How cheap dresses and shoes led to the financial crisis

Fashion has never been cheaper.

Since 2000, the ratio of clothes and footwear prices to hourly earnings fell by almost 60 percent. Around half of that decline was due to the direct effects of lower prices; the other half came from higher nominal wages.

This chart illustrates this spectacular fall in the real price of clothing. It also demonstrates the extraordinary structural change that has occurred in the world economy over the last 10 years. There was a time, and it wasn't so long ago, that Britain had a textile industry. That industry has all but disappeared. Instead, all our clothes are produced overseas, mostly in East Asia, particularly in China.

Debt problems worse now than in 2008

UK house prices to fall another 13 percent

It has been a while since we saw such a cheery forecast for the UK property market.

Aug. 24 (Bloomberg) -- U.K. house prices will plunge another 12.7 percent before bottoming out, according to bond investors surveyed by Royal Bank of Scotland Group Plc.

Britain’s homes, which have already fallen 15 percent since October 2007, have further to fall, said 86.4 percent of respondents to RBS’s poll of mortgage-backed debt investors. The U.K.’s biggest bank controlled by the government distributed the result of the survey in an e-mail to clients on Aug. 21.

“General opinion was that U.K. housing has another down leg to take,” RBS said in the note.

RBS’s survey contradicts evidence U.K. real estate is starting to recover as the economy emerges from the worst recession in decades. House prices rose for a third month in July, according to Nationwide Building Society, while the Royal Institution of Chartered Surveyors said Aug. 6 that prices will increase this year, reversing an earlier prediction of a drop of as much as 15 percent.

Lets roll those loaded dice

There is something deeply disturbing about this chart. It shows that mortgage approvals have picked up over the last four months. While lending activity hasn't yet reached the levels seen during the bubble, there is no doubt that banks are returning to the housing market.

This chart is disturbing because mortgage lending is the only credit market that has seen a pick up in activity. Credit to the corporate sector is contracting. Firms are, on a net basis, actually paying loans back. Things aren't much better for consumers. Interest rate spreads on credit cards have actually increased, and consumer credit growth is close to zero.

So why are banks ready to return to the housing market and at the same time abandon other credit activities? Well, I have my answer. This is a classic case of moral hazard.

Regardless of what the government said in public, the recent bailout had only one objective in mind - put a floor under house prices. The liquidity support and the guarantees were all aimed at stabilizing the housing market. In effect, the government offered to insure banks and their property speculating clientele. The message from Brown and Darling is clear - "we will support house prices no matter how much it will cost".

Banks have picked up on this commitment. Bankers understand all too clearly that the government didn't offer any real support to corporate or consumer lending. Only property matters. Therefore, it is rational for banks to return to mortgage lending while at the same time, cut back on other credit activities.

With this huge de facto insurance contract in their back pocket, banks are cranking up another housing bubble, and it is happening with the financial support of the taxpayer. Moreover, as recent RICS data suggests, there is army of potential house buyers out there ready to dive in and speculate again on property prices.

It is the rational response. After all, we have a government that is ready to guarantee that no one will lose if they speculate on housing. If there are any losses, the government will ensure that the hapless taxpayer will pick up the bill.

US real estate lending growing at 6.4 percent

There are many occasions when I wonder just how serious was this credit crunch. Here is a good example - US real estate lending by banks.

This chart tracks the annual change in real estate lending. Currently, it is running at about 6.4 percent. Moreover, at no time did it ever actually decline. As such, it was always possible for US borrowers with good credit ratings to get new mortgages.

We can't keep spending like this.....

During the boom years, Brown boosted public expenditure dramatically. Between 2004-8, New Labour increased the budget by 28 percent. In 2005 alone, the budget increased by over 8.1 percent.

When the economy was growing at 3 percent, Brown could plausibly argue that these increases were affordable. Today, he has no such defence. The economy is shrinking, yet New Labour have just kept on spending. This year, the government plans to increase expenditure by a staggering 6.5 percent, while next year, it will grow by a scarcely credible 8.2 percent.

The UK economy simply can not afford these extraordinary increases in public expenditure. Something has to give, and come the next election, it is likely to be Brown. The UK electorate simply will not stand for this kind of wanton recklessness.

US home sales are flat

Flat as in pancake....

To fix or not to fix

Fixed rate versus floating rate mortgages - which would you choose?

Being a renter, this isn't a question that holds my attention.

However, I do detect a treacherous little uptick in recent mortgage rates.

It wasn't our fault

Adam Posen's candidature for the MPC is currently being reviewed in parliament. However, his evidence to the Treasury sub-committee should be sufficient to disqualify him having any influence over UK monetary policy.

Clearly, he doesn't understand the current financial crisis. Apparently, the Bank of England got it right all along...

It is important to recognize, though, that those failures on the financial stability side were not the result of inflation targeting or of central bank independence. The rise of the bubbles in the UK and elsewhere were driven by a combination of regulatory and supervisory failures with structural factors not entirely under UK policymakers’ control.

In fact, the continued anchoring of inflation expectations above zero under the current circumstances, without tipping either into deflation or being pressured upwards by temporary large public deficits, represents a triumph of the inflation targeting regime of the Bank of England.

Both the direct economic outcomes of the current crisis would have been worse, and the ability to respond with macroeconomic stimulus would have been far more limited, had this system of control over UK monetary policy not been in place.

This is classic public sector blame-shifting and evasion. First, he points the figure at regulatory failure, which means the FSA. Then, he uses the old unprovable counter factual - "things would have been much worse if we hadn't acted".

The plain fact is that the Bank of England controlled interest rates. For far too long, rates were too low, and this encouraged a speculative bubble that almost destroyed the financial system. True, the FSA are deeply implicated, but inflation targeting was a disastrous policy regime that pushed us into our current calamitous predicament.

The classic green shoot chart

Apparently, the US consumer is starting to cheer up, at least according to the University of Michigan sentiment index. However, the improvement seems to be from "suicidal" to "severely depressed". Based on this sorry little uptick, it is doubtful that the consumer will rescue the US economy any time soon.

I choose freedom

When you look at long term credit data, you begin to understand the revolution in personal finance that took place in the last thirty or so years.

Back in the early 1960s, private credit was less than 16 percent of GDP. By 2007, it was over 170 percent. It is an historically unprecedented increase in personal indebtedness. GDP measurs our national income, which ultimately determines our capacity to repay debt. So this data tells us that our debt burden, which expressed in terms of income, has increased ten-fold.

To put it mildly, the data sems to suggest that we have become a nation of debt serfs. The vast majority of households, it would appear, are totally beholden to the bankers.

But not me. I proudly declare that I have no debts. The relevant number is zero. You won't find me in that chart. I have no credit card debt and no mortgage. Overdrafts are banned in the Cook household. Everything we have belongs to us. We deal in cash, and not credit.

I don't know about the rest of you but I choose freedom over serfdom.

Another beautiful chart

This financial crisis has produced some wonderful charts. Recent numbers either dive to the depths or reach for the sky.

I particularly like this one. It illustrates loan loss reserves of US banks. The reserves are expressed in terms of total loans.

The chart tells us two things. During the boom years, banks ran down the spare cash they put away to cover bad loans. Just before the crisis they were putting away barely one percent of their total loans.

Then, along comes the crisis and banks suddenly realise that they don't have enough reserves. Everything goes into reverse, and banks start accumulating reserves like crazy.

I reckon this number can only go higher. Soon, it will exceed the previous highs in the late 1980s, and hit an all time high.

Green shoots?

From the American Bankers Association:

A record wave of job losses is being cited as a major factor in a record rate of consumer delinquencies in the first quarter of 2009, according to the American Bankers Association’s Consumer Credit Delinquency Bulletin.

More than two million Americans lost their jobs in the first three months of the year with more than 6 million jobs lost since the recession began. The composite ratio, which tracks delinquencies in eight closed-end installment loan categories, rose to 3.23 percent of all accounts (seasonally adjusted) compared to 3.22 percent of all accounts in the previous quarter.

The delinquent balances on those accounts also rose from 3.16 percent to 3.35 percent of total balances due (not seasonally adjusted). The ABA report defines a delinquency as a late payment that is 30 days or more overdue.

What is going wrong with corporate lending?

Government guarantees, bank recapitalisations and quantitative easing might do the trick for mortgage lending. However, corporate lending is still in the doldrums. There is no big credit expansion here. Gross lending has not increased, while existing credit lines continue to be withdrawn.

Why? Even during the boom, UK Banks didn't like lending long-term to UK firms. It is an aversion that goes back well over a century. Back in the late 19th century, banks preferred to finance trading activities. More recently, personal credit and mortgages have been the preferred option.

The quality of collateral is always a problem with firms. In the event of a default, it is always much easier to sell off a repossessed home rather than a warehouse full of widgets.

This raises a troubling question for the current "boost credit at all costs and inflate the deficit" strategy of New Labour. Lets start with the deficit. Everyone knows it is far too big. We also know that there will be massive expenditure cuts once the election is over next year. This means that in the second half of 2010, the UK will almost certainly hit another recession. Therefore, the Banks are being very prudent avoiding the corporate sector.

Monetary policy is also an incoherent mess. The central bank claims it is trying to prevent deflation, yet inflation has been above target throughout this crisis. It has tried to lower interest rates by printing money. However, financial markets had other ideas. Reflecting higher inflationary expectations, long term rates are beginning to creep up. And despite all the monetary innovations and experiments, credit to the corporate sector is still weak.

A better strategy would be to return to economy to a path that ensures macroeconomic stability. This means cutting the deficit and putting an end to the zero-rate monetary madness of the Bank of England. The corporate sector needs long term stability, not short term fixes that New Labour think will help them during the next election.

Some things never change

For example, credit card interest rates.

Despite the massive reduction in the BoE's bank rate, credit card companies are still charging, on average, over 12 percent interest rates.

It is a good thing; the higher the better. Hopefully, it will discourage people from taking on credit card debt.

Make money in commercial real estate

Remind me again, what is happening to commercial real estate prices right now?

Spot the flaws in this short youtube clip...

UK mortgage market improves slightly

Here is some tentative evidence that mortgage lending conditins might be improving slightly. The number of mortgage applications increased sharply in March, while the mortgage acceptance rate increased marginally (from 73.1 percent to 74.2 percent).

Nevertheless, there are no signs of an early return to 100 percent mortgages with income ratios of 5 or more. I am not sure that the improving lending conditions signal a return to the crazy days of 2006.

Consumer interest rates unchanged

You won't see much evidence of the MPC's recent dramatic rate cuts in consumer interest rates. In fact, rates on personal loans, credit cards and overdraft have remained more or less constant for years.

I don't have much of a problem with that. Consumer lending is a risky business, with very default rates. Banks need to charge high rates to recover these losses.

But lets face it; personal credit is a mugs game. People who take out personal loans and actually pay them back are, in effect, subsidizing spending for those who default on their loans.

That is why it is better to avoid personal credit altogether.

US economy begins to deflate?

The headline US inflation rate is now in negative territory. So has the US economy fallen into the dreaded deflationary pit?

Strip out energy prices and inflation is firmly in positive territory. Since the crisis began, it has hardly changed at all.

Pure subprime

I picked up this mortgage ad from Soot and Ashes. It is for subprime loans from the US lender Countrywide. Once the US housing crash took hold, Countrywide quickly ran into trouble and was eventually absorbed by Bank of America.

This ad screams out bank failure. Countrywide were happy giving out housing loans to people who were heavily in debt, who could not come up with deposits and who could not verify their incomes. That was the template for an exploding bad loans problem.

Crazy stuff.