Britain faces recession without housing ATM

By J Saft
December 17, 2008

James Saft is a Reuters columnist. The opinions expressed are his own.

james-saft1Even in the good times, many British consumers were borrowing against their houses just to fund routine consumption, indicating a big hit to come for retail sales and for the banks who hold the loans.

With house prices falling rapidly and mortgage debt tougher to get, it is no surprise that homeowners are less able and inclined to borrow against their houses in order to spend.

That will be hitting the High Street now – analysts are expecting a 0.6 percent fall on the month in retail sales for November when data are released later this week. But a rise in unemployment next year could expose a really serious weakness in household finances, as consumers who counted on being able to extract wealth from their houses to smooth consumption in bad times find that, when bad times come, the wealth isn’t there and the banks don’t want to lend anyway.

Researchers at Durham University looking at survey data found that 37 percent of homeowners borrowed against their house between 2002 and 2005, typically realising about 6,000 pounds. That’s a lot people borrowing a lot of money against very illiquid and now hard to realise assets.

Even more interesting is the pattern of what householders were doing with the money and what was happening to them when they decided to borrow. Over time the proportion of people borrowing to re-invest in their houses through improvements fell, while more was finding its way into day-to-day costs, according to Susan J. Smith, a professor at Durham and one of the authors of the study.

This was borne out by a high percentage of equity borrowers who had lost their jobs, become pregnant or had a child in the year they borrowed.

How exactly a borrower who has lost his job gets a bigger mortgage is a puzzle, but one that evidently banks and borrowers in Britain together have somehow managed to solve. The record in the United States shows that the housing boom brought with it a tremendous amount of mortgage fraud, much of it abetted by people within the lending industry.

In short, it seems that even during boom times in Britain people weren’t borrowing against their houses simply to buy BMWs and fund vacations, but often to keep their households ticking over during tough times.

“The rising property market was central to encouraging people to borrow more for non housing expenditure,” said Ross Walker, economist at Royal Bank of Scotland in London.  “And with the housing market now in reverse you would expect to see a retrenchment. It reinforces the potential fault line for the UK household sector: there is a big debt exposure and the real test will come next year as unemployment rises.”

The housing safety net, such as it was, simply won’t be there next year when unemployment vaults higher, which is very likely to exacerbate a spending slowdown which itself will feed unemployment. And remember, these weren’t people who were defaulting on their house loans in order to be able to pay their grocery bills, but people who were in part paying their grocery bills because they could borrow against their houses.

I wouldn’t want to be the bank that made those loans, or the government that insures that bank. It also goes some way, in my view, towards explaining the very precipitous fall in the pound, which is down more than 30 percent on a trade-weighted basis this year.

According to a survey of households just released by the Bank of England, credit is much harder to get as compared with a year ago. A total of 16 percent of households said they had put off spending because they were concerned about access to credit, up by a quarter from a year ago.

Only six percent of mortgage borrowers said they had taken out an additional secured loan, compared with 10 percent last year and 14 percent in 2006. Nearly 40 percent took out these loans to pay down other debts. That points to higher credit card losses and delinquencies next year, as unemployment interacts with an inability to access fresh secured loans.

So 2009 looks like it will feature higher unemployment, much reduced consumer spending, impaired access to credit and a default cycle that will worsen the already difficult capital problems of the banking sector. There has been a lot of effort and exhortation to try and keep banks lending to consumers in Britain, presumably on the view that it’s best to sober up gradually.

That can only work so long, and if it comes at the expense of capital for businesses that make and sell things, especially overseas, it may in prove to be a mistake.

And while big ticket items like automobiles, which are easy to defer, are now suffering, next year may see very tough times on the British high street for more basic items.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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So while we were all releasing equity from our homes in order to pay off credit cards, pay for annual holidays etc., our employers were benefiting from the fact that we weren’t asking for pay rises, as we “felt” wealthy. Hence the gap between the rich business owners and the poor employees has grown, and no one even noticed…

Posted by Mark McCrohan | Report as abusive

We rode on the automobile economy while the Rich and Powerful ran away with our money.

Posted by Jimmer XXX | Report as abusive

The rich and poor issue is a complete red herring and always has been. If someone on £20,000 gets a 10% pay rise he goes to £22,000. If the Chairman on £500,000 gets 1% (a much more responsible and restrained pay rise you might think), he goes to £505,000. The gap between them increases from £480,000 to £483,000, but this has absolutely nothing to do with the current crisis or any crisis. It’s simply a question of rudimentary arithmetic.

The phenomenon of borrowing against a fixed asset to pay current expenditure has been going on for a long time, at least since the 80s. It has allowed successive governments to con the public that prosperity was growing under their leadership. In fact, not only was that prosperity illusory from the point of view of the individual, but the swingeing taxes that it allowed successive governments to levy from those of us who still worked have proved to have been utterly squandered and the country itself is now in serious danger of bankruptcy.

We have got to change our whole mindset. First-world countries (I am being wildly optimistic here in assuming that the UK will remain one) should be net lenders (probably to the third world), not borrowers. Home buyers almost inevitably will be borrowers but must be so on a prudential basis. And instead of screaming about big business and fat cats and such nonsense, we should all be screaming about the greatest fraud of all – the trillions (not billions) of pounds of our money (because it is ours you know) that have been utterly wasted by our bloated, incompetent and inefficient state machine.

Posted by Matthew | Report as abusive

Responsibility lies squarely with the financial institutions, possibly government and regulators, but civil servants and the elected great and good do have a different agenda that revolves more around power not greed and it was definately the money being made by financial institutions that put the economy in this mess.

Historically low interest rates ( not counting where we are now ) produced some fantastic margins, LIBOR at circa 5% gave even the most competitive credit card companies advertising APR’s as low as 13- 14% a 160 – 180% gross margin so financial institutions could not lend fast enough GREED.

Posted by Richard Taylor | Report as abusive

The primary blame lies with Gordon Brown. Banks are under short term pressure to increase returns by any means available, and a robust banking system relies on the banking regulator, and ultimately the government forcing them to take a long term view. Gordon Brown was asleep at the wheel. Many people are greedy and gullible, that’s just life and the government should factor it into its policy decisions. But Gordon Brown cynically inflated the debt bubble for party political advantage: either that or he is really, really dim. Either way, he is unfit to have power over an economy.

Posted by Oliver Chettle | Report as abusive

Richard, Banks were only able to lend so much money to individuals because individuals wanted to borrow more than they could ever afford to pay back.

If it hadn’t been for the greed of the dim-witted population at large the banks wouldn’t have been in a position to make such a mess.

But then, People Like Gordon Brown have long relied on a population that seems to be absolutely clueless when it comes to finance and economics – just what they want so they can persue the politics of mediocrity and yet still proclaim political brilliance.

Posted by nick | Report as abusive