Wednesday, 28 November 2007

Debt, credit and default - there is way too much of it out there

There is a simple chain of events that links all our current economic problems. Here are the seven steps to a crisis:

Step 1: Banks relax lending standards and lend too much money.
Step 2: People use those loans to buy overpriced houses.
Step 3: Incomes do not keep pace with the growth of debt.
Step 4: People stop paying back loans
Step 5: Banks run into trouble and stop lending to each other.
Step 6: Central banks pump in cash to save the banks.
Step 7: Inflation rises, interest rates go up, and the economy stops.

At the moment, we are somewhere between step 4 and step 6. Today's stories reflect that gradual progression towards economic disaster.

Debt distress

It is a busy time at the Consumer Credit Counselling Service (CCCS) - a charity that helps people suffering for debt problems. During the first six months of this year, 161,558 individuals called its freephone helpline - an increase of 18.5 percent on the same period last year. Moreover, this is the highest level the charity has ever seen.

Even pensioners are not immune from the unfolding debt crisis. A recent survey showed that that 7 percent of all bankruptcies so far this year were among retired people. A recent report estimated that pensioners in Britain owed a total of £57bn, with the average pensioner racking up a debt of £5,900 in credit cards and loans. Another report estimates that a fifth of pensioners - more than a million people - are still saddled with a mortgage when they retire, with one in eight owing more than £50,000.

These numbers are a dire warning for the banks, if only they were smart enough to realise it. The vast majority of those pensioners that currently have mortgages, took out those loans when house prices were considerably lower in terms of income than they are now. If a fifth of all pensioners could not clear these mortgages while they were working, what hope is there for the current generation of home-debtors? The banks have gone too far; their lending standards have been too lax and now the banks face a growing long term default problem.

Given such stupid lending practices, is it any wonder there is a credit crunch?

The credit crunch nightmare

Central bankers are having nightmares at the moment, and the monster that visits them in their sleep is a banking crisis. When they walk up, central bankers rush down to the office and turn on the printing presses. The ECB are a particular case in point; it has promised to supply money markets with euro30 billion in one week funds.

Euro -interest rates are doing weird things. Yesterday, three-month euro rates rose to 4.72 per cent. Normally, three month rates should be closely tied to the ECB's policy rate, which currently stands at 4.0 per cent policy rate.

It is just one more sign that credit markets are seizing up. It is amazing just how much of this problem traces back to bloated and overvalued housing markets.

Money causes inflation

This credit crisis is a tad inconvenient for central banks. Inflation is already as elevated levels, and all that money rushing into "liquidity constrained" banks will end up pushing prices up. It is that old line from A Level economics rearing its ugly head again - "too much money, chasing too few goods equals inflation".

Economists at the ECB are being reminded of that old rule right now. Energy and food prices pushed inflation in Germany this month to the highest level since at least 1995. Economists are now forecasting that annual eurozone inflation would reach 3 per cent or above for the first time in more than six years. The US Federal Reserve faces an even more serious inflation problem. It is already at 3.5 per cent last month, and could approach 4 per cent in the coming months.

Do you earn £100,000+ a year?

Well, if you don't then forget about buying a house in London. The average price of a house in the capital is now a bone-crunching £318,000.

But help is at hand....

It seems that houses in London won't staying that £318,000 for very long. Prices are now falling rapidly. In October, prices in the capital fell by 0.6 percent. Well, if salaries can not rise to afford house prices, then house prices must fall to meet salaries. Of course, 0.6 percent only shaves off the ludicrous top of a lunatic market, but at least it is a start on the long road back to sanity.


shtove said...

Keep up the goodness. You were praised by MaxedOutMama in today's post here:

shtove said...

BTW - interesting insider's blog on UK banking here:
Went dead for six months or so, but it's back with some scathing comments.

Savings not debt said...

Totally agree with your article. Too much debt and not enough savings! How do we turn it around...?