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 will result.

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 societies.

To regain their footing, major financial institutions are now trying to raise fast cash by selling stakes of their businesses to foreign sovereign investment funds.

Are the ever more generous central bank loans doing the trick?

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 medicine indeed.

The decline in the carry trade*2 partly 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 losses.

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 society.

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 years time.

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


comment | notes | reading | back to top | thoughts

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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 profit.

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 greater 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.

Essential Reading:
Children of Thatcher, Cuts and Central Bankers
Reflections on the Great Depression of 2010

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6 Mar: Confidence at rock bottom - £ at all time low vs Euro
6 Mar: Forced sales drive down prices as few buyers for risk
6 Mar: "Everything is telling you the financial system is broken"
5 Mar: 27 hedge funds have barred withdrawals since Nov 07
3 Mar: FTSE falls 1.8%, Nickkei 4.5%
3 Mar: Fed's rate cutting has failed to halt the downward spiral
2 Mar: HSBC raises dividend as it reveals £8bn in bad debts
1 Mar: Peloton Hedge Fund firesale to wipe out $2bn of equity
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22 Feb: Banks move to rescue bond insurer's triple-A rating
19 Feb: 51% of voters are pessimistic about economic outlook
19 Feb: Credit Suisse suspends traders over £1.5bn loss
18 Feb: Northern Rock shares suspended as bank nationalised
18 Feb: US banks just borrowed $50bn from the Fed in 2 months
15 Feb: Private investors flee from funds perceived to be risky
14 Feb: UBS bank reports $13.7bn fourth quarter loss
12 Feb: US insurer AIG admits to $4.9bn loss for Oct & Nov 07
9 Feb: UK government debt - still stable and attractive?
8 Feb: A week in which the FTSE lost 4%
7 Feb: Northern Rock shows as £55bn cost on public accounts

5 Feb: BP announces that 5000 jobs will go
5 Feb: FTSE 2.6% fall led by commercial property stocks sell-off
2 Feb: 160,000 Egg customers to be stripped of credit cards
31 Jan: US banks in crisis: borrowed from Fed vs own reserves
31 Jan: Bond insurer MBIA reports $2.3bn loss over 3 months
31 Jan: Fed drops US interest rate for second time in 8 days
30 Jan: UBS bank hit by further $4bn loss
30 Jan: UK chancellor backs covert bank rescues
28 Jan: Switching en masse into cash & low-risk savings
28 Jan: Nikkei falls 4%, Shagnhai index 7%, FTSE 1.5%
27 Jan: Research says derivatives raise risk of bankruptcies
26 Jan: 10 hedge funds suspend redemptions after big losses
26 Jan: £15bn wiped off value of UK company pension schemes
25 Jan: Sovereign funds ($3 tril. & growing) mark shift in power
24 Jan: Futures trader loses French bank £3.6bn
23 Jan: BoE predicts higher inflation & borrowing costs
23 Jan: Abbey raises rates to 8% on 100% mortgages
22 Jan: Scottish Widows blocks withdrawals from property funds
22 Jan: Fed's emergency 0.75% interest rate cut feeds panic
22 Jan: Nb: FTSE 100% shares have fallen 20% since July 2007

21 Jan: Global shares dive - FTSE 100 by 5.4%, Dax by 6.8%

19 Jan: Bush prescribes across the board tax cuts
19 Jan: Economy turns nasty
18 Jan: UK Banks & building societies desperate for cash
18 Jan: The high street just had its worth Christmas in 13 years
18 Jan: Scottish Equitable blocks withdrawals from property fund
18 Jan: Downgrade of bond insurer Ambac spells write downs
17 Jan: "Repayment holiday" idea to reduce/delay debt agony
17 Jan: Merrill Lynch posts $7.8bn loss
16 Jan: FTSE100 & Nikkei 225 both fall 3% in a day
15 Jan: Citigroup - $22.2bn losses and 24,000 jobs may go
14 Jan: EMI to axe 2000 jobs
12 Jan: One of N.Rock's best portfolios sold to JP Morgan

12 Jan: Bank of America to buy stricken Countryside for $4bn
9 Jan: M&S shares dive 20% after poor xmas
8 Jan: "shadow banking" (credit derivatives) may lose $250 bn
7 Jan: Sound as a pound?

7 Jan: "witnessing the long-feared unwind of the carry trade"
5 Jan: Dow & FTSE 100 fall 2% as US unemployment hits '5%'
5 Jan: Furniture retailer's shares fall 48% after poor Christmas
4 Jan: Getting a mortgage or business loan just got harder
3 Jan: Estate agent jobs go - transactions drop 40% in 6 mths
3 Jan: Electrical & DIY retailers' shares fall after poor xmas
2 Jan: UK debt collection industry has trebled in size since 2003
1 Jan: Door step lending London Scottish bank short of capital
1 Jan: 2007 saw 6.1% drop in sterling vs basket of currencies

31 Dec: Shoe shops & clothing retailers hit by lower sales
30 Dec: $4.4bn from Singapore not enough for Meryll Lynch
28 Dec: Report predicts unemployment in UK will jump in 2008
21 Dec: Meryll Lynch seeks $5bn cash injection
21 Dec: Exodus from UK equity and commercial property funds

20 Dec: Morgan Stanley reports 1st quarterly loss in 73 years
19 Dec: €348bn ECB attempt to free up interbank lending
15 Dec: Citigroup forced to take on risks associated with 7 SIVs

15 Dec: Weak regs lent us here. Spencer's cure - weaker regs.
15 Dec: UK: Retailers slash 36% off prices to attract shoppers
14 Dec: Stanley, Lynch, Sachs: Outlook for 2008. Oh dear...
13 Dec: UK shares drop 3%. BoE sees risk of -ve "feedback loop"
12 Dec: $100bn attempt to free up interbank lending
10 Dec:11% stake in UBS bank sold to deal with $10bn loss
9 Dec: BoE interest rate cut fails to free up interbank lending

Graph: The difference between what the BoE says is the interest rate and the lending rate banks are prepared to offer each other. This suggests that perceived risk of defaults is at its highest for 10 years.
3 Dec: Interbank lending falls to £249bn from 640bn in Aug 07
30 Nov: BoE offers banks £10bn @ 5.75% as emergency funds
27 Nov: BoE Chief Economist - this is the tip of the iceberg
27 Nov: HSBC to refund $35bn to investors in dead SIV funds
23 Nov: Revealed: massive hole in Northern Rock's assets
23 Nov: Market for bonds used to insure loans grinds to a halt
21 Nov: UK interbank lending rate hits 2 mth high of 6.49%
15 Nov: Fed injects $47bn to prop up banks - most since 9/11
15 Nov: Barclays admits £1.3bn loss, HSBC allows for $3.4bn
15 Nov: BoE Governor predicts sharp fall in share prices
10 Nov: Value of UK banks has dived by £90bn in 9 months
8 Nov: GM's $39bn second biggest loss in US corporate history
7 Nov: Downgrades = 'crushing blow' to municipal bond market
6 Nov: Markets fear banks have $1 trillion in toxic debt
5 Nov: World's largest bank Citigroup must write off up to $11bn
25 Oct: UK banks are 'vulnerable'. They may face a £150bn bill
24 Oct: Merrill Lynch takes $8bn loss due to subprime CDOs

20 Oct: Dollar continues its descent against global currencies
18 Oct: Investment outflows from US were $163bn in August
16 Oct: $100bn fund aims to stop crash in mortgage securities

16 Oct: Are the triggers for a Wall Street crash back?
8 Oct: UK house price crash - quiet before the fall (2007)
8 Oct: IMF warns of economic slowdown
5 Oct: Vietnam & Qatar cut dollar reserves, Iran asks for euros

1 Oct: UBS bank announces $3.4bn losses and 1500 job losses
28 Sep: US internet bank collapses - Netbank is bankrupt

24 Sep: No buyers for £225bn of loans banks committed to?
18 Sep: BoE offers £4.4 bn. UK banks bid for 80% more!
18 Sep: Banking contagion costs Alliance & Leicester £1.2bn
18 Sep: Banking crisis: fear spreads beyond Northern Rock
18 Sep: Rock's shares have crashed to £2.82, from £12 in Feb
18 Sep: Northern Rock- first bank run in UK since 1866

19 Sep: Fears of dollar collapse as Saudis take fright

16 Sep: Bail-out implies 'threat to stability of financial system'

14 Sep: Worst crisis for 20 years, say banks
14 Sep: One man's debt is the whole world's burden
13 Sep: First the credit cruch... now the spending squeeze
13 Sep: UK Chancellor attacks banks' reckless lending
13 Sep: Dollar's retreat raises fear of collapse

11 Sep: Dollar hits fresh 15 year low
7 Sep: Dollar & US stocks tumble as huge credit crunch looms
6 Sep: Is China quietly dumping US treasuries?

4 Sep: It's costing more than base rate for banks to borrow!
4 Sep: Barclays urges BoE to bail out money markets
3 Sep: Fed urged to cut rates or face recession
2 Sep: There's no black hole at Barclays, insists boss
2 Sep: Credit turmoil 'has hallmarks of bank run'
29 Aug: China seeks higher return on $1.33 tn currency reserves
17 Aug: "Shares to fall further, banks will go bust"
15 Aug: Funds struggle to cope as investors dash for cash
14 Aug: CEO confidence at 5 year low
10 Aug : FTSE 100 fall is its worst in over four years
10 Aug: Market turmoil - views from the floor

10 Aug: World markets reel as contagion spreads
9 Aug: China threatens to trigger US dollar crash
9 Aug: Central banks bail out cash strapped lesser banks
6 Aug: The global stock markets meltdown is now underway
1 Aug : panic hits global markets - FTSE 100 drops further 2%
27 Jul: FTSE drops 3.2% - the worst one-day slide in 4 years
24 July: Anecdotal evidence that stock market crash is imminent
24 July: Morgan Stanley predict major stock market correction
23 July: Despair as money transfer firm collapses
19 July: Hedge funds have worrying sub-prime exposure?
9 July: Rating agencies hyped bonds backed by sub-prime
6 July: Shift of risk to pension funds fed reckless lending
29 June: Bank of England warns of risks of too leveraged lending
27 June: This boom has 80s echoes. We know how that ended
26 June: The trouble with interest-only mortgages
25 June: BIS warns of Great Depression dangers

20 June: Monetary Policy Committee figures it out (Sect. 14-16)