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?

UK House Prices - Property prices in Cornwall are up 169 percent

It is just another case of UK house prices being bid up by outsiders. People from the South West often complain that wealthy outsiders, especially from London, come into the area and bid up the property prices. The consequences are stark for low and middle income families who can no longer afford to own a house in their own neighbourhoods.

House price data from Cornwall seem to support the accusation.  Since 2000, house prices in Cornwall have increased by 169 percent, far outstripping local incomes. Prices came down slightly with post-financial crisis correction.  However, prices began to rise again in 2010.

Personally, I think Londoners should only buy houses in London. If they want to go there for a holiday, then they should stay in a bed and breakfast.  Leave Cornwal alone.

The bubble is back in Beijing

Just wait, the bubble will be back in London. A wall of liquidity from the Bank of England, coupled with zero interest rates - that should do the trick....

From Moneyweek.....

"Beijing has prescribed a strong remedy" for the Chinese economy by flooding it with money, says Wei Gu on Reuters.com. Since lending restrictions were removed in November, outstanding loans are up 30% year on year.

This flood of money has buoyed asset prices: the Shanghai stockmarket is up 69% since the start of the year, while investors are now returning to the property market after the government clamped down on an emerging bubble there in 2007. Today, "long queues increasingly form whenever new apartments go on sale" in cities such as Shanghai and Shenzhen.

After a tough 2008, "the worst is over for the residential property market", says Feng Zhi Wei of Standard Chartered. Sales volumes are up, while prices have stabilised. Even in a downturn, buyers have been willing to re-enter the market now that costs have fallen far enough to be attractive. But don't bank on a rapid price rebound. "Buyers – especially at the mass to mid-end – are mostly price sensitive and are likely to hold their purchases if house prices fall outside their affordability levels again."

Michael Moore has a new film

I don't agree with his politics, but I do enjoy the movies. I will definitely be going to see this one.

Where did the high street banks go

Over the last twenty years, UK bank balance sheets exploded, but bank branch networks contracted. The reason was increased automation of banking services. It wasn't just ATMS and cash-handling, loans approvals were increasingly delegated to computers.

To what extent did this over-reliance on technology contribute to the banking crisis?

Icesave - paying for other people's mistakes

Frankly, the UK does not come out of the Icesave collapse terribly well.

It used anti-terrorism laws to pressurize a small country to pay up on the debts of one of its bankrupt banks.

When these laws were passed, did anyone think that they would be used to settle a financial dispute? If New Labour are prepared to misuse this law in such a scandalous manner, how far would they go if they were really threatened?

It was classic Gordon Brown: "by any means necessary."

US mortgage rate hits an all time low

The US 30 year fixed rate mortgage is now at its lowest level in almost four decades. According to the Federal Reserve's database of interest rates, it is now hovering around 4.78 percent.

In the past, this would have been sufficient to generate massive increases in house prices. However, US banks haven't yet recovered from the last housing bubble. Although we haven't yet heard from the Fed's big stress test exercise, most US banks are undercapitalized, and this hyper low mortgage rate has yet to feed through into the housing market.

With this crisis, you get the feeling that no one thinks too far ahead. What happens when freshly recapitalised banks meet an ultra-low mortgage rate? Could the answer be a sudden return to hyper-inflated housing prices?

Right now, the idea of a reinvigorated housing bubble seems a stretch. But a lack of foresight has always been the Federal Reserve's fatal weakness. It rarely thinks through the consequences of any policy action beyond the time horizon of more than six months. This is why the solutions is that it offers to today's problems always seem to create even greater difficulties in the future.

Maybe its because I'm a Londoner.....

...that I can't buy a house.

True, the house price to income ratio has come down a smidgen. However, it is still almost 5. Back in the mid-1990s, it was under 3.

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.

Fionnuala has a go at spinning the dreadful house price numbers.

And of course, she fails miserably.

My favourite comment was the one about the pace of decline stablising. I think she means that we've had a couple of months where house prices fell by 1 percent a month. Keep it coming Fionnuala; that kind of monthly price decline will be just fine by me.

She also thinks that the US housing bailout will help here in the UK; which will stabilise credit markets here in the UK. This is an implicit admission that housing inflation needs credit growth. Where is all that previous guff about demand pressures?

Old habits die hard, she finishes off by saying housing prices are higher by "60 percent in real terms."

The debt mountain keeps growing

Despite all the anguished talk of collapsing credit markets, lending to individuals continues to grow. According to the last Bank of England data, in July lending went up ₤84 million compared to a year ago – a 6.2 percent increase. Of course, new mortgage approvals have slowed dramatically, pulling the plug on housing market. However, remortgaging activity is holding up comparatively well, while credit card debt is still increasing, albeit at a more relaxed rate. If individuals are still piling on the debt, why is there so much concern about a credit slowdown?

The problem is not the growth rate, but the level. After a decade of unfettered borrowing, households now owe a back-breaking ₤1.4 trillion to the banks. This is equivalent to about 100 percent of GDP, and it is up 186 percent since the first days of New Labour. We are not talking small insignificant numbers here.

Debt has become the primary source of economic growth. Like a dog chasing its own tail, more debt meant more spending, which kept the economy growing, which in turn, facilitated higher debt levels

As the debt stock spiraled upwards, the UK economy’s vulnerability to a credit slowdown increased. Before the credit crunch, personal sector lending was growing at between 10-15 percent. Now it is down to 6.2 percent. It didn’t take much of a slowdown to send the UK economy sliding towards a recession.

What do they want?

During the last 12 months, one over-riding objective has dominated UK economic policy; sustain credit growth to prevent house prices from falling. The Bank of England cut rates twice, and introduced a special liquidity scheme. Darling just launched a housing rescue package that envisages interest free loans and efforts to reduce repossessions.

This raises a perplexing question; what kind of credit growth rate are they looking for? Would the BoE and Treasury like to see a return to double digit growth rates of personal debt? Even they must recognize that there is a ceiling to how much debt people can absorb. The UK must be extremely close to this ceiling right now.

This “keep the credit flowing” strategy has no sensible, orderly terminal point. If consumers stop borrowing; the economy falls into the recessionary pit. If consumers keep borrowing, the day of reckoning is delayed, but the magnitude of the crisis grows.

The vulnerable state of UK banks is another worrying factor. As the economy slows, household default rates will soar. A recession could quickly metastasize into a banking crisis. Banks simply do not have the capital to absorb a serious economic downturn.

Start downsizing the debt

Ideally, the UK needs some kind of orderly reduction in household debt. Household balance sheets need to recover. In order for households to reduce their debt levels, they need to save more. This means consuming less. It is hard to see how this could happen without a significant downturn.

The UK has become grotesque debt dependent economy, facing the fact that it has to kick the habit. However, rehab will be a tortuous experience, but the sooner we enter the clinic the better.