The Government says we’re fine. The experts disagree.
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No one is really sure whether Brown and Darling really believe, as they keep saying, that Britain is best placed of most western nations to weather the economic storms or if they are just saying it because they have to. Either way they are wrong, very wrong.
There are two vulnerabilities that point to a recession more severe than elsewhere. The first is the importance of financial services to the UK economy, not just in London but in other centres such as Edinburgh. The lack of trust that is manifest in the risk premiums required in the inter-bank market is bound to chill activity. As finance dries up, merger activity is stalling. Investors are paying down debt, not gearing up. Fear has taken over from greed, and jobs are going fast across the City.
In turn, the difficulty of interbank funding means mortgage packages are being withdrawn, particularly by smaller institutions. Far more cautious lending criteria (loan to value ratios and loan to income ratios) are being applied. The big lenders are less affected – there is a flight to safety in scale – but they will not pick up the baton from all the Northern Rocks that were growing so strongly. As a result, the housing market has turned. This will dominate consumer sentiment for years.
The housing market is like any other asset market: when prices rise, people think they will go on rising. When prices fall, they may hold out of the market until the decline is done. No one wants to buy when it may be even cheaper tomorrow, and particularly when prices are so much higher than historical relationships would suggest. The average house price to income ratio is more than 40% above its long-run average, and nearly double the last low.
Moreover, this inflation of asset prices has been built on an extraordinary accumulation of personal debt. The international comparisons are not favourable: in the UK, personal debt was 164% of disposable income at the end of 2006 compared with 138% in the US, and 104% in Germany. Ministers argue that debt levels are more sustainable because interest rates and inflation are low and employment is stable.
These points are less reassuring than they look. First, debt service – taking both interest and capital repayments – compared to income is nearly as high as it was in 1990. So low interest rates have merely allowed more gearing, leaving just as much vulnerability. Second, employment and even more unemployment are lagging indicators and may prove unstable faced with declining demand as consumer confidence slips. Unemployment rocketed from 6.9% of the labour force in 1990 to 10.5% by 1993.
The one important factor that may sustain activity is the decline in the pound, down by 12% overall in a little more than a year, which will boost manufacturing even though it will not prove much help to financial or other services. However, it means the North and Midlands may weather the storm better than London and the south-east, just as they did in 1990-1992. Moreover, the house price cum consumer confidence recession will hit middle-class southern voters hard.
In the past, it has proved sensible for governments to stop digging when the recession begins. They should take the hit on their own finances and balance sheet, because they are one of the few institutions capable of doing so. There is not, though, much point in trying to fine-tune activity with deliberate tax cuts or spending increases. The evidence is that they usually take effect after the event when they supercharge the recovery.
The one set of policy measures that might make sense are those that stop a freefall in the housing market. Instead of repossessions as borrowers fail to pay, which are then sold into a falling market and make it worse, lenders could take a broader view of equity sharing and payment holidays. With the regulators’ connivance, fire sales could be cut sharply. But with consumer confidence and asset price recessions, the best solution is always not to start from a boom. They end in tears.
