UK bond yields - where are they going?

Since early October, the yield on 10 year UK government bonds has crept up 73 basis points. That is equivalent to three typical hikes of the Bank of England's bank rate.

Should we worry? Have financial markets finally realized that the government may have difficulties in repaying the huge amounts of debt it has issued since the financial crisis began?

There are at three reasons for taking a calm and measured approach to rising bond yields:

• Yields were higher earlier this year - In February, the yield hit 4.23; currently the yield stands at 3.69.  Back then the investors were worrying about an election, and the possibility of a renewed Brown mandate.  As the election approached, investors calmed down as New Labour's poll numbers declined.   
• The government has announced a fiscal consolidation plan - The coalition has what appears to be a credible plan to reduce the deficit.  It is also prepared to enact difficult measures, such as hiking university fees, increasing the coalition's credibility in terms of dealing with our huge fiscal difficulties.
• Rates need to rise anyway - If the UK economy is to return to anything looking like normality, then interest rates will have to rise, including bond yields.  Therefore, the recent increase reflects better growth prospects and a move towards stability. As such, we should welcome this modest upward shift in yields.

Overall, these are plausible arguments.  Nevertheless, the monetary policy committee seem to be behind the curve.  Their unwillingness to raise rates has increased perceptions that the inflation rate in the UK may start to pick up.  Recent inflation data underlines this threat. The Bank of England's survey on inflation expectations, released earlier this week, confirms that people are expecting higher inflation in the future.

If inflation were to pick up further, then yields would begin to pick up extremely rapidly.  Financing new government debt will become more expensive. If yields increase dramatically, then the government's fiscal reduction strategy may be in jeopardy.  There would also be negative effects on private consumption and investment.

An early hike in the bank rate would go a long way to reducing these concerns.  It would send a signal that the MPC will tackle any inflationary pressures.  It would also signal that the UK economy has started to take the first tentative steps towards the exit in terms of the financial crisis.

Unfortunately, the MPC have one eye on the large rollover problems that UK banks have to face next year and 2012.  You see, it is always about the banks.  The UK economy would benefit from a rate hike, but that banks would be squeezed. 

In any choice between the interests of financiers and and the rest of us, the financiers always seem to win.

The great mortgage payback continues

Here is another reason why first quarter GDP turned violently negative. Home owners paid back record amounts of their home equity and mortgage loans. During the first three months of this year, the payback amounted to 3.5 percent of post tax income. A cool ₤8 billion was repaid to the banks.

Before the crash, home equity withdrawal was the engine of the UK economy. House prices went up, home equity increased and banks handed out loans to anyone who owned a home. These loans financed a consumption binge which kept taxes high and the rest of us in employment.

House prices are again picking up, and as they do, home owners gain equity, allowing them to take out loans. If prices fully recover, then the bubble back on. Banks can turn the tap back on and we can return to the good old days of asset appreciation and a consumption loaded lifestyle built on debt.

Bring it on; I can't wait.

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.

The housing equity economic cycle

There is something sad about our dependence on home equity withdrawal. When it goes up, the economy booms; when it goes down, the economy dives into a recession. Our economic fortunes have become utterly dependent on whether house prices rise sufficently quickly for home owners to borrow and consume against their imagined increases in housing wealth.

However, under New Labour this dependence on home equity withdrawal reached grotesque proportions. The government and the Bank of England have risked everything on stabilising house prices and re-establishing household sector credit growth. They have forsaken fiscal stability, cut interest rates to almost zero and started to print money. Yet despite every crazy policy gesture, home equity withdrawal has not recovered.

Mortgage equity withdrawal - UK homeowners go cold turkey

Mortgage equity withdrawal was the engine of the UK economic miracle. Without it, UK households could not have kept spending. They needed the extra boost that came from borrowing money against the imaginary capital gain in their homes.

Between the summer of 1997 and March 2008, UK homeowners borrowed ₤325 billion against the value of their houses. In the last nine months of last year, households started to pay down this extraordinary debt. So far, households have repaid ₤15.6 billion, representing about 5 percent of the borrowing binge accumulated during the previous 10 years.

This is, of course, the insurmountable problem that Brown and Darling face. During the glory days of New Labour, the UK economy had become totally addicted to mortgage equity withdrawal. Brown and Darling would like to revive the habit, but UK homeowners are determined to go cold turkey.

The home equity housing bubble

(click on the chart for a sharper image)

The recent housing bubble was strange. The volume of sales didn't increase much, yet prices shot up. This lack of activity also features in gross mortgage lending data. Loans for house purchases remained comparatively flat throughout the bubble (see the chart above).

In contrast, home equity lending exploded. By 2007, it accounted for almost 40 percent of all mortgages. Of course, these loans fed straight into consumption. Homeowners, who are mostly middle aged, borrowed and spent, based on the illusion that they were rich because house prices were inflating. In the post-bubble world of 2009, this idea seems truly bizarre, but that is how things worked in early 2007.

Buy-to-let was the other major growth area for mortgage lending. By 2007, around a quarter of loans were financing small time property investment. Many of these investors were already home owners, who used the equity in their homes to provide collateral to dive into fully fledged speculation via the BTL market.

There is an interesting implication here. While the housing bubble generated a huge amount of personal debt, it is heavily concentrated among home owners. Renters never found it easy to get access to credit. Apart from college loans and some heavy credit card balances, young people are also comparatively free from debt.

So behind the government's banking sector intervention lurks a homeowner bailout. Brown wants banks to increase their lending, in the vague hope that house prices will stabilize and the home equity bubble can resume.

This bailout works against the interests of both renters, and the young. Higher house prices shuts out renters from home ownership, while huge bailouts puts the burden of paying for this mess on young taxpayers.

There will be some pay-back for this mess. One day, those young taxpayers will have to pay for the pensions of heavily indebted homeowners. I wonder how generous they will be?

(The chart comes from the FSA's Turner report)

The party is over

It isn't hard for an economy to grow when homeowners are supplementing their income by 5-8 percent with loans collateralized on rising housing values. However, that scam is over. Property prices are crashing, home equity is evaporating and the banks have turned the tap off.

For far too long, the UK depended on home equity loans to sustain consumption. The party is now over. The hangover has just begun.

Inflation continues to rise

In June, the CPI inflation rate hit 3.8 percent. By September, inflation should be well above 4 percent and if the current trend continues, a 5 percent rate by mid-winter looks a distinct possibility.

Although the numbers are alarming, the lack of any coherent anti-inflation strategy is positively frightening. As each month passes, inflation climbs higher, yet all we here from the MPC is some lame story about a "balancing act".

So what is this infamous balance act? The last two MPC interest rate decisions have seen rates come down. Since then, inflation has climbed relentlessly. A casual look at the data provides sufficient evidence that these decisions were inappropriate and should be reversed immediately. Nevertheless, the MPC continues to "balance" the risks.

In the absence of a monetary tightening, the MPC are relying on the credit crunch to resolve the inflationary crisis for them. A 0.25 percent hike might actually push the economy into a recession, while a little patience might be all that is needed to return inflation to the 2 percent target.

Again, recent inflation data damns this strategy. Apart from two short periods, the inflation rate has been consistently above target since the middle of 2005. The MPC have been waiting in vain for inflation to moderate. In fact, their waiting game seems to be destabilizing inflationary expectations and the rate just keeps on going up.

Would a 0.25 percent rate hike be sufficient to push the economy into a downward tailspin? The economy has already slowed significantly, while unemployment is up. Unfortunately, this slowdown has put absolutely no downward pressure on prices.

A hike now would resolve a growing uncertainty that the MPC just doesn't have the commitment to bring inflation down. It would stabilize expectations. Wage setters would understand that any future increases will not be accommodated by a weak and indecisive central bank. As for the growth implications, a modest hike is unlikely to do much more damage than that already done by the credit crunch.

So, the UK needs higher interest rates and the sooner the MPC grasps this fact, the better. So, lets here no more about balancing acts, and lets see more action. Lets see the MPC develop a serious anti-inflation strategy.

It is all over

This morning, the Daily Express claimed that the credit crunch was over. The FTSE was recovering, while house prices were again rising. The newspaper proclaimed that "the long overdue rally signalled good news for savers and borrowers".and that the housing market "is defying pessimistic forecasts."

The article was short on facts, and heavy with optimism. The claim that the credit crunch had ended rested on two flimsy observations. First, that the FTSE had hit a four-month high; which could hardly be described as boom time for shareholders. Second, Rightmove's house price index had shown a 1.2 percent increase in home seller asking prices.

When it comes to this kind of tat, the Daily Express is a repeat offender. It ran a version of this story back in January. Again, relying on asking price data from Rightmove, the newspaper claimed that the market had begun to recover. In the three months that followed, house prices fell rapidly, mortgage lenders increased rates, while loan approvals fell to levels not seen since records began.

Why does the editor of the Daily Express feel the need to put out such delusional articles? The answer is, of course, sales. It is the kind of article that shifts newspapers from newsagent shelves. In such circumstances, it is hard to blame the editor. After all, editors are in the business of selling newspapers, and happy stories about the housing market work wonderfully for the Daily Express.

The more troubling question is why people want to buy this kind of nonsense. Obviously, these stories fulfil a need. For some people, it is better to read a highly distorted article, infused with wishful thinking and optimism, rather than take a cold hard look at reality.

The people that need these stories the most are those that depend upon their homes to secure their long-term financial future. When your home is your pension, it is enormously comforting to hear that its value is rising. Homeowners would be better off if they read articles that honestly told them that the home values in the long run were likely to decline; that high levels of debt reduced long-term consumption, and that homeowners would be better off if they saved more and spend less.

Those kinds of articles imply difficult short-term lifestyle changes that few people want to consider. That explains why, on a Saturday morning, it is much easier to buy the Daily Express, which will give you stories telling you that everything is all right. It will set you up for the rest of the afternoon, when you can go shopping, with a credit card and pretend that you are wealthier than your salary might suggest.

Personal insolvencies - 100,000 a year

The government has just published data on last year's personal insolvencies. Overall, the numbers filing for bankruptcy appear to have stabilized at just over 100,000 a year; roughly the same level as 2006. It is still a huge number, and reflects the deeply distressed financial situation of many UK households.

Filing for bankruptcy is a miserable experience. Nevertheless, it is hard to feel sorry for insolvent individuals. The vast majority of bankrupt individuals brought this misery upon themselves, taking out credits that they could not repay. No one is forced to go into a bank and sign up for loan or a mortgage. It only takes a sharp pair of scissors to cut up a credit card. However, many bankrupt individuals have families, who are often the innocent victims of irresponsible debt accumulation.

Why do the banks, who own the majority of defaulted debts, put up with such losses? For them, it is a simple numbers game. The losses from a 100,000 deliquents can be written off against taxes and covered by large profits generated by other household debtors.

Here is a simple idea to limit personal insolvencies. In future, banks should not be able write off debts from individuals against tax payments. Since the costs of reckless lending would increase, Banks would have to be much more careful in the future about extending credit to vulnerable and financially naive individuals. Personal bankruptcies would fall, and the misery inflicted on the dependents of bankrupts would be reduced.

The government would never consider such a radical and effective proposal. For the government, a 100,000 bankruptcies a year is the acceptable cost of an explosion of household debt. The banks, too, seem content with that level of personal insolvencies.

So, the debt cycle will roll on. Irresponsible banks will continue to lend to naive financially illiterate individuals, and a sizable minority will default. The banks will foreclose and the UK will continue to produce a 100,000 personal bankruptcies a year.

The ECB is at it too

They are all at it; the Fed, the Bank of England and the ECB. All of them are using the asset side of their balance sheet to swap their high quality paper for rubbish owned by the commercial banks.

The chart above tracks changes in the balance sheet of the ECB. The green line - long term refinancing operations picks up the commercial bank assets the ECB has picked up since the credit crisis began.


Nevertheless, the recent crisis hasn't stretched the ECB too much. Since August last year, the ECB have only used a further 8 percent of its assets in long term refinancing operations. The ECB always had about 12 percent of its assets taken up by these types of operations.

This might, in part, explain why the ECB is less willing to cut interest rates as the Fed has done since August. The crisis in Europe is more localized and the ECB is more able to help out cash-strapped banks without a desperate series of rate cuts.

The magic circle

Up to last summer, mortgage lenders enjoyed a decade of spectacular growth. The good times were based on a strategy of abandoning traditional borrowers, in particular first time buyers, in favour of buy-to-let investors and recidivistic remortgagers.

While the drift to new markets was undoubtedly profitable, lenders are now beginning to understand that these new customers were only viable as long as house prices kept rising. Now that the market is weakening, buy-to-let investors and their bloated remortgaged cousins threaten the very stability of the UK banking system.

Back in the mid-1990s, traditional home loans accounted for about 80 percent of gross mortgage lending. Last year, that figure fell to just 43 percent. Over the same period, remortgage activity increased in importance. It now accounts of just over a third of gross mortgage volumes. However, the real action was with buy-to-let lending. Ten years ago, BTL mortgages accounted for a fraction of mortgage business. Last year, it accounted for under a quarter of lending volumes, along with other exotic products, such lifetime mortgages.

Although the customer base changed spectacularly, increasing lending volumes were even more staggering. Between 1995 and 2007, gross mortgage lending volumes increased by almost 600 percent.

How did the mortgage industry pull off this extraordinary growth? Whether by accident or design, mortgage lenders benefited from the emergence of a magic circle of borrowing, buying and asset appreciation.

The cycle kicked off when interest rates began to fall and ushered in the era of teaser rates. Cheap credit and periodic remortgaging allowed homeowners to begin their long journey up the property ladder. Homeowners were always looking for bigger and better, and as trading-up took off, so did prices.

Homeowners could never trade up without the support of lenders, who provided the financing, and often generously gave a little extra for home equity withdrawal. Conveniently, a fair amount of this equity withdrawal found its way back into the housing market as deposits for buy-to-let investments. It completed the circle. Lower quality housing, left behind by trading up, were transformed into rental properties.

The magic circle pushed mortgage lenders increasingly towards remortgaging and investment and away from first time buyers. Moreover, the circle ensured that house prices kept on rising; creating an almost riskless market. Lenders could sit back and relax, happy in the knowledge that their customer base was getting richer. Even on those rare occasions when one defaulted, the value of their houses were always much larger than their loans. A lender could repossess a house, recover the loan and even munificently charge the legal costs to the unfortunate borrower.

On paper at least, the magic circle created huge disparities of wealth. As home equity accumulated, homeowners seemed to become richer, leaving everyone else behind. In reality, this wealth was little more than a twinkle in the estate agent’s window. Homeowners were actually metamorphosing into an army of highly leveraged and deeply indebted individuals.

Early last year, the magic circle broke apart. The first cracks appeared after lenders received a message from across the Atlantic that said that housing might be a little more risky than previously thought. This started out as only a marginally disconcerting message. Lenders and homeowners alike reassured themselves. The UK had no sub prime, and the comparison between the two markets had only limited usefulness.

However, the unassuming message from America fed on itself and grew. As the sub prime catastrophe exploded, UK banks felt it prudent to take a modest step back from the housing market. Nevertheless, even this limited pullback threatened continued house price appreciation, which needed a relentless flow of credit growth in much the same way as a car needs petrol.

As doubts about the future increased, banks became more fearful and tried to pull back further. What started out as a modest retreat became a riotous panic for the fire exit. Banks began to look at each other fearfully, each knowing that the other carried huge portfolios of dodgy mortgages. What followed was the now famous credit crunch; the interbank market collapsed, mortgage approvals evaporated, and house prices have begun to slide.

The mortgage market is now undergoing another dramatic structural break. Instead of explosive growth, the market is contracting sharply. Previously, lenders saw their customers as profitable opportunities with huge untapped housing equity. They now see high-risk, heavily indebted borrowers ready to default should the economy go south. Now that the magic circle has evaporated, a new, more chilling cycle is about to take its place; the great wheel of default and repossession.

In desperation, the banks are looking for help. Their balance sheets are carrying mountains of dubious debt. Even a modest economic slowdown and a rise in unemployment should be sufficient to expose the banking system to an unprecedented crisis of solvency.

Mortgage equity withdrawal is slowing

(click on the chart for a sharper image)

The UK spendfest is slowing down. In the fourth quarter of 2007, mortgage equity withdrawal slowed sharply to 3.2 percent of post-tax income. It is now at its lowest level since 2005.

The housing crash is doing all the work. With prices now falling, banks are waking up to the fact that housing equity is about to disappear. They have begun to cut back on secured lending.

The sudden slowdown in housing equity withdrawal will definitely put a brake on consumer expenditure. Although the UK is not yet in a recession, the prospect of a slowdown in growth is drawing closer.

Homeowners still pulling out cash from their homes

(Click on the chart for a larger image).

Homeowners are still at it; they are still pulling out cash from their homes using mortgage equity loans. During the third quarter of 2007, homeowners borrowed £10.5 billion, taking the 12 month total up to £47 billion.

Currently, mortgage equity withdrawal represents almost 5 percent of disposable income. This huge expansion of personal debt is propping up UK consumption expenditure and ultimately economic growth.

But will it continue? Not if house prices slow. A crash wipes out equity and when the equity evaporates, so do the loans. This means that the housing crash will feed directly into lower consumption and accelerate the UK's slide into recession.

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.

They have to be joking

I nearly choked on my coffee when I read this story from Bloomberg:

Nov. 14 (Bloomberg) -- The Bank of England signaled there is room to cut its benchmark interest rate at least once next year to prevent an economic slowdown without boosting inflation.

What? An interest rate cut "without boosting inflation"? Did anyone at the BoE take take a look at yesterday's inflation data? The RPI is running at over 4 percent, and it has been at that level consistently since October 2006. September output prices are running at almost 4 percent, which is the highest level in 12 years. Even the near-fraudulent CPI measure is running above the 2 percent government target. What is more, it is on a strong upward trajectory. World commodity prices are rising and oil is approaching $100 a barrel. Inflation is already "boosted". It is too late, the proper conclusion here is we need at least two more interest rate hikes.

However, what is this talk about a non-inflationary interest rate cut? How does that work? Well, it might happen if the economy is suffering from mass unemployment. However, with rapid credit growth and robust consumer expenditure, economic growth remains rather strong. Although some sectors of the economy are slowing, this is mainly due to housing bubble related activity, and any reduction here is healthy and should be welcomed.

Clearly, there is a lot denial over at the BoE. The MPC have spent far too look staring at their core inflation charts and like true economists, they have assumed the problem of rapidly rising prices away. However, back down at the supermarket or at the petrol station, price increases seem decidedly "core". In fact, these increases are really beginning to hurt.

Hammer and anvil

Today, the UK economy and its housing market, received two pieces of bad news. The first was on inflation; the second was on the exchange rate.

Although the the CPI inflation rate appeared to edge downward slightly in June, the much more reliable RPI measure was definitely heading north. In June, the RPI rate was 4.4 percent. Moreover, core inflation, a bogus but presentationally important indicator also crossed over the line. It is now at its most elevated level since the Bank started publishing this quasi-fraudulent index.

Unfortunately, core inflation disappointed the Bank of England. Normally, the role of core inflation is to confuse people about the true extent of inflation. In the past, the RPI inflation rate might have been powering upwards, but core inflation, which excludes marginal items like food and fuel, could be relied to stay firmly anchored just slightly above 1 percent. Not so, this month.

Here is the problem for the Bank in a nutshell. For a variety of reasons, food prices are rising worldwide. Key commodities are definitely getting pricier. Everyone knows it, including the Bank of England. Likewise, fuel prices are likely to go up. OPEC are talking of cutting production quotas, and the $90 barrel of oil is only a matter of a few weeks away. Now, core inflation is accelerating. It all makes grim reading for the MPC. Looking forward, even the dim-witted MPC can see that there is wave of inflation is about to crash over their heads.

There is only one course of action. Once everyone gets back, nicely tanned from the summer holidays, the Bank will ring in Winter with another hike in interest rates. It could come in September, but it is more likely in October.

All this talk of higher interest rates is destabilising the pound. It is now at a 26 year high against the dollar, and it could go higher. At the moment, the pound is perhaps, 25 to 30 percent overvalued. This will inevitably put the exports under some pressure, and if the overvaluation persists, it may even cause a recession.

What does all this mean for the UK's bloated housing market. Higher interest rates mean higher mortgage payments, declining demand and more repossessions. While house prices might fall in terms of pounds, the higher exchange rate will keep UK house prices high in terms of dollars. Many of those foreigners, particular from Russia and the middle east, tend to price things in dollars. When considering London, they will be faced with a strange convolution of effects; a declining housing market that is actually appreciating in the currency that denominates the bulk of their wealth. Only the really stupid homebuyer would enter that kind of market.

So, taken together, the UK housing market sits between the hammer of higher interest rates and the anvil of an overvalued and appreciating exchange rate.

The UK housing crash - it is only a matter of time.

This chart tells an extraordinary story about the current state of the UK economy. On the one hand, we see household indebtedness, as a percentage of post tax income, rising rapidly. This growth in debt starts around 1998, and its growth almost exactly mirrors the housing bubble. However, interest payments, as a proportion of post tax income, have remained broadly constant.

So what has been going on with household balance sheets? As interest rates have fallen, people have more or less maintained the same level of interest payments, but taken on more debt. It is as if they have said to themselves "I can afford to pay around 8 percent of my post-tax income on interest charges and I will take on a level of debt consistent with that interest payment". So long as interest rates are falling, or remain low, this borrowing strategy did not posed any serious financing problems for households.

What did households do with all this extra debt? They used it for three things; some of it was used to buy overvalued houses; some of it was used for consumption collateralised on rising housing values (in other words mortgage equity withdrawal); and some of it was used to finance consumption through credit cards. For the UK economy as a whole, this borrowing binge sustained growth for the last nine years. However, inflation started to creep up, and interest rates are beginning to increase.

Today, the average household is about 60 percent more indebted than it was eight years ago. Furthermore, the low interest rates that encouraged this explosion in borrowing are now coming to an end. In the short run, it is possible to roll this debt over, but with ever increasing debt servicing costs. Again, the chart shows that recently, there has been a slight uptick in interest payments as a proportion of post tax income. In the long run, smart banks reduce their exposure to ever more distressed and indebted consumers, while stupid banks suffer from higher default rates. Either way, the accumulation in household indebtedness will begin to slow.

What are interest rates going to do over the next year or so? The answer to this question depends upon how serious the Bank of England is about reducing inflation. As I keep reminding everyone, the UK money supply is growing around 14 percent a year. This is far too fast. There is enormous inflationary pressure already embedded in the UK economy.

The only way the Bank of England can reduce this pressure is by raising interest rates. In other words, the Bank of England must choose between an overvalued housing market or price stability. It can't have both. If it chooses price stability, then we are looking at a repeat of the 1989-91 recession. Again, we can see this story in this chart. Take a look at household interest payments back then. See how they spike. Back then, the Bank of England had to suddenly raise rates to curb inflation. This sudden increase in interest payments forced households to reduce their consumption expenditure and pushed the economy into a crash. What happened to house prices? They tanked.

(I found this chart on the excellent one way pendulum blog. Check it out for a different but complementary account of this chart.)

UK banks write off billions in unpaid credit card debt

UK banks have taken a serious hit on credit card debt. With sky high levels of personal debt, people are finding it impossible to pay down the plastic.

Just take a look at how that nasty red line in the chart above takes off. In the last three months of last year, banks wrote off ₤750 million, or around 3.7 percent of the stock of outstanding credit card debt debt. In the last three years, the banks wrote off credit card debts amounting to over ₤6.6 billion. Over the last ten years, the credit card write-offs have increased by a staggering 2,000 percent.

Understandably, these huge losses have forced the banks to take a more cautious approach. The stock of credit card debt has actually fallen over the last two years. However, mortgage equity withdrawal has actually increased.

If credit card debt is falling, what is fueling the UK's consumption boom? The banks now reckon that there is nothing safer than real estate. Mortgage equity loans are the current fad. In the last three years, UK home owners withdrew ₤86 billion of wealth from their homes, mostly through credit. That is over 4 times the total stock of credit card debt. The banks are happy to go along with this spendfest because the UK housing market is steaming ahead at double digit growth rates.

So what happens if housing prices start to fall? Something very nasty. Many people could easily find themselves owing more than the value of their homes. If homeowners get into payments difficulties, then the banks might find it difficult to recover the combined value of outstanding mortgages and home equity loans. Those credit card losses could easily be dwarfed by even higher write-offs from defaulted homeowner debts.

The great housing crash - it has begun

Wave goodbye to the housing bubble and say hello to the crash. The great correction has begun. In six out of ten regions in England and Wales, house prices have stagnated. House prices are rising at a slower rate than CPI inflation, which is currently 3.1 percent. House prices are also rising more slowly than wages. As a investment, housing in most of the UK is offering negative returns. Investors would be better off sticking their money into a deposit account at the building society. The only hold-out regions are London and the south, where the bubble is powering ahead, at least for the moment.

Many parts of the UK have reached the tipping point. The UK will now experience a chain reaction, which will start once prices stagnate. The delusion of eternally rising prices will be smashed. Thereafter, expectations will adjust, housing euphoria will be replaced by depression. Speculators, buy-to-yet merchants and other over-leveraged homedebtors will start to panic. It will start slowly at first, but housing inventory will begin to rise.

The story then shifts over to the wider economy. Even stagnating house prices should be enough to send the UK economy into a sharp slowdown. In large part, recent economic growth has been due to mortgage equity withdrawal, which in turn depends on ever rising house prices. In future, banks will be reluctant to give out personal loans if the value of the underlying collateral is falling. Without the mortgage equity withdrawal, UK consumption will slow, and it will take economic growth down with it. Unemployment will rise, mortgage defaults will increase and the housing prices.

However, the Bank of England is about to accelerate this chain reaction. Years of easy credit has pushed up inflation. The Bank needs to raise interest rates. There is nothing like a credit tightening to burst a speculative bubble.

So, the great housing crash of 2007 has begun. Like all housing crashes, it begins slowly, and it is greeted with denial. Real estate agents will reassure us that the slowdown is only temporary and that house inflation will shortly resume its terrible upward trajectory. They will cite the lack of supply and unsatisfied demand. However, affordability is the key. For many Britons, mortgage payments are eating up half of their post-tax income. There is nothing left to drive the bubble forward.