How is the Mortgage Industry In The UK Holding Up?

Thank you for your question Graham, sorry for the delay in reply.

As I see it, there is a fundamental problem in what Gordon Brown wants and is expecting to get from the major UK banks, and the causes that have brought this particular problem about.

A lot of the cheap lending that took place across the US, UK and mainland Europe was based on lending backed by assets. When it turned out those assets were based on Fannie Mae and Freddie Mac style repackaged subprime mortgage products that had been converted into CDO’s, not only did their value get wiped out, as the reality of this type of lending caught up with the banks, all the products associated with them (like Credit Default Swaps) also reversed from safe money-making assets into bad insurance policies that had to be paid out.

Now it can be said that moves have been made to stem these losses through government share purchases, the creation of a liquidity scheme to replace the private interbank lending that died when reality hit, and the moves to allow banks to swap bad assets for good Treasury bonds.

However, even though this is all well and good for the banks, and may just about keep them afloat (even RBS) it does not change the fact that all the industries that had created assets which backed the lending between 1999 and 2007 have now dissappeared. These assets that were part of what is being called the ’shadow banking sector’ made all this lending possible to home owners in the UK, and now it’s gone and is unlikley ever to come back, so too is the lending that made its way to UK home buyers.

So, although the Labour government keep playing the information game and convincing everyone that by saving the banks they can now order them to turn the lending tap back on, the potential profits from CDO’s (Consolidated Debt Obligations) and CDS’s (Credit Default Swaps) have gone, and the net book value that also allowed billions in lending to take place has also gone, there will be no immendiate return to what we’ve been used to in the past 8 years in terms of the high volume of lending.

It seems that this should be apparent to any policy makers looking at what has caused such destruction to the UK banking sector. Even though we see record losses posted (like the £20 billion by RBS in January) the Labour government, the Treasury and the FSA are still not allowed to mention this elephant in the room; the decimated CDO and CDS markets. In their twisted logic it probably has something to do with ’speak no evil, see no evil, and the situation will eventually go away as the market picks up’.

Fact is, that’s wrong. I don’t think any financial firm anywhere in the world, whether its banks or others, will allow subprime mortgages back into the game, so all we’ve got to look forward to is lending based on deposits which was the original core of real old style lending.

What is the longstanding affect from this disappearence of sufficient lending by UK banks? Well we’ve seen the first installment – the collapse in UK house prices. This unfortunatley is only the first wave of consequences.

Still to come we have the record repossession rates from Q3 & Q4 of 2009, and Q1 & Q2 of 2010 as the unemployment caused by struggling UK businesses combines with the real collapse in mortgage payments from people who have lost their income. This will further hurt the banks and restrict lending, and also see house prices dive further as banks swamp the auction houses with repossessed properties.

We’ll then start to hear talk of a bottom to the falls in house prices as its decided that house prices can’t fall any further and all the pain must surely have been dealt by now. Unfortunatley however that is only the end of the second wave of negative consequences.

The real end of days situation that marks the start of the third wave is when all the Labour governments’ economy-breaking spending pledges to help UK banks come back to haunt us. The first signs of problems are already on us, the price of UK bonds have collapsed. This is because as we make more promises of cash to banks with money we don’t already have, bond holders know we’ll be looking to sell about £800 billion new government backed gilts (bonds everywhere else).

The more you sell the more worried the market gets that you won’t meet the payments, so the price of them falls. Then there’s the fact that the new bonds will pay out less as the Bank of England have a very low interest rate, so the returns aren’t worth the risk, pushing prices down further. This then means that the government will need to sell more of them to raise the £800 billion it needs to fund its promises, further weakening our ability to pay the returns. At this point we’d expect to see the UK credit rating drop from ‘triple A’ as many people are  currently discussing.

How does this affect wave three of the housing market? Well, this will cause our currency to collapse and alongside the perpetually stupid idea of ‘Quantative Easing’ (printing money) which will cause a spike in inflation, we’ll see the Bank of England need to raise interest rates to counter these two problems. For UK homeowners this will mark the most devastating part of this economic collapse, because those who have hung on so far will see rising prices again and higher interest rates. As fixed rate deals are harder to get,  as banks have restricted lending, the index linked tracker mortgages and the variable rate customers will have swollen in volume and they’ll be hit by a higher mortgage cost. This will cause a new wave of defaults and reposessions, and result in a further drop in already depressed housing prices.

So overall how is the UK housing market holding up? Unfortunatley they haven’t even seen how bad or how far this depression will go, most have no idea what negative equity is or how it will bankrupt them when they get repossessed, and with 3 million unemployed by Q4 2009, they’ll wonder why no one ever warned them that a situation like this could occur.

As bad as things are at the minute, and as much as stupid people are seeing the ‘green shoots of recovery’ to entice more misguided purchases to take place, the mortgage industry is about to get a whole lot worse, and not stop getting worse for a long time to come.

At least that is how I see it. For rays of sunshine you have to be looking underground like all the UK policy makers are doing, with their heads buried firmly in the sand!