Thursday, 24 March 2011

Debt Slavery

The other week in a blog - Economy Sinking Into The Mire - I mentioned about a friend of mine who had told me about someone he knew who had found a problem with obtaining a re-mortgage. The problem basically is with people who took out fixed rate or similar mortgages a few years ago, that are now coming to the end of their period and need to be replaced.
The problem he said was that, because house prices have fallen, the Banks and Building Societies will now only provide a mortgage for the lower valuation and, because the initial price of the house remains outstanding, people are having to find considerable sums to make up the difference.

In fact, he hadn't mentioned it, but it occurred to me today that the situation is actually worse than that. The situation he was describing was the result of falling house prices, which as yet have not fallen anywhere near as much as I and other economists think they are going to fall.
But, the effects of the Financial Meltdown, and the restrictions on lending, that the Banks and Building Societies now have to impose, increase that problem several fold. Suppose someone had a £100,000 mortgage accounting for 100% of the price of their house. If the price of the house has fallen 10%, then that is the maximum value on which the Bank would lend. However, the Banks are now only prepared to lend around 75% of the value of properties, so, in fact, they would only provide a mortgage of around £72,000 (75% of £90,000). That means that the mortgagee needs to find a lump sum of £28,000 to make up the difference to cover the repayment of the original mortgage.
Given that many people have been unable to save deposits for houses, its unlikely that people, who took out mortgages 3 or 5 years ago, with no requirement for a deposit, and on low rates of interest, will, during that time, have somehow managed to save such an amount. That leaves them with the problem of raising these additional sums or face being thrown out of their house. That will undoubtedly occur in some cases, with the consequence of pushing house prices down even further. Of course, those who took out not 100% mortgages, but 125% mortgages in the madness of the pre Crunch era, will find themselves in an even worse position, especially as interest rates are on the rise, just as real wages face the biggest squeeze for 90 years!

Others will be forced to find the additional funds by borrowing at much less favourable rates on their credit cards, or via bank loans and overdrafts to find the lump sums. But, under current conditions that looks like sticking your finger in just one of an increasing number of holes in the dyke.

In fact, as I pointed out in my blog UK Debt The Facts although the Liberal-Tories have hyped up the issue of Public Sector debt, the real problem is not Public but Private Sector debt, the debt that individuals hold in mortgages, credit card debt, student debt, overdrafts and so on. This private Debt is twice the amount of Public Sector debt. The importance of that can be seen by looking at what happened in Ireland, and what has happened in Portugal, and what is about to happen in Spain.
In Ireland, the Banks essentially went bust - despite the Eurozone Bank Stress Tests passing them as fit only weeks before - because they had lent recklessly to finance a housing bubble, and consumer credit that was tied to it. When the Banks went bust, the Irish State, rather than forcing the shareholders of the Banks - which include many British and European Banks and Pension Funds - to take a haircut i.e. to lose the money they had pumped in, decided to bail-out the banks using Taxpayers money i.e. taxes taken from the pockets of Irish workers. When even that was not sufficient to save the banks, and when the consequence of the Irish State indebting itself meant that its creditworthiness was called into question, it found itself facing impossible interest rates to borrow money for day to day activities.
Hence the EU/IMF bail-out. In Portugal, the Government did not run up a large deficit bys spending money. Its problem is that its economy is old and alcking in investment. As a result it is incapable of generating sufficient income to pay its way in the world. It actually needs to massively INCREASE its borrowing to finance the investment in new infrastructure and Capital that would renovate its economy, and enable it to pay its way. But, precisely because of the problem it has, it is considered a bad credit risk, and so its problems have been made worse, precisely because it cannot borrow money at affordable rates of interest.
The credit rating agencies were busy downgrading it again this week even before the prime Minister resigned, because the Parliament refused to back any further austerity measures. Of course, the whole point of the Eurozone as a single Monetary Zone, should be that all members of it are able to borrow money at the same rate of interest as the other side of giving up control of their currency and interest rates. But, the Northern Europeans will not agree to that at the moment, because it would mean them paying higher interest rates. Spain is in the same position as Ireland. Its Regional Banks the Cajas have lent out vast sums of money to finance the Spanish Property Bubble, and a consumer credit bubble that inflated on the back of it.
But, Spain's problems are compounded compared to Ireland's. In recent years Ireland has experienced some consierable economic growth on the back of some significant investment by mostly US, but not exclusively, companies in areas of ICT, and advanced Technology. The title of Celtic Tiger was not entirely unjustified. But, Spain's much larger economy was heavily dependent upon property, and the construction industry that grew on the back of it. It does have other industries, but the largest ones tend to be in the old areas of auto production, where low wage economies in Asia and latin America have a significant advantage. It has a significant agricultural sector, but again it is under pressure from new low cost producers around the globe, especially as the vagaries of the Euro make earnings from that sector uncertain.

The reality is that the Cajas are in a worse position, probably, than the Irish Banks. Spanish property prices are a fiction maintained by Estate Agents, Property owners, the Cajas, and the State, all of whom an interest in pretending that prices are higher than they really are or should be. If the properties on the Cajas books were realistically priced, then many of the Cajas would be bust. Yet, in a recent evaluation that no one in the financial community believed, least of all the Credit Rating Agencies, the Spanish Government proclaimed that only a minimal amount of recapitalisation of the Cajas was needed. It is like De Ja Vu all over again. It is the same ridiculous attempt to present a fiction right up until the last minute of collapse that was seen in Ireland. And when Spain goes in a few months time, the consequences will be much more important than the collapse in Greece, Portugal and Ireland put together.

But, the reality is that the massive build up in Britain of private debt, the fact that hosue prices are FOUR TIMES what they should be on an historical basis, and that collapses in house prices always go way beyond what is needed to just get back to the average, means that Britain is in at least as bad a position as Spain,
not because of Public Sector debt, but because of the private sector debt that has built up, and been encouraged by UK Governments going back to at least 1970, and the Barber Boom, and arguably back to the Tory Chancellor, Reggie Maudling in the early 60's.

Moreover, Public Sector debt is easy to deal with. The Government can pay it down whenever it wants simply by printing more £5, £10, and so on notes. That is what Governments have done going back to the time of Moses! Individuals cannot do that without facing a long gaol sentence. And at a time of squeezed incomes and rising inflation, their ability to cover the debt charges, especially as interest rates rise is highly doubtful.

1 comment:

Jacob Richter said...

Although I remember still being undecided on the matter, comrade Cockshott suggested debt jubilees.