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.

Labels: Credit crunch, house prices

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Posted 12:22 PM

At long last, the bubble is bursting...

Now those of you who talk to me much know that pretty much the only thing I'm unhappy about in life is the unaffordability of houses. Now let's get this straight - house prices are in an utterly other-world realm of expensiveness. There's pricey, expensive, very expensive, way too expensive, probably a couple more layers of expensiveness, and then there's UK house prices. If you want to put it another way - currently I have what is a pretty good rental deal on my flat, however if I tell anyone aged 35+ how much it is, they say "my word, how on earth can you afford it?!" (for example, I pay over double my parent's mortgage). But, if I wanted to buy a similar property in a similar area, I'd be paying not far off twice as much.

Here's a quote from a decent article on the telegraph website called "Why is everyone worried about house prices?"
When I got married in 1981, we bought our first house, in a reasonably good postal district of London, for just over four times my fairly modest annual salary. It was a financial stretch. By my rough calculation, a person in the same situation buying the same house today would have to produce 20 times his annual salary. So he can't. He buys less, for more, or he does not buy at all.

I am surprised it has taken this long for house prices to start coming down, but now the credit crunch has come along it has finally started the process. The fact it has taken so long will, unfortunately, mean some pain for current home owners, and people who have over-borrowed. This is inevitable. There really is too much rhetoric coming from the government about "fixing the housing market", "getting the housing market going again" - quite simply, house prices have to go down, and they are going down.

There are two reasons for house prices going down...
1) The credit crunch making it hard/expensive for people to get mortgages
2) Gross unaffordability

And, in addition, there are many extra reasons for why it will continue...
1) Market sentiment - if people think house prices are going down, they will submit lower offers - becomes a cycle of house prices decreasing
2) Buy-to-let landlords - as prices come down, they will see the value of their investment drop and some will sell up (I know of at least one case of this already)
3) Bank's expectations - basically banks are expecting a 10% drop by requiring a 10% deposit. This may lead to people offering 10% less than asking prices and this feeds back into the whole market sentiment.
4) Downsizing - I think that as people can't afford the payments on their houses due to rising interest rates and cost of living, they will want to move into smaller houses, leading to general price deflation.

The only factors I can see stopping house prices going down are
1) House prices finally reach reasonable levels again
2) Mass buy-to-let landlords not selling up
3) The continued supply/demand issue here in the UK.

Nevertheless, here are my predictions. At least a 15% drop in house prices between the start of 2008 and the end of 2009, and house prices probably continue to drop through to at least 2011. Personally I'm hoping for a drop of 40% in time though that may be wishful thinking. We'll see. In the meantime I'm happy to rent & save up a deposit for the future.

One final link for you showing how ridiculous the house prices have been. Coming soon - my comments on the 10% tax row. How frighteningly intellectual!

Labels: house prices, politics, rent

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