Sunday, January 25, 2009

Posted 10:13 AM

The credit crunch part 2 - is Britain in a good position?

I love this myth, and and it is a brilliant definition of how politicians - of all sorts - are only concerned with staying in power, and will say anything to do it. Here's some quotes that outlines the government's confidence in the UK economy...
October 2007 - "the economy is starting from a very strong position" - link
January 2008 - Britain remains well-placed to withstand this uncertainty in the global economy - Link
August 2008 - I am also clear the fundamentals of our economy are strong Link
September 2008 - Britain is well placed to weather the financial crisis - Link


Linked to this claim is that is a "global problem" (or, equivalently, "started in America") which we are suffering for - seeking to absolve Britain from the blame. Whilst the current crises was indeed started in the USA, that was the straw that broke the camel's back. Problems were headed our way in any case, thanks to our outrageously overprices housing market and the great credit binge our banks have been on.

Lovely. Right, let's take this myth apart.

First, simple economics. You need to have more coming in than is going out, else you're in trouble. An easy enough thing to understand - common sense you might say. Alright, let's look at how the government has done with forecasting how much big its forecast budget surplus is - ie how much more it has coming in than is going out.

Note that in the government's figures, capital spending is on top of this. To put that in layman's terms - say I earn £50k a year, and my bills, cost of living, holidays and whatever came to £30k, and I spent £15k on building a conservatory. My budget surplus (the figures below) would be £20k, and I would've spent £15k on capital spending (and why shouldn't I, I have the spare cash to spend and it will benefit my family for years to come).

Figures are per tax year - which runs from April one year to March the next. Year of forecast down the left - forecasted year along the top.











2003-042004-052005-062006-072007-20082008-092009-102010-112011-12
2003-04-£21.3bn-£11bn-£5bn£0bn£4bn£9bn
2004-05-£16.1bn-£6bn£1bn£4bn£9bn£12bn
2005-06-£11.4bn-£7bn£1bn£7bn£10bn£12bn
2006-07-£9.5bn-£4bn£3bn£6bn£9bn£13bn
2007-08-£7.9bn-£10bn-£4bn£4bn£11bn
2008-09-£41.2bn-£78bn-£73bn-£54bn
Actual-£20.4bn-£19bn-£15bn-£4.3bn-£6.7bn-£??bn-£???bn


All figures are from the relevant budget, with the exception of the 2008-09 numbers, which were taken from the Pre-Budget Report as the 2009 Budget is not yet released.

I should also add that the Budget 2003 forecast for 2004 was -£8bn - over £12bn more than the actual. Also, the latest forecast for each year as that made at the end of the year involved (so before they can add up all the money) - I don't think you should use that as a guide for how good they are at forecasting but I included it for completeness' sake.

What do these numbers show us? Well, despite the Budget document's protestations that they forecast based on pessimistic outlooks, their forecasts are consistently too high. They always forecast "oh, in 2 or 3 years, we'll be getting more in than we will be spending" - but that "2 or 3 years" never comes. So, they have to borrow the gap. Don't forget that these numbers do not include capital spending at £10-£35bn a year, so the actual amount borrowed over this period is colossal. I can't be bothered to work it out.

So, reason 1 why the UK is not well-placed - an administration who constantly predicts things will be better than they will be - leading to a worse situation than was planned for.

OK, now you can see on the above table the massive, colossal downgrading of forecasts for the coming year, that came out in the pre-budget report. Why is this so bad? Why should the credit crunch cause such a massive increase in the budget deficit? Well there's a few reasons - and the government is only now starting to see the scale of the problem. As usual, the forecasts are optamisitc. The 09-10 and 10-11 numbers could quite easily run into the hundreds of billions.

There are two sides to every equation... the outgoings are increasing, and the income is decreasing. Reasons for the outgoings increasing include more unemployment payments.

Reasons for the drop in income - well first off we have the rather silly £12.5bn which has been blown on the VAT rate cut. The thought that I am now saving 32p more a month on my internet connection is going to mean I will spend more money would be amusing, if it wasn't so tragic.

Reason 2 - Over-reliance on financial sector. In 2007-8, the City paid £42 billion in tax revenues - income tax and national insurance on huge wages & bonuses that some employees had, and corporation tax on the companies profits. That's approximately 7.5% of the government's total income. Now given the financial industry is one of the hardest, if not the hardest hit section of the economy, what do you think is going to happen that number? Wellthis article thinks £11bn less a year. Put another way - if the government missed out on £11bn of tax revenue last year, its deficit would have been 2 and a half times bigger. Crikey. Our financial sector as a proportion of our economy is one of the biggest in the world (exceptions - Iceland, Switzerland) so we've got more pain than the rest of the world to come on this front.

Reason 3 - Housing market. Gordon Brown has often talked about Britain's "strong fundamentals" - but what are they? He used to talk about the housing market, which as I will cover in my next article, reached utterly insane prices and are now undergoing a major crash. This has direct and indirect problems for tax receipts - first the government will get less in stamp duty (a tax levied on every house sale) and capital gain tax on second homes (if you have a second home and sell it for more than you paid for it - a %age of the profit goes to the government). Also, inheritance tax receipts should be down as the values on people's estates decrease. Indirectly - there are a lot of companies who rely on the housing market - from the obvious like estate agents and solicitors, to perhaps less obvious ones like decorators and DIY suppliers.

As usual, the government has vastly underestimated the problems in the housing market (which it could've avoided or at least mitigated) - at first denying that there would be a crash, then by saying that a 2.5% drop would be sustainable, then in November forecasting a 20% drop from peak prices by the end of 2009. Well we're at 20% already and it'll be at least 35%; probably nearer 45%. Based on this 20% drop guess, the government forecast a £6bn drop in tax receipts because of the drop in house prices. However it's likely to be nearer £15bn (source). Activity in the housing market will not reach the heights of 2007 again for at least 10, if not 15 or 20 years. Our houses are (still) among the most unaffordable and overpriced in the world, so again we've got more pain than them to come on this front.

Reason 4 - personal and national debt. After a recession is over, people have more money, spend it and invest it, and the economy starts growing again - or so the theory goes. However we in the UK have some problems with this.
The level of debt we have in this country is huge, and the IMF has been telling us this since 2003 (here's some sources - 2003, 2005 and 2006). A lot of that is to do with house prices, which I will talk about in my 3rd credit crunch post.
A lot has been made of the UK government debt of circa 44% GDP - but it's not really that much worse than many other countries (eg Germany's is about 65%). What is worse, though, is the current deficit (ie - how fast the debt is currently growing) which is pretty bad, thanks to Labour's massive spending (& massive wastage), and thanks to all the above reasons, will take longer to recover. I mean, right up until last November's pre-budget report, the government was insisting it would not break it's rule of borrowing more than 40% of the country's GDP, but now it says we'll only go up to about 58%. Again, as previously noted, this is a hopelessly optimistic point of view, as it is base on the recession ending in Q3 2009. Not a chance, Darling. We'll be in for a lot of tax rises in the future to make back all this money. Alternatively/additionally, there will be inflation (along with the danger of hyper-inflation). I think I can sum up the problem in this quote...

"Germany's budget is close to balance. The UK and US have projected deficits of about 8.25 of GDP which might easily get worse. The UK government plans to sell £146bn in debt this year."

"The ironies are multiple. Having exported and saved its way to economic success, Germany could afford now to cut taxes and stimulate spending without running too much of a deficit. The UK and US meanwhile have deficit spent, consumed and imported their way into trouble - and are now planning an ill-afforded government spending and tax cut binge to get them out of it."

So, in summary, the UK, both in terms of its people (thanks to the banks) and the government, did not prepare for the bad times whilst in the good times.

Personal debt in this country is also huge, partly due to house prices, partly due to cultural reasons (people wanting to live a rich lifestyle) and partly due to financial institutions being willing to lend that extra money. In 2007, UK personal debt was running at 148% of the average income, compared to 125% in USA (the other country that has gone on a mad debt binge). While the debt is so high - and the asset against which 70-80% of that debt is secured (houses) are dropping in price, people are going to have less money to spend to make the economy start growing again.

In summary, then,
1) Government takes an optimistic view
2) Financial sector is very large and is going to take a lot of pain
3) House prices way too high
4) Massive amount of debt
Are all factors which count against the UK. Whilst some of them may affect other countries too, they are worse in our country (except, possibly, numbers 1 and 2 in certain countries).

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Friday, December 19, 2008

Posted 12:36 PM

The credit crunch part 1 - what caused it?

Welcome to my advertised series on the economy! Hopefully I'll cover a few things like what caused it, is the UK in a strong position, the effect on house prices and how it's all going to end up. Maybe I'll get bored and not finish the series though, you never know...

So first up - we have the question of what caused this mess? People have come up with all sorts of explanations, but the crux of it is not so difficult.

The crux of the matter - Greed. This has been around since the dawn of time - it happens all the time in the Bible. People want things that other people have, so they kill or steal or manipulate in order to get it. In our "civilized" society, these methods aren't so open so that leads us onto...

Borrowing too much. This is the worldly explanation and is entirely correct. This has been going on since 2000, and has been frankly obvious to anyone who cared to look at the housing market from a neutral point of view. The government and the 70% of the country that are homeowners are not neutral points of view, so there was never anything done to address this. By 2004, there was clear evidence that the situation had got out of hand. Banks were lending to anyone and everyone - regardless of the likelihood of that money being repaid. Mortgage brokers and estate agents were advising first time buyers to lie about their income so as to obtain a bigger mortgage - not talking about adding 10% onto your income here, but people putting down £50k - £55k as their income instead of £25k. Why did people go along with this - well, see point 1. Put number on bit of paper, get what you want (the house) - who cares about consequences of the actions?

If you want some firm numbers, then how about this. In 2000, the UK banks were lending equivalent to their deposits. In 2007, the UK banks were lending more than they had in deposits - to the staggering sum of £666 billion. This is all owed to overseas investors - and they want the money back.

So, how come the over-borrowing continued for so long? Well, there's two reasons as far as I can see it.

Banks disguising the quality of debt - a lot of this is far too technical for my knowledge, but basically, the banks packaged up a lot of bad debt (debt owed by people unlikely to be able to repay it) and disguised it as good debt, and sold it on. Due to the continued increase in house prices, and the myth that this would continue forever, this became somewhat of a free money merry-go-round on the international market place. Think about it - if you knew the value of something would go up indefinitely, wouldn't you want a bit of it? The big banks took leave of their senses in this regard, and just chased the profits. But there was another reason too...

Insufficient regulation/government intervention

The government's primary interest, unfortunately, is not run the country well, it is to get re-elected. Furthermore, people have a tendency not to look beyond their own vested interests. This is why, despite the fact that it was obvious that there was too much borrowing and that house prices were too high and it all had to come crashing down, nothing was done. I mean, if you wanted to get re-elected, would you tell everyone that their houses were worth too much and that they had borrowed too much?
Furthermore, the financial authorities were not keeping too close an eye on things, indeed the Labour government relaxed the rules of regulation in the late 90's. Bah.

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