Banks Housing and the Economy

I have been going on about the sustainability of house prices for longer than this Web log has existed and I have said that it would end and that prices would crash. I also predicted that the Greening of the planet was likely to start with an economic crash rather than an environmental disaster. That does not mean that there will not be something significant that will not happen. In fact I still think that we will see an environmental event so profound that it will shock us into respecting the environment, and I still think this will happen soon. By soon I mean the next three to five years. Based upon the present state of knowledge, I think it is likely to be a sudden rise in sea level. However, it is the financial events that are most profound effect at the moment.

While I will concentrate upon the British economy, many of the broad brush strokes apply across the world.

Recently it was reported that the British economy had not grown for the last two quarters, but if you take out the increases in property values from that then the British economy has in fact been shrinking. When this end to the supposedly steady growth was reported, the BBC reported that the economy over the last ten years had grown by 450 million pounds. While that may sound like a large amount what is not often understood is that when we have flooding events that cost more than a billion pounds, of witch there have been several in the past ten years, this all gets counted towards the gross domestic product the way that the economy is measured. Now, with flooding alone having cost at least 450 billion, then where is the growth?

All we have really been measuring is the cost of repairing damage, the cost of replacing what we already had.

The other important aspect of the illusion of the rise in property values. I call it an illusion as this has been driven by a supposed shortage in accommodation. Even in London more than twenty percent of homes are empty. Not a figure plucked out of the air, but statistics gathered by the housing charity Shelter. What people should have been talking about is a shortage of affordable housing.

While I don't think that it was ever planned that way, the more I have researched this the more convinced I am that the banks and the government knew that they were spinning a lie to the public as the banks were making money from making loans, the government were making billions from stamp duty (a property sales tax), and the property developers were making money from building more and more. This was all sustained only if the lie could be maintained only if we all kept on perpetuating the myth of a housing shortage.

There is also a further factor here, as no matter how much house prices rose, it never filtered through to the rate of inflation because of the way that inflation is measured. When calculating inflation it is only the cost of the loan that counts not the capital repayments. While the increases in property values has increased rents as well, as only thirty percent of us rent, then only a small portion of rent increases counted towards the measured rate of inflation. Thus we could have house prices supposedly rising by three hundred percent and it having little or no effect upon inflation.

What effects there were were also masked by the fact that so many of our consumer goods were coming from China where they could be manufactured extremely cheaply. With items like clothing, Electrical and Electronic goods actually falling in price, the real rate of our inflation was in fact being hidden.

Then it has to be remembered that this consumer spending has not been funded by earnings from greater efficiency, but from borrowing. In Britain the average person owes over twenty-four thousand pounds and that excludes housing finance. Now in Britain the average wage is twenty-four thousand pounds per year, that means that Mr or Ms average owes a years wages before tax.

All this spending created an illusion of a growing and vibrant economy, but we have been spending tomorrows earnings. The accumulated personal debt is over one trillion pounds (about two Trillion Dollars). That is greater than the gross domestic product of the UK economy and it was this debt that was funding the banks.

The money that banks were making from housing finance was minimal, only about six pounds per every hundred and that on the whole life of a twenty five year old loan. While the personal finance loans were generating earnings of twenty percent plus per annum. However, all this was only sustained by the mythology of ever increasing house prices. The moment that house prices started to fall then the whole edifice of the way the banks were lending money would inevitably collapse.

I have to say that I do feel for the many people that have been impacted by the Credit Crunch. The problem is that it is far from easy to stand out from the crowed and say that you are not going to play the same debt game that everyone else is playing, but we all need to learn to live within our means.

While the falls in house prices are are major part of why there is now a banking crisis, it is also the level of personal debt that is also playing its part, as people will try to retain their home by ensuring they pay their mortgage, they will reduce or even stop paying things like credit cards or non secured loans. That is where it hits the banks hardest as with secured loans the banks can get some of their money back by repossessing your home, on credit cards the finance is not secured.

What is actually happening is that sanity is returning to the market. It was never sensible for banks to lend mortgages of one hundred and twenty-five percent of the value of a property. While in a rising market it was likely that the increase in property values would mean that the property value could the level of the loan, it always was a gamble that the bank was taking. Further, the borrowers should have looked beyond the discounted repayment rates. It is the double impact of rising interest rates and falling property values that is hurting people. Then to really make matters even more difficult for people just when these discounted offers are ending on their mortgages the banks are not lending. While it is being called a credit crunch, there is not really a shortage of finance out there, what is happening is that that money is no longer as cheap as it was. Plus the banks have finally put their sensible heads on and are now actually looking at if people can really afford to repay the money.

While all this is very painful for many, the fact that we have been buying goods with money we have not earnt yet was never wise. Also, and for me more importantly, this has all had a disastrous effect upon the environment. With many people just buying consumer goods to replace perfectly serviceable items just because of fashion, we have seen more waste produced. With most of these goods coming from places like China, all this has added to climate change. This is where the reduction in spending on consumer goods will really help the planet.

However, the real environmental impact has been the building boom. The impact of the myth of a shortage of housing has been every scrap of land being built upon. For example in London anyone that had a seizable garden built another dwelling on the garden or sold it to a builder who built on the garden. Equally we have seen thousands of homes being built on land that was unsuitable for building, I am speaking of the many flood plains where new houses have been built. There is also the impacts to climate change from all the construction activity.

Further, where people were forced to move further away from the places they worked by rising house prices, the greater the distances people needed to drive has all added to the environmental impact of the tripling of house prices.

Now with the myth of a housing shortage blown apart we will see house prices falling to a realistic level. That average has always been about three and a half times the average wage that makes the real value of your average home Eighty five thousand pounds. Not a quarter a million or any of the other fantasy amounts that Harry Potter could have conjured up.

Apart from the fall in the price of homes to a realistic level, the end of the spending spree that most of us have been on will reduce the environmental impacts of the wasteful consumerism that has prevailed for the last ten years or more.

However it will be the way that the greed of many businesses have been harming the many for the enrichment of the few that will start to occur that will really benefit us all.

Don't misunderstand me, I do think that we will see more pain, and I suspect that the next part of this slow motion crash will be parts of the insurance industry. Also as I have already said I think that we will have an environmental event that will shock us all into taking Climate Change seriously. I suspect this will be a sudden rise in sea level of half to one metre. When this happens it well be so deviating that it will bankrupt the insurance industry. Not just the British industry or the US industry, but globally the impact will be so costly that the insurance companies will not have the funds to pay out the trillions of dollars this will cost.

However, I don't want to go off on an environmental tangent, as there is another aspect of the current banking and economic crisis that we all need to bare in mind. That of why the banks are no longer willing to lend to each other.

In the past banks it used to be that only when the banks had the cash to lend would that money be loaned to people or businesses. In that way the banks were relatively secure as they ensured that loans were secured and they knew who they were lending to. While there were other financial bubbles that burst in the past, in the 1920s banks loaned people wast sums to buy shares. When the Wall street crash occurred it was the realisation that this money had just disappeared that shocked the banks. It was this fact that caused people to commit suicide realising they had lost everything.

The depression that followed was caused by the fact that the banks quite simply did not have the money to lend to businesses, even sound businesses. That led to good businesses failing as they could not invest. But also it meant that in the US the Federal authorities placed a cap on the level of debt to assets of ten to one that banks could lend. A similar system applied here and this forced the banks to limit what lending they could make. Then in the 1980s here in Britain we had Thatcher deregulating everything, while over in the US Regan did the same. It took many years but finally the banks concocted products so that they could lend more, avoiding having to place these on their balance sheets.

When Lehman Brothers collapsed it emerged that they had a debt to equity ratio of thirty-five to one. That is for every dollar of assets the were exposed to thirty-five dollars of debt. Remember that Federal law says that they are legally limited to a ratio of ten to one.

What none of the banks are actually willing to acknowledge is that they all have a much greater debt to equity ratio than they have thus far disclosed. Therefore because all the banks know that they have this problem none of them are willing to lend to each other. If you know your lying, you are not willing to believe the lies of other institutions. They have all been playing that game. Additionally the governments and the regulators know this too.

Now remember that the major asset base of property is over valued by about two half times based upon the normal economic valuations, then there are at least six trillion dollars of loans that are secured upon worthless assets. That's a figure that is based upon the global banking system.

If you then add on the personal debt that is unsecured then the debt is over ten trillion dollars. And that is just based upon the personal debt of the US and the UK.

On a number of occasions I have spoken of the risk of debt, I never expected it to manifest in this manner. Nor did I realise just how vast the level of global debt was. What I want to know is did our government? It is clear that they have been Hyping up the housing market as it gave the illusion of growth and wealth, while in reality all we have been doing is spending our inheritance before we even get it.