CRASH 2: Banking crisis? Wait until the UK property bust really gets going….

Bank of England MPC in disarray on rates as new data disappoint

The Bank of England released the latest personal lending figures this morning. The level stayed pretty constant at £1.2billion, but is still 30% below what it was in February. In the same month for 2008, the figure was £7.8billion – over six times higher. This is, however, only the latest confirmatory piece in a jigsaw that is beginning to suggest a property implosion of unparalleled enormity. And the influential BoE Deputy Governor Paul Tucker has signalled his growing conversion to the need for interest rate rises.

The two reasons the UK housing crash hasn’t been enormous to date are (1) the banks have a gun to their heads from government forcing them to be tolerant of those behind on their mortgage payments; and (2) zero-rate interest policy (Zirp) has meant that only a fraction of buyers have actually handed over their keys to the provider.

UK Asset Resolution (UKAR), which owns Mortgage Express, many mortgages from B&B, and some £44bn of “bad” mortgages from Northern Rock is tackling the “forbearance” offered to 44,000 customers last year by reducing monthly repayments to help them stay in their homes. The chief executive, Richard Banks, a former Alliance & Leicester banker, was blunt with the Guardian last week:

“As a kneejerk reaction in the emergence of the crisis and because the government asked us to be forbearing to customers in the hope it would all go away – we as an industry have been too lenient with some customers…..You can see that if you don’t do something about it, there will be a tsunami. If you don’t get into the hills, you could get drowned by this. If you don’t manage this properly, it could get very messy.”

You can almost feel the anxiety in that quote – and, I think, the frustration Banks feels that so few homeowners or policymakers have taken in the level of catastrophe that is coming. New research from shows that 4 out of 5 homes purchased in Britain since 2006 have a value in 2011 below their purchase price. Of these, it is estimated that well over 75% are in negative equity as well. That’s around three million dwellings. Think through the effect on market values, once interest rates go up again, of that many properties coming up for auction. Auctioneers are already reporting sales going through at 40% of the original price paid by the insolvent owners.

Even half of all homes bought over the last 5 years in London are now valued below their purchase price. While this underlines how resilient the capital has been to the property downturn compared to the North and Midlands (where things are already dire) we should recognise that mortgages are on average (because of lifestage and property costs) 40% bigger in London than elsewhere – and thus exceptionally vulnerable to interest rate increases.

It’s also important to overlay onto this picture issues such as under 25 year old unemployment – now at record levels among those relationship-formers who would previously have represented the feeder-traffic into the bottom end of the market. This, too, is especially true of London.

The broader issue of rising unemployment is also one that must be addressed. It is abundantly clear now that, while unemployment has been steady for a while, the fall in full-time contracted employment has been enormous. The private manufacturing and ‘new industry’ sectors of the UK economy are doing well, but at an absolute level far too low to sustain productive growth. The IMF has reduced its 2011 forecast on UK economic growth to 1.75%….down from 2.5% in September last year. Government ministers admit in private that this may be optimistic – 1.4% may be nearer the mark – and that things will get a great deal worse before they get better. Unemployment, many observers feel, will rise further towards the end of autumn this year.

Contrary to expectations, lowering interest rates has not led to increased willingness to spend. Repaying debt has been the trend for some time now. Another sign of this is the continuing slump in retail sales, with increasing numbers of shop chains going into receivership. Thorntons have closed stores, Carpetright profits crashed by 70%, and Jane Norman has gone bust in this week so far alone.

Two weeks ago, UK house prices fell at their sharpest annual rate in 19 months. The acceleration in price falls is obvious, and this may well be connected to the fact that official statistics yesterday showed real disposable income in the first three months of 2011 suffered their most painful annual squeeze since 1977 – 34 years ago, at a time when the IMF very nearly fired the Labour Government from the job of balancing its budgets, and the top rate of tax was 83%.

So-called analysts have consistently underestimated the pace of market contraction. The 4.2% fall so far this year was expected to be 3.7%; this may not sound like much, but it proved to be a 15% optimistic outlook. The Daily Mail in January said the market would be stable.

Rather more reality is available in the shape of the gloomy forecast from investment consultancy CheckRisk, which suggests a perfect storm could send house prices down 20% this year. Even this, I fancy, is a vision of the future stuck in the past.

For me, the problem with so many contemporary predictions is that very few forecasters use their imagination to deal with new circumstances. On top of this, they talk of a ‘perfect storm’, the effect of which they have aggregated. But after a certain balance is tipped, the rate of acceleration becomes exponential. Tired parallel or not, the Titanic’s loss still remains the best analogy: 67% of the submersion of the ship took place in the last ten minutes before it disappeared below the waves.

To each physical data set, for example, one must factor in the effect of micro family bad news, macro economic bad news, and micro market bad news. This is never 2+2+2: more often the progression is (2 x 2) squared. So instead of six, the answer becomes 16. Very few people can think beyond the linear; but most case histories of market panic and economic slump show that such thinking is central to accuracy. After a certain time, the sheer weight of bad news acts like the steel of a liner that is no longer buoyant: the speed is so frightening, everyone is taken by surprise.

In just the last six days, an example has emerged right at the heart of interest rate policy: Paul Tucker, the BoE’s deputy governor, revealed he is close to voting for a rate rise – putting him at loggerheads with Sir Mervyn King, the Governor. A vote for higher rates from Mr Tucker, who many think will succeed Sir Mervyn in 2013, could very easily tip two further MPC members over to his side. To this sensitive balance has been added the Bank for International Settlements’ blunt observation that rates need to rise sooner and faster than expected. While King has been airily talking of Zirp being retained until July 2012, a number of commentators (myself included) think this to be spin: inflation is yet another economic dimension that tends to catch even experienced mathematicians out. UK inflation is already more than double that which King forecast: with a weakening Pound and still struggling exports, it could hit 10% in no time.

My money (as of yesterday) is on a maintenance of what I call Dogmatic Denialism by the US, the EU, and the UK. Debt will not be forgiven, there will be no coordinated G20 strategy on either this or inflation, China is going to find itself the less than proud owner of self-inflicted stagflation on a grand scale, and over-leveraged Russia will struggle in an environment where industrial ennergy needs evaporate. In that context, some major defaults are a certainty – and thus the banking system in its current form will not survive.
For Western property owners, that is the unfactored development. All things considered, I think we will be very lucky if the average domestic property correction this time next year is under 25%.