Tuesday, 23 October 2007

Oh no, it can't happen here

What, a housing crash in the UK? We are a small island with lots of people and very few houses. Property crashes are for the continent. They happen in big places connected to other big places like Spain or America.

Today, Kate Barker, who sits on the Bank of England's monetary policy committee, rejected the idea that the UK might be on the edge of a property crash. As far as Kate can see, it is "not immediately obvious" why recent developments in the markets should provide a "trigger which significantly alters previous expectations of continued robust house price growth".

Does Northern Rock ring a bell, Kate? Do you remember that the Bank of England has just poured in 16 billion quid into that financial catastrophe? Have you had a look at the unsustainable house price to incomes ratios, or levels of personal sector indebtedness? Have you looked across the sea to Ireland, or perhaps looked even further across the Atlantic? Seems not.

Bubbles happen when three things come into play. First, there is easy credit to finance the bubble. This is the rocket fuel that sends prices into outer space. Second, prices decouple from long run fundamentals. Finally, the easy credit and rapidly rising prices encourages all those speculative plays, which for a time generate large gains, and drags other punters into the scam.

In other words, bubbles are self-sustaining belief systems, held up by central banks, who are prepared to supply the credit to feed the dream of infinitely increasing asset prices alive. Crashes happen when the credit stops and people stop believing. This is why bubbles are so dangerous. The only thing holding them up is the willing suspension of disbelief on the part of the house buying public and temporarily low interest rates.

Kate also believes that a "major weakening in the housing market" was unlikely to have a marked impact on consumer spending since it was not expected to be linked to higher unemployment or a deterioration in households' expectations of future incomes."

Unfortunately, Kate appears to suffering from some seriously confused thinking. So let us all help Kate out with the likely chain of events that will link housing bubble to a crash and then onto falling consumer expenditure and unemployment Here are the seven steps from the housing bubble to unemployment, which she needs to focus on:

Step one - We start with our much beloved UK housing market bubble. It was financed by a huge increase in the money supply, which Kate helped supervise as a member of Bank of England's monetary policy committee. If are are in any doubt about the extent of money supply growth, Kate, all the numbers are there on there on the bank's website. Have quick look at them before the next MPC meeting.

Step two - The rising money supply and increased housing wealth has been reflected in consumer behavior. No one saves anymore. Instead, UK consumers have borrowed themselves a mountain of debt. Some of it went to buy overpriced houses, or speculating on buy-to-let investments. The rest went on flat screen TVs, cars and holidays. This debt now sits on the balance sheets of our commercial banks. All this debt fueled consumption generates inflationary pressures.

Step three - Unfortunately, the Bank ofEngland wasn't the central bank losing control of the money supply. The US Fed, the ECB, the Bank of Japan and just about every other central bank has been producing lots of extra cash. That is why there is a worldwide housing bubble and inflation is picking up worldwide. We have $90 oil, $75o gold while food prices are going through the roof.

Step four - The Bank did recognise that inflation was picking up some time ago. It raised interest rates. However, inflation hasn't really gone away. The UK's retail price index is still at over 4 percent. Meanwhile, interest rats on mortgages and over-drafts are going up. More importantly, corporate borrowing has also become more expensive.

Step five - The combined effects of inflation and higher interest rates will eventually a) raise the savings rate and therefore reduce consumption, b) reduce investment, c) kill the housing bubble (through higher mortgage payments), which in turn will make people feel poorer, and d) generate balance sheet difficulties for commercial banks, who will experience funding difficulties (like Northern Rock) and who will take fright and stop borrowing to the debt soaked and maxed-out British consumer.

Step six - Al this adds up to a credit contraction, lower consumption and lower investment, In turn, this means lower economic growth, and rising unemployment.

Step seven - Rising unemployment means more repossessions and housing collapse. Then, we go down and down until we reach the bottom. Where will we land? Unfortunately, I can't help you here Kate. It is too far down for me to see, but I fear that we will be sliding down the recessionary hole for quite some time.

So if this is not immediately obvious, what are you doing sitting on the MPC, making decisions about interest rates?


Anonymous said...


uk renter said...

well written. it always surprises me that others can't see the likely path of events that will unfold.