Chinese wages - be afraid

Personal debt in the UK

Infographic by Money Debt & Credit

Land Registry confirms falling prices

(click on the graphic for a larger version)

According to the Land Registry , UK property prices dropped by 0.2 percent in December - the fourth successive monthly fall in prices.

Nevertheless, the Guardian helpfully located the few remaining bubble boom towns.

We need new generals

How Lehman brought down the pro-western governments in North Africa

The world is always throwing up surprises. Did the leaders of Tunisia and Egypt think that their regimes could be threatened by the collapse of a highly leveraged bank like Lehman? Yet, that seems to be what is happening.

The casuality is straightforward. When Lehman crashed, central banks cut interest rates to prevent Wall Street banks and hedge funds from going under. As soon as the immediate risk of a financial meltdown subsided, these low rates unleashed a speculative bubble in commodities.

The consequences can be seen in the chart above that illustrates the FAO's world food price index. Since December 2008, world food prices have increased by 55 percent. Some items have increased much faster; sugar is up 148 percent, cooking oil is up 116 percent.

These increases can not be explained by falling supply or increasing demand. The price changes are too large and over a very short time period. No, it is the derivatives market. Speculators borrow cheaply and seeking higher yields, speculate on commodities futures. This speculative trade pushes commodity prices up, creating a massive surge in inflation.

The social and political implications of this speculation in developing countries is devastating. Regimes in places like Tunisia, Egypt and Yemen were always highly unstable. With double digit food inflation, they are crumbling. Moreover, this crisis is unlikely to stop in North Africa. Dare I mention the P word? - P---stan and their red hot nuclear arsenal.

There is now a conflict emerging between the strategic interests of Western governments and those of Wall Street and the City of London. The balance sheets of Western banks remain fragile. They need low interest rates to maintain cheap sources of financing. Global stability, on the other hand, requires higher interest rates to defuse the speculative bubbles in commodities.

Currently, this conflict is at its sharpest in Egypt. Should Mubarak fall, thirty years of carefully crafted US diplomacy in the Middle East will be destroyed. Anyone who thinks that Egypt will effortlessly transform into a thriving western democracy while food prices are crippling the urban poor is living out of fantasy.

Two years on from the Lehman collapse, what has the bailout achieved? Economies in western economies have crashed; their governments have become loaded up with debt, and inflation has ripped apart the tenuous living standards of the poor in the developing world. Yet, Goldman, JP Morgan and Merrill continue as if nothing has changed.

The world is too fragile to absorb another speculative bubble. However, that is what this extended period of low interest rates has unleashed. It has destabilised North Africa and other regions could follow. Who could have seen that when Lehman filed for bankruptcy?

Learning from our mistakes

It is a sad fact that in the last 40 years, Britain has suffered from four separate housing bubbles.

The first occurred in the early 1970s when Ted Heath was Prime Minister. He liberalized the banking sector, reduced interest rates, and tried to keep the economy afloat with a huge fiscal deficit. He also antagonised the unions and drove the UK to the edge of hyperinflation. House prices rose and fell in parallel with Ted Heath’s opinion poll ratings.

In the late 1970s, Jim Callaghan tried the same trick. He had less success than Ted. House prices didn't skyrocket in quite the same dramatic way. Nevertheless, his departure from office coincided with a house price crash.

Mrs Thatcher was a little slow in playing the housing bubble game. It was well into her second term as prime minister before she engineered the conditions for a hyperventilating property market. Nevertheless, it was a spectacular one. And when it crashed the whole economy sank with it.

John Major never got the chance to inflate the housing market. He spent most of his wretched time in office cleaning up the mess that Mrs Thatcher made. By the time he was shown the door, house prices had stabilized. This was good news for the next occupants of 10 and 11 Downing Street. The UK economy was ripe for another bubble.

Tony Blair and Gordon Brown produced perhaps the greatest bubble of them. When it finally burst in 2007, it did more than just send the economy into the longest recession since the war. It nearly destroyed the UK financial system. The UK economy came within a centimeter of Armageddon.

Have we learnt anything from these experiences? I am afraid not. As soon as this bubble has finally unwound, and the banks have recovered, the British people will be ready for another round of property market monopoly.

Deep down inside, we love it too much. We would miss those greedy conversations about how much price appreciation is now embedded in our homes. The illusion of wealth, it might be an imperfect substitute for being truly rich, but it will do for most of us.

However, there are others who look upon our experiences with unbridled horror. Having seen the harm that speculative bubble can inflict on an economy, the Singapore government introduced a series of measures designed to cool down their housing market.

The government announced its intention with extraordinary clarity: “The government’s objective is to ensure a stable and sustainable property market where prices move in line with economic fundamentals.”. Could you imagine a British government ever committing itself to that kind of sanity?

• It raised down payment requirements for second mortgages. Individuals with more than one mortgage can only borrow up to 60 percent of a property’s value, down from 70 percent.
• It extended the period homeowners must hold properties to avoid a sales tax. Sellers will now have to pay a stamp duty for all homes and land sold within four years of purchase.
• Singapore’s homeowners who sell a property within a year of purchase will have to pay a tax of 16 percent.

Earlier, the government barred interest-only loans for some housing projects. It also barred developers from covering interest payments for apartments still being built.

House prices in Singapore are rising rapidly. The risks to the financial system and economy are serious. Nevertheless, in contrast to our sorry history, the Singaporean government understands the dangers of permitting unbridled property speculation. Although, we cannot learn from our own history, there is some comfort in the fact that others can see the dangers that we cannot.

Debt problems worse now than in 2008

Running out of credit

In the aftermath of the financial crisis, consumer credit was regularly offered as one of the prime reasons behind the downfall of UK banks. UK consumers were encouraged to go on a plastic-fueled shopping spree that ultimately created a nation of debt-serfs, who couldn't repay the banks.

The story, however, was only partly true. Yes, consumers were crushed by high levels of debt, but no, the Banks hadn't been pushing individuals to over use their credits.

UK banks had become wary of consumer credit long before the credit crunch. Gross consumer lending peaked around seven years ago. Since then, banks have been quietly reducing the flows of new lending.

Banks engineered this contraction of credit by massively hiking interest rates on credit cards. You would have to be either mad or desperate to run a balance on card.

With default rates rising, banks had become wary of overextended maxed out consumers. Home equity loans and remortgaging, where consumers used their homes as collatoral, seemed a much safer proposition.

Ironically, the credit crunch has prompted banks to reverse their previous policy of reducing their exposure to consumers. For the last 18 months or so, gross consumer lending has been rising.

UK house prices to fall another 13 percent

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

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

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

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

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

Lets roll those loaded dice

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

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

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

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

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

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

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

US real estate lending growing at 6.4 percent

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

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

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

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

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

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

US home sales are flat

Flat as in pancake....

To fix or not to fix

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

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

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

It wasn't our fault

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

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

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

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

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

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

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

The classic green shoot chart

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

I choose freedom

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

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

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

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

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

Another beautiful chart

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

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

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

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

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

Green shoots?

From the American Bankers Association:

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

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

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

What is going wrong with corporate lending?

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

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

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

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

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

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