The article, including the posts can be found here (you will need to click on the link to view all comments to find mine). I have only posted my comments below rather than the whole thread. I'm afraid I am replying to the points made by others in the forum, but I hope that the posts still make sense.
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An addition to my original post. I found some earlier (May, 2007) posts where I commented on articles in the Guardian, and have added these directly below (original article here):
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Comment 1
May 06 07, 4:58am
A very good article. I first became concerned about overheating in the housing market as long ago as 2000/2001.
The reason for my concern was that I was buying a house after returning from overseas. I saw one house which I missed due to the sale of my own house falling through at �115,000. 3 months later I saw a house in the same road, same type, slightly better condition but further away from the centre, and it was selling for �139,000, and achieved this price. This was the state of inflation at that time generally.
Whilst this example was in 'Silicon Fen', as it became known, it was still an unjustifiable rise from any rational economic point of view. I have been waiting for a crash ever since.
Fast forward to now.. Why did the crash not happen. In part there have been several factors that have been in play.
World Macroeconomics
- the introduction of China (& India to a lesser extent)into the world market has introduced a huge reserve of labour, which has helped to restrain wage inflation. - As above - but the introduction of Chinese manufacturing has helped to push down prices of many goods, holding down inflation. - The massive foreign reserves held by China and Japan have provided a supply of cheap money, helping to keep interest rates down. I describe this as a conveyor, where US (the most important consumers but also the UK et al)purchases goods from China, this creates foreign reserves in China, and this is then fed back on the return conveyor into 'cheap' money which is then lent so that households can continue to buy things. - In normal circumstance the exchange rate would rebalance this trading system, with the RMB appreciating , but the RMB is not a free currency.
UK Macro
- The UK has had a massive expansion in the population due to immigration. This is a sensitive subject with many people politicking about the numbers. As such to keep the focus on the economics here lets all just agree that it is 'a lot' by which I mean enough to influence supply and demand of housing - pushing prices up.
- In addition there has been the speculative buy to let market, changes in the lending criteria for mortgages etc. pushing house prices up.
- The immigrants are here, in part, in response to the 'success' of the UK economy which provides plentiful jobs. The UK economy is, in part, successful due to the massive expansion in the money supply created through the record growth in consumer credit, and also through increased mortgage borrowing that is the result of record levels of equity withdrawal, which is the result of house price increases. This in turn allows people to spend on home improvements, goods, services etc. thereby holding up employment, thereby encouraging immigration, and pushing house prices up.
- In addition to this the government is also spending more money - resulting in borrowing increasing. Of particular note is that PFIs do not appear on the 'balance sheet' and are therefore a massive form of hidden borrowing. This is a big injection of money into the economy.
If you take out the low inflation and interest rates that would not have occurred if China had not entered the world economy, the current boom would have disappeared long ago, as a rise in inflation and interest rate rises would have occurred. As it is we have now created a monstrous bubble, that will have to burst. I do not think people have yet to grasp how bad it will be.
In particular if there is a downturn in the housing market/the economy (this is the classic chicken/egg story) - there will effectively be a loss of confidence. In each case house prices will fall/have fallen. Once they fall - they will collapse, as the equity withdrawal and 'feelgood' factor will disappear, and with it spending on goods, services etc. Banks will tighten credit in response, further pushing spending down. This will hit employment, further ratcheting the economy down. As unemployment increases some (or many) of the immigrants will start to go home, ratcheting down the house prices by reducing demand (One curious feature I discussed with an economist at Oxford University was that the immigrants will take their accumulated savings with them, which will be the equivalent of importing goods - you may wish to think about this point and realise that it makes sense - a further negative effect on the economy during a period when it will already be in trouble, and where typically the outflow of money will reduce with the tightening of spending).
Sorry, a gloomy picture. However, in the UK the belief for a while is that borrowing is the same as earnings. This is not so and the lesson will be hard. We have had a 'strong' economy due to record borrowing. As we all know, pay back time must come with all borrowing. This develops a new question, aside from the City of London - have we any new earnings to show for the last ten years?? Is the growth of the City enough to support the UK on its own? I'll leave these questions open.
Comment 2: May 06 07, 7:03amWaltz: House prices at six times average incomes.....
As I mentioned earlier house price inflation is one of the keys to the so called �success� of the UK economy. The problems in the UK economy will become visible when finally confidence/the bubble bursts. This bursting can come through many causes, including just a change of mood on housing. At this point this is where the economic outcome gets scary. As I have pointed out there has been a self perpetuating spiral, but without the usual bubble bursting mechanisms in place. Add in the final factor of immigration and what should have burst 3-4 years ago has managed to survive. The scary part is to ask the question which is; �At what point did housing overtake the normal growth in house prices�. If you take the measure of the trend for house prices as a ratio to income we start going back a several years � back to 2001 if I remember correctly. It is also worth mentioning that asset prices typically undershoot when a bubble bursts......
(note: this does not mean that prices will drop back to 2001 prices - inflation and salary increases are real drivers)
Comment 3:May 06 07, 8:33am
sandstorm:
Sandstorm: I am 100% in agreement with you over the idea of expanding the land that can be built on, though not in response to the current problems, which may turn out to be a short term problem. I'll leave my reasons to one side however, as they are not relevant to this debate.
I have to agree that the lunacy of the banks is astounding. In particular their insistence that the current interest rates make houses more 'affordable'.
A simple way to illustrate this is to jump back in time. This was when interest rates were quite high and inflation was quite high. Do you remember how it was then, for a couple who purchased their first home? At this time it was still 3 times income allowed as a multiple + deposit. Typically the couple would save up for a deposit, scrimp and save, and take on their first home. The first few years would be very tough, as the interest rate was high. They would struggle. However, every year they would find things became easier as the high inflation economy was eating away the value of their debt. After a few years life got easier. Their incomes would increase in line with inflation + real growth and life quickly got better.
Today on the other hand we have had(or rather had till the last few months) low inflation and low interest. Instead of the scenario above, we have a different form repayments. This point is best expressed in an imaginary world world where, like in the past, everyone is still allowed 3 times income multiples and still need a deposit . In this case what would happen is that the person who buys the new home would appear to be much better off than their counterpart in the past.Their initial payments, as a percentage of their income would be much less, as interest rates are relatively low. But...and here is the big but....they will not benefit from inflation eroding their debts. In light of this their total ***real*** repayments are going to be similar.
The point here is that is that the amount paid back in real terms is similar, but the timing of the payments have changed. In the earlier example you have greater pain at the start of the mortgage, in the second example the pain is spread out over a longer period.
(Note: inflation and interest rates do not move in perfect tandem, but over time there is a strong relationship - e.g. if inflation goes up now the Bank of England will **probably** increase interest rates)
Now you may have noticed that, to illustrate the point, I imagined a modern world where we were still on 3 times multiples of income + deposits. Now we all know that this is no longer the case. What does this mean? Well I suggest you return to my previous paragraphs it will be obvious.
The answer is, of course, that when the banks say that low interest rates make housing more affordable then they are not telling the truth. They have persuaded people (and perhaps themselves) that offering a 6 times multiple makes sense due to the low interest rates. However, in doing so they ignore the impact of inflation.
So - what we now have is people offering huge amounts of borrowing on the basis that housing is more 'affordable' due to low interest rates. People buy into this and overpay for their house as they can now 'afford' it. However, they struggle for the first few years and then they.....er....keep on struggling. This is because their proportion of their income they are paying towards housing has actually seen a real increase over the lifetime of the mortgage. In short it takes a long while before the proportion of income going to mortgages drops, whereas in the high inflation past on 3 times multiples this was relatively quick and painless.
Perhaps this has been one of the reasons for the sense of malaise in the UK? Perhaps this is why the loading up with consumer debt? These last comments are obviously just speculation but I've thrown them in anyway.
May 06 07, 9:46am
Suraci:
You are right that there are foreign investors in the UK market. However, they are in the market for gain and will, if they get the jitters, get out pretty fast.
With regards to housing benefit, yes, it does support some of the market but that is nothing new. I am not sure why this is different from the past, except that there is greater availability of properties for rent.
As for your 'elite banking families' - who are these people. Nearly all of the UK banks are PLCs. I can not say this is true or not true for the rest of the world but the UK banks are most active in the UK mortgage market with foreign banks at best playing a minor role, and UK those banks are mostly public companies or building societies.
I am also very interested to know what these non-existent banking families 'long term plans' might be. Reading this expression I feel you are talking about Ming the Merciless here - not about a bunch of rather boring bankers? Perhaps I have got it wrong and I will understand once you reveal what you believe these 'long term plans' might be? Maybe you just mean the plan to make money for their shareholders? However, I am not sure who these people with plans are in the context of the mortgage market.....
As to the banks giving away mortgages at a loss because they will all win in the long term..... I think that there is currently an element of desperation in the action of the banks in loosening the lending criteria. However, I think this is more about desperately trying to maintain impossible growth rates that have been promised to their shareholders. I am not sure it has anything to do with any conspiracy but more to do with the more mundane and far less interesting fact of incompetence. I think that another poster rightly pointed this out earlier.
willshome:
I read your post with interest. I have a few questions as follows:
How much social housing is enough?
How do you decide who is deserving of social housing? What fair criteria is there for giving people high quality housing subsidised by the rest of society? Or would you argue for poor quality housing?
Social housing is very expensive in terms of investment and maintenance, and subsidy. How would this be paid for? Would you use a PFI for raising the finance or borrow more directly or tax more and buy later? What other services would you cut in order to pay for the expansion in cost of social housing? How much additional expenditure would be enough to satisfy the costs as per your answer to the 'How much social housing is enough?' question?
I hope these are not too many questions and look forward to your answer.
sandywinder:
You are right that we can not blame the banks alone for the mess that we are in. However, they are playing their part as are consumers, 'buy to leters', the government and the media. It is not really about 'blame' but trying to figure out the how and what should those who are thinking about buying do.
WheatFromChaff:
Your description of what caused so many problems in the last crash is perfectly fair. I would not argue for a comparison with the past though, but rather predict the bust on the basis that classical economics always wins in the end - however many people on however many occasions tell everyone that it is different this time. I was wrong for 3-4 years (albeit ** possibly ** due not knowing about the levels of immigration). I could still be wrong and misguided to think that old fashioned economic theory will work in the end. The last time it was 'different this time' was the new economy, with a 'wall of money' chasing shares with not enough supply of shares to meet demand, and therefore a long term upwards revaluation of shares.....ooooops. Didn't quite work out though....And my comments on the Guardian in August.......
Comment1:
Aug 11 07, 5:39am
I'm not sure that there is a full and frank acknowledgement of how bad things are yet. This is not an incident, but the start of a serious collapse. The idea that central banks can halt it is absurd.
CDOs and the other derivatives that have oiled the wheels of the Anglo-Saxon economies are just the start. It is not just sub-prime that is the problem - it is far deeper.
Think of the UK as a single household. Two of the people in the house are working and earning money and they have a total combined income of £40,000 per year. However, they also live in London and own a semi-detached house. This is increasing in value by £15,000 a year - which is the same as the earnings of one of the people.
The £40,000 is enough to live a comfortable life, but the household wants better than comfortable. They want better cars, holidays and everything else money can buy. So they borrow £5000 a year using the increase in the value of their house as collateral. This is still not enough though, so they borrow on credit cards and bank loans. Another £5000 per year.
They spend all of this money on foreign holidays (moving money out of the UK), buy an expensive German car (moving money out of the UK), and the latest gadgets and gizmos (moving money out of the UK). They also spend money at bars, restaurants, on home improvements (employing builders etc.) and buy designer clothes.
Is this household richer or poorer? They have a rising asset that covers the cost of their debt so perhaps they are richer? On the other hand an asset may go down in value as well as up. Are they really richer?
According to the statistics the UK economy has shown a strong trend of GDP growth. The question to ask is where the growth has come from. Is it from asset prices? It seems to be.
The point is that, just as in the case of the household, the GDP growth measure includes debt growth as if it is income. As such, in the household analogy, they appear to be earning £50,000 per year - rather than the £40,000 that they actually earn from their work. The borrowing appears as income. In a similar way the GDP growth that the UK appears to generate is not based upon actual income, but is income plus borrowing.
The real problem arises when you try to liquidate an asset, and the asset value is not what was expected. The apparent increase in wealth is ephemeral. Instead of wealth, you have generated debt.
The reason why you should all be worrying is that the UK economic growth is built on asset price inflation and debt. This in turn has fuelled growth (?) in the economy which has also fuelled the growth in the service sector - all those smart new restaurants, shopping malls, bars, taxis, night clubs, as well as the plumbers, electricians, bricklayers, gardeners who work on your home. This increase in economic activity has also increased confidence, which in turn has increased asset prices and borrowing.
Then there is the immigration boom, itself built on a booming service sector and economy, and that in turn has put pressure on housing stocks - thereby pushing asset inflation higher, thereby fuelling more borrowing.......
Which will unwind first
- house prices? - Credit squeeze - Further stock market falls? - Household spending as jitters about the economy multiply pulling down spending? - the immigrants returning home with remittances in their hands (£5000 per year - when they take the money home it is the equivalent of importing a small car)?
Whatever unwinds first, it makes no difference - as each of the elements is related to the other elements - and each will unwind the other in time.
I'm sorry to spoil your Saturday, but the UK is entering the worst economic downturn since the Great Depression. I knew that it was coming, but the final when and how evaded me. It has now arrived, and it is only a question of how quick it bites.
Note: I hope that the above makes sense. I have tried to put some very complex ideas into a very short space. Sorry, if it is not so clear - or a bit simplistic.
Comment 2:Aug 11 07, 6:46am
Sorry - a correction to my own post. The £5000 is an estimate only for illustration. No one knows the actual levels of remittances.
Also, a question. How will Brown respond to the crisis? Can he give a Keynesian boost to the economy, and would he want to? I am not sure on either of these questions but, if he is capable of doing this, and does so....then the real pain may be delayed for a while.
Also - Perhaps an early election for Brown is more likely now? Get back in before the wheels fall off?
Comment 3
Keynes:
Point taken - but sadly this is just the start.......I think things will be far worse this time. As I said this is just the start, or the opening shots.
jeremyjames:
Yes - Brown IS the most irresponsible chancellor.
I came to the same conclusion about the Tories in power some time ago, and agree that, were they to win an election, they would destroy themselves. I have long held the view that the Tory party should not want to win the next election. The problems of today have been visible for a long time. The economy is a mess, however pretty it may have looked, and if the Tories win, they will take the 'rap' for the foolishness of Brown. Prudent - I think not. I do not know Brown but suspect that he will want power for the sake of power. As such he will call an election to win the election - not lose. I suspect that he actually believes in himself (though who knows what will happen in his head in the dark hours of night).
AndyV:
I think you have it. Can you imagine the person who says 'but this is crazy - who would want to lend to people who can not pay.....'. Can you imagine that his views would be welcome whilst everyone appears to be winning? With regards to the salary of these bankers - 100% in agreement (except for the fact that it may not just be the banks that hold the CDOs and CLOs. If you can sell a high risk loan on to another organisation - e.g hedge funds -, removing the risk from your own organisation, then that makes you a very smart snake oil salesman, and not so dumb).
alaska:
Why do you believe the EU is going to help? What can the EU do to rectify the situation. As for being at the mercy of the U.S. I am not even sure what this means. Basel II did not help (originated in Europe though not strictly an EU initiative), the ECB can not magic away the CDOs that have been purchased (such as those bought by IKB ). The regulatory system has failed everywhere. Why is the EU any better? As one poster has already mentioned, bail outs just create moral hazard encouraging greater risk taking and greater crises (Basel II has been criticised for a similar reason, a criticism that is starting to appear to be prescient).
I am puzzled? I am not sure what your point is. How exactly is the EU helpful here?
isabey:
Take a read of Adam Smith. You will find most of what was said by Smith holds up. His ideas have (largely) proved themselves over 100s of years.
caliode:
I have no idea where to put your money. This is a period of extreme risk and uncertainty. Debt collection agencies might be one place (not serious). However, a general rule is to think about what people will spend money on during tougher times. Taxis, restaurants, holidays etc. are discretionary spending and are the first to go when budgets tighten. Food shopping, and other 'essentials' will be more resilient. If Brown takes a Keynesian approach providers of services/products to the public sector are possibilities. However, all this is speculation.
chui:
The worst case scenario is that a trade war starts with China, and that China starts to sell the dollar reserves it holds. If this happens the US economy will really pay a price. You can thank your wonderful president for this gift to the US nation.
Aug 11 07, 12:09pm
alaska:
First of all excuse me for paraphrasing but....
Democracy is the worst system - except for all the rest Capitalism is the worst system - except for all the rest
It may be imperfect but the history has shown the results.
alisdaircameron:
I agree 100%. If we bail them out this time, what is to stop them taking the same risks in the future. As I mentioned earlier - moral hazard.
stevejones123:
You are both right and wrong. Yes, banks do need to make loans, but they also should only make loans with a reasonable expectation of profit on the loans. The problem which led to today's situation is that the issuer of the loan often does not hold the risk. The banks do not have to make so many loans to survive as you think. The trouble is that the capital adequacy ratio allows them to make loans far in excess of their deposits, provided that (under the Basel rules) their overall portfolio meets certain risk thresholds. They *choose* to leverage their deposits to higher levels to make greater profits. The derivatives that have caused the credit bubble have been rated wrongly for risk - which appears to be the result of the corruption of the rating agencies seeking greater profits (or maybe they really did not understand what they were rating).
misharialadwani:
What you are describing is quasi-mercantilism - not free markets. One of the great ironies of history is that Marx never managed to grasp that mercantilism and free markets are not the same. In a free market the banks would go under and the 'insurance' provided by states would evaporate. The banks would then need to take greater care - no bail outs - more risk averse.
Keynes: You say;
"The bankers" have got us all by the short and curlies. Your income after tax will go down a long way if Brown or the Fed don't "bail them out". In fact its the free-spending that has ensured what is left of the economy still survives.
But the government can only spend tax income or debt. They are not helping the economy to survive by pumping in more money, but storing up future debt. This is hardly the recipe for economic survival. Debt must be paid, and it is generally expensive. It is a short term expedient, with a political motivation.
With regards to tax going to the rich in landlord payments - what of council housing. Council houses were very prevalent during the Keynesian heyday. In this time tax went to the government - not the rich. What is tax anyway? Isn't is just government rent seeking - legalised extortion? If you don't pay - you pay big time. That aside, I'm not sure I fully understood your point here. I'd appreciate an explanation.
Just a quick note to let you know that a lot of UK debt is off the balance sheet. It is called PFI. It's a very effective way of hiding debt. I would find a link for you but, sorry, I am short of time now. (PFI = Private Finance Initiative)
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End of the posts. I hope that the point is clear.......
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