Sunday, July 6, 2008

Day of Reckoning

We're riddled with debt... but the cure is a killer

Given the levels of debt that the credit boom of the past 10 years has produced, any widespread default could bring down the entire financial edifice. After all, this is exactly what happened in the US sub-prime disaster, when interest rates on the mortgages of low-income households were suddenly jacked up to levels they simply couldn't afford to pay. Our own housing sector is now poised on a similar cliff edge.

Posted by pendulum @ 09:35 AM (1582 views)
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17 thoughts on “Day of Reckoning

  • stillthinking says:

    Fantastic post by pendulum. The first article is devoted to the unsung real problem of deflation and the unpleasant fact that the UK -cannot- repay their debts. Not much way round that. There is a slowly increasing number of punters arguing for deflation and so before long I think this will be the accepted mainstream view. An expectation of deflation is unfortunately an ipso facto prediction which will clobber the poor old UK economy.
    If, you were to accept the view that UK banks won’t be allowed to fail and will have crippling losses based not just on mortgage losses but on all other dealings(*), then at what point would the UK government be unable to provide funding? Is there one? To what extent can sovereign wealth funds can expected to buy assets they know will fall in value? Would they really risk owning more than 30% of a UK bank given the risk of political interference in their ownership?

    Basically, is it not possible that UK house prices will repeat the profile of Japanese property, and still be at a lower value in 18 years from now, which would put the eventual recovery in prices beyond my lifetime… Or another way, the house market is dead in a literal sense, as in not going to recover.

    *If the economy has truly been based on debt and artificially inflated values since 2000, then the real economy has just paid for the extremely high bonuses and wages of a million finance workers for 8 years, additional taxes have been on real value not profits. This is the real loss to the system. When the values sink back the extent of the loss will become apparent. Not just mortgage losses at all.

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  • stillthinking says:

    To put it another way, New Labour under Blair and Brown, the party that purports to support the workers of the UK, have just presided over a larger than actually possible transfer of wealth from the workers to the wealthy.

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  • The article and the one below it were crap. The premis was in order to save the economy we need to cut the base rate. *News flash*, its already happened and guess what? Mortgage rates have still increased.

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  • Hold on here:

    ”We need to construct a more radical version of the anti-foreclosure legislation currently before the US Congress – and prevent mortgage lenders from repossessing properties and, in any subsequent sell-off, driving asset prices still lower.

    Likewise, help is needed for the millions of indebted and credit-impaired Britons. Since they are, like the Third World, enslaved by unpayable debt, an extensive programme of debt forgiveness and freezing of interest is required”.

    This all sounds very much like sponsoring a bail out for all the feckless morons that have got themselves into debt into the first place. NONONO. Lessons must be learned, and consequences taken. This idiot wants to reward the spendthrifts at the expense of the thrifty. He wants us all to pick up the tab for their failures, using the specious argument that we will all suffer dreadfully if we don’t. Well I have news that may not have permeated the august walls of Cumbria University (I assume thats in some shed in Carlisle). There are millions of folk out there who didn’t get taken in by the last 10 years, who are debt free, and who will be more than insulated against the train wreck he talks about. Let the impecunious take their punishment.

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  • An article totally peppered with statistics, yet with precious little explanation as to the significance of the numbers quoted.

    If you want to know why we are not going to follow Japan into deflation, you need to look at the trade figures. Japan had a huge trade surplus for much too long, which they mistook for economic strength. They were very obstructive towards those who wanted to export to the country.

    Eventually, their currency could not be kept down any longer, and their exports began to become over-priced as the Yen rose. This caused their economic miracle to unwind. It was the undervaluation of their currency that caused their deflationary nightmare.

    Britain, along with the US and eurozone has an overvalued currency (relative to the rest of the world) and we have a huge trade deficit.

    This presents a totally different scenario to that experienced by Japan. We are already seeing rapid and inflationary increases in the price of imported goods and commodities; a trend that looks set to continue for some time, as Sterling falls against the currencies of the developing world. This will maintain upward pressure on inflation

    It is not sensible to attempt to keep inflation at just 2% now – 5% would be a better target, one that would allow some erosion of debt without propelling interest rates to impossible highs.

    Deflation meanwhile, is not on the agenda.

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  • “An extensive programme of debt forgiveness and freezing of interest is required”

    Paid for with my bloody taxes? I think not!

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  • Excellent analysis stillthinking @2.

    The more I think about this,the more I am convinced. Creating wealth in such a manner i.e. a person’s home, is intrinsically wrong (and mathematically it seems). Normally the wealth would be created first conventionally and the upgrading of the home would reflect this.
    Those that have provided the mechanism to create wealth in this reverse manner have created their own wealth from nothing.This ‘nothing’ has now been passed back to those who imagined they had some wealth.
    Very Evil indeed !

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  • Well it’s about time that cash becomes king again!

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  • Hah! One of the lunatics actually insinuated that the Govt should take back control of the BoE?? WTF?

    What do a holed ship, an empty stable with a recently closed door and the British economy have in common? The damage is already done. There is nothing we can do, but look toward and plan for the kind of economy that we want to rise from the ashes of this one in a few years’ time. And ashes there will be. It’s the BoE’s job to control inflation and if that needs 5% or 15% interest rates, that’s what they should set.

    If the government wants to control inflation – as I’ve said before, lower fuel duty, and raise a windfall tax on the oil sector to make up the shortfall.

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  • letthemfall says:

    Given that the country is heavily indebted and has borrowed from the future, one consequence of allowing inflation to rise, while holding wages back so that real incomes fall, would be to allow over-borrowed house owners off the hook. Thus some of the imbalance which has built up during the house boom would be maintained, or maintained for longer than it otherwise would.

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  • stillthinking says:

    @uncletom, the difference is between the level of real wealth and imaginary wealth. real money backed by a debt which will be repaid, and imaginary wealth backed by a debt which will not be repaid.
    These two are no longer even vaguely close to each other.
    Sooner or later (now) the imaginary wealth will realign with the real wealth. The exchange rate of sterling is based on a thus far supported imaginary level.
    To what extent can the government bridge this gap? I don’t think they can. Funding the difference is again a transfer of wealth from workers to asset holders, also at the moment 10% of government revenue goes to maintain a 40% government debt.
    Should the UK government attempt to increase this level to that of the Japanese government (160%), then 40% of tax revenue goes straight to debt repayment and public services would be finished. There are a million problems with the government trying this but the main problem is that;
    It isn’t enough anyway. No way near enough.
    I can see a case for inflation if the real economy manages to contract faster than the collapse in imaginary wealth, but this is a disaster. Everybody has said, for years, that house prices in the UK are unsustainable, yet maintain that the profits banked on these unsupportable price levels are safe… They are not.
    I feel that the extraction of wealth by the financial industry is the biggest cause though, relative to overstreched mortgage holders.

    ===
    +
    + imaginary wealth
    +
    === ===
    + +
    + real wealth + real economy
    + +
    ==================================================

    (yeah, it took a while to do this graph.)

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  • stillthinking says:

    The graph didn’t come out right. This is what I meant.

    +======================== imaginary wealth

    +============ real wealth

    +============ real economy

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  • japanese uncle says:

    As mentioned time and again, the nightmarish combination of the most vicious credit crunch and the 1.4 trillion pounds almighty personal debt means the money will be called and eventually stuck in the bank vaults never to be circulated again (to remain there just to endorse the financial viability of the banks), which is an inevitable course of events in an economy where confidence is totally lost in every respect. Unless the production capacity can be drastically reduced, causing several millions of job losses, this loss of money in circulation will be swiftly caught up by the reduction in prices, which is deflation. In such frozen state anyway, banks will have to make hundreds of thousands of employees redundant, (let alone another hundreds of thousands in the building sector) which will ripple through the whole economy, not least the sectors totally dependent on the falling crust of bread from the high earners with devastating effect. Severe recession coupled with deflation seems an almost inevitable though unpalatable scenario.

    A economy must keep reasonable balance between the three sectors, primary, secondary and tertiary. Currently British economy is deformed with far excessive weight on the tertiary industries, financial sector in particular, most of which recently proved nothing short of gambling business normally undertaken at best by William Hill or Ladbroke, and at worst by the underground mobs. UK must be reborn as a repentant economy with reasonable share of manufacturing, farming/fishery/forestry and if the perfect balance is attained, the immunity of this economy will be enhanced against the global economic turmoil. If EU wants to give advantage to the Spanish fishermen, at the cost of the Scottish fishing industry, then get rid of EU. Simple.

    Also if the voters of this country are still thinking at all, just force the government to pass a law that makes governor and other MPC members votable by the electorate, to ensure the genuine ‘independence’, not the hollow deceptive independence of the central bank, keeping it free from any vicious and selfish pressure of the private financiers. Before it is too late, before being ‘central bank deniers’ is made another criminal offence.
    We have just seen how dangerous it could be to give free hand to the central banks.

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  • question: – How much of ‘OUR’ debt (1.4trillion and climbing) has been packaged up and sold to others around the world, just like the ‘sub-prime’ of the US?? There could be a terrible financial disaster about to unfold on many who thought they were immune. Game of dominoes anyone??

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  • What this article is purporting is letting commodity based inflation rip (which from my perspective feels about the same as every other type of inflation!) through lower interest rates in order to inflate away borrower debt (inc. personal, business & government) since despite the author’s protestations wage inflation will surely follow (RE: the recent trucker dispute and the rumblings from the public services). In my opinion this idea frankly sucks since as usual it is the prudent savers (ie. the readers of this site) who will ultimately pay for the profligacy of the self-indulgent economic incompetents who borrowed too much and are now bleating for help (this of course includes many buy-to-letters and all those housebuilders who been making a mint over the past 8 years from an unsustainable boom but didn’t have the foresight to take appropriate precautions….. much like the Government itself come to think of it). In addition the author proposes anti-foreclosure legislation, I’m sorry but what about the discipline of the market? If such measures were to be instigated it would yet again lead to ridiculous levels of moral hazard (eg. would struggling buy-to-letters be helped?) and give a boost to the housing market when finally there is a chance for it to begin to revert to sane valuation levels (it is still 30% overvalued according to the OECD). What these “experts” never seem to address is that many have had their salad days borrowing on future earnings and against housing backed Ponzi scheme and now it is time to pay some of that debt back and however you cut it it is going to be painful for many people, largely those who threw common sense to the wind and is it really the responsibility of the BoE and ultimately no doubt the taxpayer to bail such people out? However the pain will be mitigated for many by the renewed opportunities it provides largely those priced-out first time buyers these “experts” purport to want to help when actually the subtext seems to be that they want the FTB’ers to be permanently improverished through the servicing of gargantuan debt-burdens in order to sustain the “house of cards” that the housing market has become through short sighted Government policymaking. I think these “experts” should declare their interest just as we do on this site by stating we’d like house prices to return to a modicum of “fair value”, I suspect many of these “experts” are most worried about their own personal situation vis-a-vis the value of their property portfolio, one has to wonder considering some of the guff they write. Articles such as these are proposterous and are surely an overreaction when apart from certainly localities (notably N. Ireland and city centres with an oversupply of new build flats) house price falls to date have been modest, and indeed in many areas including my own (Cambridgeshire) prices are still rising YOY.

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  • Good point bystander.

    The picture is very obscure. Apparently no one knows just where these ‘packages’ have ended up. This could only happen for two reasons :
    Reckless or deilberate. Suffice to say the deregulation allowed either and ambiguity with regard to blame strikes again. The fall-out is ongoing and as you say ‘domino’ in effect. Various theories are circulating. One being that Japan is holding a huge number of AAA rated bonds. The biggest worry is if Pension Funds are holding large,similar investments.

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  • Useful observation, Drewster.

    “…an extensive programme of debt forgiveness and freezing of interest is required”. This recomendation won’t work. Someone must pick up the tab, whether shareholders (highly unlikely) or subsidies to those who have over-borrowed by NuLabour.

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