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!

The UK Economy and the Pre-Budget Report

The Chancellor of the Exchequer’s Pre-Budget report was November’s big eye-opener as to how you can regurgitate 1970’s policies to deal with current problems in an old way.

The current problems are a recession, a housing market collapse, a bunch of private corporations on the brink of insolvency and ready to go into either bankruptcy or administration, a restriction of credit to small businesses and mortgage customers, deflation (supposedly), collapsing currency, collapsed interbank lending, collapsing stock market, collapsed commercial paper market, collapsing retail sales and unemployment rising to nearly 2 million. This is only the core list of problems, of which there are many more.

To deal with these problems the Chancellor plans to increase borrowing up to £118 Billion by 2010 through the issuing of more bonds (UK gilts), dropping VAT from 17.5% to 15% (worth £2.5 billion), making the 10p tax solution permanent (resulting in more money for the low paid), the part nationalisation of many UK banks (58% holding of RBS at a £2.5 billion loss 28/11/08) in a holding company called ‘UK Financial Investments Limited’ and the encouraging of the (Independent) Bank of England to cut Interest Rates to 2%.

The chancellor is reportedly working with the Business Secretary Lord Mandelson on drawing up a list of potential companies that can expect state aid to avoid the financial difficulties their reliance on customers with credit has caused.

Taken together this is very similar to the state intervention of the 1970’s where ‘Beer and Sandwiches’ with the Prime Minister resulted in state aid for strategically important industries such as British Coal and British Leyland, with the only real difference being that unions wanted big pay increases, where as the rescued businesses of today want modest % pay increases for workers, and big bonuses for top management.

While we may have dispensed with throwing state aid at corporations that don’t have shareholders (for the last 25 years), the new Labour government have in recent months turned to using every last bit of cash the country has to prop up inefficient businesses that can’t survive even the first 12 months of a downturn in the economy.

Aside from the conflict caused by rewarding shareholders with state aid (when they have invested in lame duck companies that should be allowed to go out of business) the Labour government has allowed itself to get dragged into cow-towing to CEO’s of reckless companies like Royal Bank of Scotland (RBS), because they are too big to fail. This was the same argument used back in the 1970’s for failing businesses like British Leyland, and smacks of the same failure today that was overcome through privatisation during the 1980’s.

The moral hazard of allowing a business to know it is too strategic to fail allows it to ‘name its price’ in state aid, to call the shots on pay, as happened with ‘beer and sandwiches’, and treat the government like dirt in the end, because the government have already stated they will do whatever is wanted. Majority ownership of RBS by the government is meant to head this problem off, but in the end the moral hazard of providing a consequence-free environment means RBS will eventually take advantage of this situation.

RBS can even throw the dog a bone and promise a headline catching 6 month moratorium on mortgage customers in arrears, to make it seem that the government is helping steer this corporation into doing the right thing by customers. I have concerns however about what RBS will extract as the price for this favour.

Getting back to the problem of borrowing £118 Billion to encourage spending in the economy, is that it’s a blatant ’spend your way out of trouble’ manoeuvre. I would like to believe it represents the government stimulating a recovery in the economy by latching onto an upturn in sentiment, and will help businesses and consumers pull themselves out of a recession.

The problem with this approach is that they aren’t looking to pick the economy up off the bottom, and help those surviving businesses that have run efficient operations to get the ball rolling and kick off a long overdue upswing. Instead they are trying to force the market to find an artificial bottom, they are trying to interfere in the natural deleveraging process, and they are trying to restart the credit boom without having paid the piper for the last 10 years of excesses.

This is foolish in the extreme. Labour tried throwing good money after bad in the 1970’s and using a Keynesian market intervention approach, Alistair Darling and Gordon Brown hope to spend enough money fast enough to manipulate the natural cycle of the economy, and bring it back out of recession.

It won’t work. It has never worked. In the 1970’s we proved it definitely won’t work if you do it with borrowed money, and even Keynes agrees with that point as he stated only surpluses should be applied to a recovery package. As we have no surpluses and seek to borrow £118 billion to manipulate the markets, we can expect the same IMF bailout that occurred in 1976 when finances were in better shape than they are right now.

The Shadow Chancellor George Osborne recently said “All Labour Chancellors eventually run out of money, and this one will be no different”. By the time we find out he’s right and the Labour party have spent our money trying to engineer a recovery that was never going to work while the whole world economy went into recession, it will be too late to reclaim the good money we’ve thrown at the bad losses.

The really stupid part of Labours approach is the ‘what’s counted as National debt and what’s not’ approach they’ve taken. The dud assets they’ve purchased in bankrupt companies should be marked down as part of the National debt, but they haven’t been. Instead they are noted as investments by the Government, and so are kept off the National debt. That way you can spend £37 billion bailing out banks and not have it double the National debt overnight.

The problem with this approach is that it matches the failed approach taken by these banks in the first place, who used Structured Investment Vehicles (SIV’s) as separate ‘off balance sheet companies’ to issue commercial paper and invest in Credit Default Swaps and Consolidated Debt Obligation’s (CDO’s). When Zoe Cruz at Morgan Stanley finally had to bring her £25 billion SIV back onto the books, because it was in trouble (July 2007), it marked the start of the banking crisis and gave us our first look at how these banks were hiding their real liabilities.

So to now find the Chancellor of the Exchequer allowing the Treasury to run the public finances in the same way as has just caused the collapse of the banking system, by keeping our real debts hidden and misrepresenting the UK’s real liabilities, is a complete disgrace.

The Chancellor of the Exchequer, Alistair Darling, has used the same argument in public to justify this action as the now failed banks used before the losses started to appear. The banks back then said these SIV’s were viable asset management businesses that were holding assets that had market value. When it turned out that Credit Default Swaps and CDO’s were worthless pieces of paper which actually caused heavy losses not annual returns, they went crying back to their originators (the banks) and appeared as losses on balance sheets.

Eventually the National debt will have to absorb the most of the £37 billion lost from these bad investments as the banks share prices fail to recover quickly, and in the meantime rack up billions of pounds of extra losses, due to the massive quarterly losses these business are still making. Eventually the Labour Government will have to accept these bank shares as worth far less than they paid for them, just like the banks themselves had to with SIV’s, CDS’s and CDO’s.

At that point our economy’s credit-worthiness will be downgraded, the value of our bonds will collapse, our currency will go into free fall, and if the Government haven’t already raised the £500 billion they need to pay for all the spending they’re planning, they will find no one willing to fund their manic spending spree. At that point the IMF will be called in as lender of last resort, and we’ll all want to lynch Gordon Brown and Alistair Darling for investing in worthless businesses that will have brought our country to the brink of collapse like Harold Wilson, James Callaghan and Dennis Healey did before them in the mid to late 1970’s.

Inflation or Deflation Re-examination

Before dealing with November I should address my overeager prediction made in October, that inflation won’t fall but will increase. As from September to October inflation fell from 5% to 4.5% on face value I’m not looking like I’m on-top of this situation as inflation has in fact fallen. However bear with me on this one, because although inflation has fallen due to the drop in oil prices feeding immediately into the lower petrol prices, the rest of the price decreases that should lower inflation might not arrive as fast as people expect (if at all).

Although fuel price reductions arrive quickly (not as fast as they went up but still noticeable), the banks have already shown that they will maximise the difference between savers rates and lending rates to help increase profitability, to the point that the Prime Minister Gordon Brown has to get involved.

A better example of where fuel prices match the real delivery of price decreases to the economy is in the gas market. Although the oil price has dropped to a third of its summer peak, the price of gas has failed to reach customers fast enough to avoid some rather expensive winter gas prices. Although the gas prices might eventually fall, even the government has noticed the excessive profit taking the gas companies are embarking on by charging more over winter and then bringing in cheaper prices over summer when there’s less demand. Although gas was paid for in advance when wholesale prices where higher, I would put a months wages on profit growth for all the UK gas suppliers over this winter, based on high sales price and lower supply costs. This doesn’t even account for Russia’s blatant supply threats every winter since 2005 bolstering the price of gas.

The next example of where we’ve enjoyed lower prices is in the shops, but as the situation with Woolworths shows, obtaining purchase insurance against goods (which is what allows stores to fill their stores with goods purchased on credit) which are then paid for after the seasonal sales period is over and the cash has been taken off the customers, is a practice that is coming to an end. This Xmas will probably be the last time we see the sorts of huge discounts we have seen for the last decade.

This is simply because of economies of scale – the more you buy the cheaper the unit cost. If you are buying on credit you can buy more than you can with cash, and so in the selling process you can lower the prices below your normal unit price and call it a sale. No credit insurance against these purchases means lower volumes will be acquired at higher unit costs, resulting in less price cutting at the point of sale.

As seasonal sales have helped the UK economy keep inflation down in the clothing sector, along with a strong pound, the absence of cheap clothes combined with higher import costs will really start to appear in the sales price by the middle of 2009.

Many of the businesses that are wholesale and not retail will probably want to keep hold of the profit from reduced supplier costs, to repair their own gross margins, and this will delay, if not prevent altogether, any lower costs reaching consumers in many retail businesses, anywhere from furniture to food.

Finally, just as in the 1970’s, big government spending in the economy on building projects will result in inflation, but without delivering sustainable benefits. However, this may take time to arrive in the inflation figures.

In my October post I did say inflation won’t fall, but that is rushing straight to the end of this process without accepting that global prices of goods are falling and we will see reductions in prices. However, for the reasons I’ve detailed above, I do expect the small drop in prices to be followed by a massive rise in prices, not just for the above commercial reasons but because monetary policy at the Bank of England has been relaxed so much to stimulate demand that eventually they will avoid the deflation that the government fears. However, the inflation tap they have turned on at full throttle to counter this problem will not be turned off that easily, and we will be talking of the concerns caused by double digit inflation much faster than most economists expect.

After An October To Remember What Next, Inflation or Deflation?

October has been another month of great change, starting with the US Congress finally passing the $700 Billion bail-out of US banks and now with a week to go, we have the Governor of the Bank of England (pre-empting the publishing of data) announcing in a dinner speech that the UK economy is now officially in recession.

During October we’ve witnessed the collapse of the Icelandic banking system and the bankruptcy of their government, the £37 Billion investment by the UK government into shares of RBS, Lloyd’s TSB and HBOS as part of a wider £500 Billion UK bail-out package; and similar actions by the rest of Europe to recapitalise the western baking system with taxpayers money.

To fund the UK governments spending spree we’ve seen UK borrowing for the first 9 months of the year reach £37.5 Billion and we now look well set to break £60 Billion national debt for the year. We’ve also seen the CPI measure of inflation reach 5.2%, well above the Bank of England’s target of 2%, and we have also seen the BoE lower interest rates down to 4.5%.

The results from these events on the UK are as follows, in Iceland UK councils, police forces, universities and private individuals have seen nearly £1 Billion pound of investments disappear into the black hole of bankruptcy, with only the first £50,000 worth of investment looking likely to comeback out. This means huge losses for UK investors and institutions, and the rather humbling acceptance by the Icelandic government that they are unable to financially rescue their banks or wider economy, and will probably default on payments themselves.

The bail-out of the UK banks by Gordon Brown’s Labour government was carried out through crisis talks at 10 Downing street, held with the CEO’s of the UK high-street banks, and put together a deal which would see an immediate £37 Billion investment in shares, a £250 Billion lending guarantee to kick start interbank lending which has dried up and been replaced by the BoE. The final £213 Billion would be used to purchase the ‘Toxic’ debts that are still on the balance sheets of UK banks, and are preventing this crisis from ending.

For the banks part of this package they are to end the ridiculous bonuses to employees that have seen this collapse occur in the first place, a moratorium is to be placed on the payment of dividends while using tax payers money, and the senior executives of the banks involved are to leave without taking their golden parachute payouts (severance pay).

Moving beyond the distractions of leading UK banks, I would like to deal with the real problem that is at hand, the now apparent UK recession. I have heard many commentators such as DeAnne Julius (former MPC member) or Anatole Kaletsky (Writing for the Times) suggest that we need to lower interest rates, and more aggressively that the 0.5% cut that the BoE did this week.

Both commentators suggest that a rate cut would help fix the lack of credit availability and lower the current borrowing costs between banks, known as LIBOR. This would then help stimulate the UK economy and help prevent a prolonged recession. The difference between the commentators is the acceptance by DeAnne Julius that this policy will cause long term damage, where as Anatole finishes his article by suggesting that a drop in interest rates would help lower the trading value of the pound and help stimulate export sales, further boosting the economy.

I however take a very different view on the current situation and the results of interest rate changes. I think inflation will not fall but instead will increase. This is because although prices of commodities have started to fall now that a global recession is taking hold, I don’t see these price drops being passed onto UK consumers.

After a difficult 12 months in which most companies have see their gross profits squeezed to almost nothing, the chance to buy in at a lower price while holding a higher sales price will help off-set some of the missing revenue of the last 12 months. The banks have already started to make this a reality with the latest round of interest rate cuts by the BoE not being passed onto consumers, but quickly being passed onto savers. This will maximise the banks revenues out of both savers and borrowers, but at the same time demonstrates how the current assumption, that we will experience a period of deflation, is not going to happen.

Further evidence of the UK’s inability to price downwards can be seen in the latest data coming out from the Farming industry, as despite a global fall in the price of dairy goods has already begun, the UK market has actually seen price rises.

Secondly, As Alice Cook from UKBubble fame is regularly pointing out, there is still a massive disconnect between interest rate movements and the resulting movement in the LIBOR rate. The lowering of rates is in fact making the gap more pronounced and as LIBOR refuses to budge, the gap shows how the mechanisms that make interest rate moves so effective, have now gone, and demonstrate the weakness of the Bank of England in effecting the key market area of lending rates.

This now means that the area most affected by interest rates is not lending or borrowing, but is in fact savings. As returns for savers are cut by the banks, two negative responses will occur. Firstly cash will leave UK banks for foreign banks, as they offer better returns, further damaging the capital base of struggling UK banks. Secondly, and Most importantly however will be the collapse in our currency, the Pound, on the international markets.

Unlike Anatole Kaletsky I see this as damaging the UK economy because we don’t export manufactured goods any more, and since the credit crunch started we don’t export that many financial products either. We currently have a balance of payment problem where we import £7.5 Billion per year more in goods than we export. This means that although the gap may narrow due to changes in purchasing behaviour, unlike the rest of the world where prices of food are falling, our collapsing currency will actually see our prices rise, as our imports become more expensive.

The third reason why we will see inflation not deflation is that for the last 12 months we have seen inflation increase well beyond the 2% target set by the UK Government and Bank of England. This prolonged period of high inflation has now translated into higher wage demands. My primary evidence for this (apart from it being obvious) is that my own employer agreed 18 months ago to provide a pay increase at the rate of either 2.5% (near the CPI target) or at the current level of the Retail Price Index. When this agreement was originally struck RPI was below 2.5%, so not a problem. Now however RPI stands at 5.0%, and it has been confirmed that I will very soon be getting a backdated pay increase of 5.0%. As I doubt that my company are alone, and as I’m aware that most Financial city jobs also track the RPI for pay increases, this is a clear demonstration that the wage price spiral has now begun.

Taken together, price reductions not reaching customers, a falling currency and the start of wage related inflation indicates that prices will be increasing, not decreasing. Further more, a higher national debt level and plans to massively increase government spending in the economy with that borrowed money, sound like the old inflation generating Keynesian policies that failed during the 1970’s, of ’spend your way out of trouble’. The added problem of reduced interest rates, and a disregard for inflation mean that any benefit that is derived from reducing interest rates today, will not only fail to arrive in time to help, it will undoubtedly be at the expense of double digit inflation tomorrow.

DeAnne Julius knows this, when asked in her interview about the impact of current government moves to spend £37 Billion with borrowed money, she didn’t deny it would have a serious negative (upward) impact on inflation further down the line. Gordon Brown knows this, which is why he had 2 big rules – only spend to invest & his golden 40% borrowing rule. This was because spending to stimulate demand caused hyper inflation in the 1970’s leading to the ‘Winter of discontent’ in 1979, where we had double digit inflation and interest rates.

In my estimation this is where we are headed again, double digit inflation & interest rates. As inflation isn’t dealt with because the government and ‘Leading Economists’ (who didn’t see the credit crunch coming) now claim we will experience deflation; what we’ll end up with is rampant inflation and then the inevitable move by the Bank of England, an increase in interest rates to deal with this problem. At that point we’ll have the 1979 problem of high inflation and high interest rates, huge government borrowing and crippling interest payments on the new bonds (gilts), issued to pay for the increased government spending. All we then need is increased public taxation to replace the declining revenues of businesses, and we’ll have the full set (Although this at least has not yet been announced).

The affects of 8% (or higher) interest rates on anyone who has fallen into negative equity (estimated to be 2-3 million homes) will be horrendous as the majority will be repossessed and bankrupted, and we’ll be back to 1990 again, with keys being posted back through estate agents letter boxes. As both the government and Bank of England know that a failure to control inflation will cause this, I would disagree with DeAnne Julius, Alistair Darling (Chancellor), Merv King (BoE), Anatole Kaletsky and the whole dam world by the look of it, that lowering interest rates is the right thing to do, or that inflation will be lowered by falling commodity prices.

Reality Bypass

The current UK Government is suffering from a serious case of ‘We can’t face reality’. The situation is dire because the Chancellor of the Exchequer, Alistair Darling, is predicting economic growth of 1.75% – 2.25% for this year and next, when all around him are finally getting nearer the mark, such as the IMF who are predicting 1.4% economic growth for 2008 and 1.1% economic growth for 2009, and the CBI (Confederation of British Industry) now predicting 0.4% economic growth for 2009.

This is very bad because if the UK Treasury can’t come to terms with the reality of a collapsing economy, they can’t set policy to deal with next years lack of money. No reality = no policy.

The situation will be a minimum inflation of 5%, lower tax receipts from the financial sector, housing sector (Stamp Duty) and retail sector; interest rates that are on the rise (or they should be if the BoE have any sense) and a rapid increase in unemployment which will increase government spending on benefits. This squeeze on incomes and increase in outgoings will leave the government with the same choices that we’ve had in the past.

1. Raise Government borrowing
2. Raise taxation
3. Cut public spending

Option 1 is out because the 10p tax debacle has already put us way past the safe borrowing limit that indicates a net outgoing of revenues on interest payments that will restrict economic growth.

Option 2 was tried in the late 1970’s under a Keynesian structure of tax and spend, which never works, because increased government spending when inflation is on the rise only fuels further inflation and, on top of our current high borrowing levels would result in both double digit inflation and interest rates, such as those in 1979.

Option 3 is just like Margaret Thatcher’s early 1980’s approach, rolling back the state and cutting government spending. However as the above analysis shows, we are entering a period of low government tax revenues and higher government spending on unemployment benefit, which would only leave spending cuts in other government departments such as the Department for Health (with spending up from £35 Billion in 1997 to £90 Billion in 2007), to achieve a reduction in government spending. Cutting 3,000 hospital beds while cutting back on Local Government services will be as popular today as it was during the 1980’s.

The big problem with option 3 however is it will cost too many votes in the run up to the next general election in 18 months time, and for an already very unpopular Prime Minister (Gordon Brown), this would finish him off as Prime Minister and the Labour Party as the UK Government. Besides, as Alistair Darling’s comments show, the current Labour Government doesn’t have the stones to deal with reality, let alone present a potential cure to mitigate against the coming problems, that would then cost them the next General Election.

As a result of all this we are left with infuriating persistence by the Treasury that they are right about GDP growth, and pretty much everyone else is wrong – me included.

This current problem at the Treasury is confounded by the worst offender of all, the chief turd-polisher herself, Housing Minister Caroline Flint, who in the middle of a housing collapse keeps coming up with wonderful statements to prove how this housing crisis isn’t actually a problem at all.

When speaking on Radio 4’s Today program on 10th July she made the following housing market comments:

“In terms of consumers we’ve seen a modest fall in house prices” - This comment comes 3 weeks before UK house prices showed their biggest annual fall since the Nationwide began its housing survey in 1991. The 8.1% annual decline came after house prices dropped by 1.7% in July, the building society said.

“We’ve seen an increase in repossessions, but nowhere near the sort of repossessions we saw years ago” - Home repossessions have risen by 48% in the past year. There were 18,900 repossessions in the six months to June (2008), up from 12,800 in the same period last year. While this is still not as big as the 75,540 repossessions seen in 1991, we have not yet even entered recession in 2008, while the 1991 figure was taken at the bottom of the last housing market crash during a bad and deep recession. As things stand at the moment the 75,540 mark could well be broken as unemployment rockets out of control.

“In some cases flats were necessary for first time buyers” - (1 month later) A fall in flat prices has become a key factor in the slowdown of the housing market, UK government figures show.

“And most of those people being taken to court hold onto their homes if they are given the right advice”. (5 weeks later) Last week the regulator (FSA) warned it would take action against lenders who were too aggressive to customers in arrears. But the Council of Mortgage Lenders (CML) said the FSA was wrong to suggest the whole industry was at fault. The FSA replied that potential problems with repossession policies were found with all types of lender. “There were issues discovered across the piece with all lenders which is why the warning was addressed to the whole market place,” said an FSA spokeswoman.

Between the lack of reality from the Chancellor and the Treasury, and the ridiculous comments from the Housing Minister Caroline Flint, Merv King at the Bank of England will have his work cut out bringing these two down to earth.

The US Treasury Have Thrown Good Money After Bad

It’s so obvious this would be the end result of the US Governments decision to provide a $167 Billion stimulus package, it’s hardly worth saying, yet I just can’t help but cover the point.

President Bush in May and June provided the US economy with his teams solution to a huge credit binge lasting years; he went on a credit binge and threw some cash at the economy. This ’spend your way out of trouble’ idea was poor at best, and today we find that it has in fact failed. It has failed because the problems that have brought about the looming recession have not been dealt with, and as the latest retail data shows, it has had a marginal affect on the economy. Not only has that mild effect worn off very quickly, it had no follow-through with either more cash or a resolution to the underlying economic problems.

It must therefore be seen for what it is, a crude economic stunt with only political benefits and as my title suggests, it has ended up throwing good money after bad.

In generating extra borrowing it has in fact weakened the US economy, but ,worse still, it has wasted some of the precious money that was still available to the US Treasury. With nearly all the major Dow Jones companies now declaring losses (AIG being today’s latest) and failing to generate profits that the US government loves to tax, the limited resources that the US Government had at its disposal should have been better spent, rather than being wasted on a politically motivated forlorn hope.

It is now assured that in a period of declining US Government revenues, this one- off stunt was a definite waste of money.

Financial Crisis

To start this months post I would first like to make a mention of a great blog I read every week that I consider to be well worth a look;

It’s written by Alice Cook and is called UK Bubble

The second artice I would like to recommend is from Alex Ritson (14/07/08), a reporter with the BBC’s Newsnight program. The contents of his article are so powerful and awe-inspiring that this is one situation that would never be allowed to play out. Titled ‘The US Economy’s Next Bad Thing?‘ it is essential viewing.

Even the most conservative of approaches to market intervention would still be put aside to prevent this meltdown from taking place. The scary part is that this is not some doomsday scenario, but is in fact a very real situation that will take some skillful and careful economic management from all western governments to avoid it becoming the worst economic collapse ever.

To prevent the situation identified by Alex in the above article, no bank will be allowed to fail, especially the two most precarious of giants, Freddie Mac and Fannie Mae. If you wanted to know what the gun being held to the US Treasury’s head looks like, the Credit Default Swap market is that gun. The US Treasury looks like being handed a choice between nationalising Freddie & Fannie and taking the US national debt from around $3 Trillion to $9 Trillion, or allowing them to collapse and starting the cascade effect of Credit Default Swaps being paid out by the banks that issued them.

The problem is that these banks can’t cover the payments they are meant to make and will therefore collapse. The big problem with banks collapsing is that these Credit Default Swaps are in fact insurance policies, and, to ensure they will never have to be paid out by any bank, they secured most of them on the safest assets they could find – big banks mortgage products.

When the two biggest banks in the market fail, and all the policies are paid out by the surrounding banks, then those banks paying out may also collapse. Then, the next wave of CDS’s (Credit Default Swaps) pay out on the next set of banks to fail, and, before you know it, you’ve got a cascade effect going right though the system ripping $62 Trillion out of banking.

In the UK the exposure of British banks to this problem was mentioned in Alex’s article as being unknown due to it being hidden amongst a package of credit derivatives. Notably however, the two banks that have recently been inexplicably trying to raise shareholder finance, Barclay’s and RBS, have the biggest exposure of any UK banks at £2.5 & £2.4 Trillion respectively. Is it any wonder then that they are desperately trying to raise their capital holdings?

One further notable problem connected to Fannie & Freddie is the fact that one of the biggest takers of their sub-prime related bonds are the Chinese government. If, in avoiding a Credit Default Swap situation, the US government does have to nationalise Freddie & Fannie and bankrupt its investors, this will wipe out any holdings by China.

This would really represent a Bush administration encouraging China into investing in the US economy, only to find that the US government has taken their cash and run. It’s not like the US government will have much choice, but that will still be a hard pill for the Chinese to swallow, and may discourage them from fueling any similar fires in US housing in future.

Housing & Economy Update

As the latest housing data is released showing a 64% decline in the number of mortgages completed last month, as compared to this time last year, It seems something significant is happening in the housing market and wider economy. This news combines with the inflation rate of 3.3% and the £550 million write off by Taylor Wimpey from UK losses to reveal a housing market with problems today and far worse to come.

As inflation increases the Bank of England will look again to raise interest rates above the 5% they are currently. As this happens the lenders will increase the deals they have on offer to higher levels and this is when everyone will notice that a high rate deal on a house of average price £179 ,000 – £184,00 will, in conjunction with an average 10% deposit + fees + stamp duty, result in an impossibly high start up cost combined with a huge monthly payment.

The problems of Taylor Wimpey show how the business side of this market is already suffering and now even the biggest of players is having to look for a buyout or share capital. As new business drys up and the prices of houses start to fall, all the land that Taylor Wimpey have bought for new housing projects not only stands empty, but starts to look over priced and gets re-evaluated, netting Taylor Wimpey a huge loss. Taylor Wimpey are not the only ones who are going to get caught ‘holding the baby’ with huge inventories of land; eventually the rapid decline in the price of property will result in a less well-financed business getting caught out. The shared problem now being market capitalisation dropping by 75%, meaning they can’t raise funds for new projects or lending to offset their losses.

The cyle of problems now has a lot of key pieces, as construction companies lay workers off and estate agents go too, the jobs situation will put families with mortgages in financial peril as repossessions have previously ensued in this situation. The fundamentals that I keep hearing are all fine at the moment, are not fine at all, its just the lag on the effect that is still feeding through the system. The fundamentals being the rate of employment, the rate of inflation and the rate of interest.

The real problems however will begin when the inflationary spiral tries its best to start. The fundamentals followers’ claim that there’s no inflationary spiral at the moment, so when the current fuel increases have fed through the system, the rate of inflation will fall back and everything will go back to normal, interest rates can be lowered and the housing market can recover in the nick of time.

The Governer of the Bank of England, to his credit, has not chased the housing crash like The Federal Reserve in the US have, and the current Interest Rate of 5% will make his best scenario a possibility, and a rate cutting intervention in those circumstances would make him a total superstar of economics (and rightly so). I think however, what has been overlooked is the current increase in gas and oil prices increasing the price of food and transport with them, and this will lead to inflation that may have its limit, but is enough to trigger wage-led inflation that will add to the food price increases at the point of sale and IS going to be the trigger of an inflationary spiral. That may mean that Interest rates have to go above 6% and take longer to come back down, which would then lead to a recession. It will be a close thing in the UK but some good work by The Governor of the Bank of England (in spite of some of the short-sighted retail advisers on the Monetary Policy Committee) has at least given the UK a fighting chance.

The US however have not got with the program, and having lurched after the housing crash now have Interest Rates of 2%, which are too low to fend off the inflation that has built up from high energy costs. They are starting from too low down to manage this problem properly and will end up chasing interest rates all the way back up over 4% (and probably higher), and whatever ground they may think they’ve gained from lowering them suddently in 2008 will be lost as those just hanging on finally go under and start the next phase of housing crash in the USA.

For the same reason as in the UK, they will experience fuel led inflation leading to wage led inflation, leading to higher prices at the shops and starting the inflationary spiral. The best thing the Federal Reserve could do at the moment is cut their losses and start the inflation fight right now, but instead of making the hard call like the UK and EU made to stay on top of inflation and, in effect, be proactive in the right area at the right time, the Federal Reserve are now holding Interest Rates and watching to see what happens before they will make the hard call to lift Interest Rates. By the time they have data on the start of an inflationary spiral it will already be too late to get on top of it quickly. This then means that instead of taking on a recession, the Fed are waiting to buildup a bad recession, and will take this on instead. I feel they either lack the courage to make a move or have some Presidential legacy to protect instead, consequences be damed.

Henry Paulson, US Treasury Secretary

Having seen this week Henry Paulson’s latest words of wisdom, “Later this year, I expect growth will pick up.” (Paulson sees end), I declare he is a guy stood in the eye of a hurricane proclaiming that the worst of it is over. I’d have thought after spending $150 billion he would have managed to buy a clue, but then I remember that he’s give up on serious economics, and now wants to give this recession a political makeover so that his boss, President Bush, isn’t blamed for causing this mess.

This idiot actually thinks that not only can America spend its way out of trouble, but that the turn around will be seen well before the worst of the recession has even got underway. I’ve heard of stupid blind optimism before, but this lack of understanding can only be put into context by knowing he won’t be around to deal with this situation much longer, so its open season for any and all stupid comments.

I mean, its well known for being a strategy that works; as you enter a big recession try and spend your way out of it, because its not like a spending binge got you in this mess in the first place.

Besides the fact that this gamble won’t work, and will only make matters worse, he lacks any incentive to be truthful because he won’t be around to live with the aftermath. As far as this genius is concerned its a win-win strategy.

I think this would be a good time for a recap on how well this guys superb predictions have stood up so far, so we can see what to make of this latest gem of wisdom:

22 October - “The consensus was that markets are better than in August,” said US Treasury Secretary Henry Paulson. “It has been slowly improving, but it is going to take a while.” (World economy now recovering)

3 December – “Mortgage lenders and regulators are close to finalising an aid plan for homeowners hit by the credit crunch”, US Treasury Secretary Henry Paulson said. (Mortgage aid close)

The length of time between these two comments = exactly 6 weeks. His latest comments are only 8 weeks and 2 days after the total collapse of Bear Sterns bank (17th March). He could have at least waited until the end of May when Americans had spent their governments cash, before he declared victory.

It seems that Paulson’s idea of how long this recession lasts will be 15 months, with it starting around July 2007 and ending between October and December 2008. This would mean that the economy has gone from prosperity and growth to the total collapse of one of the largest US banks, (with a $200 billion bailout for all the other banks and $150 billion for the domestic market) and back to prosperity and growth again, all in the space of 15 – 18 months.

If this idiot worked for anyone other than the guy who caused this mess then he would be sacked for such a stupid prediction, but alas he doesn’t and he won’t be.

Problems in the UK Housing Market

The UK housing market has big problems that have been building for over a decade now. The cost of homes has been highlighted for some time now as being well beyond the reach of most UK first time buyers, with the charity Shelter reporting that the average price of a first home was around £52,000 in 1997, and is now around £160,000.

As a first time buyer myself I have been very aware of the extraordinary growth in prices. The over-supply of cheap credit by banks and lenders has seen the demand for homes grow to a very high level. This problem has created a situation where key housing market institutions (who shall remain nameless) proposed the very stupid idea that a shortage of supply will ensure that homes in the UK will not fall in price.

These two market events created a feedback situation where people desperate for a home believed these supposed market experts and tried to get on the property ladder before they could no longer get a mortgage offer, and in doing so helped the demand spike, resulting in yet further comments scaring people into believing prices couldn’t fall.

This awful situation was not challenged by a weak government in the UK which did nothing to discourage this problem. They instead allowed these comments to go unchecked and have presided over a situation that looks like unfolding as a complete disaster.

I say this because it is painfully obvious to anyone who isn’t a mortgage adviser, but knows about economics, that no single factor alone (namely a lack of supply) can ensure a single section of an economy will be shielded against the affects of a recession and continue to grow while the rest of the economy either stalls or shrinks. The problem of glorified salesmen/women, who earn commissions on sales of houses and have a vested interest in speaking out of their arses, helped this situation get to stupidly dangerous levels of home ownership.

I say the levels of home ownership are stupid because not only are most buyers since 2004 buying over-priced houses, they are not prepared for the high interest rates that will result from a recession in the UK economy. Most worringly though is the unchallenged nature of sales in two very bad groups of this home ownership market.

Back in the late 1980’s and early 1990’s the word ‘Second Mortgage’ was synonomous with those who had lost their homes, and was largley blamed for the worst of the housing crash. Since then lenders pretended that they had disappeared as a product – this is not the case however. They instead were rebranded as ERL’s (Equity Release Loans) because of the bad press assosiated with the term ’second mortgage’, and have been fuelling the building of extensions, conservatories and holidays ever since.

This time bomb will come calling in about 2010 when the UK government and regultors pretend they had no idea this was happening, as tens of thousands of ERL customers end up with negative equity and eventually reposessed homes. Spending on your home to incease its growth in price was seen as a sure thing and was supplied with lots of cash from lenders, but when the party is over and the property prices fall (as they are now), all these investments will only amount to debts with no asset growth to show for them.

Basically someone will get caught at the top of this game with mortages worth way more than the house, and not only will they not be able to afford the mortage, they won’t be able to sell when the market gets flooded with homes that no one can afford to purchase. Thats why they will all get repossessed.

The second and and probably most devastating part of recent lending practice is something no housing market has seen anywhere in the world before (and I believe i’m the first to really discuss this problem although please correct me if I’m wrong); the backing of unaffordable house purchases by parents’ who act as guarantors to their childrens home loans. This practice will result in not only the repossession of one family home, but will result in the forced sale or more likely second repossession of the lenders parents’ home as well.

This will see, for the first time, the crumbling of 2 generations of family home ownership in one market collapse, and when taken in conjunction with the miss-selling of ERL’s, will see a market collapse the likes of which has never been seen before. This will go down in history as the worst economic catastrophy in the UK since the development of the modern financial system.

I hope I’m wrong of course, but so far I’ve put my money where my mouth is and resisted the 6-monthly enquiry by my bank, as to whether I would like to take advantage of one of the special graduate mortgages to which I’m entitled. Given how the threats from the market suggested if I didn’t get a mortgage I would never own my own home, due to prices never falling back to my level, I’ve run contra to the choices recommended by the media, my brother and some friends, by staying out of the purchasing game. I worry that too many of the people around me have not seen the worrying signs in the market I believe are present, and that they are now exposed to the threat of repossession and financial ruin.