Wednesday, 20 March 2013

Osborne's Big Budget Boo Boo

In today's Budget, George Osborne seems to have demonstrated the incompetence of the Liberal-Tory Government once again.  In a grandstand announcement, no doubt intended to grab the headlines and shore up their core support, he announced two policies designed to keep the huge bubble in house prices inflated.  The trouble is they are likely to do exactly the opposite.

In a two part proposal he announced that they would give more money so that anyone wanting to buy a new house would be enabled to do so, by being given a government backed guarantee for a shared equity loan.  The first thing to say is so much for their criticisms about unregulated bank lending causing the financial crash!  The second thing to say is that it depends on enough new housing been built.  The third thing to say is that by effectively subsidising new house prices, it will put further downward pressure on the prices of existing houses.

But, the second part of the proposal is where the real incompetence is demonstrated.  The Government has proposed to make available a government guarantee for all mortgages on any house up to £600,000.  Buyers would have to provide only 5% as a deposit, with the government providing a further 20% as a loan to be repaid when the house is sold - assuming of course it ever was!  In other words its a direct subsidy from the poor who cannot afford to buy a house, to the better off who can!  Its a similar kind of expropriation as that just proposed in Cyprus!

But, it gets worse.  This blatant bribe is not to be introduced until 2014.  Has anyone seen the obvious problem with this?  If you are a bank considering providing mortgages, why would you lend money out this year, when next year, £130 billion of mortgages were going to be backed by the Government???  Why would you make the risk now, when in a year's time the Government will be providing you directly with 20% of the house price?  But, also if you are thinking of buying a house at the moment, why would you?  Simply wait until 2014, and the Government will give you 20% of its cost!!!!

A policy designed to prop up a collapsing property market is likely instead to crater current demand, and send house prices much lower, because no one in their right mind would buy now, given the bribe they are being offered in a year's time!!!!

Of course, as with their arbitrary policy to guarantee the savings of 3,000 British troops in Cyprus, whilst not providing the same guarantee to the 60,000 British citizens who have retired to Cyprus, the decision to hand over up to £120,000 to anyone buying a house, is a thoroughly arbitrary measure, because it penalises those who choose not to, or cannot buy, but are forced into renting.  One of the basis elements of bourgeois democracy, and the Rule of Law, is that government decisions should not be arbitrary, but increasingly the decision of the Liberal-Tories, as with the decisions of right-wing politicians in the EU, is precisely that.  It is totally arbitrary, and will have the consequence of increasing uncertainty, and fear, thereby curtailing economic activity even further.

A similar arbitrary measure is the decision to give £1200 to people with children in childcare.  That is arbitrary, because there is no reason that people who choose to spend their money by having children and placing them in childcare should be subsidised by other workers who choose to spend their wages in other ways.  It is even more arbitrary, because the subsidy is not available to those workers who decide to stay at home and look after their children rather than putting them in childcare.

And, of course, what this subsidy for childcare will actually do, is to mean that childcare providers will be able to increase their profits, because they will now be able to increase their prices accordingly to absorb the subsidy!  Finally, what it also does is to provide a bigger subsidy to the better paid.  Because it is a tax allowance it is worth twice as much to someone paying the 40% tax rate than someone paying the 20% tax rate.

When governments start making these kinds of ill-thought out, arbitrary measures it is a sign that they are panicking and in trouble.  That was the nature of the decision to expropriate workers savings in Cyprus.  It runs throughout Osborne's Budget, as it has run through Government policy for some time now.  Markets themselves should be extremely worried about the mortgage guarantees in particular, because if it ever sees the light of day, it means that the government will be stepping in to assume £130 billion worth of debt that is almost certain to go bad.  It will be a repetition of the experience of Freddie Mac and Fannie May in the US, prior to the sub-prime crisis.  In fact, it is an almost direct repetition of the mistakes that were made then, which led to the sub-prime crisis.

Osborne is clearly out of his depth.  This must rank as one of the most incompetent and inept Governments on record.


George Carty said...

It certainly looks like the government is throwing everything including the kitchen sink at the task of keeping house prices high. Do you think they could delay the crash until after the 2015 election?

Boffy said...

Its impossible to know. As Keynes pointed out, markets can remain irrational for longer than most people can remain solvent! However, as I'm writing in a blog today, we've seen a 6% collapse in the price of gold over night, and an almost 12% fall in its price in 2 days.

Since it peaked in September 2011 at $1943, its lost $550 or nearly 30%. That is despite, the Bank of Japan announcing in the last week that it intends to double Japanese money supply, and despite continued QE in the US and UK. The money drugs are not working any more.

It confirms the thesis I have put forward that we have experienced a change of economic conjuncture. We have moved from Long Wave Spring to Summer. The vigorous growth of the Spring slows down - but I hasten to add that this is still a Long Wave Boom period, the kind of move is illustrated by China, which has moved from 10% annual growth to around 7-8% annual growth.

It means productivity growth slows, so unit costs rise. The volume of profit continues to grow, but the rate of profit begins to slow down. The consequence is the cost of capital rises, and so interest rates rise. Money moves from financial assets to productive assets - proportionately - Bond prices fall, and probably share prices fall as firms issue new shares to raise capital i.e. supply of shares rises relative to demand.

QE is no longer getting increased money into the economy, but in any case it is the shift in the demand and supply of capital that raises interest rates, increased money printing is either ineffective, or if it is effective it only changes relative prices not interest rates.

The slightest sniff of higher interest rates means house prices collapse along with all of the loans to zombie companies etc.

George Carty said...

How much is the lack of a major fall in UK property prices up to this point down to geography?

The United States and Ireland both have low population densities, and I suspect many of the houses whose values fell the most were inconveniently located in rural areas: only really suitable for retired people or for holiday homes, as there were no good jobs within a practical commuting distance. One of the most dramatic crashes in house prices at the moment concerns second homes in the French countryside.

Here in the densely populated UK, however only the Scottish and Welsh mountains are "rural" in the sense that an American or Frenchman would define the word, and almost no properties are built there anyway because of the inhospitable climate of such mountain areas.

Even in Spain, house prices have fallen far less in Madrid than in the coastal areas.

Boffy said...

I think very little. House pirces in Dublin, for example, have more than halved. France has not particularly suffered a house price boom or bust, because like Germany and other Northern European countries, a large proportion of people rent rather than buy their homes. But, Paris has just experienced a big fall in prices of expensive homes.

In the US, some of the biggest house price falls were in dense, urban areas. Indeed, it was in those poor, working-class areas, where the majority of sub-prime mortgages were issued. Places like Detroit and Baltimore have been decimated. But, as I've shown before, there have been 75% falls in prices of luxury homes in Kissimee in Florida, near to Disneyworld and so on.

In Spain, the biggest price falls are also in urban areas, where it is Spanish workers who are being foreclosed upon by cajas, and banks. In areas like Costa Blanca that I know very well, prices have fallen by around 30-50%, which is less than in other areas, because a lot of property is owned by Northern Europeans, as holiday homes etc. I know of some cases, where owners unable to sell have settled for just renting them out, because villa rentals are still bringing in good income.

Also, I think, the truth is that in Britain prices have fallen significantly, and they have done so in towns more than elsewhere. The figures for selling prices are significantly lower than what is quoted for Asking prices. I live in a rural village that is 3 miles from the City boundary. Its desirable because of the nature of the village, and because of its location providing access to the City and motorway. But, two houses here have now been up for sale for more than a year, they have gone through 3 different agents, and both have reduced their prices several times, now down by 20%. Other houses that have sold in the village since I've been here, went for 30% less than the original asking price.

In the City, modernised terraced houses are selling at auction for between 20 - 30,000, whereas 4 or 5 years ago, they were selling for £70,000.

The reason prices have not fallen more here compared to the US and Ireland, is simply that in the latter the crash came before massive money printing, and associated measures were introduced to stop it. In fact, in the US, if you look at the effects of the measures that have been introduced now, it is in places blowing up bubbles yet again.

I note that the Commons Treasury Committee has now itself warned of that danger in relation to Osborne's measures, and of what would happen to taxpayers money when a house price crash does occur. In Spain, a similar situation exists to that here. prices started to collapse, but they have been supported from the final collapse, by ECB money printing that has allowed Spanish banks to hold off on foreclosing.

But, Spanish banks are foreclosing on the worst loans, and every month, now you can find on the Internet, thousands of properties being sold off in bank sales with around 80% discounts. Some are closed sales to people like the bloke I was speaking to a couple of months ago. Property dealers and agents, buy them up at 80% discounts, and then list them at much higher prices. They only have to sell one out of five to recoup their money, and in the meantime it eases pressure on the prices of the other property on their books. But, they now have huge amounts of unsold property on their books, which is only sustainable so long as interest rates remain low. My guess is they will be hit in the same way as the BTL's here, as rates rise, which will cause an even bigger rush for the exit.

George Carty said...

On the issue of zombie companies, which sectors of the economy do you believe to be the most "zombified"? Retail is an obvious one (given the retail overcapacity which built up during the '00s, as well as the rise of e-commerce), but which other sectors are especially vulnerable?

Boffy said...

There are 150 retail companies - some of which are chains, so that is far more stores - that are essentially bust, according to a report I read a while ago.

According to 3R there are 160,000 zombie companies in Britain only able to pay the interest on their loans. That figure has risen 10%. It accounts for around 2 million workers, on my estimate.

By nature these are small companies who are dependent upon access to bank credit. Larger companies are able to tap finance directly from capital markets, for example by selling shares, or bonds. Large companies in the UK as in the US, have huge amounts of cash on their balance sheets in any case.

The kinds of small company that will be in this kind of position is going to be those that have longer turnover periods for their capital. For example, if you are a hairdresser, you will if you are at all solvent, have income coming in each day, that should cover your wages, plus other revenue expenses, like rent, electric, materials. Your fixed capital costs should also not be that great, covering things like dryers.

However, a small boat builder or repairer, like say some of the companies near here that repair canal boats, will be laying out money for wages and materials every day, paying rent etc., and may also have had to lay out significant amounts for fixed capital - winches, cranes, machines of various kinds, but they may have to wait weeks before they get any income from the work done to recover their expenses.

The hairdresser is less dependent on bank loans to cover any cash flow, because revenue covers costs, but the boat repairer continually has to lay out new capital, which they probably have to borrow.

Similarly, any company that has large amounts of fixed compared to circulating capital will be more dependent on borrowing, because they will need to have laid out capital to buy the fixed capital in one lump sum, but they will only recover its value over many years.

The other types of company that are likely to be zombies are those involved in low value, low profit areas. A group of science academics might set up a small biotech company for example, which might require comparatively little in the way of capital equipment. Their main costs may be their own wages. The latter might be covered by them continuing to work as University lecturers - I know of a number of University lecturers who run companies in the line of their expertise, who are able to remain in business even during slack times, because they continue to draw their lecturers salary - so they may be able to manage without loans, and although they might have long turnover periods, the high rate of profit in the business, enables them to build up sufficient working capital, to pay additional workers, and other revenue expenditure.

My guess would be that although some success stories have been reported, small companies that are dependent on exports might struggle. The depreciation of the pound has helped competitiveness, but continual exchange rate fluctuations make life difficult, and small companies usually cannot engage in currency hedging. Its one reason the UK should have joined the Euro.

Small firms in areas where state spending was high, and has been cut will and have suffered. They lose from state sector contracts being cut, and from state sector workers losing their jobs and income, so causing falling demand.

Any firm in low value production that can be produced in low wage economies will suffer.

George Carty said...

Wouldn't we in the UK have been as badly off as Spain if we'd joined the Euro (due to the inability to devalue)?

Boffy said...

I don't think Britain actually does benefit from devaluation in most cases. The reason inflation has been high is because Britain has to import a lot of food, materials, and now consumer goods. The prices of all these rise when the pound falls. In so far as they form necessary inputs, that effect makes British goods less competitive to export.

Britain is likely to continue to import them despite the higher price. It has to for raw materials, but for things like Chinese consumer goods, even after the devaluation, and despite rising Chinese labour costs, the imports remain cheaper than home grown manufactures, in many cases.

The things Britain exports are thinks like high value services, and these tend not to be dependent on price, so a devalued currency does not help, in fact if could hinder.

The main problem for businesses is the currency risk, and fluctuations. For example, when I first started looking for a house in Spain in earnest 5 years ago, the £ stood at €1.47. A couple of years ago it had fallen to more or less parity, a 30% devaluation. By the end of last year, it had risen to around €1.27, or a 27% revaluation. Then a couple of weeks ago, it had fallen back to around €1.10.

Its bad enough with such wide variations if you are just thinking of buying a house, but imagine running a business where from one month to another the price you get for what you sell and the price you have to pay for what you buy could rise or fall by 10 or 20%. That is why large companies hedge their currency risk in the futures market. But, its an additional cost that British firms face compared to their competitors in the Eurozone. So much for a single market providing a level playing field!

Moreover, I don't think that the solution for Spain or Greece is devaluation anyway. The real solution for them, is to be able to borrow at the same costs as Germany, and for the EU to act as a proper state, with a single fiscal policy that could provide the necessary investment, and counter-cyclical policies. That would be the case, more or less for a workers' Europe too, though its implementation would be different, and its goals would be different.

I think it could have been a solution for Cyprus. Had I been the Cypriot Government, I would have left the €, printed the needed Cypriot £'s to provide the liquidity for the banks, and kept attracting the Russian deposits.

Cyprus is a tiny enough economy to have done that in a way that say Greece was not. But, they have cut that option off now anyway.