Credit Crunch 11: The Abyss

Cheer up! It could be worse. At least estate agents themselves have been the first casualties of the credit crunch. The greatest collapse in the housing market since records began, with home loan approvals down 70 per cent on the year, has turned the high street into a killing field. At least 15,000 estate agents will lose their jobs this year alone, according to the Centre for Economics and Business Research. It may be the first time in history that estate agents become objects of public sympathy.
Britain, like the United States and Europe, is now entering a recession and it won’t be a shallow one. As the Governor of the Bank of England, Mervyn King made clear in his latest exceptionally gloomy forecast, we have come to the end of the “nice” age – defined by “non-inflationary continuous expansion. Encouraged by central banks which kept interest rates too low for too long, the western banking system built a huge tower of debt on the uncertain foundations of inflated real estate values. As house prices plunge, this edifice is collapsing and the losses will be in the trillions.
Few will shed tears, though, at the impoverishment of the buy-to-let landlords, the other big early losers in the credit crunch. Britain’s one million amateur property tycoons are finding they can’t let their pokey flats at an economic rent and that the banks refuse to roll over their cheap loans. Thousands face bankruptcy as the value of their properties fall.
The good news is that once the correction has happened, houses will be affordable again. And, as owners dump unsold flats on the letting market, rents are also likely to fall. And who could resist just a little Shadenfreude at the news that Land Rover sales are down 32 per cent? We may be seeing the beginning of the end of the “Chelsea Hearses” – those big black monsters with smoked windows that clog our streets. Falling bonuses in the City are blamed. Mind you, even in what many are calling the worst financial crisis in 60 years, City firms still managed to increase bonuses this year to a record £13bn. It’s an ill wind, all right.
The more public money that goes into the banking system to beat the crunch, the more seems to go out to the private pockets of those who were responsible for causing it in the first place. The great survivors of the credit crunch are the bosses of the big high street banks, like Sir Fred Goodwin of Royal Bank of Scotland, who have had to write off billions in mortgage-related assets and have seen their companies’ share price collapse, but keep their jobs and fabulous remuneration.
The real casualties are inevitably old people, and low-income families who have been hit from all sides as housing, transport, heating and food prices take off. But young professionals face difficulty too, especially those who threw caution to the winds to get on the “housing ladder”. Among these, 1.7 million recent home buyers will find themselves in negative equity within the year, according to Standard and Poors, meaning they will owe more than their houses are worth. House prices have fallen 11 per cent this year already, the steepest fall ever recorded. If house prices fall by 35 per cent, as expected, three million could be hit before the market bottoms out around 2010.
These families could be saddled with debilitating debts for at least a decade, for that is the minimum that it will take for house prices to recover. In the US, where house prices peaked in 2005, prices are still falling, despite interest rates being slashed to 2.5 per cent and hundreds of billions of federal dollars being pumped into the banking system in the form of “liquidity loans”. A third of all American homeowners who bought in the past five years are “underwater”, something that hasn’t happened since the Great Depression.
In Britain the slide has only just started. Many are still in denial. Moreover, the first year of the credit crunch has been something of a phoney war. Unemployment is rising (July saw the biggest jump since 1992) but most people are in work and hope to remain so. Students have come to accept debt as a way of life and remain unmoved by a financial upheaval that still seems remote from their lives.
Of course, there are lots of things you can do to protect yourself from the affects of recession. Simple budgeting for a start; that £5 lunch every day adds up to £100 a month. Turn down the thermostat and save hundreds more. If you can sell your house, do, and rent instead; it’s cheaper than getting a mortgage. Don’t take on more debts and consolidate those you have. Cut up credit cards or get an interest free one. Don’t get behind with bills because it will affect your credit rating. Avoid branded goods. In other words, be more prudent. The evidence suggests we can all benefit psychologically from giving up the frenetic shopping culture of the boom years.
Politicians, though, are living in the past, hoping that a miraculous recovery in the housing market will bring back the good times. MPs, like many middle-class, middle-aged people are largely insulated from the crunch by housing equity, index-linked pensions and other assets. But now that the days of easy credit are over, those under 40 are going to find themselves living in a very different world.

Day of reckoning

The bubble decade destroyed the last vestiges of the secure and predictable post-war society of ordered career paths, jobs-for-life, final salary pensions and steadily increasing prosperity. Even the Church of England is talking of abandoning its occupational pension scheme. People are having to learn to live with debt and insecurity (though fewer than half of us are saving for a pension and, according to the Pru, those who do are halving contributions because of the downturn).
People have become used to seeing their homes as pensions and as sources of easy cash through remortgaging. Now that this is being closed off, the day of reckoning is here. We collectively owe £1,400,000,000,000 in Britain and the banks want it back. Britain has one third of all Europe’s unsecured debt, so it is not surprising that personal bankruptcies are increasing ominously. The banks are using ever more ingenious means of relieving us of our funds, from credit cards with 25 per cent interest,to unlawful bank charges on overdrafts. Current accounts should bear government health warnings.
So, with easy credit and housing equity lost, people are going to have to learn to live within their means. The problem is that living standards are being eroded as wages and salaries stagnate while inflation rises inexorably toward 5 per cent, even on the government’s discredited CPI inflation index. According to the price comparison website mySupermarket.com, the cost of a basket of staple family foods has increased 20 per cent in a year, equivalent to £1,000 to an average family. Politicians warn of hyper-inflation if workers do not accept below-inflation pay settlements; but for people on low incomes, hyper-inflation is already here. Domestic fuel prices have risen by 19 per cent in a year, and petrol by 25 per cent. British Gas increased prices by 35 per cent last month and others will follow. Water companies have served notice that they too will be joining the inflationary spiral.
Yet only three months ago, the Bank was forecasting steady growth, low inflation and stable prices. One of the difficulties for ordinary people trying to cope with the credit crunch has been the failure of forecasters, private and public, to admit the severity of it. Central banks and financial analysts have been following events rather than forecasting them. We keep being told “the worst is over” when clearly it is not.
This leads to a kind of fatalism; a feeling that each of us is individually at the mercy of events. We live in a world in which the market has largely replaced politics and collective action. All those institutions of civil society – churches, trades unions, political parties, associations – that once sustained people in adversity have withered, replaced by the solipsism of the internet. Social networking sites offer a semblance of community, but are quickly invaded by commercial interests which, as with eBay, Google, Facebook, rapidly subvert the original social ideal.
What we need is a new generation of post-consumerist initiatives, like Freecycle and Gumtree, which allow people, by mutual self-help, to bypass the debt cycle.

Where is the left?

In the past, people looked to the state to protect them from the ravages of the market, but not any more. Where is the Left in the worst capitalist crisis in half a century? The government seems to have given up too. A defeatism about the credit crunch pervades Whitehall; a sense that there is nothing that can be done, apart from trying to use public funds to fix the holes in the financial system. One intellectual casualty of the crisis has been the myth of deregulation. Joseph Ackermann, chief executive of Deutsche Bank, said recently: “I no longer believe in the market’s self-healing power”. Many financiers have echoed his view. This is a paradigm shift, but Labour has failed to keep up. It has been left to bankers like Sir Ronald Cohen to condemn the greed of what the BBC’s business editor, Robert Peston, calls “the new plutocrats”. It was the Governor of the Bank of England who condemned the “bonus culture” of the City, not a Labour minister.
Instead, the government agreed, in April, to an extraordinary £50bn bailout of the banks in exchange for their unsellable mortgage bonds. The deal was supposed to be that the banks would reduce mortgage rates and free up lending to first-time buyers, but they simply pocketed the money and put rates up even further for people who couldn’t put up large deposits. This was a humiliation for the government. At the very least, ministers should have secured something tangible in return for giving the banks privileged access to public funds – restraint on bonuses perhaps, or help for people about to lose their homes.
The government should also be devising regulations and protocols now to prevent another housing bubble. Government was not blameless. Concessions on home ownership taxes (capital gains and inheritance tax) encouraged people to save in houses instead of pensions. It was the egregious tax concessions to buy-to-let landlords, who can set mortgage interest payments against profits, that led to the building of tens of thousands of tiny city flats unsuitable for families.
Above all, it was the collapse of social housing, through council house sales and the ending of council house building, which compelled people to take on ever larger mortgages to get a roof over their heads. For many people in insecure and low paid jobs, mortgages are a seriously bad idea because they lose everything if they can’t keep up the payments. They should have had a choice. If the £50bn given to the banks in April had been used to finance council housing, the government could have begun to solve the housing shortage and saved thousands of jobs in the construction industry.
Instead of dithering about stamp-duty holidays and tax free savings accounts for first time buyers, the government should be addressing the central problem: risk. Bankers lost any sense of it when they began handing out mortgages of 125 per cent, loans on multiples of six times earnings, not to mention self-certificated “liar loans” where people were encouraged to inflate their incomes so that they could get mortgages they couldn’t afford.
In Britain, mortgage borrowers shoulder most of the risk when they take on a mortgage. They can lose all their savings and end up in debt for years. But in America, most home loans are “non-recourse” loans, which means the borrower has limited liability in the event of repossession. If there is any loss in the sale at auction of a repossessed home, the bank that takes the hit and the borrower can walk away. This is a simple measure which would make a difference to victims of the credit crunch. The banks would hate it but it would encourage banks to lend more responsibly.
Beyond that we need a government prepared to recognise that a stable economy cannot be built on debt. We need a return to productive investment instead of speculation; a savings culture instead of credit; sound money instead of inflation; redistribution of reward instead of socialism for the banks. The great challenges we face, like climate change, need an economy, in which science and technology are deployed to create new markets in areas like renewable energy, conservation, agriculture, information technology and sustainable transport. Wealth is good but it should be made out of making things, not making debt. The New Labour economy has been built on the dream of unlimited housing wealth, on money for nothing. It is time to wake up to reality. l