Friday, 7 December 2012

The Zombies Are Coming! - Part 4

Zombie Properties

One consequence of the money printing and financial deregulation of the 1980's was that property prices ballooned up at a massive rate. They collapsed by 40% in 1990, but with yet more money printing, they had recovered by 1996, and from 1997, they began soaring once again. The Financial Meltdown in 2008, brought house prices in the US and Ireland down by between 60% and 75%, depending on the area. (In comparing these percentage increases and decreases its important to remember that a 75% fall is much more in absolute terms than a 75% rise. For example, if something increases by around 70% a year, then after 4 years, it will approximately have quadrupled. However, a single 75% fall from that level will take it back to where it began!) In the UK, prices fell by around 20%, but with interest rates being slashed, and forbearance by banks, that was quickly reversed. But, as the effects of rock bottom interest rates wore off, and as the Liberal-Tories drove the economy into recession after 2010, house prices outside London – where the effects of very rich foreigners buying property distorts an already grotesquely distorted market – once again began to fall.

According to the House Price Indices produced by the Mortgage providers, which are a complete fiction, the average price of a house today is only marginally higher than it was after the Financial Meltdown. But, the asking prices that they quote are meaningless. What is relevant is selling prices, and these are significantly lower. When I sold my house in 2009, ready to move to Spain, it sold in just over a month, and for a price 10% higher than it had been in 2008. Looking at the situation today, all of the houses around me have been up for sale for around a year. Two houses, six months ago, had £50,000, more than 10%, knocked off their price, and there are several luxury, houses in the area that have been reduced from around £1.5 million, down to £800,000. Yet, they still cannot find a buyer.

This six bedroom house in Florida was recently
for sale for £70,000.  In 2008, it was $400,000!  There
are many such houses available, which is why the
US market has stabilised at these more reasonable prices.
In the US and Ireland, because house prices have fallen to more reasonable levels by historic standards, the market has stabilised. Demand has returned for now affordable houses, and in the US, that has begun to also stimulate new building. Sooner or later, house prices in the UK, and in Spain, will have to similarly correct by around 70-80%, before the market stabilises. That may not happen overnight, and some of it may be achieved as a result of inflation – though its hard to see where the necessary wage inflation will come from at the moment – but it must happen, as sure as what goes up, must come down. It will only take some of those zombie companies to start going bust, and that will create the necessary spark to start a surge in mortgage defaults as happened in 1990. Forbearance by the zombie banks can only go on for so long. Sooner or later, they will begin foreclosing. Then it will be seen that the forbearance has actually been in the interests of the banks not of house buyers.

According to Money Marketing the forbearance may have put a lot of borrowers in a worse position than had they been foreclosed upon. They cited one of the FSA's risk assessors,

..lenders may have left ‘hundreds of thousands’ of borrowers in a worse position by providing forbearance when they have experienced money problems”.

George Osborne has bailed out his friends the
Money Capitalists with billions of pounds in
various schemes, as well as via the
 Bank of England's massive Money Printing.
That is because, like the zombie companies, they are likely in future to have no possibility of repaying the capital sum they borrowed. In effect, the interest they have paid, has been no different than paying rent, with the house itself returning to the ownership of the bank or building society eventually anyway. The Liberal-Tory Government, just as they present the Welfarist subsidies to inefficient, low paying capitalists, such as Housing Benefit, Child Benefit, Tax Credits and so on, as though they were subsidies to workers, so they present subsidies to the banks and building companies, as though they were subsidies to home buyers.

The Government, as well as bailing out the banks with billions of pounds of money printing to enable them to deal with their liquidity problems, and begin rebuilding their Balance Sheets, has introduced various other bail-out schemes. For example, they introduced the Funding for Lending Scheme, which they said was designed to help house buyers, by providing banks with guaranteed cheap money where they provided mortgages for buyers of new homes. But, in fact, very little of this was taken up, because, although interest rates are at unsustainably low levels, buyers cannot raise the necessary level of deposits. Besides which, most people outside London, recognise that house prices continue to fall, so why would you borrow to buy a house today, that will be thousands of pounds cheaper tomorrow?

What Funding For Lending has done, is to allow banks to provide safe loans to those people who can put up a 40% deposit for a mortgage. That benefits the bank, because it gets a subsidy on a loan, it would probably have made anyway, and to a lender who is unlikely to default, and who if they did has a house that would fully compensate the lender. In addition, because this scheme is designed to provide a subsidy on mortgages for new built properties, it represents a subsidy to the house builder as compared to the private seller of an existing house.

At the same time other new regulations demonstrate how the screw will be tightened on mortgage borrowers. The Mortgage Market Review has put the onus on lenders to ensure that borrowers can afford their interest only loans. That means that interest only mortgages are being withdrawn. With many people on mortgage deals that have to be reviewed every few years, this means that many people with such loans are finding that they are being told they have to move to a repayment mortgage. That can mean borrowers facing anything up to a 25% increase in their monthly payments even without any change in interest rates. As with the Funding For Lending Scheme, many lenders will only now provide interest only mortgages where the borrower puts up a 40-50% deposit on the house. With the price of houses having fallen by around 20% since many of these original loans were made, the actual amount the bank is prepared to advance is also reduced, leaving the borrower with the problem of making up the 20% differences in capital value from their own resources!

Mortgage borrowers barely able to meet their monthly
payments at today's unsustainably low levels are unlikely
to be able to pay, when they are moved to repayment mortgages
or when interest rates rise, or to have savings to cover capital
shortfalls.  Rather, the data shows large numbers of people
unable to make ends meet to the end of the month, and an unsustainably
large number of people having to resort to borrowing from the
Pay Day Loan Usurers, and worse.
Given that many of these borrowers were barely able to make their monthly payments, even with the unsustainably low interest rates, they are unlikely to have built up sufficient savings to cover this capital gap, and so will be forced to sell their house, and move to something cheaper, or into rented accommodation. So far, the full effects of that have not been felt, because of forbearance by banks. A while ago, Paul Diggle of Capital Economics tried to assess the effects of this forbearance. He concludes that had banks been less forgiving, then the proportion of home loans currently in arrears of three months or more would probably be around 5-6%. That’s “in line with the peak reached in the 1990s”. The Bank of England estimates that 11.8% of borrowers have benefited from some form of forbearance.

The forbearance by the banks is not unusual. On the contrary, it is typical of what happens during a banking and property crash. It goes through a series of stages. First the banks are bust. They pretend they are not. That's why before they shut the doors, the bank manager always comes out to emphasise that the bank is solid. If they can, they try to carry this pretence forward, by not trying to call in loans they know are essentially going to not get paid, at least not in full. So, they engage in forbearance with those borrowers. The same thing can be seen with the lending to Greece. Rather than forcing the borrower to default, you extend the length of the loan. Banks, for example, have taken the arrears on mortgages, and simply added it to the outstanding capital sum of the mortgage! That means the real arrears do not even show up as arrears. This stage is called “pretend and extend”.

During this time, of course, if the Bank is not receiving the payments on these loans, this can result either in a crisis of liquidity or of solvency. If the bank really believes that it will get paid eventually by the borrowers, then this is a crisis of liquidity. It simply needs working capital – cash – to enable it to keep trading until such time as the payments from borrowers are restored. However, if in reality the borrower is never likely to pay all or any of the loan, or the interest, and if the underlying asset – here a house – has fallen in value below the loan value, then the bank has a crisis of solvency. In other words it is bust. It has lent out money, that it owes to savers, or to the Capital Markets, which it is not going to get back. In short, it cannot pay back the people who have lent it money. The reality is that pretty much every bank has been insolvent, because they borrowed money on Capital Markets, which they lent out for a range of purchases of assets, whose prices have been inflated over the last thirty years, but whose real value is only a fraction of their current nominal level.

Because, all of this lending was channelled through the mushrooming of various Financial Derivatives, and because the banks themselves padded out their balance sheets by also buying, and trading in these Financial Derivatives, pretty much every bank in the world has liabilities that exceed the true value of the underlying assets on their balance sheets.

That is what was exposed in the sub-prime crisis. As stated previously, the US and Ireland have largely dealt with that. Property prices collapsed, and so the prices of those assets on the banks' balance sheets had to be written down accordingly. That meant, in order to comply with international bank regulations, they had to raise large amounts of additional capital, which was provided by the State. In the UK and Europe, that has not happened.

Mario Draghi at the ECB, like Mervyn King at the
Bank of England has provided European Banks with
lots of cheap money with no questions asked about whether
they will be able to pay it back.  They are
the Central Bank equivalents of Wonga, except Wonga charges
usurious rates of interest to cover not being repaid, whereas
the Central Bankers don't even bother to do that.
Instead, a crisis of insolvency of the banks, has been treated as a crisis of liquidity. In other words, although the banks are unlikely to get back large chunks of the money they have lent to home buyers, and small businesses, they have been allowed to continue as though they will – just as the fiction has been maintained that Greece will at some point pay back its lenders – and, they have been provided with more and more cheap money by the Central Bank in order to keep trading. That only puts off the question of dealing with the insolvency. What has been different with this banking crisis is the extent to which the banks were insolvent after 2008. That is why the bail-outs have had to be so large, and why the process of pretend and extend has been more protracted.

At the same time, the banks begin to deal with the underlying insolvency, by tightening down on their new lending. They still can't call in all of the dodgy loans, because to do so would put too much stress on their balance sheet. That is why, despite all the Government incitement to do so, and all the incentives to encourage them, the banks have refused to issue new loans to anyone other than the most credit worthy, and have started raising loan rates, as well as removing some of the more risky types of loans, such as the interest-only loans, many of the fixed rate loans and so on.

As the banks repair their balance sheet, they get to a position, where they can begin to call in the dodgy loans, begin to foreclose on people in arrears etc. Of course, events can force the banks hand. In 1990, unemployment rose, and interest rates also rose. As people began to default, and property prices fall, the banks were forced to begin foreclosing anyway, because otherwise, they faced being unable to recover the loans, and unable to recoup its value from the sale of the property it had been lent against. The ensuing fire sale simply forces prices down even further. This is one reason that when prices have spent any time above the long term average, they always fall sharply to be equally below that average. So, in 1990, house prices were 20% above their long term averages, but fell 40%, to be 20% below it. According to the IMF, and OECD, UK house prices are today 40% above their long term average.

In Spain, the banks are going through this process now. House prices have fallen by around 50%, but are still hugely overpriced. Recent analysis suggests they need to fall a further 50% to get down to a realistic level. The State is trying to recapitalise and restructure the banks from above. It is merging the small regional banks – the cajas – and trying to get larger banks to take them over. Even some of the larger banks, like Bankia, have been nationalised, and recapitalised by the State. Spain has reached a deal with the ECB to provide financing for its banks up to around €100 billion – though its currently only asking for €39 billion – but, on a more realistic assessment of how much will be required given the likely level of defaults, and true value of Spanish property, the amount ultimately needed is more likely to be around €400 billion.

As, the banks balance sheets are provided with this support, and because the Depression in Spain's economy, makes it necessary to take action quickly, the Spanish banks have stepped up their foreclosures and repossessions. Under pressure from workers, they have pulled back from evicting those with nowhere else to live. But, in Spain, there are lots of houses that are second homes, villas owned by foreigners etc., as well as villas built by builders that have never been occupied. There are around 1.5 million empty homes. The banks have begun to sell these at very low prices. My wife saw a very nice villa a few days ago in northern Costa Blanca, being sold in a bank sale for just €20,000, about £16,000.

That is bound to have a cascading effect on reducing house prices in general, particularly, as now we have a housing market that effectively stretches across Europe! In other words, we have a Zombie housing market, whose outer appearance is fictional asking prices, but whose hollowed out insides are thoroughly decayed. Like every such body it is extremely fragile and brittle. It is being sustained by the kind of State support and protectionism described previously.

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