Ba Da Bing

(not Charlton related)

Uh oh. Bradford & Bingley were on the brink of collapse last night. It turns out the rhetorical question I asked about the UK's buy-to-let cheerleader back in September wasn't so rhetorical after all. Make no mistake, this is another government-engineered bailout by another name. We'd better hope it sticks.

The UK economy is an utter mess. The relentless tide of bad news from banking to retail to housebuilders, is vindicating my long-held view that ten years of a supposed Labour-led economic miracle was nothing more than a sham.

The near-term will be extremely painful unfortunately for those with unserviceable debts, but the post-bubble shake-out is a required step if the UK is to have any hope of remaining a relatively rich nation long-term in the face of extraordinary developing country growth. The rapid and equally painful rise in food and oil prices meanwhile is not an unlucky coincidence, but an inevitable and related consequence of the same 'unstable equilbrium' that existed before.

In short, global interest rates were kept improperly low because those developing nations from whom the likes of the UK and US were buying deficit-inducing goods and commodities, were happy to continue to generate their own growth from external rather than internal domestic growth. Their exchange rates were artificially held down, and the required recycling back of our foreign currency was manna from heaven for Wall Street and the City of London.

However thanks to this apparently virtuous cycle, the developing nations (notably China, India, Brazil etc..) began to grow their own economies at far higher rates than previously thought achievable, driving up their own demand for the exact same supply-constrained commodities that we were so happy to become indebted to consume in the first place. Throw a few political mistakes (eg. biofuels) and geopolitical fears (eg. Israel/Iran) into the mix, and hey presto, you get $145 crude oil and a global inflation problem, concurrent with an enormous debt deleveraging.

'Build it and they shall come' could easily have been the slogan of the West's highly-paid financial geniuses, as they provided their eager yield-hungry customers with a tide of absurd credit-oriented products that sported ever dodgier collateral (subprime mortgages, LBO loans etc..), and even more ridiculous names (CDOs, SIVs etc..). Those that weren't geniuses after all (eg. UBS, Citigroup) ended up stuck with their own self-made mess on their own balance sheets when the music suddenly stopped.

And then one day (around about 26 Feb 2007 incidentally), the world began to realise, beginning with those backed by US subprime mortgages, that the products were utter garbage. All of the bank failures, recapitalisations, forced mergers, and write-downs that together comprise the so-called 'Credit Crunch', can be seen as an inevitable chain of events in light of the above. It may be termed the 'Great Unwind'.

And thus every day, it becomes increasingly apparent that the so-called 'NICE' decade in the UK ('non-inflationary, constantly expansionary') was infact a fraud, with growth mistaken for leverage, and permanence mistaken for merely fleeting.

Where, when all is said and done, are the great new British companies and innovators which were supposed to have driven this economic miracle? When all the French and American investment bankers have returned home, and their City employers have completed their downsizing, what will we have to show for it? If it's any consolation, the same question will be asked even more desperately in Spain and Ireland, economic basket cases if ever I saw one.

Unfortunately for some, but fortunately for most, an economy built essentially upon selling overpriced homes to one another is unlikely to feature very highly in this new world. From a personal perspective, at least I can now safely attend dinner parties and declare "as it happens I rent", without wondering whether "as it happens I'm a racist" might not have generated less social opprobrium.

The media is as ever obsessed with house prices (as I am incidentally, ableit from an opposing viewpoint). Interestingly, when house prices fall, it brings 'gloom' yet when oil prices fall, it brings 'relief'.....go figure as they say over here. Yet as Warren Buffett is fond of explaining with regard to his love of hamburgers, "...if you plan to eat hamburgers throughout your life, and you are not a cattle producer, should you wish for higher or lower prices for beef?"

Likewise, if you want to 'buy more house' throughout your life (as all but the soon-to-retire surely do), but you aren't an estate agent or housebuilder, why exactly are falling house prices such a doom-laden prospect? Nothing to do with the completely inappropriate levels of debt attached to them requiring ever rising prices in order to service, dare I suggest? Sounds an awful lot like the subprime problem to me, not that the UK has one of course.

Back in 2005 on a different blog, I posted what I saw as the seven great myths about the UK property market. Each has finally begun to unravel pleasingly, providing intellectual vindication if not yet financial:

1. House Prices Always Rise - thanks to the honesty of the vested interests like Nationwide, Halifax and RICS, I think we can safely knock that one (back) on the head;

2. Renting is Dead Money - probably my second favourite myth after no. 7 below. Rental yields are barely 5%; short-term fixed mortgage rates are 6-7%, not to mention maintenance, insurance, stamp duty, etc.. You don't suppose Myth No.2 might rely upon Myth No.1 do you? If so, you're starting to get my drift.

3. House Prices Can't Fall - The Bank of England Won't Allow It: they can't stop it, let alone allow it. And anyhow, Mervyn King is too busy writing explanations to the Chancellor about 3%+ inflation, who in turn is too busy worrying about the loan he's made to Northern Rock (as large as the UK's annual budget for defence incidentally).

4. House Prices Won't Fall in Nominal Terms: see Myth No.1. Thanks to low inflation (compared to history at least), nominal prices will have to fall further than before to return to their pre-1995 trend line (about 50% to be precise). The early 1990s bust occurred in an environment of far higher nominal inflation, and prices only fell about 16% in nominal terms (not that anyone remembers those years fondly).

5. Affordability is the Key Determinant of Value: maybe my third favourite myth after 2. and 7.. This beauty postulated that you could take out a whopping great mortgage, so long as you could afford the monthly payment. This was akin to me stating that I could afford a private jet so long as Boeing would allow me to spread my payments out over 100 years (strangely this flawed logic never fooled otherwise sane homebuyers when buying cars for example). With the refinancing window all but closed, and 2-year fixed 'teaser' rates rapidly moving onto standard variable rates, it seems the total amount borrowed did matter after all. Alas, this was another one that relied upon Myth No.1 to create a quick equity buffer, and thus be satisfied (I'm seeing a trend here - Ed.).

6. House Prices Won't Fall in the Absence of an Increase in Interest Rates: base rates were 5.75% in mid-2007 and now they're 5%, yet prices are still tumbling. Unfortunately banks and other participants in the wholesale markets don't seem particularly interested in what the Bank of England thinks, sending the rate that they lend to each other (LIBOR) rocketing. When lenders believed in Myth No.5, then Myth No.6 broadly held too. Now that they don't, they're simply not willing to lend at any rate because they know the game is up. Thus the Bank of England is irrelevant at this point.

7. Prices Will Be Held Up by Demand/Supply Factors: my all-time favourite, the great British housing shortage which miraculously has only become apparent since 1995. Ah yes, who could ignore the heartbreaking sight of all those millions of middle-class families forced to live in tented cities across the nation? And who could ignore the inexorable rise in housing demand relative to supply which miraculously did not lead to an increase in rents? There was never a shortage of housing, just a shortage of housing for sale (at a price that someone with their full faculties would want to pay for). Now according to Rightmove last week, there are 15 properties for sale per buyer; the demand/supply imbalance thus solved it seems thankfully, all in the context of most of the UK's housebuilding industry having downed tools. Incredible.

Oh well, look on the bright side....Happy Independence Day.