Britain is about a year behind the United States in its property crash but seems to be doing its level best to narrow the gap, with prices falling at about 1.5 percent a month and mortgage availability collapsing.
Mortgage lender Bradford & Bingley (BB.L: Quote, Profile, Research, Stock Buzz), the nation’s ninth largest, was nationalized on Monday after it could no longer fund itself in an increasingly dysfunctional interbank credit market. B&B’s death will worsen mortgage conditions which are already pretty terrible. Net mortgage lending in August was only two percent of the level of a year before, and was the lowest since records began in 1993.
The announcement helped push the pound into its biggest one-day percentage fall against the dollar in over a decade on Monday. Whereas the United States has effectively nationalized its mortgage industry and is considering the further $700 billion bank bailout plan that is now struggling in Congress, Britain is still trying to fight fires as they flare up.
It probably has very little choice. Unlike the United States, which benefits from the dollar being the pre-eminent global reserve currency and is generally an 800-pound gorilla, though an increasingly battered one, Britain simply could not get away with borrowing and spending freely to try and stem its crisis. If Prime Minister Gordon Brown and his finance minister Alistair Darling tried to hatch a plan of proportionate size to the U.S. one, investors would sell the pound and shun British government debt, sending interest rates higher.
"Try to do a major bailout here and it would be a massive struggle," said Marc Ostwald, strategist at brokerage Monument Securities in London.
This doesn’t mean that Britain’s authorities won’t at some point feel they must intervene more forcefully — either by backstopping mortgage issuance or bailing out banks directly — but that they will pay a higher cost for doing so and get less return on money spent.
There have already been rumblings from financial institutions that Britain needs to do more, and former Bank of England official Willem Buiter has explicitly called for a British version of the Paulson plan to buy up toxic assets from banks.
PROPERTY CRASHES AND BANKING SYSTEMS
Really in some ways the remarkable thing isn’t that Britain would see its currency hit and interest rates rise if it takes on too much government debt, but that the same hasn’t happened to the United States.
That may well change, but if it doesn’t it means that the U.S. plan will help to limit the possibility of a very negative outcome.
The same can’t be said for Britain, which has a really unfortunate combination of characteristics; it is heavily dependent on property and finance and its consumers are very stretched.
First off, the size of the property bubble in Britain was if anything bigger than in the United States, with the highest ratio of prices to incomes in the developed world. British households are also more indebted than their U.S. counterparts and arguably save less. Excluding corporate pension contributions, net savings in Britain turned negative in 2006 and have headed further south ever since.
And, as is proven by the massive fall in mortgages, Britain was even more dependent on securitization to make up the shortfall in savings.
But a crucial difference is that Britain has no equivalent of the now nationalized Fannie Mae and Freddie Mac, which while they bear some responsibility for the bubble are at least now still able to lend. "With current levels of mortgage approvals consistent with a drop in house prices of at least 20 percent by early next year, even the most bearish housing market commentators may yet be surprised," Seema Shah, a property economist at Capital Economics in London, wrote in a note to clients.
The implication for banks is that they will see their loan losses climb and that their problem when the next round comes will not be funding but capital. That crisis may not arrive for some time, but remember too that capital raising has not proven easy for British banks or successful for their investors.
It is possible that Britain tries to head off the situation by extending and loosening the Special Liquidity Scheme, allowing banks to swap new loans with the Bank of England. But Bank of England Governor Mervyn King has thus far resisted. My best guess is that Britain will sit tight, hope measures in the United States provide some relief for them and deal with banks as they become critical.
They may at some point try and go large, but if they do Britain risks a financing crisis. The U.S. has gotten away with it so far, Britain may not be so lucky.