Re-heat you are wrong... plane and simple... and I know.... it is my job (c15yrs 60-70 hours a week analysising bank balance sheets should put me in a position to know... and yes before you ask I was negative on Northern Rock)... you price a mortgage loan AT ORIGINATION off the yield curve. This determines your cost of funding the mortages. If you move base rate you do not necessarily change a banks cost of funding.
What you link the mortgage rate to post origination via a SWAP or whatever else is up to you. Why do you think there is not just 1 LIBOR rate but overnight, 1 month, 3 month, 6 month, 12 month etc etc... all those different durations till you have built up a yield curve (Base rate you might notice is just 1 rate... not a curve). Here is a beginners guide to how you price a mortgage in an ideal world....
Step 1) Assume duration of the mortgage you want to write e.g. 2-3 years
Step 2) Fund mortage with liability of similar duration e.g. 2-3 years (e.g. securitisation was one method of duration matching).
Step 3) Price mortgage based of cost of raising 2-3 year money i.e. the 2-3 year interbank rate/yield curve whatever you want to call it.
Step 4) Add your spread to the 2 year cost of money
Step 5) Write the mortgage.
Base rate does not come into it unless post writing the mortgage you want to link price moves to it (I guess you could use a simple swap to do this).
The initial pricing is done off the yield curve/inter-bank rates to make sure you are duration matching... is part of bank asset and liability management.
A banks equity captial is typically only c5% of its total funding in the UK so cost of equity is not that relevent. Cost of term wholesale funding is everything once you have more loans than deposits like most UK mortgage banks.
so why no mortgages at the moment?? Well we have more loans than deposits and people are not prepared to lend banks money in wholesale markets for more than 1-2 months at the moment hence you cannot fund a mortgage product with and expected life of 2-3 years without taking unacceptable risk of the funding being pulled before the mortgage martures (this is a small part of a complicated funding issue).
But this is beyond most everyday armchair economists (understandably) but an important part of why base rate is not important for pricing mortgages when you ORIGINATE them.
So Re-hear your comments are not accurate... what are you equity sales with 2-3 years experience??
Last edited by getoffmycloud; 22nd Dec 2008 at 15:00.