I noticed your article last week mentioned the current credit crunch and the issues with Northern Rock, I am not sure I understand the current credit crunch and its impact on the housing market. Can you explain it please?
The credit crunch referred to is simply a lack of trust in the system. US banks loaned capital to people with poor credit ratings and decided to reduce their risk by packaging the debt and selling it on. Pension funds and Hedge funds around the world bought the debt.
That’s all very well. The difficulty is no one really knows the extent of the bad debt and also where it is now. Moreover there is also the concern of bad debt in the UK.
Borrowers have been borrowing against property at levels way above where they should, and the concern is that this could unwind itself in a less than funny fashion.
Whilst I might have highlighted this two years ago, the market has carried on its merry way and unfortunately the bigger the bubble the bigger the pop.
The Bank of England were slow to increase interest rates and borrowers approached banks on the basis of what they could afford and not on what they may afford in difficult times.
Whilst we could borrow at a base rate of 3.5% in July ‘03, the same debt today is 65% more expensive at 5.75% – and it could become more expensive. 1
The consequence of this is that banks tighten up policies and tar up the system by not lending to each other as they have a fear over the strength of the bank they are lending to. That’s fair enough. The difficulty is with this mistrust, banks tighten up on their risk, begin to charge more for their rates between each other and this inevitably has to be passed onto the borrower.
All this adds to extra expense to a borrower already faced with a 65% increase in debt expense over the last four years. Finally, throw into the pot the fact the UK is in record debt and you have bubbles brewing which are less than perfumed.
In the United States, where they have introduced higher interest rates earlier than the UK, there is a glut of repossessions, and with borrowers finding it difficult to borrow money, the squeeze has been painful as there are fewer buyers, and of course extra properties. It’s generally believed that interest rate increases take eighteen months to make their way through to the economy properly.
If the UK market goes the same way, there is no doubt demand will decrease and supply will increase. If that’s the case, and you need to sell your house and there is no market, there is only one way the house price can go.
The evidence is already there, with new builds struggling to sell against aggressive targets. Northern Rock and other sub prime (lower credit customers) organisations are also struggling to borrow money to lend to customers due to the tightening of these controls.
What will really help the credit crunch go away is lenders all agreeing to show each other their books, and come clean with the bad debt they have. Once this happens lenders will feel safe about lending to each other and liquidity moves back into the market and lenders can again lend with confidence.
What is most concerning is the fact lenders have not openly moved to do this. On that basis, I can only assume a number have information they do not wish to share and that’s not good news.
As I said last week, the key information is coming through to show a slower interest in new property and also fewer completions. Whilst an average house price might show as still level, an average can be distorted by extremes. The key point to look at is completions and they are falling.
If you have a financial query or want to speak to Peter McGahan, call 0800 0112825 or e-mail peter@wwfp.net
Source
(1) Bank of England
The value of shares and investments can go down as well as up
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