UK Base rates cut (again) – another record

In sport, it’s common for records to fall at each Olympics.

In banking UK history, it appears that no-one is willing to wait four years to smash a record, but that the Bank of England want to set a new “lowest ever” on a monthly basis.

In a move that was, frankly, anticipated by just about everyone, the MPC again reduced the UK base rate, from 1.5% to 1.0%.

Customers on tracker mortgages will see the benefits, as will (according to the FT) customers of the standard rates of Nationwide, Halifax, Lloyds TSB, Woolwich and Skipton Building Society. This is, on the face of it, good news for borrowers… sort of…

Specifically, it’s good news for borrowers who have already got mortgages, but not altogether great for those looking for mortgages.

The problem is that, as a result of the rate cuts, over 14% of UK savings accounts are now paying 0.1% interest a year – that’s to say 10p interest for every hundred pounds in savings. Under these circumstances, people are saving less (despite the offset in savings growth caused by “I might lose my job” fear.)

When people save less, banks have less money to lend. It’s nothing like as simple as “one pound in savings means an extra pound to lend”, but there is a relationship – in that regulators only allow banks to lend a certain multiple of the cash they have.

However, banks are caught in a double-whammy: One the one hand, people are saving less (because they can only get tiny interest on their savings)… but on the other hand the regulators are requiring banks to hold MORE cash per million of lending than they were a couple of years ago… so even if savings returned, the money available to lend wouldn’t come back to the same level.

So, harder to get a mortgage – in that you probably need a much bigger deposit. Truth be told, finance was much too easy to come by in the past – some made a killing by borrowing to buy in a booming market and got out in time before the crash… others, however, borrowed too much because the banks were falling over themselves to lend money… and then got stuck with property encumbered with massive mortgages in a falling market. Those who concentrated on positive cash-flow over the last few years (as I’ve been banging on about since 2004) seem to be OK, but those who bought anything in the belief that “properties go up in value” or with the intention to “flip” them have been left holding the bag when the music stops.

My own position is that I’m waiting, but not yet buying again. I see the potential for bargains getting better each month, as credit (slowly, very slowly) improves, prices continue to fall, but rents (round here, at least) are holding up.

Property Crashes compared to Stock-Market Crashes – long term

This week’s Economist has an interesting article based on research done by Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard. (The original paper, The Aftermath of Financial Crises is available to download – click on the title in this blog.)

The paper investigates “severe financial crises”, including “headline names” like the US (1929), Argentina (2001), Hong Kong (1997) and Japan (1997), as well as more minor crises.

Some interesting statistics, though:

• In major financial crises, House Price falls have averaged 36% from peak to trough, and the slump has lasted 5.0 years on average
• In major financial crises, Share Price falls have averaged 56% from peak to trough, and the slump has lasted 3.4 years on average

So, we can see that house prices do fall less than shares, but that house price slumps can last a very, very long time.

Of course, a lot hinges on whether we really are in a “severe financial crisis” – if we are, then we could see another 3-4 years of property price falls in the UK. But if we aren’t, well things might turn around. That having been said, the most hopeful forecasts I’m seeing from serious ecomists talking about how things might reach the bottom by the end of 2009, rather than carry on falling.

Buying rental property? Not me, not this quarter.

The failure of capitalism vs. the failure of communism

I heard a phone-in on the radio this week, in which the punter was basically saying that Capitalism had failed in the same way that Communism failed.

I was, to put it mildly, shocked by this claim.

In the current “failure of capitalism”, in the last twelve months, approximately 1 in 1,000 home-owners has defaulted on their mortgage, and in some cases had their homes repossed. In the vast majority of cases, the former home-owner has either found private rental accomodation, or been housed by the social sector.

In the “failure of communism” in the 1970s and 1980s, communist governments provided living conditions so poor that they had to erect machine gun towers and minefields to stop people fleeing.

Moving into a rented house vs. risking your life being machine-gunned in a minefield. Fair comparison????

The Dr. Who Theory of Recessions

Depending on your age, you may believe that Dr. Who is either a trendy young man, who appeared on our screens a couple of years ago… or you may believe that he wears a long flamboyant scarf. (I’m firmly in the latter camp, by the way.)

What you may have missed is that the only person who can say we’re entering a recession in the UK is the good Doctor, because doing so requires the ability to time travel.

This is because, here in the UK, we have a precise definition of what a recession is, and it’s different to the definition they use in the USA. Over in the States, there’s a body called the National Bureau of Economic Research, and part of their job is to say when the US economy enters a recession. They use a broad range of factors, and basically announce what they’ve decided.

Here, however, a recession has a specific meaning – it’s two consecutive quarters of “negative growth” (which sounds like a politician’s way of saying “shrinkage” to me).

Now, back in October, it was announced that Q3-2008 was negative… no surprises to anyone who’d actually lived in the UK during the months of July, August and September.

The question now is whether anyone even vaguely believes that Q4 will turn out positive? I’ve not found anyone making such predictions, by the way.

So, here’s the way the logic works.

In late January, the Office of National Statistics will formally announce the Q4 figures. At that point, it will be announced that we are in a recession…

… but this is where the Doctor comes in. What will actually be announced is that we’ve been in a recession since July.

OK, maybe you don’t have to be a Time Lord to have worked that out by now, but it is one of those odd little quirks of UK life that we won’t “officially know” for another month or so. This is why investors spend so much time trying to work out “forward looking” measures, rather than only looking at out-of-date statistics.

For the record, the first time I used the r-word was on the 22nd January 2008, but that was talking about the US economy, not the UK… but still a good YEAR before the UK Civil Service

Inflation bad, deflation bad, high interest rates bad, 0% interest rates bad

It’s hard to know what to make of the global economy, and the UK economy in particular, at the moment.

A few months ago, all the papers were worrying about inflation, how the cost of everything apart from DVD players was going through the roof, and how this spelt poverty for millions of Britons. We in the property world were worried about high effective interest rates, and mortgages being hard to get.

Suddenly, the headlines are things like “Mervyn predicts inflation-free zone” and “Bank rates head for zero per cent“.

Now, you might have thought that if inflation was bad, then deflation would be good… and that if high rates were bad, then low rates would be good… but the truth is more complex than that.

Inflation tends to be frowned upon because it hits those who have assets… the money they currently have will be worth less this time next year. The obvious people are, say, pensioners with savings, who have seen that their savings didn’t go as far as they’d hoped. Less obviously, though, are investors – if you are investing in a country with an high inflation rate, then you need outstanding returns to make it worthwhile, and an awful lot of investors think globally (even in property – look at the invvestments in Spain or the US.)

Deflation though, is more subtle. What deflation tends to do is stop people buying. We all know that you should never buy a laptop before Christmas, but wait for the sales… or actually, that you will always get a better deal on such technology items if you wait… but what happens when everything goes down in price? Generally, people come to expect further price decreases, and buy less and less. The experience of Japan over the last ten years has shown us that this leads to companies going down the tubes since no-one will buy their products (they’d rather wait), and therefore jobs are lost.

Likewise, high interest rates tend to put the brakes onto house price rises… though in fact, “brakes” is the wrong metaphor, because if I put the breaks on in my car, it slows down… but doesn’t actually go into reverse.

Low interest rates are, likewise, more pernicious. The problem that Central Banks have is that it tends to be rate CHANGES that have an impact, not the absolute level of rates… so once a rate is at 5%, or 2%, or 0%, the market adjusts to the new level in response. The problem is that, if a rate’s at 5% you can tweak it up or down… if a rate’s already at 0%, you can’t reduce it any further.

So zero interest rates, while good for house buyers who time things right (though actual mortgage rates never go to zero), tend to be bad for economies, because one of the key possible actions that a central bank can use to get things going again is no longer possible.

The ideal for most people seems to be the combination of about 4-5% interest rates, with about 1-2% inflation. We know how to operate in those areas… anything outside tends to be uncharted waters, and the danger is that while some will make a lot of money while gambling right, others will get wiped out – the uncertainty increases the risk.

Bank Rates Cut, but don’t expect the savings to be passed on

Yesterday, the Bank of England cut its base rate by 1.5%… taking it down from 4.5% to 3%. Today, the newspapers are full of stories about “greedy bankers” not passing on the rate cuts.

This makes good headlines, after all, we all understand that banks have a lot of money yes?

Well, no actually. The problem isn’t the rates – the problem is the fact that most banks DON’T have a lot of money – at least, they have a lot LESS money than people want to borrow.

The way that interest rates tend to work is as a sort of bidding mechanism. Suppose that we have three people:

• Dave wants to borrow £100, and will pay 8% interest
• Sharon wants to borrow £100, and will pay 7% interest
• Steve wants to borrow £100, and will pay 6.5% interest

You have £100, that you’d like to lend out. Who will you lend it to?

Well, all other things being equal, I’m guessing that you’ll lend to Dave at 8%. OK, it’s more complex, because you’ll probably take into account Dave’s “track record” and other assets, but let’s assume that you know them all equally well, and take the view that each of them is as likely to pay you back as the other.

Now, the Bank of England cuts its rates by a third. Let’s re-run the question:

• Dave wants to borrow £100, and will pay 8% interest
• Sharon wants to borrow £100, and will pay 7% interest
• Steve wants to borrow £100, and will pay 6.5% interest

You have £100, that you’d like to lend out. Who will you lend it to?

If you answered “Dave at 8%”, then you’re a greedy, bloated capitalist. After all, you SHOULD, according to newspaper logic, now be lending at 6.5%. Obviously, you now have a choice of people to lend to – and it really doesn’t matter which one you lend to, because you should be willing to accept the lower return?

Huh? How’s that meant to work then? Surely the idea is that you lend to the person who has the best mix of “rate (s)he’ll pay” and “likelihood of paying back”, depending on how risky you’re feeling, and what other loans you’ve got out there at the moment. You don’t just slash your rates.

The mechanism that ACTUALLY causes rates to be cut is COMPETITION. If you are only lending at 8%, and I come in, with £200, willing to lend at 7%, then you will either get no business at all (and therefore 0%), or you’ll have to drop to 7% to get someone’s business, and you and I will fight it out to make Dave and Sharon both think that we’re a good lender. Obviously, Steve still doesn’t get his loan… unless one of us decides that 6% is better than nothing, and drops the rates again.

The basic problem is twofold:

• There’s still far more of an appetite for loans that there is cash in the lenders’ pockets
• The Government are insisting that banks INCREASE the amount of cash they keep “in reserve” and DON’T lend out, so that they can avoid another Northern Rock.

Very few banks actually borrow from the Bank of England. It’s the Lender of last resort. Kick-starting the mortgage process again isn’t about reducing a “published” rate – it’s about making cash available, and the only real way to do THAT causes inflation, and headlines about the price of bread and fuel increasing. At the moment, inflation still looks a scarey risk.

My “out on a limb prediction”? Give it another year, and the Government will decide that enough is enough, and the pain of inflation is less bad than the paid of more business failures and redundancies – until then, expect headlines about greedy bankers but not real solutions.

Is the credit crunch affecting the “real economy”

One of the things I learnt from Nassim Taleb is to not particularly bother about keeping up to date with every piece of noise that goes on in the media, but wait until conversations are filtered. Taleb reccomends parties as a good solution – once subjects are being talked about there, they have probably become mainstream enough to affect markets.

Well, at a party last week (OK, technically a committee meeting for the trustees of a local charity) the subject turned to the credit crunch. One of my friends – Penny – is a stock market pro, and expressed the view that, actually, the credit crunch is really only affecting those who work in the finance industry, and while the media are heavily reporting it, it isn’t really affecting those “in the real world.”

So, I’ve done an incredibly unrigorous straw poll of my friends.

• Susan, early 40s, recently divorced mother bringing up young child and hoping to go back to University next year. Now renting, paid for by Local Housing Allowance. Next to no practical impact.
• Mike, late 30s, runs an IT consultancy. Working with leisure company on the planning of a multi-million pound IT project. Real danger that the project will be shelved for 2 years since the company’s owner was considering a bond issue to pay for it (to improve cashflow), and that issue no longer looks viable. Impact on Mike personally – about £70k over the next year.
• Simone and Nigel, late 40s, landlords. Had to refinance their portfolio putting BACK about £80k worth of equity this year. Fortunately, they have cash reserves that meant they could afford to do that easily, but the days of refinancing to take money OUT aren’t currently with us.
• Umesh, early 30s, network manager for a high-street name large company. Recently had to take “grade reduction” and pay cut, along with the rest of the department he works in, as part of the company’s cost-reduction excercise. The job market is currently sufficiently poor that he accepted it rather than leave.
• Liz, late 30s, office manager. Was made redundant by a publishing company late last year because of cash-flow problems related to sales of non-fiction books.
• Chris, early 50s, property developer / financier. Currently owed about £100k by a joint venture partner after a deal went south. The JV partner – an established industry pro – has, on paper, several million pound worth of equity, but nothing like £100k in cash at the moment

[Some names have been changed to protect identities.]

Now, I concede that not all of these are directly related to the credit crunch – Liz and Umesh might be better pinned on overall cost-savings maybe caused by an economic downturn – and the nearer you get to the property or finance industries, the more you’re affected… but Mike in particular commented that he’d never been affected by a client’s ability to raise capital before this year!

Want to buy bank shares (If you’re a taxpayer, you just did)

It would appear as if Governments around the world have finally realised that the current financial crisis isn’t just about saving bankers’ bonuses, and that normal businesses and their employees are being affected.

So, we have the UK’s biggest (to date) bank bailout, with the Government putting up to £400,000,000,000 (four hundred billion) of money up.

Basically, in various ways, the Government is becoming a big investor in the stock markets and the money markets as follows:

• Up to £250 billion in loan guarantees. (Basically, a form of insurance policy, where a bank making a loan can pay a premium to the UK Government in exchange for the Government bailing out the loan if the organisation / person who borrowed the money defaults.) Potentially a nice little money-earner… but potentially a way to lose a lot of our cash.
• An increase of £100 billion in the Special Liquidity Scheme. This is a scheme in which we (as taxpayers) lend money to banks, but the banks put up their assets (mortgages) as security, so if the banks default on the loan to the Government, the Government can take over the mortgages.
• A straightforward loan of £25 billion to eight banks.
• An investment of £25 billion in bank “preference” shares.

The preference shares are interesting – they get a guaranteed rate of interest, and get that payout before ordinary shareholders would. However, in order to participate, banks need to make new promises on executive pay and normal dividends (which are likely to be cut.)

The executive pay one is interesting – the normal argument against this is that banks need to attract the “best” managers, and if they are only allowed to pay “only £500,000″, then “the best” will turn down the jobs and go and work overseas. I’m cynical about this – “the best” are, in many cases, the same people who steered the banks into this mess, and it’s not at all clear that economies where the top 1% earn 100 times what the bottom 10% do fare better than those where the ultra-rich / poor gap is a lot closer (say, Germany!)

Overall, there are some fine details to criticise in the plan, but overall it strikes me as a lot better than doing nothing.

However, it’s a gamble – if the economy recovers, then actually, the loans and investments the Government has made could pay off well for us. However, if the economy tanks anyway, then the bailout money could be throwing good after bad. The hope is that, in making this offer, the chances of avoiding a serious recession are much improved. It may well be that, even if this money is lost, it’s still better than the alternative of millions of more people out of work for several years.

Obviously, as a property investor, I’ve got a lot of self-interest riding on this – on the one hand, I want lending rates to come down, and it to be easy to borrow mortgages again… On the other hand, I’d like property prices to come down another 20-25%.

So, a cautious thumbs up, and fingers crossed on this.

My slides on the credit crunch – now online

Last weekend, I gave a presention on the credit crunch at an investors’ event organised by Angela Bryant and Claire Wray in Ipswich.

The slides are now available, either for viewing online or download here.
, or (if you are viewing this directly on my site you may be able to see them below.)

Lloyds get to buy HBOS, HBOS shareholders get something, and first time buyers get a ray of hope

Lloyds TSB buying HBOS – well, that news is already nearly 12 hours old…

The deal is worth about £12bn, but HBOS shareholders (including me) are getting 0.83 Lloyds TSB shares for each HBOS share they had. At today’s prices, this is worth about 232p per HBOS share.

Those who bought HBOS at the lowest price of 88p yesterday must be laughing (though a lot will hinge on what Lloyds TSB shares end up being worth when the deal goes through.)
On the flip side, those who bought shares at 275p earlier in the year when HBOS offered existing shareholders a rights issue must be kicking themselves. (I didn’t buy anything at that time, not least because the day I looked, the rights were “under water” – that’s to say, shares were already trading at less than 275p, so I could have bought them cheaper on the open market than through the “special offer”).

But the oddest piece of news today is that the deal was brokered by Gordon Brown at a drinks party on Monday, and that part of the promise is that Lloyds TSB have given the government a pledge that they will keep on lending to first time buyers. In return, the new company will have about 28% of the mortgage market, and the government will waive its right to call in the Competition Commission to investigate (which would normally happen if any company were about to get more than 25% of the market as a result of a merger.)

The saddest new is the politicians who want to turn this into a political issue, and are using soundbites like “Spivs” and “Short-selling” as if the problems in the credit markets were caused by short sellers. The bulk of opinion from economists who aren’t trying to win soundbite games is that MORE short-selling last year might have stopped the bubble that led to the crunch from getting so big, but that point seems to be being lost in the race to find someone to blame. Looks like the legacy of blaming “The Gnomes of Zurich” is still with us.