Thursday, 8 November 2007

Lessons from America

Yesterday, one of America's largest mortgage lenders - Washington Mutual Inc. said that 2007 credit losses could amount to between $2.7 billion to $2.9 billion. This was shocking news, since it was almost double the company estimates issued in July. That date is significant because it was at the height of the US subprime meltdown. So yesterday's news strongly suggests that the credit crunch in the US is far from over. In fact, things could be getting worse.

Reaction here in the UK to this kind of news and to the US subprime mess in general has been somewhat bipolar. On the one hand, UK commentators and lenders are ready to blame the US supprime debacle for the slowing housing market and declining consumer confidence. Press releases are regularly throwing out the line that consumers here are somehow disheartened by events across the Atlantic. As the wave of bad news is reported here, consumers have decided to stop buying houses, and this accounts for the temporary slowdown in sales activity. This line of thinking is highly implausible, but nevertheless, it regularly fills newspaper columns.

However, UK lenders are very keen to avoid any comparision regarding lending practices. Here, lenders have been "much more prudent". There has been no subprime lending here, thank you very much. UK banking balance sheets are, supposedly, in much better shape. Here, we are expected to believe that there are no useful parallels between the US and the UK.

Yet here is the funny thing - the US housing bubble was a comparatively modest event, when compared to the UK bubble. Take a look at house prices here and in the US. Go to Zipreality - a US real estate website - and pick any city. See what $500,00 will buy you and compare it to what it would buy in the UK.

Look at housing affordability indicators; house price to income ratios, rental yields - and it is the same story. The US bubble, although unprecedented in recent history, looks much more reasonable compared to what went on here.

Personal sector indebtedness tells the same story. Although the US consumer is sinking in debt, private sector balance sheets over here are in much worse shape. UK consumers are the European leaders in credit card debt. One third of all such debt is found here. UK personal indebtedness is currently running at 1.6 times disposable income, compared to 1.3 in the US.

This brings us back to UK lenders, who have lent out money into a more inflated bubble, to borrowers who have lower earnings, and who are carrying more unsecured debt. Add to this, we have our own unique vulnerability - the buy-to-let brigade. Although there were speculators in the US driving up the market, their influence was minor compared to the BTLers.

It was no accident that the first major run on a large OECD bank happened in the UK. Northern Rock was merely the most vulnerable of a long list of highly leveraged UK lending institutions. The UK bubble has barely begun deflating. Once it does, UK lenders will begin to record losses just like Washington Mutual. The fear must be that Northern Rock was just the beginning of a UK banking crisis.

Ultimately, it comes down to this: the US might have subprime, but the UK has more of everything else. It has more distressed borrowers, more speculators and more reckless banks. So forget talk about subprime depressed UK consumers, focus on our banks. That is where our true problems lie.

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