an entrepreneur capable of making those decisions". We have not had a firm point of view on that, but the actual proposal that is in there at the moment would be, if anything, a deregulation from the present level, and I am sure there will be arguments for and against that that will come forward in the consultation process.

Q36 Mark Garnier: Lord Turner, I just want to ask you your response to a letter that I received from a solicitor in my constituency of Wyre Forest, who wrote to me saying that, as a result of the Mortgage Market Review and actions by the FSA and one or two other things, HSBC is making a significant alteration to its approach in the management of its panel of approved solicitor firms for conveyancing transactions. As I understand it, up until now there have been an unlimited number of firms, but HSBC, as the result of the MMR, is now saying it is going to reduce the numbers of solicitors on this approved panel to just 43 across the whole country. Were you aware of that?

Lord Turner: I was not aware of that, and I am not aware that that should in any way be a logical or direct consequence of the Mortgage Market Review, though I would have to come back to you to work out whether that is the case. I really will have to come back to you. I have been fairly close to this throughout. I know most of the details of it, and therefore all I can say is I cannot remember anything in the Mortgage Market Review that gets to the definition of appropriate panels of approved firms, and therefore I am a bit surprised at that.

Q37 Mark Garnier: The inference from this solicitor is that, because of that and because of fraud and the rest of it-of course, MMR is dealing with fraud and everything else-what is happening is that they have decided they are going to treat this differently and there are going to be a number of effects on this. Consumers will obviously lose out with choice in terms of where they can go and get a solicitor. They cannot choose their family solicitors. There is going to be £48 administrative fees, and there is a whole range of things. I can get you a copy of the letter, but there does seem to be a whole range. I will not give you too much on this one because clearly you do not have the details, but my overall question is, are you aware of this type of unforeseen circumstance coming along that is reducing consumer choice at the secondary level of this?

Lord Turner: We certainly have to make sure that we have understood if there are any knock-on consequences that we have not anticipated. It sounds as if this approval issue really relates to-it may be some indirect knock-on consequence of the fact that we have been trying to tighten up on some of the frauds in the mortgage area, which is a somewhat separate issue from the core of the Mortgage Market Review. We know there were some just pure frauds, and it may be that some of the ways that we have tightened up and made firms more aware of it, that HSBC have chosen to interpret it in that fashion. Can I ask that you give me a copy of it and we will respond, and that we will try to make sure that we have thought through whether this is in any way related to the impact of the MMR?

Q38 Mark Garnier: I am very happy to do that. Can I just turn quickly as well to the loan-to-value, and loan-to-income ratios, which we talked about earlier? You have decided not to impose fiscal limits on LTVs and LTAs, but isn’t it unhelpful to the consumer that you do not have a published list on this when people are planning for their house purchases?

Lord Turner: There are a lot of arguments for and against these, and we did go through this in immense detail. We found that it was very difficult to set, for instance, a loan-to-income ratio or a debt-servicing ratio that had high discriminant power. What you would love is to be able to find some measure and you say, "Well, below that measure, 99% of all people manage to pay back their mortgage and above that, oh my God, 25% got into trouble. 25% is too much; let us use that as a rule". What you find is that it is almost impossible-we found it impossible-to find such a figure that had a strong discriminant. It was always a spectrum where even at quite high LTI levels you find that there were many people who were borrowing and were managing to pay back the mortgage. Of course, if we then came along and said, "We are going to have a 4 or a 4.5 LTI", we would be restricting the ability of some people who have made perfectly responsible decisions and paid it back.

We did go through those debates at great length. Some other countries do have those controls. I think that is an issue that we should keep under review. Parliament should keep it under review, because there are different approaches to that. The impact of our requirement on lenders to have affordability criteria may be that we will find some of them more overtly saying what they think is a reasonable LTI, or a level above which they will have to investigate more carefully.

We did at one stage think about, could we have a level of LTI below which you did not have to do more investigation and then a range over which you had to do greater investigation? We did look at it carefully. I entirely accept that there would have been some advantages in having nice, clear, simple rules, but we did go through the arguments very carefully and decided against it.

Q39 Mark Garnier: That is a very well-argued response, and thank you for that, but of course the FPC can then step in and impose those anyway, so does it not come back to the point where-and Martin Wheatley, this may be a better question for you because you will have this dual role in the future-it would just make it a lot easier for consumers if the FPC said, "Look, we are happy at this level and it will go from there."? Or do you think the FPC can just make a random intervention at some point in the future when it suddenly decides that an intervention is necessary?

Martin Wheatley: There are two points. In terms of clarity, absolutely; if there is a clear line in the sand, then that allows people to plan and it provides absolute clarity, but it does switch off mortgage availability to people who may want to borrow more than that and have the wherewithal to be able to afford mortgage repayments.

Q40 Mark Garnier: But you cannot do anything about that with the FPC. If the FPC cannot promise-

Martin Wheatley: It would obviously be a fairly carefully constrained ability, which would have to go through a proper parliamentary process as to whether that lever exists, but yes, if the FPC-

Mark Garnier: Sorry, if that lever exists?

Martin Wheatley: The powers for the FPC need to go through a proper parliamentary process, and as Adair mentioned earlier, the FPC is in the process of trying to recommend what those powers should be. If and when they have been given, then the FPC can clearly-

Q41 Mark Garnier: But there are powers of direction and powers of advice as well.

Lord Turner: Yes, precisely. If I could just be absolutely clear about what the FPC is literally doing last week and this week-and, as I say, we will come up with a statement shortly-there was a list of 13 different tools, which we described in the discussion paper in December, and we will now be coming forward with a recommendation to Government, and therefore to Parliament, as to which of those we think we should have directive control over and which should be recommendation, but of course that is something that then has to be reflected in the legislation now going through Parliament, because Parliament has to give the FPC that directive power. The issue of whether those directive powers should include the ability to set an LTV or LTI limit, and possibly to vary it over time in order to slow the market down or stimulate it, is one of the crucial issues that the FPC is thinking on. As I say, I will not tell you; the debates are going on and there will be a statement from the FPC within the next few weeks.

Q42 Mr McFadden: No one wants to go back to the lending conditions that were in place in the run-up to the boom-free and easy lending, not enough questions asked and so on-but how does the FSA judge the right balance between prudence and opportunity here? How concerned are you that the age of first-time buyers without access to the bank of mum and dad is now in their late 30s? All of us were probably able to buy property at a younger age than that. Are you concerned that you are engaged in an exercise in pulling up the drawbridge from the next generation with the introduction of rules that might go too far from the free and easy conditions, which everybody knows were a problem?

Lord Turner: That was an issue that we looked at very carefully, but the summary is we are convinced that the MMR will not have that effect. It is very important to understand that the average age of first-time buyers, when you strip out the right to buy effect-because a lot of right to buy council-house buyers were counted as first-time buyers but were quite late in life, so you have to strip them out so that FTB is separate from the RTBs-was increasing significantly from the mid-1990s onwards. A large increase had occurred before the crisis for the simple reason that, when you have easily available mortgage credit, that drives up house prices, and it is the drive-up of house prices that is the thing that makes it most difficult for the FTBs.

We did look very carefully, and if you look at the cost/benefit analysis, it very carefully tries to say, "Can we, as best as possible, work out what the impact of the affordability rule, the interest-rate only rules and the interest rate stress rules are, separately, on the availability of mortgage supply to first-time buyers, to home movers and to remortgagers?" and the figures suggest that the impact is least, certainly in the subdued period, on first-time buyers. That, when you think about it, is not surprising, because first-time buyers, because they are constrained by their inability to get a deposit, tend sometimes to have slightly lower levels of loan-to-income ratio than some of the home movers, because the home movers are able to mortgage up against income because they have the equity to deal with the deposit. That is why we end up with a smaller effect on first-time buyers, and it is also true that the interest-only proposals have a very small effect on first-time buyers because very few first-time buyers are given interest-rate only mortgages. We were very aware of this issue, and we do think we have the balance right, but that is why we analysed it very carefully.

Q43 Mr McFadden: Do you think in the UK-does the FSA take a view on this point?-that expectations of when in life we should be able to buy a house are set too young when comparing the UK housing market with other European countries, where often the tradition is, if you do buy a house, you would do it later in life?

Lord Turner: We are wary of having a point of view of what the correct social pattern is there. You are absolutely right that many countries, if you look at Germany or Italy, have much higher levels of typically entering as purchasers into the housing markets. We are really somewhat neutral on that issue, but simply want to make sure that there is a reasonable supply of mortgages available to those first-time buyers who have a reasonable chance of paying back the loan.

We do keep returning to this principle of affordability, at the core of which is you want to lend money to somebody where there is a reasonable expectation that they can repay the interest and capital without relying on house price appreciation. The big problems on the mortgage markets always emerge when somebody is taking on a mortgage where, in their heart of hearts, both the borrower and the lender know that they cannot afford to repay it, but they think, "Oh, but the great thing is house prices will go up and another lender will give me a new deal in three years’ time. I will just survive by a continual series of remortgaging". That is the essential thing that these principles, these rules, would prevent. You would not be able to lend on that basis.

Q44 Mr McFadden: But is there not a real danger of sort of shutting this door long after the horse has gone? I was speaking to a young person working in London, earning in sort of mid-£20,000s on salary. She told me, if she sets aside £100 a month of savings, which is a reasonable amount, she has calculated it will take her 40 years to save enough for a deposit for a flat in London, so she might just about be able to put the deposit down as she is retiring, all other things being equal, if her salary does not go up in that period. Isn’t a new set of rules making access to mortgages more difficult for young people in that kind of environment creating a generation that is going to be locked out of the advantages of home ownership that we enjoy?

Lord Turner: As I say, I think the impact of these rules, certainly in the present conditions, is very small, and the fundamental issues of lock-out from the housing market lie elsewhere. As I say, on the whole, first-time buyers have been squeezed out of the housing market by rising prices, which tend to come from two things, either very easily available credit or restrictions on the supply of new homes. Let us go absolutely back to the core of the issue of house prices and rents in the UK. You will never be able to solve that problem by extra credit availability. Extra credit availability will simply push up the price earlier. If you want to change that, you have to make sure that there is an adequate supply of new houses and new flats being built.

Q45 Mr McFadden: I just want to ask this one final thing, and perhaps you might want to comment on this as well, Mr Wheatley. You said in response to Teresa Pearce that the rules in the run-up to the boom were being ignored; there were perfectly sensible rules in place. I am slightly wondering what the point of all this is. If we had good rules already in place that were not being enforced, why aren’t those just enforced?

Secondly, a couple of times, Lord Turner, in response to me you have said, "This won’t really have very much impact". "What is the point of a three-year exercise if we already have perfectly sensible rules in place that if they were enforced would avoid all this?

Martin Wheatley: Let me just pick up on that. What we had in place were general principles of sound lending, so they were not as specific as the rules we are now proposing. They were general principles, and if people had adopted those general principles then we would not have got into quite as bad a situation as we had.

Q46 Mr McFadden: What were the powers of the FSA to kind of force them to do so?

Martin Wheatley: We would have had powers to investigate. General principles, by their nature, are slightly more difficult to take enforcement action against.

Q47 Mr McFadden: Did you fall down on the job here, as an organisation? I do not mean personally.

Martin Wheatley: Again, it is difficult for me to comment on whether we fell down on the job or the extent to which the banks moved away from those general principles, but I will pick that up again. Can I come back to one of your earlier points about first-time buyers? One of those stark facts about the last 20 years is that, despite the availability of cheaper and easier credit, in the 1990s around half of all mortgages were to first-time buyers. In 2007, it was 20%, so despite the availability of credit, the first-time buyers were getting squeezed out of the market, and as Adair said, it is not a question of the rules per se, it is the fact that house price inflation was way out-pacing wage inflation, and that was the problem, and that cannot be turned around quickly. Our rules will start the process of turning that round, but it is not going to suddenly change overnight and make mortgages or houses affordable to first-time buyers, but it will take out some of the worst excesses of the market, which pushed the market up to a frothy level.

Lord Turner: Can I just be clear on principles versus rules? We did not previously have a clearly expressed rule that said, "When you lend money on a mortgage, you have to do so on the explicit understanding that this is repayable in and of itself". We had not specifically said, "It is not okay to lend money against the expectation of rising prices". Although this is hundreds of pages long, that is probably the single biggest principle there, which is, "You are not okay to lend money knowing that the person cannot afford to pay it back but assuming that it will all be okay because house prices are bound to go up", which was the problem to a degree in the UK, and was the absolute core of the US sub-prime disaster.

Q48 Chair: Mr Wheatley, are you confident, can you give us an assurance, that in translating those principles into a 100-plus page document of rules you are not in the future going to stifle innovation?

Martin Wheatley: That comes back to a question at the start, which I did not pick up on, but the implication, I think, or the assumption is that all innovation is good, and our experience is that there is good innovation and there is bad innovation.

Q49 Chair: Is it going to stifle all innovation that is worthwhile, that is not designed to rip off the customer?

Martin Wheatley: It is quite hard to give absolute blanket assurances, but clearly that is our intention, to stop-

Chair: No, I am not asking about your intention. I am asking whether you are confident you have got it right.

Martin Wheatley: I think we have a good set of proposals here, and despite the fact that the document is quite weighty, it is fairly simple proposals that we are coming forward with, and I think they are fairly commonsense proposals that we are coming forward with.

Q50 Chair: I am asking you this question because of course people put it to us and they put to me the opposite.

Martin Wheatley: Which is?

Chair: That it will stifle innovation, so of course I want to hear your response.

Martin Wheatley: I am hoping it will stop certain types of practices. You can call it innovation, but one of the innovations that we saw in the 1990s, early 2000s-

Chair: I am not talking about rip-off operations. I am talking about innovation that we would like to see, of healthy new products.

Martin Wheatley: One of the innovations was to rely on self-certification; to not bother to check, but rely on somebody’s word-that was seen as an innovation.

Q51 Mr Mudie: I think underpinning a lot of the questioning is the question of proportionality. When Hector was last before us, for the first time I heard him mention property and problems with property. Do you have a review or do you have documents as thick as that to deal with the investments in property that have caused and are still causing so many problems and have real risks for stability? You seem to have spent a hell of an amount of time on this, but the major stability problem seems to be with property.

Lord Turner: I can assure you we do spend a hell of a lot of time focused precisely on commercial real estate, property investment and so on.

Q52 Mr Mudie: Right, and do you have a similar book that is available to the big banks that have the same restrictions on lending on property that have been needed for decades? It is the one thing that is cyclical.

Lord Turner: It is a very good challenge and you are absolutely right, it is the one thing that is cyclical. Behind every major banking crisis there has pretty much ever been has been lousy lending on commercial real estate. It is the sort of fixed law of banking that, every 20 years or so, somewhere in the world a banking system goes crazy on lending to offices and retail parks and so on. Do we have one big book like this? We don’t, because we don’t conduct regulate that area, because that is an area of a relationship between banks and companies, so there isn’t the same body of conduct regulation. Do we spend a lot of time on our prudential side looking at real estate risks? Yes, we do now, but not enough in the past. The perfectly reasonable question that is raised by the HBOS document that came out last week-which tells a terrible story of bad lending in the commercial real estate and bad controls of that-is what was the FSA doing at the time? It was not doing enough. We were not focused enough on it.

Q53 Mr Mudie: That is a perfectly-in the context of the way you phrase it-good answer, but my question is whether it is financial conduct. If is not financial conduct, what is the FSA doing? You are bringing in these regulations that affect youngsters, affect families-you must be very proud of yourselves. Where the hell is the same thing on property?

Lord Turner: For instance, we are intensely involved with the banks at the moment-

Q54 Mr Mudie: No, I do not want to hear that you are intensely involved. Do you have the same type of restrictions, the same type of thinking, that would stop the banks lending as badly as they have over decades on property?

Lord Turner: I think it is more difficult to do it through rules. It is an area where it is more appropriate to do it through appropriate capital requirements, so, for instance, we are working a lot on capital requirements, and again, it is a very important issue for the Financial Policy Committee. Again, one of the tools that were set out in December is the ability to vary capital weights according to-

Q55 Mr Mudie: No, that is your right, if you want to take refuge in capital, but I mean, if you are regulating a bank and the bank is heavily into property, that could have a systemic risk. HBOS is a walking example.

Lord Turner: Oh, absolutely. I totally agree.

Q56 Mr Mudie: Well, you are the regulator. What lessons have you learned from HBOS not to say, "Oh, it is going to be covered by capital"? What regulations? You are regulating mortgages. Why aren’t you getting stuck into getting the banks operating within regulations on land?

Lord Turner: I agree with you that this is an incredibly important issue. We are crawling all over it, but I think the nature of commercial real estate does not give it to a set of rules; instead, it gives to another set of intervention. We can debate that, but what I can absolutely assure you is that on the prudential side, the issue of commercial real estate lending is now and will be in the future a key focus of the PRA and the FPC, because it is clearly the case that it is important.

Q57 Mr Mudie: Let us go back to it. In response to Mr McFadden, you have reassured us that first-time buyers will be okay, that it is not restricting them and so on. Were you consulted on the Government proposals to put a guarantee in on the 5% first-time buyers on new homes initiative?

Lord Turner: They do not formally consult us for our approval, but we were certainly-

Mr Mudie: Were you consulted?

Lord Turner: We were certainly in discussion with them. We have kept the discussion two-way in terms of telling them where we are at with the MMR. I had a meeting, for instance, with Mark Hoban, Grant Shapps and Oliver Letwin before Christmas. We have discussed these issues and I think what they have intended to do there is fully consistent with this. I do not think it is in conflict with it.

Q58 Mr Mudie: In your proposals you can come to this Committee and say, "These proposals will deal with the problems; every confidence in them". Why do you need a Government guarantee? This is a very interesting new initiative. We have looked at "too big to fail" in banks. Here is the Government moving into guaranteeing mortgages.

Lord Turner: It is doing it for a particular slice; it is deciding that there is a particular problem with first-time-

Q59 Mr Mudie: You think that is necessary?

Lord Turner: I think that is ultimately a political judgment. Our point is it is not-

Q60 Mr Mudie: But you are a politician. You are in the House of Lords. Give us one.

Lord Turner: If I was putting forward a political point of view, I think what is being proposed, since you have forced me to be political, is a perfectly reasonable, balanced initiative that is not going over the top in terms of throwing away good lending practices. It is not restimulating on some massive scale excessive lending. It is trying, on a targeted base, to provide a limited element of support for first-time buyers. I think it is a reasonable balance that I could have imagined almost any Government bringing forward at this period of time.

Q61 Mr Mudie: Except that it is tied to the 5% and you have waived the 5% aside and said-and I think it is sensible-we go on affordability, so what is the relevance of the 5% and the Government guarantee for that type of mortgage when the mortgage lender is getting instructions from you not to look at the 5% because it is irrelevant, and the issue is the affordability of that mortgage? So why are we giving a 5% Government guarantee?

Lord Turner: Because, quite separate from what we do, the lenders make their own decisions. As it happens, one of the best indicators of what banks lose on mortgages over time is the LTVs, for obvious reasons. If something is unaffordable but has an LTV of 60%, the consumer can have a problem and be repossessed, but the bank is okay. If it is 100% and the consumer cannot pay back and the bank repossesses, the bank is not okay. It loses money. From a bank point of view, LTV is one of the biggest and clearest indicators of the loss they could suffer, which is why the banks have tended to tighten up very strongly on LTV criteria. That proposal from the Government is basically-through an element of Government subsidy, and that is what it is-encouraging the banks, enabling the banks to lend money in a situation where they would choose not to.

Q62 Mr Mudie: Well, it is not a subsidy, is it? It is a guarantee, so there is no subsidy, but there is a guarantee. If it goes wrong, the Government will pick it up.

Lord Turner: Guarantees are not subsidies as long as nothing goes wrong, and they are subsidies if they do go wrong. They are contingent subsidies.

Q63 Mr Mudie: Let us move on to the other matter, which I would like to know if you were consulted on and you had a view. It is clear from your figures, incredibly, because it was an interesting answer you gave to Pat, repossessions or failure to meet the mortgage was not really related to the size of deposit, because in the area of right to buy, those individuals with a discount have probably a bigger equity in the house than anybody who puts 5% or 10% in. This is the biggest problem area in terms of repossession and debt. The Government initiative is to raise the cap to £75,000: were you consulted on that and do you have a view on that?

Lord Turner: I am afraid I do not know the details of that and I would have to come back to you on that.

Mr Mudie: So they have not consulted you?

Lord Turner: I would need to find out. We have talked to them in some way, but I would have to come back to you on the details of that. That is honestly something I do not know the details of.

Martin Wheatley: Just to pick up on the second point about whether we would have a view on that, our view would be that that would have to be an advised mortgage. We would be very concerned if people did not get appropriate advice when they were buying on a right to buy, even with that very large discount.

Q64 Mr Mudie: The fact is, although you have spelled this out, you do not seem to have any specific proposals to deal with the right to buy problems. It is the biggest problem in the whole field.

Martin Wheatley: It is the highest level of arrears, yes, I agree.

Mr Mudie: There is no detailed proposal?

Martin Wheatley: No, not specifically, but generally the need for advice, so we believe anybody should be advised on their mortgage, and particularly in cases where they are taking the benefit of a right to buy scheme.

Q65 Michael Fallon: If we turn, Mr Wheatley, to interest-only mortgages, how will you determine what is an acceptable repayment strategy?

Martin Wheatley: Again, one of the interesting transitions between the early consultation and here is the level of prescription that we put in place. We have said it is for the banks to determine that there is a credible repayment strategy. It is not for us to say exactly what that would be. It is for the bank that is making the loan.

Q66 Michael Fallon: So you will not be issuing any guidance on that?

Martin Wheatley: Obviously we have not come to the end of the consultation process, and if we get a lot of strong feedback that says we need further guidance, then we would have to consider that, but we think that is something that a bank should be able to take account of, and what we are asking them to do is to make sure they have evidence to support their judgment.

Q67 Michael Fallon: Right, but the evidence is that they make checks at the start, and then you are proposing that over 25 years they only check once with a borrower that there is a repayment strategy in place, so they could do that a year after the 25-year mortgage starts, could they not?

Martin Wheatley: Again, this comes back to this question of proportionality. If they had done it once, to require that they do it every year, I think the banks would see that as a disproportionate response, so I think what we have tried to come forward with is something that is balanced, that it is done at the inception of the mortgage and one more time, but not something that is a repeat assessment.

Michael Fallon: Yes, but can you answer my question? It meets your test that somebody who has agreed a repayment strategy with a borrower would only have to write to them a year later to check it was all still in place, and that would satisfy your criteria for the next 24 years?

Martin Wheatley: I think that is right. Again, without being too prescriptive, we have said it has to be a reasonable test, so a reasonable test initially and a further test at a reasonable time. We have not specified whether one year is adequate or not.

Q68 Michael Fallon: But it could be one year after the mortgage starts, could it not?

Martin Wheatley: It could be, and I think we would have some questions for a bank if that was the case, as to how that was really meeting the principle of validating that that strategy remains in place.

Q69 Michael Fallon: How do you validate whether or not the borrower has replied?

Martin Wheatley: That is for the banks. That is a bank responsibility. We cannot control every aspect of a bank’s commercial operations. They have a set of rules. We inspect the banks on a reasonably frequent cycle. When we inspect the banks, we pick up the themes that we want to look at at that particular time. This may be one of the themes that we decide to look at, if we have had concerns about it. There will be many other aspects of their business that we look at, but for all of the major banks we have a rolling two-year cycle of inspection where we look at different aspects of their business.

Q70 Michael Fallon: Isn’t there a slight danger of moral hazard here; that the borrower may say, "I filled in that form. I replied two or three years after I took out the initial mortgage. I heard nothing back from the lender, and therefore I assumed the lender was perfectly happy and it now turns out I can’t repay."?

Martin Wheatley: In any mortgage, whether it is interest-only or any form of mortgage, life events happen. People lose their jobs; people’s relationships change. There are lots and lots of life events that will happen that unfortunately put people potentially into a position where they fall into arrears, and that would be another of those life events. We cannot legislate for life events.

Q71 Michael Fallon: No, but you are controlling the rest of the mortgage market. Is it not going to be the position that an awful lot of people in their 50s who have interest-only mortgages are then going to find it very hard at the end of the term to be able to remortgage, and may find it extremely difficult to repay the existing capital sum? There is a ticking time bomb here, isn’t there?

Martin Wheatley: There is a ticking time bomb that has been created over the last 20 years. What we are trying to do is make sure that that ticking time bomb does not get any worse from here on in.

Q72 Michael Fallon: But you are not defusing the bomb. You are doing it for new borrowers on interest-only mortgages.

Martin Wheatley: Yes.

Michael Fallon: You are not tackling what I think is going to be quite a serious problem, and an awful lot of people in their late 50s are not-under your regulations, your new toughened-up guidance, which I fully support-going to be able to remortgage.

Martin Wheatley: We are looking at-you are right-new business. There is a ticking time bomb and it exists today.

Q73 Michael Fallon: Yes, and what are you doing about it?

Martin Wheatley: I am not sure our regulation can solve all ills. We can ensure that new mortgages taken on are done to sensible, reasonable measures. I don’t know that we can solve the problems of the last 20 years, where people may have mortgage strategies that will not pay off their home, and I think individuals will have to take their own advice as to how they do that if they have a strategy that will not repay the capital at maturity.

Q74 Michael Fallon: So you are just going to let this bomb go off?

Martin Wheatley: We have suggested some transitional arrangements for people who might otherwise be unable to remortgage or refinance, so there are in our proposals transitional arrangements that will allow, subject to certain conditions, the rollover into a new mortgage. That is trying to prevent the immediate crystallisation of that problem, but I do not think we can solve the whole problem.

Q75 Michael Fallon: Are you keeping proper statistics of this? Are you aware of the number of people who might be in this category?

Martin Wheatley: We have very detailed statistics on the mortgage market, yes.

Q76 Michael Fallon: Yes, but how many people are on interest-only mortgages in their late 50s? What are we talking about here?

Martin Wheatley: We are talking about a large number. I do not know; I do not have it off the top of my head.

Q77 Michael Fallon: What is "a large number"?

Martin Wheatley: I think we are talking about around 1 million or so interest-only mortgages that will become repayable in the next ten years. I do not have off the top of my head the age bracket profile of those, and I am sure we can provide some more information on them.

Q78 Michael Fallon: But of the 1 million, have you made any estimate of those that are likely to get into serious difficulty under your new proposals that make it more difficult for them to remortgage?

Martin Wheatley: We have done a cost/benefit analysis on the impact of our proposals on people who might want to remortgage, and we have looked at the profile of that, so the people over the most recent period and then the more distant past, and we have come up with estimates as to how our proposals would affect that group. We think around 3% of remortgages from the 2009-2011 period would be affected by our proposals.

Michael Fallon: But of the 1 million, how many will be affected?

Martin Wheatley: Again, I would have to come back to you with more information on that.

Q79 Michael Fallon: You seem very complacent about this. You agree with me it is a time bomb, and you say it is just going to happen.

Martin Wheatley: No, no, I agree with you that there are problems that have been built up. We have a number of strategies to try to deal with that. One of those is to deal with new mortgages; one of those is to deal with people who otherwise might need to remortgage. I am not sure that we can deal with every aspect of it.

Q80 Michael Fallon: But the side effect of your strategy is to make it even more difficult for those people on interest-only mortgages to escape. You accept that.

Martin Wheatley: No, the side effect of our strategy is to make people-well, it is not a side effect. A direct effect of our strategy is to make people take on affordable loans.

Michael Fallon: In the future.

Martin Wheatley: Yes.

Q81 Chair: I think we had better have a look at this cost/benefit analysis. Could you send that?

Lord Turner: Can I just say one thing? The transitional arrangements are important here, because this issue of people being trapped can exist in the interest-rate only mortgage, but it could exist in people wanting to move home or issues like that, and there are very specific transitional arrangements that we spend a lot of time thinking about that would enable, for instance, an existing lender who had lent £200,000 to a borrower on an interest-rate only basis to roll that over in a way that was outside our new rules, because it was to an existing borrower in the same amount.

There are very carefully defined transitional rules, which obviously we are consulting on, precisely to deal with this really inherent problem. If you have inherited from the past some bad lending experience and you want to have better lending rules for the future, you have an inherent problem of how you do that, because if you do not at some stage impose the new lending rules and you allow endless rollover, you will never end up with a good system, so you have to do it by an intelligent balance of new rules and transitions, and that is what we have tried to do. The transitional rules are important in general, but they will have an impact on this interest-only area.

Q82 Mr Love: Lord Turner, can I come back to the issue of responsible lending? Your initial proposal some years ago caused a storm of opposition from across the industry. On the basis that your new proposals, the ones that we are debating here today, seem to have met with greater industry approval, is that sufficient to believe that these are a proper balance, the balance between customer protection and consumer choice? Are you getting the balance right?

Lord Turner: We are hoping so. One way of trying to work out whether you have the balance right is whether you hear roughly the same degree of criticism from both the representatives of consumers and the representatives of the industry. It is not a perfect way, but on the whole we have been heartened that these latest proposals have received from some of the representatives of both consumer groups and the industry a feeling that we have got the balance right, subject to detail. That is a reinforcement, but the key way we think we have got the balance right is through looking at the proposals themselves. We did come out initially with some fairly prescriptive ideas and, as I have indicated earlier, those were ones that the board of the FSA were willing to put out for consultation, but I can assure you there was the challenge at the FSA at the time, "How are we really going to work out with this degree of detail from board members what precise expenditure patterns people have?" We had concerns about whether we had overdone the detail at that stage.

If you look at what we have ended up with, it is in some senses the same principle of affordability, but with a more simple implementation, and then in some other aspects it has been a softening of the stance. We have not argued that we have to limit the repayment term to 25 years-we would still allow 30-year mortgages-and I think we have been more flexible on the interest-only side; that there are sometimes some legitimate ways of repaying. For instance, I think if somebody aged 70 takes out an interest-rate only mortgage at 20% LTV on a house and says to the lender, "How is this going to be repaid? Well, sorry, it is going to be repaid by my inheritors, who are not going to get that 20% of the house", that strikes me as perfectly reasonable. That is not a harmful thing to do. We have somewhat restricted that in our initial proposals, so we have tried to end up with both a more pragmatic way of implementing the basic rule of affordability and I think we have softened some of the specific rules in ways that are legitimate when you think about it. So yes, we do think we have got the balance right.

Q83 Mr Love: But is it not the case that the campaign run by the industry-that your initial proposals would restrict the number of mortgages very, very significantly-is the telling fact in all of this? I come to your cost/benefit analysis, and it suggests that under the subdued conditions at the moment, 2.3% of borrowers will be affected by your proposals, but in boom times 11.3%. Are you worried by this 11.3% figure?

Lord Turner: No. I think I would be more worried if somebody said to us, "Are you absolutely sure that your cost/benefit analysis has not just ended up supporting the conclusion that this is a good package?" I do not think it has. I think we have gone through it in a really rigorous way, but the result that we have ended up with, if it is true, is an extremely good effect. If we end up being able to produce a set of rules whose impact on the level of lending now would be relatively trivial, 1% or 2%, but which would have limited the degree of lending by 7%, 8%, 10% back in 2006 or 2007, I am fairly confident that that would be a good thing for customer protection and, indirectly, the steadiness of UK economic growth. I am not worried by the fact that, back in 2006, if I remember rightly, there was getting on for £300 billion-odd new gross mortgage lending. If that had been 10% lower, £270 billion, would the UK economy have been harmed? No, I think it would rather have been helped.

Q84 Mr Love: I may be slightly confused by what you meant by "boom conditions", but let us assume that the market returns to what we would call normal conditions, and that is in a situation where there is going to be more demanding prudential regulation, and there is going to be obviously-and you touched upon it earlier-the continued shortage in the supply of housing. Under all scenarios, there will be a shortage of supply. House prices will continue to rise, although I notice that you are suggesting that MMR will dampen house price rises. In those circumstances, does an 11% effect on borrowers not lead to fewer people being able to get into owner-occupation?

Lord Turner: Part of that of course is remortgaging and equity release, but the impact on the first-time buyers is smaller, and although we have to be very, very careful of placing too much on the macroeconomic simulation because models only tell you so much, if you look at the results that are set out in the appendix, page 74 of the appendix, what we have suggested is that if we had these rules, it is not that household liabilities relative to GDP would go down and down and down. They would be roughly stable, whereas, without these rules, we would be returning to a gradual upward path of household debt to GDP.

I do not think that a relentless upward path of household debt to GDP is in the long term sustainable, so we do think that we have ended up describing a set of rules that we are intuitively convinced are the right balance, and insofar as one can draw reassurance from the modelling-and I do stress I would only get so much reassurance from modelling of this sort-that tends to support the idea that the net effect is a beneficial one. That is what I have said.

Q85 Mr Love: A final question on this. I want to ask a couple of other questions on other matters. In normal circumstances, when you are in a depressed market, as we are at the present time, the level of owner-occupation will reduce, and that is happening at the present time, but when you return to more normal conditions, people get much more in tune with the idea of being owner-occupiers; the young, as Mr McFadden said, crave to enter the housing market. Have you done any figures in relation to the impact on the levels of owner-occupation and how the trend will go as a result of the Mortgage Market Review and the other factors that are affecting the housing market?

Lord Turner: We have looked carefully at the trends in the past on owner-occupation. There is an interesting phenomenon that has been going on for about the last 10 years, which is that owner-occupation is roughly flat but with a combination of more people owning houses outright, because these are elderly people who have fully paid off their mortgages, and a decline in the percentage of the population who own with a current mortgage. But these are trends that have been going on for the last 10 years. They are nothing to do either with the crisis or with our rules.

We would not anticipate that these rules are fundamentally in a dramatic sense going to change the percentage of owner-occupation, which is about 70%. As I say, some of the biggest drivers of the trends that we are seeing-for instance, particularly in places like London we have seen a 10-year trend of an increase in the private rental market. I think there are drivers of those things, but they are somewhat independent of what goes on in the mortgage market, and certainly independent of these rules, because, as I say, some of the most powerful tendencies are ones that we can track in the figures beginning back in the 1990s, not beginning over the last few years.

Q86 Mr Love: Someone during Mr Fallon’s questioning talked about a time bomb. The fact that the trends that you indicated are becoming stronger in the marketplace, where the elderly own their houses outright from a younger age, but the young simply cannot access the housing market, is very worrying. It is not for the Mortgage Market Review to solve these trends, but I am anxious that it does not intensify them.

Lord Turner: We do not think it does.

Q87 Mr Love: Let me go on to two final questions. One is in relation to the sale and rent back market. You were given regulatory oversight two years ago. How has it taken you so long to take action on this matter, and are the customers who were mis-sold these policies going to be compensated?

Lord Turner: You can maybe answer that, Martin.

Martin Wheatley: I cannot. I would have to come back to you on that.

Lord Turner: I am afraid we will have to come back to you on that. That is not something-I know it is in there, I know I have discussed it before, but I am afraid I cannot give an adequate answer now. Can I please come back to you on that?

Q88 Mr Love: Yes, you can, although it does surprise me and worry me somewhat that there is not an answer to that, because, although I suspect the numbers of consumers affected are relatively small, it is an important issue and I would have expected firmer action in relation to that.

Can I come to another issue that I, through the Committee, have taken up? This is this issue about whether or not a credit footprint should be left on a consumer’s credit rating as a result of them asking for a credit search, and it is this issue about whether the industry could move from doing credit searches to quotation searches, because quotation searches do not leave a footprint on their credit reference. The FSA investigated this matter and found that, on the balance of benefit to the consumer, as opposed to the disbenefit to the industry, it did not feel that it could move on this issue. Most consumers do not know that this is happening, but it does affect their credit rating very much. I wondered whether this is something that the FSA-or the FCA now-would look at again. Are you aware of the issue, and can you give us some assurance that the FSA or the FCA is taking this seriously?

Martin Wheatley: The answer is yes, but again, if I can put it in the context of the Mortgage Market Review, credit scoring was relied on quite heavily in the fast-track type mortgage structures that existed in the past, so credit scoring took on a much higher profile in people’s availability for a mortgage. Under our current proposals, where we are asking for income verification, it becomes less of a significant issue, but it is certainly something that is on our agenda and I will make sure that it stays on the FCA agenda.

Q89 Mr Love: Just finally, this issue about leaving a trace on someone’s credit records, that is affecting people’s ability to get credit or to get a mortgage in the case of a house purchase, yet most consumers do not know that it is having this adverse impact. Advice to the industry on this matter would be a first step, but I think suggesting that the industry should do quotation searches rather than credit searches would be very helpful to consumers. I will leave it at that.

Lord Turner: Can I just say, this is probably an equally important issue in relation to unsecured credit as it is in relation to mortgage credit, and of course at the moment we are not the regulator of the unsecured credit market, but it does not mean that we should not look at this issue insofar as it does mortgages, but I think it illustrates some of the natural overlaps between the unsecured market and the secured market, because what you can get is something where somebody has something about their credit card behaviour that is impacting their mortgage behaviour. Of course, at the moment the regulatory responsibility for those two is divided between the OFT and the FSA.

Q90 Chair: I just want to bring both of you back to some points that Michael Fallon was making earlier. On page 115 of your document, you made clear that under the transitional arrangements, these will not compel the lender to lend, even where the borrower meets the relevant conditions. This is for dealing with a situation where somebody, an existing borrower with a good payment history, clearly may want to enter into a new mortgage for the same amount or less, and it is closely related to the time bomb issue on the interest-only mortgages. I understand the reason that you have come forward with in your next sentence, which is that these are commercial decisions, but that leaves us all with a problem, does it not? What mechanisms can you use to ensure that borrowers do not end up unable to borrow in these circumstances with the risk of losing their home?

Lord Turner: You are quite right; there is a balance to be struck here. It is quite difficult for us to end up with a set of rules that compel a lender, having made a mortgage for another 20 years, to extend one-

Chair: I understand the argument, but we have to think of something, do we not?

Lord Turner: We have to track very carefully how this develops. My own judgment is that, where you have a situation where it is the same amount of money against a house that the person has been living in for some time and with a good record of paying off on time, there may well be a high tendency of the existing lenders to say, "That is a good credit". I mean, lenders are always in the business of wanting to know what is a good credit, and one of the best indicators of a good credit is a customer who has been a good credit for many years, so I think, even with this, we may see a very significant degree of rollover where that is required, but I agree it is something that we need to track very carefully.

Q91 Chair: Just taking you back to this HBOS fine, did you have any conversations or contact with the Government directly or indirectly or UKFI before taking the decision not to levy a fine?

Lord Turner: No.

Q92 Chair: I note in the interview that you are coming near the expiry of your term and it says you are looking for major jobs in public policy. Do you have anything in particular in mind, Lord Turner?

Lord Turner: I tried to avoid that question from the journalist, and I will try to avoid it from you now.

Chair: Thank you very much for coming today. It has been very helpful evidence.

Prepared 22nd March 2012