Pop goes the UK; first housing then the rest

Britain's house price bubble is bursting, popped by a credit famine and its own remarkable proportions says James Saft

As the United States has demonstrated, once a debt-supported bubble begins to deflate its momentum will damage both the economy and the health of an already fragile banking system.

Remarkably, Britain's recent housing falls have not been caused by double digit interest rates or unemployment, but by the same sudden drying-up of credit that brought down Northern Rock. The securitisation market for mortgages, which in 2006 provided 20-25 percent of all UK mortgage loans, has shut up shop leaving no forwarding address. That leaves Britons reliant on the money their peers save to fund their borrowing needs. With consumer debt levels considerably higher than in the United States, those savings just aren't enough.

"Most of the recent news has been concerning," said Ed Stansfield of consultancy Capital Economics in London. "It's looking as if the chances that we follow the United States in terms of scale of (house price) falls are rising all the time."

Mr Stansfield is predicting a five percent fall in house prices in 2008, followed by another eight percent next year. A Reuters poll conducted recently showed prices falling by 0.8 percent this year and two percent in 2009, according to the median of 30 analysts' forecasts.

However, between 1989 and 1993 UK house prices fell by 20 percent in nominal terms, according to Nationwide data. That was a time of high interest rates and rising unemployment, but not a time of global financial distress.

Looking at the situation now, three conclusions are relatively easy to draw.

First, Britain is likely to suffer a substantial housing decline, which easily could snowball and become steep - as in the United States.

Second, that housing decline poses huge risks to an overleveraged economy accustomed to easy debt and house price inflation - as in the United States.

Third, as prices fall and the economy struggles, a lot of UK mortgage debt will go bad, hitting banks and investors in Britain and abroad - as in the United States.

All three will magnify and feed one another.

Lenders compete to not lend
As the global credit crunch deepens, and as British banks grapple with a world where loans cannot be sold on, terms for borrowers are getting worse. A number of UK banks have raised the rates they offer on formerly popular mortgage products recently, effectively pricing themselves out of the market in an apparent effort to avoid building up more exposure.

Recently, Nationwide, which is the second largest lender in Britain, raised the rate on one of its main mortgages by about a half a percent. A unit of Halifax, the number one lender, increased its rates a similar amount.

Smaller rivals have followed suit, raising interest rates, tightening criteria and all but eliminating deals that allow a borrower to finance 100 percent or more of the purchase price. "A lot of the banks are actually getting more business than they can deal with," said Howard Archer of consultancy Global Insight. "The funding side is difficult, and things are looking more and more risky."

He said there was a danger that the psychology of house prices turns abruptly, and the rush to get on the ladder before prices rise we saw last year becomes a rush to get out or delay purchases. 

The truth is that most British homeowners couldn't afford their houses if they didn't already own them. Take a buyer on an average salary of about £23,000 buying an average house for about £174,000. Even if by some stroke of luck the buyer had managed to save 35,000 pounds for a deposit, finding a lender who would lend them six times their salary today is all but impossible. This is beginning to dawn on many, to judge by a recent survey of British consumer morale, which showed it had fallen to its lowest level in more than 15 years.

The UK has been heavily dependent on consumer spending that is housing related in one way or another; either due to investment in housing or based on spending predicated on house price gains past and future.

That is likely to reverse rapidly.

To be fair, there are differences between the United States and UK. Britain has more constraints on new housing supply and lending terms did not get as loose.

Then again, the United States began to fall apart all on its own, while Britain has had the global credit crunch to give it a shove downhill.

We will have to see how far it rolls.