Brown May Have to Ignore King's `Warning Shots' on U.K. Housing

By John Fraher and Brian Swint

Sept. 12 (Bloomberg) -- Prime Minister Gordon Brown may have to ignore the advice of his own central bank if he wants to kickstart an economy that's headed for a recession.

Bank of England Governor Mervyn King, 60, told lawmakers in London yesterday it's an ``illusion'' that the government could rescue the housing market without jeopardizing taxpayers' money and warned that increases in government spending risk fuelling inflation expectations.

His comments come as Brown, 57, considers proposals to revive a mortgage market that's almost ground to a halt and exacerbated the worst property downturn since the early 1990s. A Treasury- commissioned report in July said the government could guarantee all securities backed by home loans or encourage the Bank of England to extend emergency lending.

``The governor seemed to be firing some warning shots,'' said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. ``It was interesting the amount of emphasis he put on the implications of the taxpayer underwriting the mortgage-lending process.''

Brown faces pressure from his own ruling Labour Party to revive the economy and its popularity, which has slumped to the lowest in more than a decade. While he announced plans to help first-time buyers and cut taxes on property purchases last week, the yearlong credit-market rout is making banks reluctant to hand out mortgages to potential homebuyers.

Chancellor of the Exchequer Alistair Darling will receive final proposals in coming weeks on how to fix the logjam and still has an ``open mind'' on the issue, said King. Neither Darling nor Brown have yet expressed their preferences on the matter.

Liquidity Measures

``If the government wants to do something, it will,'' said Peter Dixon, an economist at Commerzbank AG in London. ``The Bank of England is providing liquidity. A guarantee is a whole different ball game.''

King, who claimed that he doesn't want to ``take a position'' on what the government should do, still spent much of his testimony outlining the risks of guaranteeing mortgages.

``It may seem at the first round that it's attractive,'' said King. `The difficulty is, you throw out the baby with the bathwater, and this is what's happened over years in North America where the private-sector mortgage market has been squeezed out.''

U.S. Treasury Secretary Henry Paulson was forced on Sept. 7 to seize control of Fannie Mae and Freddie Mac after the U.S. housing slump threatened to topple the companies making up almost half of its home-loan market.

Lending Plan

King also indicated the central bank won't extend its ``exceptionally generous'' emergency lending program. He instead plans to introduce a regime that only provides an emergency credit line to banks facing temporary liquidity problems.

``The bank is saying it can help with short-term liquidity issues but it is not its job to fund long-term lending and a recovery of the mortgage market,'' said Leigh Goodwin, a London- based analyst at Fox-Pitt Kelton Ltd.

King also expressed skepticism about the government's own revenue forecasts and said its fiscal framework risks losing credibility, which could fuel inflation expectations and ``make our lives more difficult.'' Inflation is already more than double the Bank of England's 2 percent target.

Questioning the government's projections is ``new territory'' for King, said Nick Kounis, an economist at Fortis Bank NV in Amsterdam and a former U.K. Treasury official. ``Usually what he says is: `What the government presents to us is what we'll use in our forecasts.' They take it as a given.''

King's performance was so striking that Labour Party lawmaker George Mudie asked whether the governor had overstepped his remit.

``Attached to the guarantee proposals is a view implicit in it that, in some ill-defined sense, the Bank of England can fund and finance these things,'' said King. ``I am not giving the chancellor a public lecture. It is perfectly reasonable to explain what central banks can and can't do and that is what I am doing.''

Some of the governor's exchanges with lawmakers ``seemed more animated than usual,'' RBS's Walker said.

``I thoroughly enjoyed it,'' said Philip Shaw, chief economist at Investec Securities in London. ``King was on great form. It's the best performance I've seen in a long time.''

To contact the reporters on this story: John Fraher in London at jfraher@bloomberg.net; Brian Swint in London at bswint@bloomberg.net.