Tuesday, August 05, 2008

S&I Elsewhere - The Banks That Like To Say 'No'

Matters credit-crunch related have been covered elsewhere in the Scottish blogosphere in recent weeks, notably by Bill Cameron. However, in a bid to maintain frequency during a relatively fallow blogging month [Blame the by-election/moving house/ a crawling GPRS internet web connection - but broadband should be on it's way in a week's time - hooray!] here's my column from this month's Scots Independent.

The credit crunch. It almost sounds like a new kind of chocolate biscuit, albeit one which threatens not to leave such a nice taste behind.

We know the story. Banks in America lent too enthusiastically in a market of cheap credit to 'sub-prime' mortgage customers, who had stretched themselves to their financial limits. As the cost of living rose, people found themselves unable to repay their debts on the terms agreed. Falling house prices then left the assets worth less than the loans they were supposed to guarantee.

And then the fun really began. Financial institutions which had bought packages of consolidated mortgage debt started to panic, since in light of the defaults and property market falls, they could no longer say with certainty what these investments were worth. Banks became reluctant to lend to one another, inter-bank lending rates soared above official central bank interest rates and in short order, there was a 'liquidity' crisis which threatened to bring the banking system grinding to a halt, like an engine without oil.

But why should the inability of homeowners in the US to repay their mortgages be pushing up our cost of living here? Simply, it's because our economies are now so open and interlinked. The whole basis of our economic system is confidence – we don't insist that every pound in circulation is backed by an asset of similar value, because we have confidence in the money we carry around with us. And like the banks with other banks, when our creditors lose confidence that their loans will be repaid, they become reluctant to lend and the cost of borrowing begins to rise.

I've been feeling the effects of this myself in recent weeks as I've sought to buy a house in the constituency I hope to represent following the next election. Getting a mortgage was far harder than it was last time I bought a flat, and the providers are now hiking up interest rates, padding their 'arrangement fees' and reducing the maximum loan-to-value they are prepared to offer. Bad enough for a second time buyer like me with a modest amount of capital, but disastrous for first-time buyers already struggling to scrape together sufficient deposits.

Some 42,000 home loans were approved in May, a 28% fall compared with the previous month and 64% down on a year before. The Bank of England has also reported that the number of new mortgages approved for house purchases had fallen to its lowest level since figures began in 1993. The number of mortgages available on the market has also plummeted, from over 11,000 different types a year ago to fewer than 4,000 today. As indicators go, they make for pretty grim reading.

Our homes have been the way we have funded much of our recent consumption. Rising house prices made us all feel prosperous, even if that profit was only a paper one until such time as you either traded down or got off the property ladder altogether. It stands to reason, if not logic, that a period of falling prices will make us feel more gloomy.

Almost certainly, personal credit has been too free and easy over the past decade or so. For a while, it seemed like anyone could get a credit card with a debt limit representing a significant fraction of their income. With banks falling over themselves to offer 0% deals, juggling card debt between one introductory offer and another seemed to become something of a national sport. After all, we worked hard, and what the hell if income didn't match expenditure? That better paid job was only a couple of years away, so what did it matter if we borrowed to get the holiday, the suit, the car or the mobile phone straight away?

That said, debt, quite rightly, is no longer something to be ashamed of. If you go to university these days, it's practically state-sanctioned and compulsory. I certainly don't want to return to a situation where you are made to feel that the building society is doing you a favour if it deigns to lend you the money to buy a house, or release home equity to start a business. However, it's another matter when our levels of unsecured debt, from personal loans or credit cards, becomes almost a rueful badge of pride.

But then, we've had a lousy example of financial management over the past decade from the man who only last year moved from number 11 to number 10. Gordon Brown has racked up £40bn of government debt this year, with the UK fast approaching a cumulative debt of £650bn. He's also about to break his self-imposed 'golden rule' of only borrowing to invest over the economic cycle.

That rule, alongside his professed desire to keep debt below 40% of GDP, is certainly of greater symbolic than economic importance. Why does it matter, then? Well, Brown has been like the schoolboy who sets his own exam questions before marking his own papers. He's basked in his own self-proclaimed brilliance for a decade, on a boom fueled by consumer debt, and shifted the goalposts when it suited. Having set the terms by which he wanted to be judged, he can hardly complain if he is now found wanting when judged in precisely that manner.

The biggest surprise of the credit crunch is that anyone is surprised it came at all. Our debt-fueled splurge of the past decade was always going to have to be paid for at some point and after all, in any market economy, there are always periods of expansion, followed by periods of contraction or slower growth. But then, surely none of us were daft enough to swallow Brown's claims to have ended boom and bust in the first place?


debt consolidation said...

For home loan financing, figure out how much you can afford. The calculators can help, but it is best to visit a lender to find out for sure.

Bill said...

A good article (not least for your 'plug' for one of mine) which I agree with in the main; as a former banker I've got quite an 'old fashoned' view about debt so far as my own personal finances are concerned; I have none and in the days when I did have substantial debt it was always easily within my current resources to repay more or less on demand, the benefit of keeping the debt in place being simply the arbitrage between preferential borrowing rates as a bank employee and what I could get for depositing money elesewhere (usually with my own employers or a subsidiary).

What really intrigues me, though, is how long the government can go on massaging the inflation statistics to make it seem a lot less high than most of us experience on a daily basis.

We in the UK have been living beyond our means for many years, but it's as nothing compared to the overspending in the US; most Americans in my estimation simply have no conception of what is going on in the wider world economically and how their own economic futures (and by extension our own) are in peril. A classic example was the barring a few years ago, against the advice of the President (yes, I know he's an idiot, but he was right on this occasion) of the takeover of the New York Ports Authority by a Dubai sovereign investment fund; the protectionsist mindset exhibited then, by the Democrat-dominated House of Representatives, remains valid in a free-market global economy only when the nation which is doing the objecting is reasonably solvent even without looking through the wrong end of a telescope, something it is patently not; the only thing which keeps it going is that they now owe so much that the lending nations can't take too much of their funding away all at once to protect their own economies. The kind of thing the gold-selling former Chancellor who is now our Prime Minister has not a clue about either.