- Bank of England synthetically depressing core interest rates to a 50 year historic low:
- Insane Parameters adopted by Mortgage Lenders: including up to 120% Loan To Value; 28 year terms; Income Multiples up to 8.5; Lack of Test of affordability:
- Abuse of Mortgage Backed Securities (Securitisation, i.e. Derivative Products):
- Lack of Effective Capital Bases of Mortgage Lenders:
- Bank of England’s lack of control over Money Supply:
An economy predicated on house price escalation and
- The import, distribution and sale of foreign goods mainly on credit.
Right at the beginning of Tony Blair’s New Labour landslide electoral victory, one of his government’s first crucial acts was to create separation between Britain’s Central Bank, the Bank of England and Government.
In theory: because in practice it is another one of them nice theories!
In March 2007, the Governor of the Bank at the time its independence was created, “Hard” Eddie George (so called owing to his apparent steely mien and tight grip), was called before a Commons Select Committee to give evidence: the committee was tasked with investigating and reporting to parliament on the ostensible success of this act.
Now Sir Eddie, as he has become, stated unequivocally that the MPC (Monetary Policy Committee, which he as Governor, chaired: the inside body which sets policy on Money Supply and Base Rate), were deeply concerned that a recession was brewing and would hit in Labour’s first term and accordingly, they depressed interest rates, synthetically, to stave off this problem.
The bank’s base rate was lowered and lowered to what became an historical 50 year low, eventually, of just 3.5%.
When questioned, George admitted that the MPC were aware that as a direct result of their action, first it would trip a massive house price spiral and second it would cause a consumer credit binge like never before!
They considered, however that the “Risk was worth taking………..”.
Well, now we see the result.
Free Wheeling Thatcher and her Big Bang
In order to fully understand the core problems, however, first once more, we must retreat further still into economic and political history.
Margaret Thatcher and her coterie of public asset strippers and Right Wing ideologues were determined to boom up the UK economy in favour of the private sector: more critically, she and her advisers believed implicitly that Free Market Theory was the correct way to achieve not only economic expansion but also a more robust system of commerce.
Amongst her first acts was to repeal the Exchange Control Act of 1948: this was brought in by Labour, in the immediate post war era to prevent the flood of “Funk” money leaving Britain in droves, as many super-capitalists sought to extract their mainly ill gotten gain (much of it from armaments manufacturing and war profiteering) before Britain sank without trace. The country was effectively bankrupt due only to the immense cost of World War Two.
Her critical second move was to liberalise the City of London: colloquially this was called The Big Bang.
And was it ever an explosion! It allowed all and sundry to come into London, pick off the bits they wanted and junk the rest. Yet with no true reciprocity.
But that’s another story for another day.
One effect of this change was in home loans. Since the early 1800s and the establishment of mutual savings funds for house building, a unique British institution, the Building Society came into being.
They were what is called “Friendly Societies”, or if you like, Mutuals; non-profit earning and with the sole objective of enabling the thrifty and hard working to achieve their realisation of home ownership. Hence their name.
The core and unique character of Building Societies was that savers saved hard and regularly towards the future time when they might apply for a mortgage: amassing capital and a track record of regular savings indicated probity.
Now the societies broke the first law of banking: one never ever lends long and borrows short. In other words taking in short term money and then lending it out for 17 years ought to be a recipe for disaster!
In the case of the societies, however, a regular stream of new savers smoothed any liquidity problems.
As home purchase soared from about 1965 onwards, Building Societies came into their own and underwent a massive expansion of business and capital reserves. During this period, bank mortgages were mainly the preserve of businessmen and commercial property.
After the Thatcher led, Big Bang, retail banks, ever hungry for more profit looked longingly at the residential mortgage sector and campaigned for certain tax advantages enjoyed by the societies to be removed.
As a net result of this and in an era focused on financial services expansion, many building societies “De-Mutualised” converted into banks and floated their common stock, alive to the plundering opportunities presented by the Thatcher age of greed. Members of the societies were bought off by “presents” of a few token shares: and the rapacious executives could then access all those nice reserves, built up over nearly 200 years in some cases.
This circumstance eerily shadowed the American S & L scandals during the 1980s.
As honeymoons do, the expansionist gung ho any thing goes freewheeling Thatcher miracle came to an end, an overheated residential property market tanked, and many homebuyers were propelled into bankruptcy. Hundreds of thousands of more recent buyers just a year or two into their mortgage were left with serious Negative Equity overhangs.
This was nothing new, of course, since a similar era of cheap credit and insane lending parameters created an identical Boom-Bust and property market crash back in 1973-4. And that was also a gung ho Conservative government leading the charge.
Tony the Tiger and Iron Man Brown
Fast forward to the late 1990s. After Blair’s first government took over in 1997, the chancellor, Gordon “Iron Man” Brown stated there would be no more Boom-Bust scenarios on his watch! The economy was now in a safe pair of hands: he was the Iron Chancellor. He would manage the economy with prudence: it became his sort of middle name.
As the newly “Independent” Bank of England lowered and lowered interest rates two things happened. Firstly and not surprisingly the housing market reacted and values started escalating. Second, an ever-increasing quantity of cheap money sloshed around the system and credit card operators and banks were fast to react!
Every day, the consumer was besieged with mailers offering loans. So, they took them. The consumer credit binge was on. This was not helped – quite the reverse - by a parody of the early 70s and mid 80s, when US banks and financial players rushed hotfoot into London to share in the bonanza.
Corporations like Maryland Bank of North America (MBNA) and Capital One hot-footed it into town. The gold seams were open and the sheriff on vacation.
Now the few building societies left and the retail banks and well, everyone else really perceived mortgage lending as a safe and very lucrative opportunity. The cash was safe, secured by a tangible asset: rates were at an all time low and employment was booming. It couldn’t go wrong could it.
As each lender competed with the others, effective insanity hit risk managers.
Lending probity became a thing of the past. LTVs (Loan to Value) escalated from a sane 85% to a final 120% in some cases!
Tenor (The life of the loan) expanded from 17 years to 20, then 25 and eventually up to 30. Income Multiples moved from a traditional 3.5 times income to a peak of 8.5 in many cases.
The range of mortgage products on offer became dazzling. Low Start, cheap interest rates beneath market for the first three years: trackers: options: fixed; interest only.
As each lender determined to dominate this market another pitched in with an even better offer!
The value of property of course reacted in a straight relationship: up, up and ever up.
MEWing became common. (Mortgage Equity Withdrawal). Traditionally, borrowers moving up in the property market would essentially be paying down some of their debt. Not this time around. Each time they moved, on a cycle time which became ever shorter, they opted to extend their loan period: worse, they would expand the capital obligation and extract some of their “Profit” to buy cars, boats, vacations to Bali, whatever.
When people moved, they joined in to another feeding frenzy: junk the kitchen, bathroom, curtains and carpets. Also have a new conservatory; new windows; new furniture.
This frenetic buying binge boomed up the British economy; most of the stuff they bought was imported and thus transport logistics, road haulage warehousing, distribution and multiple retailing exploded too.
At the same time, random Consumer Credit, much of it unsecured and at Sub Prime Rates boomed too: on top of mortgage debt. This credit overhang now exceeds probably, £1.3 Trillion! The “Spread” between Deposit and Lending Rates head towards usury, with some credit and store card operators charging up to 40% APR when base was hovering at 3.5%!
Nice Mr Brown comfortably ensconced in his chair as the Iron Chancellor, of the Exchequer, prudence dripping from every pore could do no wrong, since his tax take from VAT (Sales Tax) and income tax on companies boomed also.
Now Mr Brown predicated both his own reputation and the nation’s economic and fiscal futures on what became know as his Golden Rules: one was to set total government borrowing to equal no more than x% of GDP.
Unfortunately, either his accounting and audit were flawed – which considering the singular fact that by profession he is an accountant! – or, like many of his predecessors, he was shall we say economical with the actuality!
Simply because in adhering to his golden rule, he forgot to add in to government debt the vast current and forwards value of public sector pensions obligation which in the main are paid from revenue since no government had been astute enough to fund them!
And each and every time he delivered his budget speech and stated how much PSBR (Public Sector Borrowing Requirement), a short time after, it magically escalated. In fact his forecasts were so poor they became laughable.
Unfortunately, as the author warned back in 2004, all this import activity caused Britain’s Balance of Trade to slip increasingly into massive deficit: which had to be financed.
Meantime, employment boomed. Of course it did! The property and consumer buying frenzy meant increasing amounts of people were needed to service the rapid economic expansion. Building trades had never been so busy.
In fact a new phenomenon was created: Mr White Van Man. Increasing numbers of tradesmen and cowboys, hacked around main roads is overloaded panels vans to take part in the gold rush. For some reason not known a majority were white: and driven by lunatics.
Such is the way legend and lore are born.
To finance this never ending eureka, banks and financial manipulators had to find a new way to lend and lend without rapidly expanding their capital base.
Help was at hand!
In the financial insanity that is the current capital markets, new products are created almost every day. Securitisation was one such financial engineering product which seemed to offer all things to all men.
When a lender has amassed a good portfolio of loans, they are “Packaged” into a convenient parcel and sold on. The lender receives his cash back, less service costs and can thereafter re-lend the same money to another set of hungry borrowers. This concept allowed banks and other lenders to sell off mortgage obligations and expand rapidly on a slender capital base.
Most MBAs (Mortgage Backed Securities) were sold “Without Recourse”, which means simply that if the loan went South, then the original lender was free and clear.
Sounds too good to be true!
As mortgage lenders were expanding their loan books in synchronism with the rapidly rising property market, they needed to fund the period between granting the loan and it being drawn down: and until they had yet another package of tempting debts all neatly wrapped up. So they turned to the Interbank Market.
Now traditionally, this market is precisely what it implies: it brokers short and long positions between banks.
Unusually, the mortgage lenders were able to tap into this source. Most interbank deals are on name only: the giver of funds – another bank of financial institution – takes no security and is assured by the obligor’s credibility and creditability.
The first crack appeared last year when a British ex-building Society turned bank, the Northern Rock hit the wall: expanded dramatically by a set of gunslinger executives, using MBAs and too tempting offerings to potential borrowers, on the back of the market misgivings on sub prime lending, the Interbank market slammed the tills shut.
The Rock couldn’t look to its hordes of little savers, patiently waiting until it was their turn for a mortgage: since there were none. The concept of actually having a deposit had been negated by the idiocy of slack lending policies and banks offering 100% plus mortgage deals!
Thus by this point, all mortgage lenders, both banks and previous building societies masquerading as banks were breaking that hallowed First Law: Lending Long –up to 30 years – and borrowing short. On the premise that once the assembled packages of MBSs were sold off, then their loan book would once more reset to zero.
Worse, as the US mortgage market was increasingly hit with a deluge of defaults, many leading banks were sitting on large portfolios of almost worthless MBS products.
This rapidly drained the capital markets of ready risk funds. And despite vast injections from the Fed and the Bank of England, those tills remain firmly locked.
Further misfortune was realised: due to the now global nature of the in International capital markets, much sub prime MBSs had been sold to Asia and Europe: the pain resulting meant that these sources for capital remained sceptical and closed also.
Hugely indicative of these realities perhaps is the singular fact that one of the main British banks, Barclays, has had to secretly take in large funds from overseas Sovereign Wealth Funds. These include the Bank of China, forsooth and Qatar, currently awash with cash from their booming natural gas fields.
Most of the rest are desperately floating huge rights issues to boost their capital bases. More surprising still, perhaps is they are tending to be fully subscribed.
Thus a major British financial asset is now partially owned by the Chinese!
So what is the current reality? Where does the British economy go from here?
Perhaps the most indicative sign comes from that place again: the Interbank Market. Normally, it tends to follow the Bank of England’s lead on rates. Not this time!
LIBOR (London Interbank Offered Rate) is the financial thermometer. It shows what rate lenders demand in all periods from overnight and call through to ten years when the market is bubbling.
Now, LIBOR stubbornly refuses to track the bank’s base rate, mainly since the lenders realise that rate is too low: far too low.
"The Wrong Stuff" - Too little, too late
Worse for the government perhaps, the mortgage lenders are now tracking LIBOR and despite attempts to stimulate the housing market by inching rates down and injecting massive tranches of cash into the system, it’s all going the wrong way!
Government and the Bank have foolishly elected to try and control Britain’s economy with one weapon: interest rates. Trouble is it’s an axe, which can cut two ways. And a pretty blunt axes too, when what is needed is a scalpel made from finest surgical steel.
Raise rates to damp down demand and stem inflation: the housing market tanks. Lower rates to ease the housing market and inflation roars away. Worse, in the age when the Euro has overtaken the US dollar as the prime reserve currency and when Britain imports far too much, lowering rates de-values sterling.
What the bank ought to have done was limit excessive lending with controls. The classic methodology is to introduce the “Corset”. Lending institutions are required to lodge matching Special Deposits with the Bank of England as a percentage of lending; and at punitive rates well beneath market.
The true role and function of any Central Bank is foreign exchange balance and monetary equilibrium: despite the boasted independence of the Bank of England, they are now taking monetary decisions on social and political terms of reference, in cohorts with Government, which sends out clear alarm calls to the international markets of lack of judgement, lack of control and panic.
Trouble is, securitisation has effectively boomed up money supply, since it acts as “Credit Money”; thus the essential balance between gross money supply or what is called Sterling M1 is way out of kilter with GDP.
Worse, as the inevitable reality strikes and rates rise to stem inflation, now technically well above four percent and heading for five, this will trip the last lack of affordability factor on the average British family’s budget.
With rapidly escalating food, fuel and heating costs, as well as raised taxes, a small hike in mortgage rates in the nature of 1.5-2% will prove the tipping point. Mortgage facilities and house sales are now at a thirty-year low: this trend is due to accelerate. The support activities – all those white vans – and the vast network of businesses importing and selling goods of all sorts, mainly on the back of a synthetic “Feel Good” factor, imbued by consumers feeling suddenly awash with illusory “Profit” from insane house price escalation, will crash.
Unemployment will rise; the Chancellor’s tax take will plunge further. Having borrowed to the hilt and wasted all the cash on grandiose schemes such as the NHS computer system, which despite now exceeding £10 billion plus, still doesn’t work, he has nowhere to go.
Additionally, with sterling weakened to the point of anaemia on the Forex markets, Britain’s import bill for essentials, such as crude oil, gas and food is currently rocketing; this reality shoves the current account (Balance of Trade) yet further into deficit and this has to be funded.
The forecast unfortunately is bad: and getting worse.
With no meaningful industrial base and an economy previously predicated on house price rise and the import, distribution, sale and fitting of foreign goods, there is no where to go and no salvation in sight.
The music just stopped and there are no spare chairs.
© Copyright 2008 by AxisofLogic.com
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