Today's morning news highlighted some further developments in the current catalogue of economic woes: Firstly, a meeting with 'the banks' at No 10. Secondly the reporting of a 'widespread' fall in house prices. To paraphrase 'Private Eye': Are they by any chance related?

The BBC has reported this morning that there is the most 'widespread' fall in house prices, according to the 'RCIS Survey', that has occurred over the past thirty years. This is obviously bad news, but the 'small print' does bear some examination. In particular, this headline does not relate to the size of the falls, but simply to the fact that they have fallen consistently across a range of geographic locations.

Our view is that, while there is undoubtedly bad news out there, this particular headline is rather unhelpful.

It seems likely that the regions of the country are now more financially interconnected than they were during the last period when house prices fell significantly, and that there is also a greater uniformity of driver factors. This means that any significant downward pressure would probably be expected take effect in a more synchronized way than has been the case in the past. So, although this is not a good sign, it is not necessarily as bad as it seems.

It has also been reported that one of the items on the agenda for the meeting with bankers at No 10 will be the issue of whether banks should be able to use their mortgage debt to obtain additional financing from the authorities.

This is an interesting idea, and one that parallels earlier developments in the US. However, there are pros and cons, but fortunately there is also a sensible middle ground, if there is a common will to find it.

The main argument against, is that banks that have leant irresponsibly would be able to offload some of their risks, ultimately onto the taxpayer. The main argument in favour is that, by easing liquidity, the banks would have much more room for manoeuvre, and so benefit us all. However, both of these arguments are superficial, and bear closer examination.

From the risk management perspective, it is undoubtedly true, as we have commented in the past, that some very unwise lending decisions have been made, particularly since the turn of the millennium.

However, there are a few 'buts' that should be emphasised. Firstly, it is often the more irresponsible lenders that get noticed - at least by those informed enough to question their business practices. Secondly, the UK's major banks are not in the category of the most irresponsible, although there has perhaps been a tendency to 'jump on the bandwagon' of cheap credit, this has been done on the back of both substantial balance sheets, and on-going risk assessment.

We can also look at this from the 'portfolio risk management' perspective. Many banks and other financial institutions have a large proportion of their exposures in the form of mortgage debt, and also in the form of 'inter-bank' loans to other banks. In risk-speak, this situation is known as a 'concentration', and is normally something that a good portfolio risk manager would either avoid or 'price in'.

Concentrations are bad for a number of reasons; they mean that relatively small changes in the quality of an asset can have a disproportionate effect on the risk profile of an overall portfolio. Concentration reflects a lack of diversification. If we use sensible ways of measuring risk, rather than simplistic methods (such as 'Expected Loss'), then the effect of such concentrations is starkly reflected in the behaviour of these risk measures.

However, clearly mortgages are a vital part of the financial framework of the country, and will always form a significant part of the portfolios of our banks. Therefore, it is worth considering whether there are any sensible ways of addressing this situation, and reducing some of these overall systemic risks.

In the present context, there are two main factors that could make a bad situation much worse, and unnecessarily so. Firstly, market psychology - which tends to create a momentum, even when it is not necessarily justified. Secondly the overall reduction in liquidity means that banks are unable to oil the wheels of the engine of the economy to help remedy the situation. These two factors are also strongly inter-related, a lack of liquidity drives, both directly and indirectly, negative market sentiment.

Unfortunately the term 'liquidity crisis' comes from the language of banking, and will strike most people as rather divorced from everyday life. However, such a crisis, if sustained, could act as a major force that would throttle back the economy and precipitate a much worse crisis. This would drive increasingly negative market sentiment, and set up a self sustaining vortex of financial self-destruction.

It is particularly important to address this problem in the UK at the present time. This is because there are, for the moment at least, a number of relatively positive factors in the present economic climate - although these tend to be eclipsed by the bad news. This means that, although some pain is inevitable, some of the most dire projections can probably be avoided, given the right action now.

The authorities should take action to ensure that the positive elements in the present situation are not jeopardised unnecessarily, and can continue to counterbalance the negative forces that are currently at work. In particular, one of the most important considerations should be to make sure that businesses, and particularly small and medium businesses, which are always particularly vulnerable to economic fluctuations, and are regarded by lenders as 'risky', are sustained.

So how does all of this relate to the banks using mortgage debt to raise finances from the authorities? Like the rest of us, banks decide how much they can afford to risk (and particularly lend) according to how much they can afford to lose, which is based on their available capital, and how much they can themselves borrow.

As has often been stated, banks do not currently want to lend to one-another, partly because they fear that their counterparties may suffer serious losses and become less creditworthy. To some extent, this is also technically because in doing so, they would directly increase the concentration of their exposures to other banks, and indirectly and inadvertently, increase it to property and mortgage-based assets.

This problem is fuelled by the fact that, in a market, the value of an asset (for example a share in a company) is only what someone is prepared to pay for it, regardless of what we might think it is 'really' worth. This means that the value of mortgage debt, which is actually genuinely valuable, becomes progressively less valuable as banks are increasingly reluctant to either trade it, or recognise its value when assessing the creditworthiness of a trading counterparty.

So, should the government allow the banks to raise finances using their mortgage debt? The answer to this would depend on the extent and on the mechanism used.

In our opinion the government should be extremely cautious about taking on this mortgage debt directly, for example by swapping it for government bonds, as has been suggested in some quarters. This could have a number of unforeseen longer term consequences, which could be ultimately counterproductive.

For example, the perversity of the markets means that, if the government did this, it might then be more difficult (and expensive) for them to borrow money in the long-term money markets to fund government spending, so the taxpayer might end up footing the bill indirectly for injecting liquidity into the markets.

Some measure of asset swap between mortgage debt and government bonds might be a worthwhile exercise to loosen liquidity constraints, but there are some important questions: How big would this exchange be? What valuation metrics would be used? Would it be a permanent exchange, or a temporary swap? and could it turn out to be just the thin end of a rather expensive wedge?

In our opinion, a much better alternative would be to allow the banks to use mortgage debt as collateral against loans from the authorities. In this case, the government would not actually own the mortgage debt, but could claim it in the event that the bank did not meet their payment obligations.

In addition, conditions could be placed on the valuation of these assets for collateral purposes, so that they would be valued at a significant discount. This would mean that this mechanism could be used to ease liquidity, but would not be used excessively, and also would not be taken as a sign of government weakness by the markets.

A suitable valuation metric would though, of course, have to be agreed.