UK financial crisis 2007 | 2008
Where to next?
The UK is now experiencing a downturn. Nowhere is this more apparent
than in the number of '50% Off' signs in shop windows. I don't remember
the last time I saw such aggressive discounting before Christmas.
Meanwhile, the house price wheel of fortune has ground to a halt. This
is in spite of strenuous
efforts by the TV and media to keep it turning.
According to the Nationwide, the average UK house price has now fallen
over two successive months. Whilst, in local property supplements, the
'reduced price' labels have been multiplying for over 6 months.
The ailing Northern Rock bank remains unsold, apparently the victim of
its own success. Its share price has fallen from a high of over £12
in February to under £1 in November '07.
The Bank of England warns of hard times ahead, but talks less of its own
contribution to today's unsustainable debt. The bank dropped the UK
base rate repeatedly after the Dot
Com crash of 2000. At July 2003 it was down to 3.5%, by which point
house price inflation (12 monthly) had escalated to 20%
- its highest level since the 1989 crash.
Predictably, the falling base rate prompted a resurgence of the borrow
and spend mentality. In fact, by 2003 cheap loans were being offered with
such wild abandon
that just about every adult believed they could take on an overpriced
property or, perhaps, a buy-to-let portfolio.
Recently, almost overnight, it seems that the media has been given the
green light to openly expose the flip side of the equation. All of a sudden,
the worry isn't just about the cost of Home Information Packs, or rising
mortgage arrangement fees, or the availability of shared ownership schemes
for key workers. The worry isn't even about the record numbers of people
seeking debt counselling.
The fear now is that many people simply won't get a mortgage in 2008,
and many of those on a 2 -3 year introductory deal will be crushed by
the jump in repayments when their current deal expires.
Fear of job losses is also rising. According to Lloyds TSB's research,
the number of consumers feeling insecure about their jobs is at a six
month high. Employers who rely on a buoyant house market (builders, building
suppliers, estate agents, DIY stores) must all be revising their outlooks
as first time buyers take fright and developers retreat.
As job losses begin, mortgage repayments will falter and, with no benefits
safety net left to fall back on*1, repossessions
As the media belatedly unveils the downside of the boom
bust cycle, the headlines now turn on stories of imminent bankruptcy
amongst mortgage repayment insurers, of property fund withdrawals being
suspended, of financial institutions seizing up as each one looks to reduce
its own exposure to risk by refusing loans to others.
Lack of lending between banks has forced central banks in the US, UK and
Europe to intervene on an unprecedented scale, offering the equivalent
of hundreds of billions of dollars in 'emergency' loans to bail out banks.
This is supposed to have the effect of rebooting interbank lending. But
investors have responded by selling off their shares in banks and building
To regain their footing, major financial institutions are now trying
to raise fast cash by selling stakes of their businesses to foreign sovereign
Are the ever more generous central bank loans doing
Perhaps not. In one way it just delays an inevitable 'correction'.
The current crisis is partly a result of investors over-confidence of
access to never ending cheap loans and ever greater inflows of cash. This
makes the central banks' auctions of virtually unlimited, ever-cheaper
cash (with fewer and fewer strings attached), seem like a very strange
The decline in the carry
explains the contracting liquidity in 2007. But complicated investment
vehicles have also come unstuck. These bank sponsored creations have enabled
banks to offload risk by creating a market in which third parties buy
up or insure debt in return for high yields.
One approach has been to bundle up mortgages and to sell them to institutional
investors in the shape of bonds. Now the housing market is heading south
- surprise surprise - these bonds have become illiquid. Nobody wants to
buy them. But, as a fire sale would kill the credibility of these investment
vehicles (eg. CDOs), banks are eating humble pie and taking the risk back
on their own books. This is forcing banks to absorb multi-billion dollar
So, what is the outlook for 2008 and beyond?
As just about all desirable assets, including shares, have been super-inflated
by the availability of cheap loans, the probability of any of them retaining
their peak 2006/7 value is slim.
If the UK 1989 housing crash is anything to go by, property will become
harder to sell, prices will drop sharply and repossessions will rise.
Affordable loans will be less widely available, demand for non-essential
goods and services will fall. Businesses and households will be forced
to reduce costs. Full time permanent positions will be lost and demand
for temps will rise. Wages will stagnate. A new escapist mind and mood
altering drug will be embraced by youth culture – or not.
What shocks might be in store?
A sudden hike in UK interest rates at some point can't be ruled out, particularly
given that the base rate since 1999 has been historically low*3.
Economists may argue that high interest rates are history, but then Brown,
you'll recall, said the same of boom and bust...
What is a safe investment right now?
My favourite investment of the moment is storable bulk food essentials,
my daughter's nursery education, and a savings account in a mutual building
What opportunities might lie in store?
Some things are easier during a recession – like doing the unpredictable.
Living as cheaply as possible and saving might not be a bad option right
now. The next few years could provide some of us with the opportunity
to make a radical departure from what we are currently doing.
The emerging markets are enjoying plenty of incoming funds at present.
It could be an exciting time to be somewhere else.
There might be an opportunity to go on that 12 month round the world sailing
work adventure, or to write the book, the album, the play, the show.
There might be options to become a VSO or charity volunteer, to apply
to study for a degree or part time course, or to do some part-time teaching.
Working out a better way to share resources
within the local community might be time well spent.
And finally, if you are lucky enough to ride the recession with barely
a bump, you might find that saving up money to put down on a house will
serve you well. UK house prices should be affordable again in about 3
Whatever we wind up doing, let's do it with passion and persistence.
'Hard times' can also be, for all sorts of reasons, good times.
Happy New Year.
Ends | 29 Dec 2007 | The Leg
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*1 In the aftermath of the 1989 crash,
the state maintained UK homeowners' interest payments in the event of
them losing their jobs. This facility has since been removed.
*2 The idea of the carry trade is simple.
A major investor (bank, hedge fund, high net worth individual etc) takes
out a short term loan from a bank in a country where the interest rate
is next to nothing, or 0%. The investor then converts the loan into the
relevant currency and deposits it in a savings account (or bond, commodity,
property fund) in another country where the interest rate or promised
rate of return is much higher. By doing nothing more than pay off the
original lending bank on schedule, the investor pockets the interest or
That's the theory. However, the Japanese carry trade has somewhat lost
its sheen. Investors came unstuck when Japan's base rate went up in July
'06, after 5 years at 0%, and again in Feb '07. This forced the sale of
assets in order to pay off the outstanding 0% loans, visible as dips in
the Dow Jones and FTSE
100. Some writers argue that, by tempting speculators to take ever
risks with the promise of free money, the carry trade is mainly to
blame for today's financial crisis.
Postscript: The carry trade collapsed in 2008 as illustrated by this graph
from the Financial Times (Oct 2009).
*3 Look back a bit and you find the average
UK base rate for the years since
1975 is over 9%. The rate peaked at 16% in 1980, and hit a low of
3.5% as recently as 2003.