Tuesday, April 10, 2007

Credit Failure

Few people in the UK are aware of the problems of the US sub-prime credit market. Even if people are aware of the fact that the market there has dramatically tightened, not many from outside the industry are aware about what that means.

It means that in a period of about six weeks, credit has suddenly become very difficult to find- people who were financially stretched are now being forced to sell up, and the consequence is a serious down turn in real estate prices.

The over extended US credit market is facing the consequences of the bankruptcy of sub prime lenders and in their struggle to survive the remaining lenders are now lending "by the book". So, although interest rate rises have been relatively modest, the available liquidity has fallen sharply. Finally the US consumer faces serious pressure, and the decline of the US housing market is headed towards a rout.

Although the UK consumer lending market has not become as over extended overall as the US market; compared with the European markets, overall debt levels are much higher. Admittedly part of this is the high level of property ownership, as opposed to rental. However consumer lending too has been historically higher in the UK than in continental Europe.

A global tightening of liquidity in the consumer sector may begin to change the UK market in two ways: firstly the supply of credit may become more difficult- 110% mortgages may become impossible. Secondly the price of credit, interest rates, which have been flattening out after previous rises, may also unexpectedly rise. At the moment the forward yield curves show that UK interest rates are likely to fall over time. However after the sharp tightening of credit supply in the US, we should watch the British curves to see whether the market is concerned about a deleterious effect on the UK consumer market and also, especially, on the mortgage market.

At a time when UK bankruptcies are high and rising, despite relatively benign interest rate conditions, the economy could face serious disruption if the consumer credit market tightens significantly. By the time that house prices fall, it may already be too late.

These are nervous times in Downing St, but also in Threadneedle St: the home of the Bank of England, which now faces the first serious test of its independence.

3 comments:

Anonymous said...

Cicero, the sub-prime crash is directly resultant from the greed of investment banks on Wall Street. I know, I work nearby. Just as they have cashed in on predatory lending practices with credit cards, they moved onto mortgages. With the housing bubble bursting in most of the States, this is the harbinger of the recession we all expect -- with the downturn starting by Q4 or Q1 '08. Most people think the country will be in a mess by the November '08 elections.

If London (and Frankfurt) plays its cards right, they will win at the expense of New York. If it strengthen itself now and insulates itself as much as they can from the upcoming US mess (it's impossible, especially if it drags Asia down, but minimising damage is possible), they will come out the leaders of the new, post-Dubya financial world.

Goodness, wouldn't the pro-business Republicans love that bit of W legacy?

Etzel Pangloss said...

There are an awful lot of us few Cicero.

When the market in credit derivatives crashes we will dance to a sorry tune.

We are in an economic winter that as been salvaged by printing money: what comes next nobody knows...

Anonymous said...

Oh Cicero, did you see a unit of RBS this morning just bought a hunk of the sub-prime rubbish from New Century? Goodness, they are selling it over the Ocean now! What's next, BoS-Halifax? Is this an anti-Scottish ploy?