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You’ve never had it so tough

It is widely assumed that the UK mortgage crisis is part of a worldwide situation but the reality is that the problem has been brewing up in the UK for five years or longer and is much more deep rooted. The Treasury and the Government have known about it and have failed to act.

About five years ago, a senior Treasury civil servant expressed his concerns to me about soaring house prices. His concern was that the boom was adding to inflationary risks by raising the money supply and causing excess liquidity in the economy as people were borrowing excessively against the rising value of property, which was adding house price inflation to excess demand in the economy.

The blame, in his opinion, fell on the banks which were not lending responsibly. He admitted that because so much of the excess lending was coming from foreign banks, the Government was powerless to act to curb their activities. He said that what he really wanted to happen was that where banks lent on excessively generous terms relative to proven incomes and on high loan to values, the excess would be deemed to be non-recourse lending.

He was right about the irresponsible lending and how it has damaged the economy.

The house price boom has been part of a complex combination of features which are probably unique to the UK. It would not have happened if interest rates in the UK had not been so much higher than in other countries for so long, making secure lending in the UK very attractive.

High interest rates made it very profitable to lend money on housing compared with elsewhere in the world. Sterling was flying dangerously high for the health of the UK economy. The world monetary system was awash with liquidity, derived from the trade surpluses of Germany, China, Japan and other Far Eastern countries as well as Russia and oilproducing countries. Much of that money found its way into the UK through swap arrangements.

The UK was the only country where you could buy real assets such as utility companies, manufacturing companies, airports, and so on, and share prices were ridiculously low in international terms.

These companies were underpriced and sold off to foreigners far too cheaply, thanks to the fact that they were bought with cheap debt, where the interest was tax-allowable.

Thin market capitalisation made financing a company purchase using debt, rather than shares, a very low-cost option in the UK. Of course, corporation tax receipts are permanently reduced on account of that.

The recycling of trade surpluses of countries with big balance of trade surpluses, lending money at high interest rates (compared with the UK) and also using the money to buy British assets and finance house purchases in an inflationary property market, has driven up the pound to a probable 20 per cent overvaluation compared with, say, 10 years ago in international trade valuation terms, even allowing for a recent 15 per cent fall against the euro.

It is hardly surprising that we have almost no manufacturing left, as an overvalued pound has almost wiped out manufacturing by making imports so cheap that we could not compete.

The balance of payments deficit at about 6 per cent of GDP – the worst in the world – has been balanced by the equivalent sale of UK assets abroad, maintaining our excessive living standards by mass sale of assets.

A very significant statistic is to be found in the National Income Blue Book. This shows that between 2005 and 2007, net income from abroad declined from 2 per cent of GDP to -0.4 per cent of GDP. This shows beyond all doubt that the UK has been on a reckless spending spree, over-borrowing and selling off assets to maintain an unsustainable standard of living.

Using foreign money to finance house inflation, where that money was recycled from sale of UK assets to foreign owners, has financed the apparent boom and economic growth but it has been a gigantic illusion. The hangover will take at least a decade to correct and the loss of invested assets will aggravate the problem of financing retirement to an unprecedented degree.

In 11 years, Gordon Brown has presided over a collapse in retirement funding, a loss of UK profit-producing assets, a collapse in the balance of payments and indebtedness abroad and internally, with a Government spending/income gap at around 4 per cent.

We are living beyond our means to a desperate degree and a recent discussion paper published by the National Institute of Economic and Social Research demonstrates just how far this is the case compared with France and Spain. The 42-page report should be compulsory reading for all politicians, including Brown and Chancellor Alistair Darling.

Lord Adair Turner’s report on retirement, published about three years ago, understated the pension problem for the UK.

The problems of retirement funding, house prices, inflation, a falling pound, excess borrowing, the credit crunch, inadequate investment, poor labour productivity in manufacturing, huge hidden unemployment and the loss of nearly all UK manufacturing are all small parts of a bigger picture of severe problems for the future because we are less structurally competitive than our major competitors.

This disaster will have to unravel. As the feelgood factor created by rising house prices and easy credit comes to an end, the hangover will be painful.

The UK has to start paying its way in the world, exporting goods and services to pay for those that we have imported. We will have a permanent burden of dividends and interest to be paid abroad on the assets which we have sold, including all the companies which were once UK-owned.

As so much money for mortgages has come from foreign banks, interest on those loans will be a burden on our economy for probably a generation to come.

Brown’s economic agenda has given the UK the biggest phoney boom, built on asset price inflation and debt, beyond anyone’s worst imagination. It will mean poor economic growth from now on.

There will be an inevitable decline in living standards and inflation as the pound falls on account of falling demand, raising the cost of imports.

The long-term effect will be to make the UK decidedly unattractive to live in unless you are seriously wealthy and deriving income from foreign sources.

Pensioners will have a hard struggle unless they are fortunate enough to be members of Brown’s army of public sector workers. For the rest, working on later in life will be inevitable.

A recent report from Peter Askins, former head of pension fund trustees and administration at the Department for Work and Pensions, says people will have to work part-time at least until they are 70. He refers to pension personal accounts as a confidence trick at worst and ludicrous at best.

Pensions were sacrificed in Brown’s first Budget when dividend relief was wiped out, making equity holdings by pension funds less attractive.

Equally, replacing Peps with Isas, with no dividend tax relief for basic-rate taxpayers, has made holding equities less attractive but rendered UK shares very cheap, which is another reason why the UK has been bought up by foreign interests.

We can see the reason for lowering the 22 per cent tax band to 20 per cent and abolishing the 10 per cent rate. Brown wanted to cut the tax relief on pension contributions to save around £2bn a year.

His dislike of equities and dividends is clear, as pension funds and Isas pay no tax on bond/gilt income and deposits compared with 20 per cent tax on dividends.

The other reason why Brown has declared war on pensions is that he wants people to spend, as the drug of spending results in euphoria, creates a form of employment and increases tax revenue. This gives an illusion of economic growth, which in reality is made up of employment in worthless jobs creating no new wealth.

Classic examples are the London congestion charge and the army of jobsworths in anything to promote a politically correct initiative or further bureaucracy.

Having lost almost all our manufacturing industry, new jobs in services will not earn enough in foreign exchange to pay for the inflated imports bill.

Coming back to where we started, suppose that banks had been warned that they would not be able to recover debts on houses beyond, say, 80 per cent loan to value.

Suppose that if banks had lent money to householders in excess of, say, 3.5 times their proven incomes, that excess would not be recoverable if the borrower could not service the loan.

Suppose that no debt other than a mortgage could ever be recoverable against a family home, so that credit card balances, other bank loans and hire purchase agreements could not be recoverable in this way.

Suppose that car leasing arrangements had to start with a significant deposit of, say, 25 per cent of the cost of the vehicle.

These measures would have deterred banks from reckless lending. Why was it not possible to have a maximum permissible interest rate on any loan of, say, 10 per cent over bank rate? That would have deterred banks from lending to borrowers who were poor risks and where proper affordability checks had not been performed.

The Treasury knew the problems were building up but I suggest that politicians and financial institutions had a common interest to ride the gravy train while it lasted.

It has now come to an end and the price will have to be paid in increased saving and investment, less consumption, fewer unnecessary imports and a rundown in debt levels. This will cause unemployment and pain in retailing and other luxury services.

We have to balance our payments sooner or later, now that we have little or nothing else to sell and have lost the investment assets which gave us investment income. A lower exchange rate for sterling will raise inflation but make imports less competitive and exports more so.

Inflation helps to wipe out debt, so we should not be obsessively concerned about it. It is a symptom of the problems described above, not the cause. It is inevitable and, in the UK’s case, desirable as a corrective economic factor. Hopefully, the Bank of England understands that.

That is the way I see the economy. Life will be tough for many years ahead. After the binge comes the hangover.

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