Optimism gets mugged in the dark alley of reality. UK banks, especially the retail ones, are still in trouble.
LONDON (Reuters) - Britain's banks are likely to see their battered retail arms slide to a loss in the second half of 2009, as the cost of bad loans, tough competition and wholesale funding continues to weigh, a survey by accountants KPMG found.
"Retail banking is just profitable at lower levels, but with rising impairments. It seems probable that it will fall into loss making in the second half of this year," KMPG said in its UK Banks Performance Benchmarking Survey on Wednesday.
David Sayer, head of retail banking for KPMG's advisory practice, said he was "slightly pessimistic" about the second half, though banks' retail losses could reverse in early 2010.
"It's not a catastrophic shift, but if you are slightly pessimistic on house prices, if you believe there is a lagged effect on unemployment, and therefore you believe bad debts on credit cards and personal loans will rise, then you believe a marginal profit will become a marginal loss," he said.
Showing posts with label price-to-income ratio. Show all posts
Showing posts with label price-to-income ratio. Show all posts
Wednesday, August 26, 2009
Thursday, April 23, 2009
False choices; irrelevant counter factuals
Just before Alistair Darling finished his budget speech yesterday, he made the following supremely fatuous comment:
You can grow your way out of recession. You cannot cut your way out.
The first statement was an oxymoron. If an economy is growing, then it's not in recession. If it is in recession, then it's not growing. The second statement is just plan wrong. If an economy has a large public sector, which crowds out and weakens the private sector, then cutting public expenditure will stimulate growth.
In the mid-1980s, the Irish government provided an excellent example of the merits of public expenditure cuts as a pro-growth strategy. After a decade of appalling fiscal deficits, it introduced a highly successful expenditure reduction programme, which re-established long run fiscal sustainability, and laid the basis for 10 years of solid economic growth. In fact, the Irish experience introduced a new concept - the expansionary fiscal contraction. Of course, the Irish ruined everything by pumping up a huge and unsustainable housing bubble, but that is another story.
However, this is not my main objection to Darling's foolish play on words. He displayed the typical New Labour tactic of posing an irrelevant question in order to deflect from the root of our economic difficulties - debt. Darling wants to distract us from New Labour's continuing contribution to the UK's horrific debt levels.
Households and firms owe too much, while the banks have too many loans that are unlikely to be repaid. Rather than go through the painful process of unwinding this debt, which necessarily involves an deep recession, Darling thinks he can escape the consequences of New Labour economics. The answer, absurdly, is more debt. The public sector, he believes, can take over as the borrower of last resort, and keep the economy growing. He has co-opted the Bank of England, who have obligingly cut interest rates to almost zero.
Eighteen months into this crisis, and this strategy has failed miserably. The economy has already slipped into a nasty downturn, while unemployment is rising. Darling would no doubt argue that things would be so much worse if the government hadn't stepped in, raised borrowing and kept aggregate demand high. This brings us to the second highly dubious tool of the discredited politician - the counter factual. "Things are bad, but there would be so much worse without me."
Indeed, the situation is bad, and Darling made it worse with his reckless budget yesterday. Even under the best case scenario, New Labour has bequeathed this country a decade of historically unprecedented fiscal problems. In the worst-case scenario, the UK could be slipping towards a fiscal crisis, where financial markets question the long run solvency of the UK government and refuse to finance this profligacy.
You can grow your way out of recession. You cannot cut your way out.
The first statement was an oxymoron. If an economy is growing, then it's not in recession. If it is in recession, then it's not growing. The second statement is just plan wrong. If an economy has a large public sector, which crowds out and weakens the private sector, then cutting public expenditure will stimulate growth.
In the mid-1980s, the Irish government provided an excellent example of the merits of public expenditure cuts as a pro-growth strategy. After a decade of appalling fiscal deficits, it introduced a highly successful expenditure reduction programme, which re-established long run fiscal sustainability, and laid the basis for 10 years of solid economic growth. In fact, the Irish experience introduced a new concept - the expansionary fiscal contraction. Of course, the Irish ruined everything by pumping up a huge and unsustainable housing bubble, but that is another story.
However, this is not my main objection to Darling's foolish play on words. He displayed the typical New Labour tactic of posing an irrelevant question in order to deflect from the root of our economic difficulties - debt. Darling wants to distract us from New Labour's continuing contribution to the UK's horrific debt levels.
Households and firms owe too much, while the banks have too many loans that are unlikely to be repaid. Rather than go through the painful process of unwinding this debt, which necessarily involves an deep recession, Darling thinks he can escape the consequences of New Labour economics. The answer, absurdly, is more debt. The public sector, he believes, can take over as the borrower of last resort, and keep the economy growing. He has co-opted the Bank of England, who have obligingly cut interest rates to almost zero.
Eighteen months into this crisis, and this strategy has failed miserably. The economy has already slipped into a nasty downturn, while unemployment is rising. Darling would no doubt argue that things would be so much worse if the government hadn't stepped in, raised borrowing and kept aggregate demand high. This brings us to the second highly dubious tool of the discredited politician - the counter factual. "Things are bad, but there would be so much worse without me."
Indeed, the situation is bad, and Darling made it worse with his reckless budget yesterday. Even under the best case scenario, New Labour has bequeathed this country a decade of historically unprecedented fiscal problems. In the worst-case scenario, the UK could be slipping towards a fiscal crisis, where financial markets question the long run solvency of the UK government and refuse to finance this profligacy.
Tuesday, April 21, 2009
The end of the big LTV mortgage
Anyone who wants to buy a house today needs to come to the market with a huge deposit. A year ago, around 60 percent of mortgage products offered customers the opportunity to borrow 90 percent or more of the house price. Today, that figure is a litte over seven percent.
Tuesday, March 10, 2009
Alice's bubble wrap
The Case against Twitter
Guido Fawkes takes on Twitter: "The idea that it is some kind of revolutionary form of social media interaction is laughable".
Credit cards are the next credit crunch
If you have one, cut it up right now. Get a debit card instead.
More Debt Won’t Rescue The Great American Ponzi
It won't rescue the UK Ponzi scheme, either.
Japan at 26-year low
Japanese stocks hit a 26-year low on the announcement of the country's first current account deficit in more than a decade.
Have Pensions Succumbed to Casino Capitalism?
You need to ask?
Citigroup: Posted a Profit? Surely That Can't Be
The Financial Ninji calls for a reality check on Citi.
Sell them gilts, buy them gilts, sell them gilts
The government sells debt; the Bank of England buys that debt. Doesn't the government own the Bank of England?
Where Were The Media As Wall Street Imploded?
There are plenty of people to share the blame for the collapse of the nation's financial system. Greedy speculators, mortgage executives and banking chiefs; pliant credit rating agencies; and absentee government regulators come to mind. But what about the self-described watchdogs in the media?
Hanging On, or How to Get Through a Depression and Enjoy Life
Denial might be the best strategy.
Guido Fawkes takes on Twitter: "The idea that it is some kind of revolutionary form of social media interaction is laughable".
Credit cards are the next credit crunch
If you have one, cut it up right now. Get a debit card instead.
More Debt Won’t Rescue The Great American Ponzi
It won't rescue the UK Ponzi scheme, either.
Japan at 26-year low
Japanese stocks hit a 26-year low on the announcement of the country's first current account deficit in more than a decade.
Have Pensions Succumbed to Casino Capitalism?
You need to ask?
Citigroup: Posted a Profit? Surely That Can't Be
The Financial Ninji calls for a reality check on Citi.
Sell them gilts, buy them gilts, sell them gilts
The government sells debt; the Bank of England buys that debt. Doesn't the government own the Bank of England?
Where Were The Media As Wall Street Imploded?
There are plenty of people to share the blame for the collapse of the nation's financial system. Greedy speculators, mortgage executives and banking chiefs; pliant credit rating agencies; and absentee government regulators come to mind. But what about the self-described watchdogs in the media?
Hanging On, or How to Get Through a Depression and Enjoy Life
Denial might be the best strategy.
Friday, June 13, 2008
Fools rush in
Although house prices began to weaken last summer, the BTL brigade didn't get the message. In the last six months, landlords have taken out over 94,000 new loans - 49,000 since the beginning of the year.
This was not the only number going up; BTL mortgages in arrears is also rising. Currently, almost one BTL mortgage in 100 is at least three months in arrears.
This was not the only number going up; BTL mortgages in arrears is also rising. Currently, almost one BTL mortgage in 100 is at least three months in arrears.
Sunday, May 18, 2008
The mood is turning ugly
Yesterday, the Daily Express told us that the housing crash was over. Today, we hear from the Times and the Observer that the middle classes are drowning in debt and the "love affair" with real estate is over.According to the Observer, debt advice agencies are seeing a "new type of customer - the cash-strapped middle income family". The backbone of Middle England went a little crazy at the high Street bank. Those cheap teaser interest rates were just too attractive; forms were filled out, money was dished out, and far too many consumer durables were purchased. Now, it is payback time, and people just can't cope. Suddenly, it is boom time for debt advice agencies in those dainty little English towns like Tunbridge Wells, Cambridge and Horsham.
Ironically, it is those typical working-class concerns that are now pushing the middle classes over the edge. Big increases in food and utility costs are starting to financially stretch middle-class budgets. With income and wealth polarising in the UK, maybe we are all becoming working-class now.
Middle-class anxiety will not be soothed by today's article in The Times. Six months behind the news, the Times reports that "the consensus has it that the housing boom is over."
Unfortunately, the Times was too blinded by advertising revenues to see the turning point. All the major house price indicators suggest the market turned somewhere between August and October last year. Perhaps, its clarity of vision today comes from a sudden drop-off in calls from developers anxious to promote their latest two bedroomed apartment project in south London.
Whatever the reason, The Times has finally found the housing crash, and thinks it will have a profound effect on the way we see the world. "Downturn, correction, bust: whatever the name, the present situation may even be causing many Britons to question the very structure of home ownership in the UK". Does this mean some of us might prefer to rent and be free rather than buy and live like a serf?
Friday, May 16, 2008
Running for cover
Credit availability is crumbling. Not only are banks pushing up interest rates on high loan to value products, they are also removing the number of loan products available to customers.The most recent Bank of England inflation report pointed out that since the credit crunch began, the number of credit impaired mortgage products has fallen by 75 percent. The number of self-certification mortgage products has also taken a dive, falling by two thirds between February and April this year. The infamous 100 percent LTV loan products have disappeared completely.
Declining credit availability will have a devastating effect on the housing market. Last year, around 30 percent of new lending was to individuals with LTV ratios greater than 90 percent. Another 20 percent of lending went to customers with LTV ratios of between 80-90 percent. These high-risk borrowers are now finding it almost impossible to find banks willing to lend.
Easy credit drove this market into an unsustainable bubble; declining credit availability will destroy it.
Wednesday, May 14, 2008
Mortgage approvals take a dive
Yesterday, the Council of Mortgage Lenders published data on the number of new mortgages. However, the bad news from the banks was buried beneath yesterday's terrible inflation numbers.They can run, but they can't hide. Here is a picture of the sorry tale coming from the house lending business. The number of new mortgage approvals is way down. Moreover, the number appears to have reached a dismal plateau of about 40 thousand a month. Normally, January and February are quiet months in terms of lending activity, whith things picking up in March. Not so this year. The March number is actually a fraction lower than February.
Remember the golden rule of real estate - the supply of credit determines house prices. No credit equals a housing crash.
Thursday, May 8, 2008
The FSA discovers excessive concentration
If the UK slips into a systemic banking crisis, we won't be short of people to blame. Top of the list of guilty institutions will be the FSA. Since the FSA took control of financial sector regulation back in 1997, banks and building societies have run amok. At times, the FSA's lack of capacity and judgement reaches almost comical proportions.
The FSA's naivety was again on public display this week. Hector Sants, chief executive of the FSA,was guest speaker to the Building Societies Association's annual conference. He took the opportunity to "warn" his audience about the dangers of "excessive concentration in the buy to let market."
Over the last ten years, the number of buy to let mortgages has risen from a smidgen above zero to over one million. The time to warn about "excessive concentration" was about five years ago, just as the market was taking off and it became obvious that banks and building societies were taking on a potentially dangerous level of risk. Warning the building societies today, when they are struggling with liquidity and rapidly depreciating collateral is just a little too late.
His wisdom didn't stop at warning about "excessive" lending concentration in housing speculators. Saints also gave the building societies some advice on funding strategies. He took particular aim at building societies' over dependence on the wholesale market for funding liabilities. "If wholesale funding is being utilised, it should be in a proportionate manner and the overall funding model sensibly diversified. In particular, the wholesale component should be diversified in term and maturity."
Hello!!! Is there anyone in there? It is the FSA's job to ensure that the financial sector has appropriate liability management. The FSA should be monitoring key financial sector indicators like maturity structure, credit and default risk. When banks step out of line, it is the FSA's job to hammer them with fines.
The FSA isn't an advisory service for the financial sector. The FSA should regulate these institutions. It should protect the rest of society from dangerous risk taking by greedy banks, blinded by the profit motive. It needs to prevent banks from pushing out loans to individuals who have a high propensity to default. It needs to ensure that banks behave.
It is time to call a halt the FSA. Financial sector regulation should be returned to the Bank of England. Mr. Saints should be cut loose from the public sector and allowed to pursue a career more suited to his talents, which appears to be some kind of low level management consultant working within the retail banking sector. It is time we had a financial regulator that knew what it was doing.
Thursday, May 1, 2008
How much is enough
If I could put one question to the banks it would be "how much debt can UK households take on before they think it is a problem?"
Current debt levels are staggering. As of January this year, the ratio of total household debt to post-tax income was 167 percent. Since 2000, this ratio has risen by about 60 percentage points. This is a huge, historically unprecedented increase. We have become a nation of debtors.
Mortgage debt accounts for the greater part of this increase. In January this year, debt secured on housing accounted for about 75 percent of the total.
Until recently, the housing bubble was the great factory of debt. It was a simple production process; banks provided the credit, which increased effective demand for housing. As people used this credit, house prices inflated. People then began to believe that prices could only go one way. They demanded more credit; the Banks provided it; and prices went up further.
Last summer, debt production ground to a halt, at least in the housing sector. Banks went on strike and as soon as debt factory stopped, house prices began to tumble.
However, it is not just housing debt that has been increasing. Unsecured debt - mainly credit cards - is also on the rise. Again, in terms of household post tax income, unsecured debt is up around 10 percentage points since the beginning of the decade.
I look at these debt numbers and three thoughts enter my mind.
The first is a sense of detachment. These numbers have nothing to do with me. I have no debt, and my personal finances simply have no connection to this deeply troubling vista. Moreover, I know some people who, like me, have avoided personal debt. So, these debts are concentrated in some but not all of UK households. This suggests that on a personal level, these debt numbers understate the problem.
However this sense of detachement is limited. I know plenty of people struggling to cope with debt. Within my circle of family and friends, those who went down the rocky road of debt found only misery and unhappiness. Debt ruined their peace of mind. It raised stress levels and just brought unnecessary financial pressure. It also prompted a lot of futile consumption, as if a flat screen TV could make debt worries disappear.
Second, these debt levels look like modern form of serfdom. Debt limits one's options, it compromises one's independence. It forces people into crappy, marginally better paid jobs, just to pay off the banks. When you owe debt; the bank owns you.
Finally, the overall magnitude of personal debt is now so great that it has distorted economic policy. Rather than pursuing the objective of low inflation, which would require significantly higher interest rates than we have now, the bank of England have cut rates. Low rates are necessary because commercial banks could not absorb even a modest increase in household default rates.
This brings me back to my original question; how much more debt could UK household possibly accept? Would the banks be happy if the ratio of household debt to income crept up to 180 percent? Would they feel comfortable if it tipped 200 percent? Could the banks live with a 220 percent ratio?
Perhaps the question should be how much debt are we willing to accept from the banks? Over the last decade, households have taken on too much. Perhaps the credit crunch is a blessing in disguise. It may begin a process where household debt levels begin to fall to lower and more sustainable levels.
Current debt levels are staggering. As of January this year, the ratio of total household debt to post-tax income was 167 percent. Since 2000, this ratio has risen by about 60 percentage points. This is a huge, historically unprecedented increase. We have become a nation of debtors.
Mortgage debt accounts for the greater part of this increase. In January this year, debt secured on housing accounted for about 75 percent of the total.
Until recently, the housing bubble was the great factory of debt. It was a simple production process; banks provided the credit, which increased effective demand for housing. As people used this credit, house prices inflated. People then began to believe that prices could only go one way. They demanded more credit; the Banks provided it; and prices went up further.
Last summer, debt production ground to a halt, at least in the housing sector. Banks went on strike and as soon as debt factory stopped, house prices began to tumble.
However, it is not just housing debt that has been increasing. Unsecured debt - mainly credit cards - is also on the rise. Again, in terms of household post tax income, unsecured debt is up around 10 percentage points since the beginning of the decade.
I look at these debt numbers and three thoughts enter my mind.
The first is a sense of detachment. These numbers have nothing to do with me. I have no debt, and my personal finances simply have no connection to this deeply troubling vista. Moreover, I know some people who, like me, have avoided personal debt. So, these debts are concentrated in some but not all of UK households. This suggests that on a personal level, these debt numbers understate the problem.
However this sense of detachement is limited. I know plenty of people struggling to cope with debt. Within my circle of family and friends, those who went down the rocky road of debt found only misery and unhappiness. Debt ruined their peace of mind. It raised stress levels and just brought unnecessary financial pressure. It also prompted a lot of futile consumption, as if a flat screen TV could make debt worries disappear.
Second, these debt levels look like modern form of serfdom. Debt limits one's options, it compromises one's independence. It forces people into crappy, marginally better paid jobs, just to pay off the banks. When you owe debt; the bank owns you.
Finally, the overall magnitude of personal debt is now so great that it has distorted economic policy. Rather than pursuing the objective of low inflation, which would require significantly higher interest rates than we have now, the bank of England have cut rates. Low rates are necessary because commercial banks could not absorb even a modest increase in household default rates.
This brings me back to my original question; how much more debt could UK household possibly accept? Would the banks be happy if the ratio of household debt to income crept up to 180 percent? Would they feel comfortable if it tipped 200 percent? Could the banks live with a 220 percent ratio?
Perhaps the question should be how much debt are we willing to accept from the banks? Over the last decade, households have taken on too much. Perhaps the credit crunch is a blessing in disguise. It may begin a process where household debt levels begin to fall to lower and more sustainable levels.
Tuesday, April 29, 2008
Mortgage approvals are falling
Before we dive into the usual hyperbole that characterizes this blog, I thought it might be useful to take a longer term perspective on today's mortgage approvals data. The Bank of England website offers data going back to April 1993. Today's number - 64 thousand was the lowest in that admittedly limited data set. The previous lowest was 69 thousand back in June 1995.So, today's number is bad. In fact, it is badder than bad. It is awful. Lenders have abandoned the market. In fact, there is a whiff of desperation in the air as one lender after another have tightened their lending conditions.
It is hard to overestimate the importance of the mortgage approvals number. While it is true that some houses are bought with cash, the housing market needs mortgages like the rest of us need air. If there is no credit, the housing market seizes up. That is what is happening right now across the UK.
How far will prices fall? I have a rather modest forecast. I reckon house prices will fall by around 9 percent from the peak within a twelve month period. After that, I expect them to fall further still. Over the medium term, a 20-30 percent drop seems reasonable, though I wouldn't be surprised to see prices fall even further.
Tuesday, February 5, 2008
UK price to earnings ratio at an all time high
(click on the chart for a larger image)The UK house price to earnings ratio has actually fallen marginally in the last months of 2007. House prices are now crashing; they are already down almost 5 percent since July 2007. However, prices will need to fall much further before the price to earnings ratio reaches its long term equilibrium level.
Wednesday, December 12, 2007
Location, Location, Location
Go on, admit it; you would just love to join Kirstie and Phil and have your home featured on Channel 4's property-pumping show "Location, Location, Location".
Well, the UK housing bubble blog can show you the way, just click here and register.
Here is the sales pitch from the website:
"Channel4's top-rating property programme wants to help you in your search for the perfect home. To do this we are seeking house hunters who would appreciate expert opinion and advice from professional property hunters Kirstie Allsopp and Phil Spencer on what and where to buy in your desired area. The show will focus on the process of your search. It will be a frank and factual account of all the negotiations.
We need to be sure that everyone we are talking to has genuine intentions to move house and are in a position to do so (i.e are sold/under offer and chain free). Please read all questions carefully and ensure your responses are detailed. We want to find out as much about you as possible - who you are and what you are looking for. What may seem trivial to you may be just what we are looking for.
We really can help people to find their dream home as the service that Kirstie and Phil provide is second to none. If you want to take part in this fantastic show, and are ready to place an offer on a new home, then begin your application now!"
You just have to admire the cynicism: "Channel 4's top-rating property programme wants to help you" and "We really can help people to find their dream home". Lets not forget that "the service that Kirstie and Phil provide is second to none".
Do you think Channel 4, Kirstie and Phil would want to help me with my rent. Why aren't there any shows about people looking for new rental properties? Why doesn't Channel 4 have a programme called "rent, rent, rent".
I think I know the answer. Property programs like this one, appeal to the base activities and instincts such as greed, speculation and misrepresenting the truth. In contrast, renters today understand this this housing market is a con and a fraud perpetrated on vulnerable and gullible people. Renters are too smart to be taken in by the likes of Kirstie and Phil with their fairy stories of easy money coming from housing speculation.
Here is the sales pitch from the website:
"Channel4's top-rating property programme wants to help you in your search for the perfect home. To do this we are seeking house hunters who would appreciate expert opinion and advice from professional property hunters Kirstie Allsopp and Phil Spencer on what and where to buy in your desired area. The show will focus on the process of your search. It will be a frank and factual account of all the negotiations.
We need to be sure that everyone we are talking to has genuine intentions to move house and are in a position to do so (i.e are sold/under offer and chain free). Please read all questions carefully and ensure your responses are detailed. We want to find out as much about you as possible - who you are and what you are looking for. What may seem trivial to you may be just what we are looking for.
We really can help people to find their dream home as the service that Kirstie and Phil provide is second to none. If you want to take part in this fantastic show, and are ready to place an offer on a new home, then begin your application now!"
You just have to admire the cynicism: "Channel 4's top-rating property programme wants to help you" and "We really can help people to find their dream home". Lets not forget that "the service that Kirstie and Phil provide is second to none".
Do you think Channel 4, Kirstie and Phil would want to help me with my rent. Why aren't there any shows about people looking for new rental properties? Why doesn't Channel 4 have a programme called "rent, rent, rent".
I think I know the answer. Property programs like this one, appeal to the base activities and instincts such as greed, speculation and misrepresenting the truth. In contrast, renters today understand this this housing market is a con and a fraud perpetrated on vulnerable and gullible people. Renters are too smart to be taken in by the likes of Kirstie and Phil with their fairy stories of easy money coming from housing speculation.
Monday, December 3, 2007
Pleading and Begging
The demands for an interest rate cut are growing. Financial markets are "seizing up" again, credit lines are closing down, and asset prices, particularly housing, are beginning to slide. Banks, newspapers, homeowners, and speculators are now looking to the Bank of England for a helping hand. "If only interest rates could come down 0.25 percent", so the pleading goes "everything would be resolved". Banks would begin lending to each other, house prices would stop falling, and a recession would be avoided.
If only it were that easy. Sit back and ask the following question - how did we get into this mess? It all started about five years ago when the Bank of England started to print more money than it should have. This easy money found its way into the housing market, and prompted an unsustainable rise in property prices.
The Bank of England were not alone. Other central banks, most notably the Federal Reserve in America, were at the same game. In Spain, Ireland, Eastern Europe, and Australia, house prices were rising at an unsustainable rate due to an unprecedented relaxation of lending standard and an environment of historically low interest rates. In the frenzy that followed, banks extended loans to people who had no real prospect of repaying.
The bubble wasn't just contained within the property market. Easy credit and low interest rates encouraged people to consume more and save less. Rising consumption may have kept the economy growing, but at the expense of ever rising levels of personal debt.
Of course, this could not go on forever. At some point, the banks began to realise that a large proportion of their customers did not have the income to sustain the growing levels of personal indebtedness. Everyone knows that there are piles of worthless credit agreements sitting on the balance sheets of the banking sector. Now, banks are scrambling for cash, to ensure that they don't follow the sorry path that Northern Rock took the summer. At least for the present, cash is king and no sensible bank will risk lending to bail out any other cash-strapped competitor.
Here in lies the problem. An interest-rate cut won't help much if many the customers are ready effectively bankrupt and cannot repay you. At the margin, it might prevent one or two of your more sensible clients from defaulting. However, the relief will be limited and temporary. Furthermore, there is a selection problem that interest-rate cut won't help resolve. Any bank looking for short-term loan runs the risk of admitting that it has serious funding problems. Any bank asking for credit right now is almost certainly a bank that other banks should avoid.
What would happen if the Bank of England succumbed to all this pressure and cut rates? Households would probably go on another credit card driven spend fest over Christmas. Perhaps house prices might stabilise for a few months. Higher demand for consumer goods would probably keep inflation boiling over. However, by February or March, all the underlying problems would remain. Inflation would be red hot and rising, personal sector indebtedness would be higher, and house prices would still need to come down. Perhaps more importantly, banking sector balance sheets would still be in poor shape.
Here, the United States provides a telling example. During the summer, the credit crunch reduced interbank lending. Short-term interest rates increased suddenly, and many banks and financial institutions were scrambling for cash.
In a moment of panic and desperation, the Federal reserve cut interest rates by 0.5 percent. For a time, the liquidity crisis subsided. However, nothing fundamentally changed. The banks were still carrying large amounts of bad debts. After the euphoria of the interest-rate cut, doubts began to creep back in. The credit crunch returned. Short-term interest rates again are rising, and the Federal reserve are threatening a further interest rate cut.
The lesson from the US is clear. Lower interest rates can only provide an illusion that the credit crunch has been resolved. However, all those bad debts and unpaid loans are still there. There is no easy way out of this mess. It would be better to face up to the problems we now face.
Higher interest rates will discourage consumption, people will again have an incentive to save, and house prices will return to more reasonable levels. Lower consumption will probably result in a slowdown in growth. The banks need some time to work off all those bad loans. It will be a difficult time. However, if the Bank of England recklessly cuts rates, it will only delay the moment of truth. All our problems will will grow, and we won't avoid the need for adjustment.
If only it were that easy. Sit back and ask the following question - how did we get into this mess? It all started about five years ago when the Bank of England started to print more money than it should have. This easy money found its way into the housing market, and prompted an unsustainable rise in property prices.
The Bank of England were not alone. Other central banks, most notably the Federal Reserve in America, were at the same game. In Spain, Ireland, Eastern Europe, and Australia, house prices were rising at an unsustainable rate due to an unprecedented relaxation of lending standard and an environment of historically low interest rates. In the frenzy that followed, banks extended loans to people who had no real prospect of repaying.
The bubble wasn't just contained within the property market. Easy credit and low interest rates encouraged people to consume more and save less. Rising consumption may have kept the economy growing, but at the expense of ever rising levels of personal debt.
Of course, this could not go on forever. At some point, the banks began to realise that a large proportion of their customers did not have the income to sustain the growing levels of personal indebtedness. Everyone knows that there are piles of worthless credit agreements sitting on the balance sheets of the banking sector. Now, banks are scrambling for cash, to ensure that they don't follow the sorry path that Northern Rock took the summer. At least for the present, cash is king and no sensible bank will risk lending to bail out any other cash-strapped competitor.
Here in lies the problem. An interest-rate cut won't help much if many the customers are ready effectively bankrupt and cannot repay you. At the margin, it might prevent one or two of your more sensible clients from defaulting. However, the relief will be limited and temporary. Furthermore, there is a selection problem that interest-rate cut won't help resolve. Any bank looking for short-term loan runs the risk of admitting that it has serious funding problems. Any bank asking for credit right now is almost certainly a bank that other banks should avoid.
What would happen if the Bank of England succumbed to all this pressure and cut rates? Households would probably go on another credit card driven spend fest over Christmas. Perhaps house prices might stabilise for a few months. Higher demand for consumer goods would probably keep inflation boiling over. However, by February or March, all the underlying problems would remain. Inflation would be red hot and rising, personal sector indebtedness would be higher, and house prices would still need to come down. Perhaps more importantly, banking sector balance sheets would still be in poor shape.
Here, the United States provides a telling example. During the summer, the credit crunch reduced interbank lending. Short-term interest rates increased suddenly, and many banks and financial institutions were scrambling for cash.
In a moment of panic and desperation, the Federal reserve cut interest rates by 0.5 percent. For a time, the liquidity crisis subsided. However, nothing fundamentally changed. The banks were still carrying large amounts of bad debts. After the euphoria of the interest-rate cut, doubts began to creep back in. The credit crunch returned. Short-term interest rates again are rising, and the Federal reserve are threatening a further interest rate cut.
The lesson from the US is clear. Lower interest rates can only provide an illusion that the credit crunch has been resolved. However, all those bad debts and unpaid loans are still there. There is no easy way out of this mess. It would be better to face up to the problems we now face.
Higher interest rates will discourage consumption, people will again have an incentive to save, and house prices will return to more reasonable levels. Lower consumption will probably result in a slowdown in growth. The banks need some time to work off all those bad loans. It will be a difficult time. However, if the Bank of England recklessly cuts rates, it will only delay the moment of truth. All our problems will will grow, and we won't avoid the need for adjustment.
Friday, November 30, 2007
Take no comfort from LTVs
Are we talking down the housing market? The answer appears to be yes for James Harding, Business Editor of the Times. Harding takes comfort from the fact that things are different this time. "A repeat of the negative equity blight is unlikely because, despite the concerns about reckless lenders, banks and building societies have been more conservative in managing loan-to-value ratios (LTV) than they were in the late-1980s."
Unfortunately, Harding hasn't thought this one through. He is taking far too much comfort from seemingly prudent LTVs. Unfortunately, LTVs are ratios, they can move. Rather than ensuring that banks make prudent lending decisions, LTVs often lure them into making bad ones.
The following simple example will illustrate the point. Take an individual that earns ₤10,000 a year; takes out a mortgage out for ₤30,000 and buys a house for ₤40,000. To keep things simple, we will assume an interest only mortgage of 5 percent. The house price to income ratio is 3; the LTV is 75 percent, while the interest costs are 15 percent of income.
Sometime later, this same individual wants to trade up. The value of her house has increased to ₤60,000 and as such, she has ₤30,000 in home equity. At the same time, her income has risen by 50 percent to ₤15,000. She puts down her ₤30,000 as a deposit and like the previous purchase, she buys a new house with a 75 percent LTV. With the higher deposit, this allows her to buy a house for ₤120,000. Interest rates are unchanged at 5 percent.
The LTV might be the same, but everything else is different. Interest costs have doubled and are now 30 percent of income, while the houseprice to income ratio is now 8. Athough the home owner's income has increased, debt servicing costs have risen faster. The capital gain from the previous house sale has allowed our home-buyer to take on a higher level of debt relative to their income. Naturally, the LTV ratio doesn't capture this fundamental change in the level of indebtedness.
One day, the banks wake up and stop looking at LTVs and start looking at repayment capacity. The banks take a look at the ratio of personal debt to disposable income in the UK and see a number 1.6 staring back at them. Some of the smarter banks realise that this is an unprecedented level of indebtedness and tighten up lending standards. The more stupid ones, like Northern Rock, just keep on lending.
The gradual tightening of credit reduces the number of mortgages, and demand falls away. Remember, the UK has already reached this stage, mortgage approvals in October were down 37 percent compared to last year.
When house prices fall, what happens to the LTV. Yes, it suddenly starts to rise. To illustrate the point, our homeowners house falls by 25 percent, taking back half the gains from house price appreciation. The LTV goes up to 100 percent. There is nothing conservative or prudent about a 100 percent LTV.
Now here is the kicker - banks were not giving out loans with LTVs of 75 percent. The average is much closer to 95 percent. Some banks - like Northern rock - offered loans of 125 percent. It won't take a big fall in prices before many LTVs go above 100 percent.
Here is what Harding has really forgotten. LTVs only determine what a bank will recover when it has to repossess a defaulted mortgage. If prices fall, LTVs rise, equity falls and the bank takes more of a hit. Low LTVs can not sustain high house prices.
As for "negative equity blight", it is coming back. Just give it a year or so of solid falling prices, and negative equity will replace property prices as the great national obsession.
Unfortunately, Harding hasn't thought this one through. He is taking far too much comfort from seemingly prudent LTVs. Unfortunately, LTVs are ratios, they can move. Rather than ensuring that banks make prudent lending decisions, LTVs often lure them into making bad ones.
The following simple example will illustrate the point. Take an individual that earns ₤10,000 a year; takes out a mortgage out for ₤30,000 and buys a house for ₤40,000. To keep things simple, we will assume an interest only mortgage of 5 percent. The house price to income ratio is 3; the LTV is 75 percent, while the interest costs are 15 percent of income.
Sometime later, this same individual wants to trade up. The value of her house has increased to ₤60,000 and as such, she has ₤30,000 in home equity. At the same time, her income has risen by 50 percent to ₤15,000. She puts down her ₤30,000 as a deposit and like the previous purchase, she buys a new house with a 75 percent LTV. With the higher deposit, this allows her to buy a house for ₤120,000. Interest rates are unchanged at 5 percent.
The LTV might be the same, but everything else is different. Interest costs have doubled and are now 30 percent of income, while the houseprice to income ratio is now 8. Athough the home owner's income has increased, debt servicing costs have risen faster. The capital gain from the previous house sale has allowed our home-buyer to take on a higher level of debt relative to their income. Naturally, the LTV ratio doesn't capture this fundamental change in the level of indebtedness.
One day, the banks wake up and stop looking at LTVs and start looking at repayment capacity. The banks take a look at the ratio of personal debt to disposable income in the UK and see a number 1.6 staring back at them. Some of the smarter banks realise that this is an unprecedented level of indebtedness and tighten up lending standards. The more stupid ones, like Northern Rock, just keep on lending.
The gradual tightening of credit reduces the number of mortgages, and demand falls away. Remember, the UK has already reached this stage, mortgage approvals in October were down 37 percent compared to last year.
When house prices fall, what happens to the LTV. Yes, it suddenly starts to rise. To illustrate the point, our homeowners house falls by 25 percent, taking back half the gains from house price appreciation. The LTV goes up to 100 percent. There is nothing conservative or prudent about a 100 percent LTV.
Now here is the kicker - banks were not giving out loans with LTVs of 75 percent. The average is much closer to 95 percent. Some banks - like Northern rock - offered loans of 125 percent. It won't take a big fall in prices before many LTVs go above 100 percent.
Here is what Harding has really forgotten. LTVs only determine what a bank will recover when it has to repossess a defaulted mortgage. If prices fall, LTVs rise, equity falls and the bank takes more of a hit. Low LTVs can not sustain high house prices.
As for "negative equity blight", it is coming back. Just give it a year or so of solid falling prices, and negative equity will replace property prices as the great national obsession.
Wednesday, November 28, 2007
Debt, credit and default - there is way too much of it out there
There is a simple chain of events that links all our current economic problems. Here are the seven steps to a crisis:
Step 1: Banks relax lending standards and lend too much money.
Step 2: People use those loans to buy overpriced houses.
Step 3: Incomes do not keep pace with the growth of debt.
Step 4: People stop paying back loans
Step 5: Banks run into trouble and stop lending to each other.
Step 6: Central banks pump in cash to save the banks.
Step 7: Inflation rises, interest rates go up, and the economy stops.
At the moment, we are somewhere between step 4 and step 6. Today's stories reflect that gradual progression towards economic disaster.
Debt distress
It is a busy time at the Consumer Credit Counselling Service (CCCS) - a charity that helps people suffering for debt problems. During the first six months of this year, 161,558 individuals called its freephone helpline - an increase of 18.5 percent on the same period last year. Moreover, this is the highest level the charity has ever seen.
Even pensioners are not immune from the unfolding debt crisis. A recent survey showed that that 7 percent of all bankruptcies so far this year were among retired people. A recent report estimated that pensioners in Britain owed a total of £57bn, with the average pensioner racking up a debt of £5,900 in credit cards and loans. Another report estimates that a fifth of pensioners - more than a million people - are still saddled with a mortgage when they retire, with one in eight owing more than £50,000.
These numbers are a dire warning for the banks, if only they were smart enough to realise it. The vast majority of those pensioners that currently have mortgages, took out those loans when house prices were considerably lower in terms of income than they are now. If a fifth of all pensioners could not clear these mortgages while they were working, what hope is there for the current generation of home-debtors? The banks have gone too far; their lending standards have been too lax and now the banks face a growing long term default problem.
Given such stupid lending practices, is it any wonder there is a credit crunch?
The credit crunch nightmare
Central bankers are having nightmares at the moment, and the monster that visits them in their sleep is a banking crisis. When they walk up, central bankers rush down to the office and turn on the printing presses. The ECB are a particular case in point; it has promised to supply money markets with euro30 billion in one week funds.
Euro -interest rates are doing weird things. Yesterday, three-month euro rates rose to 4.72 per cent. Normally, three month rates should be closely tied to the ECB's policy rate, which currently stands at 4.0 per cent policy rate.
It is just one more sign that credit markets are seizing up. It is amazing just how much of this problem traces back to bloated and overvalued housing markets.
Money causes inflation
This credit crisis is a tad inconvenient for central banks. Inflation is already as elevated levels, and all that money rushing into "liquidity constrained" banks will end up pushing prices up. It is that old line from A Level economics rearing its ugly head again - "too much money, chasing too few goods equals inflation".
Economists at the ECB are being reminded of that old rule right now. Energy and food prices pushed inflation in Germany this month to the highest level since at least 1995. Economists are now forecasting that annual eurozone inflation would reach 3 per cent or above for the first time in more than six years. The US Federal Reserve faces an even more serious inflation problem. It is already at 3.5 per cent last month, and could approach 4 per cent in the coming months.
Do you earn £100,000+ a year?
Well, if you don't then forget about buying a house in London. The average price of a house in the capital is now a bone-crunching £318,000.
But help is at hand....
It seems that houses in London won't staying that £318,000 for very long. Prices are now falling rapidly. In October, prices in the capital fell by 0.6 percent. Well, if salaries can not rise to afford house prices, then house prices must fall to meet salaries. Of course, 0.6 percent only shaves off the ludicrous top of a lunatic market, but at least it is a start on the long road back to sanity.
Step 1: Banks relax lending standards and lend too much money.
Step 2: People use those loans to buy overpriced houses.
Step 3: Incomes do not keep pace with the growth of debt.
Step 4: People stop paying back loans
Step 5: Banks run into trouble and stop lending to each other.
Step 6: Central banks pump in cash to save the banks.
Step 7: Inflation rises, interest rates go up, and the economy stops.
At the moment, we are somewhere between step 4 and step 6. Today's stories reflect that gradual progression towards economic disaster.
Debt distress
It is a busy time at the Consumer Credit Counselling Service (CCCS) - a charity that helps people suffering for debt problems. During the first six months of this year, 161,558 individuals called its freephone helpline - an increase of 18.5 percent on the same period last year. Moreover, this is the highest level the charity has ever seen.
Even pensioners are not immune from the unfolding debt crisis. A recent survey showed that that 7 percent of all bankruptcies so far this year were among retired people. A recent report estimated that pensioners in Britain owed a total of £57bn, with the average pensioner racking up a debt of £5,900 in credit cards and loans. Another report estimates that a fifth of pensioners - more than a million people - are still saddled with a mortgage when they retire, with one in eight owing more than £50,000.
These numbers are a dire warning for the banks, if only they were smart enough to realise it. The vast majority of those pensioners that currently have mortgages, took out those loans when house prices were considerably lower in terms of income than they are now. If a fifth of all pensioners could not clear these mortgages while they were working, what hope is there for the current generation of home-debtors? The banks have gone too far; their lending standards have been too lax and now the banks face a growing long term default problem.
Given such stupid lending practices, is it any wonder there is a credit crunch?
The credit crunch nightmare
Central bankers are having nightmares at the moment, and the monster that visits them in their sleep is a banking crisis. When they walk up, central bankers rush down to the office and turn on the printing presses. The ECB are a particular case in point; it has promised to supply money markets with euro30 billion in one week funds.
Euro -interest rates are doing weird things. Yesterday, three-month euro rates rose to 4.72 per cent. Normally, three month rates should be closely tied to the ECB's policy rate, which currently stands at 4.0 per cent policy rate.
It is just one more sign that credit markets are seizing up. It is amazing just how much of this problem traces back to bloated and overvalued housing markets.
Money causes inflation
This credit crisis is a tad inconvenient for central banks. Inflation is already as elevated levels, and all that money rushing into "liquidity constrained" banks will end up pushing prices up. It is that old line from A Level economics rearing its ugly head again - "too much money, chasing too few goods equals inflation".
Economists at the ECB are being reminded of that old rule right now. Energy and food prices pushed inflation in Germany this month to the highest level since at least 1995. Economists are now forecasting that annual eurozone inflation would reach 3 per cent or above for the first time in more than six years. The US Federal Reserve faces an even more serious inflation problem. It is already at 3.5 per cent last month, and could approach 4 per cent in the coming months.
Do you earn £100,000+ a year?
Well, if you don't then forget about buying a house in London. The average price of a house in the capital is now a bone-crunching £318,000.
But help is at hand....
It seems that houses in London won't staying that £318,000 for very long. Prices are now falling rapidly. In October, prices in the capital fell by 0.6 percent. Well, if salaries can not rise to afford house prices, then house prices must fall to meet salaries. Of course, 0.6 percent only shaves off the ludicrous top of a lunatic market, but at least it is a start on the long road back to sanity.
Saturday, November 24, 2007
The harsh world of small-time property speculation
It must be difficult being a buy to let investor these days. In October, house prices fell right across the country. Even in London, perhaps the most overvalued housing market in the world, prices started to return to Earth.
A belief in continued house appreciation is what drives the buy to let investor. It is this belief that pushes them into the real estate agency, to buy up those inner city slums, and then down to the bank to take out a mortgage. The idea that property keeps growing at 10 percent a year clouds other financial considerations.
The buy to let investor rarely gives any serious consideration to rental yields. Today, in most UK cities, rental yields are between three and four percent, which is approximately half of the rental costs of money - the interest-rate on a mortgage. The only way that a buy to let investment to make sense is if one expects house prices to appreciate sufficiently to recoup the a) differential between rental yields and interest rates; b) the rate of inflation, c) any other extraneous costs that comes from renting to unreliable tenants, such as the tenants skipping off and not paying the rent.
The low rental yields means that any buy-to-let investor, dipping into the market today, must come with deep pockets. They have to be prepared to offer a considerable subsidy to any tenants fortunate enough to take up the newly purchased house.
Unfortunately, there is no prospect of pushing up rental yields. The supply of rental properties is to say the least, healthy. In any event, renting has this wonderful flexibility. When the landlord tries to squeeze the tenants for more rent, the tenants simply has to move and that 3 percent rental yield crashes down to zero. In other words, buy to let landlords need tenants more than tenants need landlords.
During the early months of this year, there were plenty of investors prepared to make huge sacrifices on behalf of their tenants. Around one in four mortgages were taken out by these generous and selfless souls.
However, will this generosity continue when house prices really start to tumble? Almost certainly not. As these cash flow problems grow, and it becomes increasingly clear that the losses cannot be recouped with future appreciation, then it becomes a matter of racing to the exit. A new principle will emerge; the quicker a buy-to-let investor gets out, the lower the losses.
In some respects, the UK housing market is entering uncharted territory. The market is now dominated by small-time property speculators, who have misjudged financial returns, and who are starting to lose serious amounts of money. There is nothing like hard and immediate financial losses to clear the fog. Buy-to-let investors will learn that it is rental yields and not appreciation that matter. As this lession is learnt, panic will take hold, housing inventory will increase, and prices will tumble.
A belief in continued house appreciation is what drives the buy to let investor. It is this belief that pushes them into the real estate agency, to buy up those inner city slums, and then down to the bank to take out a mortgage. The idea that property keeps growing at 10 percent a year clouds other financial considerations.
The buy to let investor rarely gives any serious consideration to rental yields. Today, in most UK cities, rental yields are between three and four percent, which is approximately half of the rental costs of money - the interest-rate on a mortgage. The only way that a buy to let investment to make sense is if one expects house prices to appreciate sufficiently to recoup the a) differential between rental yields and interest rates; b) the rate of inflation, c) any other extraneous costs that comes from renting to unreliable tenants, such as the tenants skipping off and not paying the rent.
The low rental yields means that any buy-to-let investor, dipping into the market today, must come with deep pockets. They have to be prepared to offer a considerable subsidy to any tenants fortunate enough to take up the newly purchased house.
Unfortunately, there is no prospect of pushing up rental yields. The supply of rental properties is to say the least, healthy. In any event, renting has this wonderful flexibility. When the landlord tries to squeeze the tenants for more rent, the tenants simply has to move and that 3 percent rental yield crashes down to zero. In other words, buy to let landlords need tenants more than tenants need landlords.
During the early months of this year, there were plenty of investors prepared to make huge sacrifices on behalf of their tenants. Around one in four mortgages were taken out by these generous and selfless souls.
However, will this generosity continue when house prices really start to tumble? Almost certainly not. As these cash flow problems grow, and it becomes increasingly clear that the losses cannot be recouped with future appreciation, then it becomes a matter of racing to the exit. A new principle will emerge; the quicker a buy-to-let investor gets out, the lower the losses.
In some respects, the UK housing market is entering uncharted territory. The market is now dominated by small-time property speculators, who have misjudged financial returns, and who are starting to lose serious amounts of money. There is nothing like hard and immediate financial losses to clear the fog. Buy-to-let investors will learn that it is rental yields and not appreciation that matter. As this lession is learnt, panic will take hold, housing inventory will increase, and prices will tumble.
Saturday, September 15, 2007
Forecasting the housing crash
Fionnuala Earley, Nationwide's group economist, said this weekend she expected house price inflation to slow to around 3 per cent next year. The forecast represents a major downward revision for Earley, who has a long and dubious history of talking the housing market up.
Nevertheless, one could be forgiven for thinking that this even this forecast of modest real growth seems somewhat disconnected from this summer's events. Last Friday, we witnessed the first run on a major high street bank in living memory. Over the last year, interest rates have risen sharply. Throughout the global banking system, there are billions of dollars of worthless US sub-prime mortgages. No one knows where this rubbish is lurking. However, everyone knows that it is out there, threatening the financial viability of any institution that has it on their balance sheets.
As a consequence, the interbank market has ground to a halt; fear is the order of the day. Moreover, every conceivable housing market indicator, from house price to income ratios down to rental yields are screaming one message - the UK housing market is at the tail end of an historically unprecedented bubble.
Yet, despite all this, the Nationwide still thinks that house prices will still keep on growing. Such forecasts from the mortgage industry need to be first decoded and then re calibrated. Lets start by decoding the 3 percent forecast.
Earley and others like her in the mortgage industry now work in a deeply conflicted environment. The needs of her employer struggle desperately with the reality of a collapsing bubble. The Nationwide need house prices to keep on rising. It is a frantic need, for if prices stall or start to fall, the Nationwide and institutions like it, will be faced with a avalanche of repossessions. Far too may home buyers have gambled their financial futures on ever appreciating housing values; buy-to-let idiots, second-homers, and housing-as-a-pension speculators. If these gamblers lose faith in housing,at a minimum, profits will collapse and if repossessions really take hold, the very existence of Nationwide is called into question.
The fate of the Nationwide is now trapped in the circular reasoning that sustains the housing market. Prices keep on rising, because people believe they keep on rising. People believe they keep on rising, because they keep on rising. Once this circle of lunacy is broken, housing market fundamentals re-assert themselves. Ratios return to long run equilibria, and this all points in one direction - downward.
Earley's role here is clear - her forecasts must keep the circle of speculative reasoning intact. So her forecast must always show positive growth. However, any attempt at inflating the growth rate threatens the credibility of the message. It would be counterproductive, for example, if the Nationwide were to suggest 10 percent growth. People are beginning to sense that something is going seriously wrong with the housing market, and these cracks can not be pasted over with a rosy press release announcing 10 percent housing inflation next year.
The three percent number wasn't plucked out of nowhere. It is, in fact, one percent above anticipated CPI inflation. In other words, it is the absolute minimum figure that Earley could present that would be acceptable to her employers while retaining a semblance of credibility. The public message is "don't worry, folks, prices are still going to rise". Nevertheless, the decoded message is stark; in reality housing prices will first decelerate rapidly, and then begin to fall.
So what about re-calibrating this 3 percent forecast; can we infer anything about what Earley and her ilk really think about house prices next year? Privately, Earley would probably admit that a crash is immanent, and the Nationwide should begin to prepare for some stormy and difficult market conditions. In other words, this 3 percent forecast should be re-calibrated into a significantly negative number.
Economic forecasting is a dubious business, where self interest and feigned optimism often plays a crucial role. Nevertheless, the message from Earley isn't hard to read; prepare for the worst. This week's disintegration of Northern Rock is but a prologue for an all-encompassing and comprehensive housing market crash. Any home owners ignoring Earley's message, do so at their own peril.
Nevertheless, one could be forgiven for thinking that this even this forecast of modest real growth seems somewhat disconnected from this summer's events. Last Friday, we witnessed the first run on a major high street bank in living memory. Over the last year, interest rates have risen sharply. Throughout the global banking system, there are billions of dollars of worthless US sub-prime mortgages. No one knows where this rubbish is lurking. However, everyone knows that it is out there, threatening the financial viability of any institution that has it on their balance sheets.
As a consequence, the interbank market has ground to a halt; fear is the order of the day. Moreover, every conceivable housing market indicator, from house price to income ratios down to rental yields are screaming one message - the UK housing market is at the tail end of an historically unprecedented bubble.
Yet, despite all this, the Nationwide still thinks that house prices will still keep on growing. Such forecasts from the mortgage industry need to be first decoded and then re calibrated. Lets start by decoding the 3 percent forecast.
Earley and others like her in the mortgage industry now work in a deeply conflicted environment. The needs of her employer struggle desperately with the reality of a collapsing bubble. The Nationwide need house prices to keep on rising. It is a frantic need, for if prices stall or start to fall, the Nationwide and institutions like it, will be faced with a avalanche of repossessions. Far too may home buyers have gambled their financial futures on ever appreciating housing values; buy-to-let idiots, second-homers, and housing-as-a-pension speculators. If these gamblers lose faith in housing,at a minimum, profits will collapse and if repossessions really take hold, the very existence of Nationwide is called into question.
The fate of the Nationwide is now trapped in the circular reasoning that sustains the housing market. Prices keep on rising, because people believe they keep on rising. People believe they keep on rising, because they keep on rising. Once this circle of lunacy is broken, housing market fundamentals re-assert themselves. Ratios return to long run equilibria, and this all points in one direction - downward.
Earley's role here is clear - her forecasts must keep the circle of speculative reasoning intact. So her forecast must always show positive growth. However, any attempt at inflating the growth rate threatens the credibility of the message. It would be counterproductive, for example, if the Nationwide were to suggest 10 percent growth. People are beginning to sense that something is going seriously wrong with the housing market, and these cracks can not be pasted over with a rosy press release announcing 10 percent housing inflation next year.
The three percent number wasn't plucked out of nowhere. It is, in fact, one percent above anticipated CPI inflation. In other words, it is the absolute minimum figure that Earley could present that would be acceptable to her employers while retaining a semblance of credibility. The public message is "don't worry, folks, prices are still going to rise". Nevertheless, the decoded message is stark; in reality housing prices will first decelerate rapidly, and then begin to fall.
So what about re-calibrating this 3 percent forecast; can we infer anything about what Earley and her ilk really think about house prices next year? Privately, Earley would probably admit that a crash is immanent, and the Nationwide should begin to prepare for some stormy and difficult market conditions. In other words, this 3 percent forecast should be re-calibrated into a significantly negative number.
Economic forecasting is a dubious business, where self interest and feigned optimism often plays a crucial role. Nevertheless, the message from Earley isn't hard to read; prepare for the worst. This week's disintegration of Northern Rock is but a prologue for an all-encompassing and comprehensive housing market crash. Any home owners ignoring Earley's message, do so at their own peril.
Friday, June 8, 2007
House prices ten times income by 2026? I think not.
Can you imagine a world where house prices are 10 times income? Apparently, today's Times can envisage such a state of affairs. In an article today, the newspaper predicts that house prices will keep on rising so that by 2026 the typical income will only be a 10th of the price of the typical house.
But what would such a ratio mean to a new homeowner? Let us assume that a person takes home ₤50,000 a year and has a mortgage for ₤500,000. At a 6 percent interest rate, the annual interest costs would be ₤30,000 a year. In other words, interest charges alone would account for 60 percent of income. So if the Times is right, we can be sure about one thing; there will be no first-time buyers in Britain in the 2026.
Perhaps such a ratio could be sustained if homebuyers have large down payment. In such circumstances, homes will be transferred between affluent homebuyers, while the poor and propertyless can continue renting. Those who are desperate to own a house will have to resign themselves to years of savings, building up a deposit sufficiently large to make it possible to enter the market.
Alternatively, interest rates might fall to say 3 percent, making the ratio somehow affordable in terms of monthly payments. If the Bank of England became really serious about inflation, and pushed price growth down to something close to zero, then perhaps nominal interest rates could fall further. Judging by the arguments presented above, one need some fairly contorted arguments before a ratio of 10 seems reasonable.
However, there is a stronger argument suggesting that house prices will be somewhat depressed in 2026 - demographics. The UK's population is ageing rapidly. Without immigration, the UK's population would be falling slightly. Over time, increasing numbers of migrants will be required in order to keep the population constant. However, will all those Polish plumbers, and Latvian waitresses keep coming to the UK?
If housing costs keep on rising, the answer is probably not. Within the next few years, continental Europe will gradually relax its migration policies, and those Polish plumbers will be able to settle in Germany and France, where housing costs are significantly cheape than the UK. Eastern European workers may also stay at home. Furthermore wage rates are rising in Eastern Europe, and although they have some way to go before they reach UK levels, wages are catching up.
Furthermore, far too many people have relied on housing as a substitute pension. Presumably, these pension schemes will start a mature somewhere around 2026. It's not hard to imagine the housing market for the impoverished 67-year-olds pedalling their dilapidated houses. It will be a market full of fixer-uppers reeking of that odour that only old people produce.
Demographics might tell us that there will be plenty of bargains around in 2026, but we don't have to forecast 20 years into the future to figure out that the housing market will crash. House prices in the UK are high because of a series of temporary and unsustainable factors.
It started back in 2001 with a foolish Bank of England pumping the economy full of money, which reduced interest rates. The long run consequences of that irresponsibility is inflation, which if it were properly measured by the retail price index, now stands at a 17 year high. However, initially this tidal wave of easy credit flowed into the housing market.
Equally stupid mortgage lenders took their cue from the Bank of England and started extending ever larger loans to desperate housebuyers, who in the face of soaring house price inflation somehow convinced themselves that house prices never fall. Some housebuyers got carried away and thought that they could make easy money by buying additional houses and renting them out. Again, mortgage lenders were complicit. They made it increasingly easy for small-time property speculators to take out massive loans.
This process was further strengthened by the collapse of pensions and the general loss of confidence in financial markets following the dot.com bubble. Houses speculation and the buy-to-let racket became a substitute for long term savings in anticipation of retirement.
Rapidly rising house prices temporarily sustained economic growth. People used rising house prices as collateral and took out mortgage equity withdrawal loans and use them to finance essentially frivolous consumption. The strong growth attracted migrants from abroad, which helped sustain the buy to let market. London, in particular, attracted an unusual form of migrants; Russian oligarchs anxious purchase a bolthole should political circumstances in Russia require a sudden exit.
If any one of these factors were to change, the housing bubble would crash. For example, suppose that the stock market started to produce higher returns. Investors would exit the buy to let market and return to buying equity. Alternatively, the Bank of England might get serious about inflation and put in a few more interest-rate hikes. In fact, it isn't hard to think up half a dozen plausible scenarios which all give the same result - crashing housing prices.
So, a house priced income ratio of 10 is not reasonable, either today, tomorrow, or in 2026. UK house prices are massively overvalued. A correction is coming, and when it does come, it will be painful.
But what would such a ratio mean to a new homeowner? Let us assume that a person takes home ₤50,000 a year and has a mortgage for ₤500,000. At a 6 percent interest rate, the annual interest costs would be ₤30,000 a year. In other words, interest charges alone would account for 60 percent of income. So if the Times is right, we can be sure about one thing; there will be no first-time buyers in Britain in the 2026.
Perhaps such a ratio could be sustained if homebuyers have large down payment. In such circumstances, homes will be transferred between affluent homebuyers, while the poor and propertyless can continue renting. Those who are desperate to own a house will have to resign themselves to years of savings, building up a deposit sufficiently large to make it possible to enter the market.
Alternatively, interest rates might fall to say 3 percent, making the ratio somehow affordable in terms of monthly payments. If the Bank of England became really serious about inflation, and pushed price growth down to something close to zero, then perhaps nominal interest rates could fall further. Judging by the arguments presented above, one need some fairly contorted arguments before a ratio of 10 seems reasonable.
However, there is a stronger argument suggesting that house prices will be somewhat depressed in 2026 - demographics. The UK's population is ageing rapidly. Without immigration, the UK's population would be falling slightly. Over time, increasing numbers of migrants will be required in order to keep the population constant. However, will all those Polish plumbers, and Latvian waitresses keep coming to the UK?
If housing costs keep on rising, the answer is probably not. Within the next few years, continental Europe will gradually relax its migration policies, and those Polish plumbers will be able to settle in Germany and France, where housing costs are significantly cheape than the UK. Eastern European workers may also stay at home. Furthermore wage rates are rising in Eastern Europe, and although they have some way to go before they reach UK levels, wages are catching up.
Furthermore, far too many people have relied on housing as a substitute pension. Presumably, these pension schemes will start a mature somewhere around 2026. It's not hard to imagine the housing market for the impoverished 67-year-olds pedalling their dilapidated houses. It will be a market full of fixer-uppers reeking of that odour that only old people produce.
Demographics might tell us that there will be plenty of bargains around in 2026, but we don't have to forecast 20 years into the future to figure out that the housing market will crash. House prices in the UK are high because of a series of temporary and unsustainable factors.
It started back in 2001 with a foolish Bank of England pumping the economy full of money, which reduced interest rates. The long run consequences of that irresponsibility is inflation, which if it were properly measured by the retail price index, now stands at a 17 year high. However, initially this tidal wave of easy credit flowed into the housing market.
Equally stupid mortgage lenders took their cue from the Bank of England and started extending ever larger loans to desperate housebuyers, who in the face of soaring house price inflation somehow convinced themselves that house prices never fall. Some housebuyers got carried away and thought that they could make easy money by buying additional houses and renting them out. Again, mortgage lenders were complicit. They made it increasingly easy for small-time property speculators to take out massive loans.
This process was further strengthened by the collapse of pensions and the general loss of confidence in financial markets following the dot.com bubble. Houses speculation and the buy-to-let racket became a substitute for long term savings in anticipation of retirement.
Rapidly rising house prices temporarily sustained economic growth. People used rising house prices as collateral and took out mortgage equity withdrawal loans and use them to finance essentially frivolous consumption. The strong growth attracted migrants from abroad, which helped sustain the buy to let market. London, in particular, attracted an unusual form of migrants; Russian oligarchs anxious purchase a bolthole should political circumstances in Russia require a sudden exit.
If any one of these factors were to change, the housing bubble would crash. For example, suppose that the stock market started to produce higher returns. Investors would exit the buy to let market and return to buying equity. Alternatively, the Bank of England might get serious about inflation and put in a few more interest-rate hikes. In fact, it isn't hard to think up half a dozen plausible scenarios which all give the same result - crashing housing prices.
So, a house priced income ratio of 10 is not reasonable, either today, tomorrow, or in 2026. UK house prices are massively overvalued. A correction is coming, and when it does come, it will be painful.
Monday, May 21, 2007
Buy-to-let morons "still confident"
Here is a cracking piece on the buy-to-let brigade. Apparently, a minority of these part-time property speculators are going to push through higher rents to cover their higher interest rate costs. However, the majority are swallowing the higher costs with lower profit margins, so should that read, "greater losses".
I enjoyed this article.
Paragon Mortgages, buy-to-let specialists, sent out a press release last week proclaiming that all‘s well with the buy-to-let market.
Apparently, in a recent survey, “almost a third of landlords said they were reacting to rising borrowing costs by increasing rents, while another 43% reported they are taking no specific action as a result of the interest rate rises.”
That’s not all. “As further evidence of their confidence in the future, in the survey 12% of landlords said they were increasing their involvement in buy-to-let as a reaction to the rises in borrowing costs.”
Wait a minute. Did we miss something here?
So “almost a third” of landlords - that’s less than 33% - are trying to push through rent increases to protect their profit margins against rising interest rates. Meanwhile, 43% - that’s nearly half, if you want to be really rough and ready about it - aren’t going to do anything. And that leaves at least another 25% - a quarter - who presumably have been unable to raise rents either.
In other words, more than two thirds of landlords aren’t going to raise rents, even though interest rates are rising. That can’t be good news for the buy-to-let market - particularly when so many recent entrants to the landlord market are already stuck with negative yields (in other words, their rental income doesn’t cover the payments on their interest-only mortgages).
The second quote is even more telling - 12% of landlords are taking rising interest rates as a cue to buy more property. This is “further evidence of their confidence in the future.”
There’s a few bits of twisted logic to untangle here. For a start, if 12% are buying more property, that leaves 88% of landlords who don’t feel confident buying more property when rates are rising - which strikes us as sensible.
Thinking charitably, the “confident” 12% (that’s just under one in eight, by the way), have decided that rates won’t rise much further. That could mean this is a good opportunity to drive down selling prices as others panic about the prospect of a 6% base rate by the end of this year. Or less charitably, it suggests that one in eight landlords don‘t really know what they are doing and have fallen for the whole “property prices never fall” hype.
In any case, it certainly shows that the providers of landlord mortgages are rattled. And that’s unsurprising. Even the mainstream press is catching on to the idea that interest rates haven’t peaked - high profile columnists Roger Bootle (The Telegraph) and Anatole Kaletsky (The Times) are both calling for rates to hit 6% or more.
And at the weekend, the Sunday Times, for example, ran a piece on why householders need to be planning for a base rate of at least 6% - that would put the typical standard variable rate at 8%.
None of this bodes well for buy-to-let or the wider market.
I enjoyed this article.
Paragon Mortgages, buy-to-let specialists, sent out a press release last week proclaiming that all‘s well with the buy-to-let market.
Apparently, in a recent survey, “almost a third of landlords said they were reacting to rising borrowing costs by increasing rents, while another 43% reported they are taking no specific action as a result of the interest rate rises.”
That’s not all. “As further evidence of their confidence in the future, in the survey 12% of landlords said they were increasing their involvement in buy-to-let as a reaction to the rises in borrowing costs.”
Wait a minute. Did we miss something here?
So “almost a third” of landlords - that’s less than 33% - are trying to push through rent increases to protect their profit margins against rising interest rates. Meanwhile, 43% - that’s nearly half, if you want to be really rough and ready about it - aren’t going to do anything. And that leaves at least another 25% - a quarter - who presumably have been unable to raise rents either.
In other words, more than two thirds of landlords aren’t going to raise rents, even though interest rates are rising. That can’t be good news for the buy-to-let market - particularly when so many recent entrants to the landlord market are already stuck with negative yields (in other words, their rental income doesn’t cover the payments on their interest-only mortgages).
The second quote is even more telling - 12% of landlords are taking rising interest rates as a cue to buy more property. This is “further evidence of their confidence in the future.”
There’s a few bits of twisted logic to untangle here. For a start, if 12% are buying more property, that leaves 88% of landlords who don’t feel confident buying more property when rates are rising - which strikes us as sensible.
Thinking charitably, the “confident” 12% (that’s just under one in eight, by the way), have decided that rates won’t rise much further. That could mean this is a good opportunity to drive down selling prices as others panic about the prospect of a 6% base rate by the end of this year. Or less charitably, it suggests that one in eight landlords don‘t really know what they are doing and have fallen for the whole “property prices never fall” hype.
In any case, it certainly shows that the providers of landlord mortgages are rattled. And that’s unsurprising. Even the mainstream press is catching on to the idea that interest rates haven’t peaked - high profile columnists Roger Bootle (The Telegraph) and Anatole Kaletsky (The Times) are both calling for rates to hit 6% or more.
And at the weekend, the Sunday Times, for example, ran a piece on why householders need to be planning for a base rate of at least 6% - that would put the typical standard variable rate at 8%.
None of this bodes well for buy-to-let or the wider market.
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