Mortgage News

With news of banks facing bankruptcy across Europe, these are nervous times.

There are few things that financial authorities and governments fear more than a rush to withdraw savings from banks. It evokes memories of the Great Depression, and in Germany the hyper inflation which made money worthless, facilitating the rise of the Nazis.

In the UK, the government explicitly guarantee the first £50,000 of savings in a bank account (having recently increased it from £35,000. In practise, the government would not want to let any bank go bankrupt for the negative impact on confidence. However, there is a reluctance to explicitly guarantee all savings because this encourages banks to  engage in risky behaviour, because the government will always secured savings should banks go bankrupt.

The problem is that now Ireland and Germany have abolished an upper ceiling on bank deposits, it creates an incentive for savers to move their savings to Germany and Ireland where they can have 100% security. If there was a widespread withdrawal from British banks, it would be very damaging. At the moment, banks are desperate for more savings to improve their battered balance sheets.

Therefore, to prevent a flow of savings from the UK to Ireland and / or Germany, Gordon Brown is under pressure to abolish the limit on savings. This would mean the UK government promising to honour upto £2 trillion worth of deposits. It’s a difficult choice, and no wonder they are not happy with the Germans and Irish for raising the stakes of securing bank deposits.

Original post by Tejvan R Pettinger

Even before the recent problems in the financial markets, the UK economy looked to be heading into recession. Economic growth was 0% in the second quarter Now, the recession could be much deeper than previously anticipated.

Bad News on Economy

• Falling House prices reducing consumer confidence and consumer spending
• Problems of Bradford & Bingley and HBOS will lead to less mortgages on market and likelihood of further house price falls.
• Manufacturing output, and employment decreased at the fastest rate since the severe recession of 1982. Manufacturing output has now fallen for 5 consecutive months, and illustrates how the ‘real economy’ is being affected by the slowdown - not just stock markets.
• Burdgeoning National debt leaves the chancellor with little room for manoeuvre. Expansionary fiscal policy requires more government borrowing, but, this would be difficult.
• Rising Unemployment. After a decade of low unemployment, unemployment is now rising very quick. Rising unemployment will increase mortgage defaults and cause more problem for the beleaguered banking sector.
• Credit Crunch - More still to come. A recession and continued fall in house prices will only cause further problems for banks who have holes in their balance sheets. There will be further difficulties on the stock market and borrowing will become more difficult, reducing investment.

Good News

The ray of hope is that at least cost push inflation appears to be coming down, the producer price index dropped last month, indicating lower retail inflation in the future. With oil prices also coming down as well, it enables the MPC to be able to cut interest rates which will hopefully lessen the impact of the slowdown.

Original post by Tejvan R Pettinger

If the government nationalise Bradford and Bingley, the taxpayer is taking responsibility for the mortgage loans. This gives the government a balance sheet of £150bn in mortgage loans (£50bn from Bradford & Bingley, £100bn from Northern Rock)

It is misleading to say this will cost the taxpayer £150bn (like the Telegraph does in the heading). It means the taxpayer is potentially liable for the mortgages. However, it is not unfeasible, the government will receive most of these mortgage payments back. It would only cost £150bn, if there was a 100% default rate on mortgage payments from Bradford & Bingley and Northern Rock)

Despite, the much publicised problems in the housing markets, default rates are still relatively low - even for high risk groups like self certification mortgages.

The one positive aspect of the current house price crash is that at least interest rates are low (5%) and is likely to fall even further. Therefore, this will prevent a rapid rise in mortgage defaults.

However, given deteriorating economic conditions. In particular rising unemployment, 2009 is likely to see a worsening of mortgage defaults. Unemployment is one of the biggest causes of mortgage defaults.

Falling house prices will also exacerbate the losses of mortgage companies - especially for mortgages which were 95% or even 100% of LTV.

Falling house prices are a big concern for landlords who need to refinance their mortgage deals by using the (falling) value of existing housing stock.

My feeling is that the actual cost to the taxpayer will be relatively low (certainly lower than if the banks had been allowed to go under) Nevertheless it is still a salient reminder of the fragile state of the banking industry that the on average every UK taxpayer is liable for £5,500 of mortgage debt.

What is Cost of $700bn US Bailout?

• The equivalent of 2,000 Big Macs per American!
• See: Freakonomics blog - How big is bailout
• Questions about Financial bailout at Economics Help

Original post by Tejvan R Pettinger

HBOS, the owner of Halifax, admitted that they were in talks with Lloyds TSB to try and work out a merger deal. The two banks are working very fast to arrange a deal to safeguard the company. The Competition Commission is likely to grant special permission for the merger (despite increase in monopoly power) given the acute crisis that would occur if it was not rescued.

The government will be desperate to protect HBOS, the scale is far greater than Northern Rock. A collapse of a bank the size of Halifax would be unthinkable.

Why is HBOS in difficulty.

Like Northern Rock, HBOS, used money markets to finance its lending business. The traditional mortgage was financed out of savings and deposits. But, increasingly banks like HBOS have been lending on the basis of money raised in money markets.

However, since the collapse of the American subprime sector in 2007. Many banks lost money from the defaults on these subprime loans. Therefore, there has been a shortage of funds in these money markets.

In July, HBOS issued a share rights issue to try and raise £4bn of funds. But, investors shunned the deal, creating uncertainty over their ability to raise finance. This year, HBOS has frequently been the target of speculators seeking to bet on the possibility of a collapse.

This involves people holding ’short positions’ which means if share prices fall, they can exercise their options to sell at a higher price.

Original post by Tejvan R Pettinger

After rescuing Bear Sterns, Freddie Mac and Fannie Mae, the American government decided that it had to draw the line somewhere and not use public funds to rescue Lehman brothers. The effect is that the big investment bank, Lehman Brothers has gone bankrupt leading to almost 20,000 job losses. However, although this is a high personal cost to those concerned, the repercussions could spread far across the banking and financial system.

It shows a year after the credit crunch started, we are far from reaching the bottom.

Lehman brothers were part of the ’shadow banking system’ - The banking system that doesn’t rely on deposits to fund loans. Instead Lehman brothers helped to sell on debt from other banks (including the notorious subprime loans). They were also heavily involved in derivative trading. Yesterday, as stock markets plummeted, traders tried to unwind $700bn worth of derivatives - a scale never seen before. Wall street admits that derivatives trading has grown so fast, that there is hardly any regulation of this trading.

What does the Future Hold?

The fact another big bank has gone under will send shock waves throughout the financial system. There are real concerns that the problem could spread. In the US, Ken Lewis, head of Bank of America, said he thought that up to half of the country’s 9,000 banks would ultimately go under or be taken over.

The danger is that the collapse of Lehman brothers will trigger a fall in confidence. Combined with the long standing shortage of funds, we could see higher interest rates (the libor interbank rate rose 0.5% yesterday alone) and the possibility of the credit crunch getting worse, pushing the economy further into recession.

A recession would only exacerbate the current problems. A recession would lead to more mortgage defaults - the last thing banks need at the moment. If home repossessions continue to rise and house prices fall; the losses of banks could grow even higher.

Economists such as Paul Krugman fear the worse, saying the collapse of Lehman Brothers reminds him of Russian Roulette

• Credit Crunch Explained

AIG a big insurance firm is the next finanicial institution that is in the firing line.

Original post by Tejvan R Pettinger

After falling for 15 years, unemployment has increased by 70,000 during 2008. A report published today shows the amount of permanent jobs available has fallen to its lowest level since 2001. Many also predict a rapid rise in unemployment towards 2 million - a figure last seen during the 1991 recession.

This year, David Blanchflower has often been a lone member of the MPC calling for a cut in interest rates. He now feels the string of depressing news vindicates his call for lower interest rates.

David Blanchflower says, in an interview with Reuters that “We are going to see much more dramatic drops in output,”

Another factor that increases the likelyhood of an interest rate cut is the fall in oil prices. After reaching $150 in the middle of summer, oil prices have slumped to $105 as disruptions to supply have failed to materialise. Lower oil prices will help reduce the cost push inflation which caused the MPC such a headache. With a fall in inflation in 2009. it opens up the way for a cut in interest rates.

With house prices continuing to fall, lower interest rates would certainly be welcomed in that market as well.

Original post by Tejvan R Pettinger

Definition of Negative Real Interest rates - When the inflation rate is higher than the Bank of England Base Rate. Negative real interest rates are bad for savers and good for borrowers (assuming their income increases in line with cost of living)

The UK, is now experiencing negative real interest rates for the first time in 27 years.

• RPI inflation is 5.1% (rounded down to 5%) This is the most comprehensive measure of living costs
• RPIX inflation is 5.3%
• CPI inflation is 4.4% (this is the government’s preferred method, but, excludes housing costs and council tax)
• Base rates are 5%
• Food inflation is in double figures.
• Rising inflation and falling growth is known as ’stagflation’

This 16 year peak in inflation puts pressure on the Bank of England to increase interest rates (or at least not cut them. Inflation is now far above the government’s target of 2%. The Bank will also be concerned that the current spike in inflation will increase inflationary expectations and make it more difficult to reduce in the long term. (When inflation is high people will start demanding higher wage increases and this cements the higher inflation)

Any Good News on the horizon?

• Oil prices are starting to drop after their summer peak. Supermarkets like Morrison’s are cutting petrol prices. Lower petrol prices, would definitely help reduce inflation over next few months.
• Lower economic growth and rising unemployment is keeping a lid on wage inflation (although the downside here is that people are not experiencing increases in living standards)

What Will Happen To Interest Rates?

The MPC face a difficult dilemna. They will be hoping inflationary pressure work their way out of the system soon. They don’t want to increase rates with the risk of recession. But, they don’t like to see inflation above the target. I think they will keep interest rates the same at 5% for a few months and see how things develop.

Original post by Tejvan R Pettinger

Debt levels in the UK have been growing significantly for both:

1. National Debt (Government debt. The amount government spending exceeds tax revenues)
2. Personal debt (consumers, firms)

Personal debt levels in the UK

Personal debt includes both secured (usually mortgages, loans against value of home) and unsecured (personal loans, credit card debt). The level of both types of debt have increased in the past few years. Generally, secured debt is seen as less harmful, but, with falling property prices there is the prospect of more people facing negative equity and difficulties of repaying should they default.

• Consumer debt totals £1.4 trillion (about 80% of this debt is in the form of mortgage loans secured against property)
• Over 100,000 go insolvent each year
• UK has highest levels of consumer borrowing in Europe. (but less than US)
• In the past year borrowing has increased whilst saving has fallen. For every £1 saved. Britons borrow 69p (on loans, credit cards but excludes mortgages).  A year ago, this ratio was 29p borrowed for every pound spent.
• Falling house prices could make secured debt unsecured and leave people with negative equity
• According to National Consumer Council, about six million people are struggling to meet credit demands.

National Debt in UK

Government debt is the amount the government need to borrow from the private sector, usually in the form of selling bonds to investment trusts and pension funds.

• National debt in UK stands at £555bn in June 2008.
• As a % of GDP national debt has increased from 30% of GDP to a forecast 38% in 2009 (forecast is likely to be wrong and an underestimate)

Graph of National Debt

After reaching a peak of 43% in 1997, National debt fell to just 29.8% of GDP in 2003; this was due to restrained government spending and consistent economic growth. The increase in debt since 2003, reflects ambitious spending plans by the government.
Furthermore as the economy slows down, the government debt will only increase. Income tax revenues will fall, VAT revenues will fall. Unemployment will increase, increasing cost of benefits to unemployed. The government has even postponed petrol tax rises which will cost an additional £2.5 bn. Therefore, most economists now predict that National debt will soon exceed the 40% of GDP, Gordon Brown once set as a limit for Government borrowing. The UK has had worse levels of debt before, but, it will be embarrassing politically and represents a sharp reversal in borrowing in the past 5 years.

Government debt increases the burden on the future tax payer; debt interest payments already account for nearly £30bn a year.
Annual Government Borrowing.

Public sector net borrowing in 2008/09 is forecast to be £43 billion. Although with the economic downturn and cancellation of petrol tax increases, borrowing could increase sharply in 2009.

Again, this is likely to break the government’s rule of not borrowing more than 3% of GDP in one particular year.

Links and Sources of Statistics

• Consumer Borrowing in UK at BBC statistics
• Consumer borrowing soars at Guardian
• National Statstics online - National debt

Original post by Tejvan R Pettinger

Unemployment in the UK is rising at the fastest rate since 1992, inflation has shot up faster than wage growth, house prices are falling and general economic confidence has slumped. Most economists feel that some form of a recession is now inevitable. These are some tips to help survive an economic downturn.

1. Don’t Panic

Things are bad, but the media tends to exaggerate the extent of a downturn. Statistics can be misleading as media tend to focus on the most eyecatching statistics. For example:

• Petrol and food prices are increasing by 20%, but, other items in the CPI are falling.
• Unemployment is rising at the fastest rate since 1992, but, comparatively it is much lower than any time in the 1980s.
• Recessions tend to be short lived 12-18 months. (see: How long do recessions last?)

2. Spend Frugally

With disposable income stagnating or even falling, spend frugally. Discount shops such as Matalan, Aldi and Primark have seen increased demand as people look for good value. A squeeze on household income is a good time to look at reducing unnecessary expenditure and making economies which don’t harm your living standards. See: Ways to avoid overspending

3. Stay Positive.

If your firm is looking to make redundancies, it is important you give compelling reasons for the firm to retain you. Dress smart, be cheerful and optimistic. Don’t annoy your boss by asking for a large payrise or always talking about redundancies. If you are willing to adapt to more difficult circumstances and work with a helpful attitude, the firm will be much more likely to retain you in any wave of redundancies.

4. Be Aware of Alternatives.

Don’t feel your present job is the only option for you. The labour market is becoming increasingly flexible for skilled and motivated workers. Stay alert for ways to increase your skill base or  options for second incomes. Don’t wait before you are made unemployed; keep your eyes out for alternative jobs - changing sector if necessary.

5. Different Sectors will be Affected in different ways

The current recession is hitting hard sectors such as construction, motor industry, real estate, retail and banking. If you are in these sectors it is even more important to work on alternative sources of income and jobs. Some sectors such as education may be largely unaffected.

6. Recessions create opportunities.

Recessions generally lead to lower demand. But, some sectors can profit from recessions. For example, high oil prices are encouraging people to consider cycling and public transport; consider the options in these sectors.
7. Dealing With Unemployment
If, despite your best efforts, you are made unemployed, these are some tips

• Don’t feel guilty or bad
• Keep positive in your job search
• Be willing to consider jobs outside your previous employments
• Try to avoid financial misery create difficulties in your relationships. Talk through economic problems and avoid unrealistic expectations.

8. Struggling with Mortgage

If you are struggling with your mortgage payments, you may face a double problem of negative equity as well. There are various things you can do if struggling with mortgage payments, such as temporarily choosing interest only mortgage or extending mortgage term. See: Struggling with mortgage payments

9. Remember Money isn’t Everything.

Don’t feel that financial well being is the only thing that matters. Even in difficult times, don’t lose perspective and allow yourself to be depressed. With the right attitude a frugal lifestyle can have its own pleasures. Just remember the Monty Python sketch - The Four Yorkshiremen

THIRD YORKSHIREMAN:

But you know, we were happy in those days, though we were poor.

FIRST YORKSHIREMAN:

Because we were poor. My old Dad used to say to me, “Money doesn’t buy you happiness, son”.

FOURTH YORKSHIREMAN:

Aye, ‘e was right.

You Tube video

10. Budget

If your income falls, work out a budget to deal with the new financial reality. It may be painful, but, it is worse to live with the same expectations as before and end up with increasing levels of debt.

• What does it mean to be in a recession?

Original post by Tejvan R Pettinger

Recent data suggests that the UK’s long record of unbroken economic growth may, at last, be coming to an end. The latest snapshot of the UK economy presents a relatively good economic situation; however, this mask a variety of data suggesting the economic situation is sharply deteriorating.

The Bad News on the UK Economy

• Falling disposable incomes due to rising oil and energy prices
• Falling house prices. Falling house prices reduce consumer wealth, consumer confidence and the ability to remortgage. Rising house prices have long sustained UK economic growth, but, now prices are falling, the opposite is occurring.
• High Street Sales slumping. M&S has reported a series of disastrous results. Food sales fell by 4.2%, clothes sales by 6%. The problems of M&S are revealing because M&S targets the luxury end of the food market. It appears that price is becoming the important factor in consumer shopping. The likes of Netto and Aldi are likely to do fine in a recession as they target the best value, rather than selling the most expensive organic food at any price.
• Rising Mortgage Costs, despite base rates staying the same. The credit crunch is forcing up the cost of fixed rate mortgages.
• Rising inflation could even force the MPC to increase interest rates, a sure way to make the downturn worse.
• High Levels of Consumer Debt. For several years we have benefitted from high consumer confidence which has encouraged record levels of consumer debt both secured and unsecured. As confidence in the economy falls, consumers are likely to try and increase their savings ratio, leading to a fall in consumer spending.
• Government Borrowing is likely to increase to £60 billion, well above the governments target, leaving no room for expansionary fiscal policy.

The Good News on UK Economy

• A technical recession is negative growth of two consecutive quarters. This is still unlikely. Although many feel that growth of less than 1% is effectively a stagnating economy.
• The commodity price spike inflation can’t last for ever. When price rises moderate, disposable incomes will recover again.
• Recessions are an inevitability of a modern capitalist economy. We have avoided a severe downturn since 1991; evidence suggests this downturn will not be as severe. - There is no necessity for interest rates to rise to double digits as they did in 1991.
• A falling pound will help boost exports.

Related

• Are falling house prices good or bad?
• Mortgage woes lead house prices lower

Original post by Tejvan R Pettinger