UK net mortgage lending last year totalled £108 billion (see here). Of this, only £27 billion ended up on the books of banks and building societies. The other £81 billion was assumed by “other specialist lenders” – often bank subsidiaries largely funded in wholesale markets.

Reflecting the shut-down of wholesale funding, these specialist lenders reduced their mortgage book by nearly £5 billion in the first two months of 2008. Assume – optimistically – that their net lending is zero for the year as a whole. If mortgage demand remained at £108 billion, and banks and building societies planned again to lend only £27 billion, this would imply a “funding gap” of £81 billion.

The actual gap is likely to be significantly lower, for three reasons.

First, banks funded £10 billion of the £81 billion advanced by specialist lenders in 2007. This £10 billion will be available to finance their own lending in 2008, reducing the estimated funding gap to £71 billion.

Secondly, mortgage demand would have fallen as a result of Bank rate rises and a slowing economy even in the absence of the recent tightening of lending standards. In the last housing slowdown in 2004/5, when supply conditions remained generous, the 12-month running total of net mortgage lending declined 22% from peak to trough. A drop in mortgage demand on this scale in 2008 would cut the implied funding gap from £71 billion to £47 billion.

Thirdly, a portion of the funds that last year were invested in wholesale markets will this year end up in bank and building society deposits, creating extra lending capacity.

Of course, any contraction of specialist lenders’ mortgage books would offset these factors, boosting the funding gap.