Home-Owner-Ism unravelling before your very eyes.

Just to recap:

1. At the start of a house price/credit bubble, a house is worth (say) £80,000. Mr B, the owner, has financed this with a mortgage from the bank for £80,000. Mr A, who sold it to him, has £80,000 in the bank. So the bank is due to receive £80,000 from Mr B (an asset) and has to repay Mr A £80,000 as and when he needs it (a liability). The bank is charging Mr B slightly more interest than it is paying Mr A, so the bank makes a small profit of (say) 2% x £80,000.

Mr B then sells it to Mr C for £100,000, repays the mortgage and puts the balance of £20,000 on deposit with the bank. So the bank now has an asset of £100,000 and liabilities of £100,000 (it owes Mr A £80,000 and owes Mr B £20,000).

Several iterations later, Mr G buys the house for £200,000. It's the same house and the same people in the same economy and the same bank with the same initial capital, but now the bank is making a 2% x £200,000 net interest margin.

2. This is all a slightly negative sum game, of course, so to keep the wheels oiled, the bank doesn't just have to trick Mr G into paying double what the house is really worth, it also has to convince Messrs A to F that Mr G can afford to repay them all. It helps if there are some countries like China who are exploiting their slave labour to sell Messrs A to G flat screen televisions and so on, so China has surplus money that it (rather naively) lends back to UK banks to then lend to Mr G (just in case Messrs A to F want to withdraw some of their money to buy things like flat screen televisions).

3. In absolute terms, UK household debt doubled from £700 billion to £1,400 billion over the last ten or fifteen years, and about half that came from abroad (China, petro-states etc). The very important bit is that as houses are largely bought with mortgages, they are only worth as much as people can borrow and as much people are prepared to lend. And sooner or later the bubble bursts, the music stops and the whole house of cards collapses (plus any other random metaphors).

4. As Robert Peston explained (I haven't checked his figures, but they look roughly right - even if he is out by a factor of two the outcome is the same):

UK banks face a deadline of the end of 2012 to repay £165bn of high-quality liquid assets supplied to them by the Bank of England under the Special Liquidity Scheme. And over the same timescale, British banks will have to find £120bn to pay back debt that has been guaranteed by the Treasury under the Credit Guarantee Scheme (there is an option to roll over a third of these government guarantees to 2014).

Now as bad luck would have it, this schedule for repaying the Bank of England and the Treasury coincides with a spike in repayments on other substantial debts of British banks, in the form of bonds and residential mortgage-backed securities. What this means, according to the Bank of England, is that banks need to refinance or replace up to £800bn of term funding and liquid assets over the coming 30 months.

The Bank of England estimates that simply to replace this finance, British banks need to sell about £25bn of new bonds and asset-backed securities every month. Here's the troubling news: what's required is 66% more debt issuance per month on average by banks than actually took place during the boom years of 2001-7. And banks are currently issuing (selling) less than half the debt that's needed.

So it's a fair assumption that house prices will fall as a result of this. How much and over what timescale, we can't begin to guess, as government intervention is difficult to predict. And to be fair to the last Labour government, they managed to stave off the inevitable for two and a half years (heck knows what the long run cost to our economy or even our social fabric will be).

5. That most Home-Owner-Ist of newspapers, The Daily Mail (via Miken at HPC), also appears to have cottoned on:

Britain could be on the brink of another mortgage drought, the Bank of England warned yesterday. Lenders expect the number of loans to plunge over the next three months, research published by the Bank showed, as fears of a second credit crunch grow.

So far so good. The Daily Mail sees all this as A Bad Thing rather than the laws of commonsense and economics reasserting themselves, which is A Good Thing, but hey.

6. My favourite bits from their article are:

a) "But any mortgage squeeze is likely to enrage taxpayers, whose money was used to rescue banks including Halifax, one of Britain's biggest lender of home loans, and Royal Bank of Scotland. "

Well duh. This was not a one-off 'rescue', this was just the first few instalments in the massive transfers of wealth from the taxpayer to the banking system to try and patch up the holes and prop up house prices.

Maybe Mr G lost his job or something and couldn't keep up his repayments. So the government collects a bit of extra tax from Mr A to Mr F to bail out the bank to help it insure or repay their deposits. Home-Owner-Ism only works by bribing people with their own money. But imposing higher taxes doesn't help Mr G find a job, so we're into a downward spiral already.

China would like its money back, but luckily the money they lent was denominated in sterling, so one swift devaluation later, they've been conned out of a quarter of the money they originally lent and they are not so keen to lend on such favourable terms in future and/or want to be repaid.

b) "There would be a knock-on effect for anyone who needs to sell their home if potential buyers back out because they cannot get the financing. The CML predicts that there will be just £15billion of net mortgage lending this year, compared to nearly £110billion in 2007."

Well duh. If Mr G wants to sell the same old house to a first time buyer, Mr H, all he has to do is to drop the price to something that Mr H can afford to repay, like about £80,000, simples.

Had Mr A kept the property all those years, this wouldn't be so bad, but this is one example of the Home-Owner-Ist ratchet at work: Mr G doesn't want to end up in negative equity; Messrs A to F want to be repaid in full, or have their deposits insured by the government, which can only do this by slapping extra taxes on them, and so on. In the meantime,

Chinese workers have woken up to the scam and are going on strike, but the Chinese government is too embarrassed to admit that they've lost a quarter of all those lovely profits and simultaneously damaged the very economies they relied on as export markets.

8. Seriously, who really wins out from all this? Answers on a postcard. And don't tell me there's nothing we can do about it because of The Hallowed Green Belt and Poor Widows In Mansions.

UK housing - a classic 8 ball?

A post below got me thinking. Set your mind back to 2001, the notorious 'Women Empowering Women' 8 ball pyramid scheme. I heard from a reliable source that it got so stupid on the Isle of Wight that some bank branches turned off their atms.
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Apparently participants were so frightened of it collapsing they were emptying their own bank accounts to lend new participants the money to join. Have a look back at the news:

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"One week the NatWest had so many withdrawals of £3,000 that it was concerned its branches would run out of money."

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It's a shame they make the connection in about 2004 isn't it?

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"...the Community Investment Club, based in a shopfront in Newport, promised via details in the window to turn £100 into £88,300 ... 'We are a group who lost out in the collapse of the old pyramid. We are keeping the initial investment down so more people can invest' says Duncan"

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Shared appreciation mortgages? Affordable housing schemes? QE?

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"Not everyone has lost on the schemes, though, and among the minority who emerged winners was Lady Anson, a cousin of the Queen ... the richer members of Circles, many of whom spend much of their spare time trying to recruit new members, meet regularly in some of London's top restaurants."

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Or you could say - "Among the minority who emerged winners were some very rich hedge fund managers, who persuaded their very rich friends to buy the dodgy mortgages in some of London's top restaurants" Couldn't you?

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Discuss?

The onslaught resumes

Now that the new lot have their feet firmly under the table, the onslaught of government sponsored advertising on the telly appears to have started again.

I've been watching Channel 4 and ITV for the past couple of hours and saw one for Barnardo's and one to remind you to renew your Tax Credits. And one for a state-owned bank, Halifax, in which a woman drops a cup of coffee, an idea which they might have pinched from the Microsoft advertisement, in which a woman knocks over a cup of coffee.

All links to TellyAds.com, who don't appear to have the up-to-date Tax Credits propaganda - so I linked to the more repulsive of the two available. Thanks to Pavlov's Cat for alerting us to this most useful resource.

While I'm on the topic, here's my favourite ad of recent months: Am I dead? No, you're in Frinton-on-Sea.

Small Print Of The Week

From the Builder's Merchant Journal

Communities are to get new powers to build affordable housing in their areas without planning permission. Housing Minister Grant Shapps MP told the Community Land Trusts that developments proposed by new Local Housing Trusts will need only to meet basic standards if they are backed by 90% of local people.

Oh yes you can.

Adam Collyer left a comment on Markets Work. The Other Thing Doesn't:

All agreed, except for the passing mention of "ever increasing quantities of credit, based on fractional reserves to inflate economies and buy votes". You can't have banks really without fractional reserve banking - you certainly can't have loan finance.

Consider if you insist on 100 percent reserves. So you put £100 in the bank. They can't lend it out because they need to hold 100 percent of it in reserve. And that's it. No loans - banks become just a safe place to store money - like a fortified version of your mattress.

1. Although nobody in his right mind suggests banning FRB entirely (i.e. insisting on a 100% ratio), it would not be the end of the world. When you go to the bank with your £100, you can either:

a) Invest it as share capital (or buy existing shares to the value of £100), or
b) Invest it as a debenture or bond (or buy existing bonds to the value of £100), or
c) Invest in an interest bearing current or deposit account, or
d) Pay it over as a pure deposit or current account for safe-keeping for a small monthly or annual charge.

With a) to c), it is implicit that your money is lent on at interest and you expect a share of the profits (the more risk you accept, the higher your return). With d) there is neither risk nor return.

2. FRB is like most things - it's good up to a point and 'too much' is a bad thing. So whether we measure the old-fashioned reserve ratio (ratio of liquid assets to total deposits) or the more modern Basle ratio (ratio of share capital-plus-retained profits to total assets) is neither here nor there. A ratio of anything above fifteen per cent appears to be, in practice, more or less rock solid. Anything below ten per cent usually leads to disaster.

3. Even without FRB, businesses can still borrow from the public directly without the bank as an intermediary (although admittedly it is much easier for very large companies to borrow in this way than it is for small, medium or quite-large ones).

4. To really get a credit bubble going, you also need an asset price bubble (usually land and buildings), because then the debits and credits more-or-less create themselves (nearly every penny that the banks lend to Mr Purchaser as a mortgage gets deposited back with the banks by Mr Vendor). Sorting out land price bubbles once and for all is dead easy of course - by shifting taxes from income and output to land values - provided we can first wean the general public off the idea that rising house prices = increased wealth.

Re what Lola was saying...

... about there being hardly any free markets any more, I refer you to today's FT:

Vince Cable and George Osborne held a “banking brainstorm” at Number 10 on Wednesday with leading economists and industry experts to thrash out some of the possible ways of forcing banks to lend more...

The meeting followed a similar one at the business department between Mr Cable and Stephen Hester, chief executive at the Royal Bank of Scotland, which dealt specifically with lending to small and medium-sized companies. The two meetings marked the first drive of an effort to find ways to make banks lend, after the two part-nationalised banks, RBS and Lloyds Banking Group, missed their net lending targets under the previous government.

WTF are they playing at? Vince and George are the government - if they want businesses to have more money they could just tax them less. Instead of giving the banks £1 billion of taxpayers' finest and telling them to lend (which doesn't appear to be working), how about just cutting taxes by £1 bn? Let's not forget that raising that £1 billion in tax costs the economy > £1 billion; and has to be paid back (unlike a tax cut).

And if you're old enough to remember Altman's Z-Score (and assuming it to be broadly correct) you will know that retained/reinvested profits are given a higher weighting that pure share capital or loans, so a business that has grown organically out of retained profits is slightly 'better' than an otherwise identical one that has expanded more rapidly by issuing shares and debentures.

Another one of those holes that has mysteriously appeared

From The Metro:The article ends in fine style: "But since no one has yet come up with a definitive explanation as to the appearance of the hole, officials continue to look into it."

Lib Dem Fun

28 June 2010: Britain's car industry can no longer rely on taxpayer 'emergency' bailouts, new Business Secretary Vince Cable warned today. He said:'We don't want to go around the country waving a cheque book.'

29 June 2010: Nick Clegg outlines £1bn fund for areas hit by cuts: The government says it is creating a £1bn fund to help English regions which depend on the public sector for jobs.

Notwithstanding the fact that increasing public spending in certain areas to compensate them for the fact that public spending in those areas will be cut...

Markets Work. The Other Thing Doesn't

I am not Mark Wadsworth

Listened to The Moral Maze driving home last night. Didn’t hear all of it, but they seemed to be discussing how it could possibly be that bankers and footballers earned more than teachers. There was the usual lefty blaming ‘the market’, or ‘market failure’, but I was astounded to hear an American witness allowed to say (on the BBC!) that ‘actually, the market was us’.

It seems to me that here in the UK these wage anomalies (if you insist that this is the case) do have a common cause, but it is not us. It is not ‘the market’. It is, in fact, the government, or State if you prefer.

Consider. Teachers work for a monopoly, the State. The banks are a state sanctioned (and funded) cartel. Overpaid footballers (and yes, I do think they’re overpaid) work for football clubs owned by heavily leveraged rich men, able to borrow at low rates of interest set by the State.

So, in my hypothesis there is no ‘market’ at all operating in these three sectors, except insofar as talented footballers use skilled agents to broker their services from club to club, and even that is heavily regulated by the various Football Associations.

The State has intervened in each market. It has cartelised the banks with regulation that erects massive barriers to entry. It has colluded with them, through its agent central bank, to supply ever increasing quantities of credit, based on fractional reserves to inflate economies and buy votes, at too low a price. And the state has acted as rescuer when the banks over leverage themselves, turning private profit into socialised losses, a practice that has exponentially increased moral hazard.

In football rich operators have accessed this excess of under priced credit and bought into football clubs at over-inflated prices, usually as trophy purchases. And then set to in an arms race with other highly leveraged rich men to see who can get the big prizes first. And of course the fallout from this is that fat wages get paid to trophy players.

Teachers are employed by the State. There is an actual monopoly in education. There is no market at all. Consequently the State Education monopoly does what all monopolies do; it overcharges its customers and exploits its employees. Not all of its employees are exploited. Some are part of the monopoly management and as they either need keeping on side, or achieve positions of power in the governing bureaucracy, extract very high rewards and accolades (knighthoods for example) for very little work.

In all the three cases there is no ‘market’ as such. The State has intervened in the efficient functioning of human action with the predictable consequences that I have set out. Excess rewards for the wrong people, exploited workers and over-charged customers.

Lola

That could be awkward

From the BBC:

The government unit dealing with forced marriages received 65% more calls about male victims last year than the previous year, figures show. In 2009 it received more than 220 emails and calls to its help line about male victims, up from 134 in 2008. Many male victims were forced into marriage because their families know or suspect they are gay...

Crikey. I don't like the idea of forced marriage one bit, but imagine you were forced to marry another man because your parents wrongly suspect you are gay...