Safe as houses - part 1

In the beginning

Safe in their hands? Safe in their hands?

Introduction - At the start of what we now call the credit crunch I sensed that this was to be no ordinary event. As an avid reader of any business and economics news I developed a near morbid interest in this subject, so kept a diary. On a personal level, I once had a Northern Rock deposit account and own some bank shares.

In 2007, when some families in the UK were coping with the damage to their homes caused by the floods, another disaster was gathering pace. Unlike the floods, which at the time went straight to the top of the nation's concerns, the sub-prime crisis of the USA began at first as a mere trickle in the the depths of reporting. Not at all photogenic, this event took a long time to get the attention it deserved. Eventually we saw the Northern Rock (NR) investors form into queues to get their money back, the outcome from this event will, in time, be seen as a force equal to the UK floods, and reaching far beyond any flood plain or barrier. So how to describe the sub-prime crisis? An act of pure folly, or merely a market correction?

Back in the spring of 2007 it would have been the norm to describe the UK financial services sector as 'dynamic' and 'creative'. Only later would the criticism rain down upon them. And following this criticism it could be a while before the general public return to full confidence in those who look after their money. In terms of the economy,the remark, 'what goes up must come come down' was never more apt. Economic cycles, including those presided over by Gordon Brown, or any Chancellor of the Exchequer for that matter, cannot defy gravity as a matter of course. By early spring 2007 other factors in this tale began to show themselves. It was by then possible to talk aloud about the end of the property boom, and when this was written, to do so without the tail of the sentence being propped up with a question mark.

The answer or the problem?The answer or the problem?
The Buy-to-Let (BTL) housing market was no longer the place to be. At first BTL was promoted as if it was an almighty, benign and unstoppable force for good. But time moves on. In early spring 2007 I got an opinion from a Midlands-based bank official who described the new entrants to BLT as amateurs. His was not a sneering remark but made more in a mix of annoyance and exasperation. For he knew that many of them had set themselves up for a bleak financial future, as they lacked the experience of the proper professional landlord. He also knew of pros who had got out of some aspects of BLT as soon as they saw the amateurs moving in. Not so much, there goes the neighbourhood, as, there goes the profit. Few of these amateurs would have bought their property wisely with the right mix of financial resources. Most would have taken a simple approach and used mortgages alone. In some cases the income from the Let paid the 'other' mortgage, this was the mortgage on the family home, hence the exasperation of the bank official. There was no business plan, no plan B, and no escape. In fact this was not business but madness.

In some parts of the UK the sales of property had slowed considerably, vendors in this fix could either lower the asking price, or put the house up for let. Here the latter option added to the pain of the BTLs by increasing competition in the market and further depressing income opportunity. And one of the reasons why property sales had problems was the rush to get property onto the market before the introduction of the much vaunted HIP's scheme. Home improvement packs were supposed to be a help in the buyer/vendor relationship, in fact for a variety of reasons they have been a disaster, and as you might have guessed there is an EU dimension here. It is an EU driven idea and all countries of the EU are supposed to introduce some form of this scheme in due course. While lucky amateurs and pros alike have in years gone by done well with BLT, it can now be shown that money in an individual savings account, or ISA, is doing better. Furthermore, it was also established that the USA was on the verge of a housing slump not seen since the 1930s, with savings in the USA at their lowest since 1934. Towards the end of July there were now regular reports of repossessions; at one UK auction the closing bid price for some flats being below the sum paid for them a few years before. Also at the same time, from the USA came news about Countrywide Financial (CwF).

Not the American dreamNot the American dream
This was a mortgage lender, and they had problems. CwF has been seen by many in the UK as the sole reason for what we now call the sub-prime crisis, but this is an exaggeration. Formed in 1969 it became the largest mortgage lender in the USA and to have got to that position over that period of time CwF must have been doing some things right. It would seem that CwF had spotted problems with the sub-prime sector, indeed they had recently halved their activity in the sector but it would also seem they moved too slowly to avoid trouble. As some people got ready for their August break with hopes of re-stocking last year's fading tan, so faded hopes of ring-fencing the USA property crisis. Then shares in both the UK and the USA fell dramatically; for most would-be holiday makers the Mediterranean is a long way from the Mid-West, but not if you are a banker. It was reported that some bankers cancelled holidays. And prior to all that holiday spending, we heard the sobering comment from Sir John Gieve, the Deputy Governor of the Bank of England, who said that we all have too much debt on our credit cards. Then more gloom from the USA, it emerges that three quarters of a million homes could be repossessed if it all goes wrong and the crisis gets worse, this alone shows up the scale factor between the UK and the USA. Also we are told that billions of dollars worth of this lending has been turned into collateralised debt obligations. And that both types of debt, sub-prime and prime, has crossed from the USA over the Atlantic to the UK, because of the bundling system. A 'pig in a poke' I hear you say?

Also in August 2007 the UK banks are unveiling their profits. The biggest is for HSBC at £6.9 billion, we also hear that it is the UK bank with the highest risk from CDOs going sour. Shares for UK banks and mortgage lenders wobble on the stock market, we are told to ignore this as they all have made so much profit. Mind you, I cannot help recall a meeting with another UK bank official in 2005. This fellow was employed to investigate fraudulent customers. His opinion was that banks were lazy, so long as the sums involved were reasonable, not much would change, this because UK banks care more about their image than to get active on debt and have this matter get publicity. I wish now I'd asked for a definition of 'reasonable'. At this point in time there are several articles in the business press of the tut tut type, 'pull yourselves together', 'all is well' etc. We are told by Alistair Darling the the UK economy is 'strong'. Other business reporters got stuck into the important bit, the blame game and this was a rich seam. Some French and German bankers had made sniffy remarks about lending criteria in the USA. The Yanks replied by suggesting that if the Continentals had spent less of August at the beach, they might have been more aware of what they were buying (CDOs) and anyway, caveat emptor applies both sides of the Atlantic.
Beware the greenback?Beware the greenback?

Part 2 of this article will appear shortly.