U.K.'s Subprime Crisis May Be Worse Than U.S.'s: Matthew Lynn
By Matthew Lynn
collection of estate agents signs Aug. 8 (Bloomberg) -- We are now all familiar with the damage that can be done to financial
markets by a subprime lending crisis. Global equity markets have taken a battering recently because of concerns about U.S.
So which country is next?
The U.K. has had a property bubble every bit as crazy as the U.S.'s.
Valuations were stretched, and lending criteria loosened. And now arrears are starting to rocket, even while the economy remains
Not only does the U.K. face its own subprime crisis, it could be far worse than in the U.S.
figures on debts and mortgage arrears in the U.K. certainly make grim reading. Households ``are getting into more trouble
when it comes to their mortgages,'' London-based consulting firm Capital Economics Ltd. said in a note to investors. ``With
higher interest rates yet to have their full effect, mortgage arrears are likely to rise further, while unsecured bad debt
might start to rise again too.''
The signs of trouble ahead can be seen in the number of homes now being repossessed
because their owners can't keep up the payments. According to the Council of Mortgage Lenders, lenders foreclosed on 14,000
properties in the first six months of the year, 30 percent more than in the year-earlier period. That reflected ``the impact
of an increasing amount of subprime lending within the overall market,'' the council said in a statement on the figures.
Arrears aren't in great shape either. An estimated 125,100 households are behind with their mortgage payments,
about 1 percent of the total, according to the council. Home owners behind with the payments will have their homes repossessed
a few months down the line, unless their finances improve.
The wider picture of indebtedness isn't much more comforting.
The British are deeper in the red than any other major economy. According to data from the National Institute of Economic
and Social Research in London, the ratio of household debt to personal income is 1.62 in the U.K., compared with 1.42 in the
U.S., 1.36 in Japan and 1.09 in Germany.
The U.K. is now facing a subprime crisis on a similar scale to the U.S. As
anyone who has taken out a mortgage in Britain will know, banks shovel out money without asking many questions. A review by
the U.K.'s Financial Services Authority last month criticized reckless lending in the subprime sector, which has, it said,
``resulted in the approval of potentially unaffordable mortgages.''
No Proof of Income
The British market
doesn't fall neatly into ``prime'' and ``subprime'' categories. Most of the mainstream lenders offer so- called self-certified
mortgages, which require no proof of income. Plenty of prime borrowers -- meaning people who haven't defaulted on a loan yet
-- are likely to take out mortgages that will be hard to make the payments on.
The U.K. subprime crisis may be a lot
nastier than the U.S one. Here's why.
First, despite the mounting evidence that people can't afford them, house prices
continue to soar. The National Housing Federation predicted this week that British house prices will rise 40 percent in the
next five years, taking the average value of a home to 302,400 pounds ($618,000) by 2012.
The average British home
already costs 11 times the average local salary, and that figure continues to increase. It is driven mainly by the U.K.'s
small geographic size, high levels of immigration, and very low levels of house building. People have to live somewhere --
a home, after all, isn't an optional item for most of us.
The net result is that even as payment problems mount, people
will carry on taking out bigger mortgages. What choice do they have?
Next, U.S. interest
rates may have reached their peak and could soon fall. In the U.K., that isn't the case. The Bank of England is likely to
raise borrowing costs at least once more to 6 percent. If the housing market and general inflation don't show any sign of
responding to that treatment, interest rates could go higher still. That won't help borrowers already hard-pressed to make
There should be two self-correcting mechanisms for fixing a subprime crisis in the housing market.
House prices should gently fall, making properties more affordable, and reducing the size of loans. And interest rates should
stabilize or fall, making the payments on those loans easier to maintain.
Neither seems to apply in the U.K.
interest rates are rising and so are house prices. The result is that thousands of families are left in a vulnerable position
-- and so are the banks that have lent them money (not to mention the investors who have bought those loans as they have been
Just Walk Away
While the property market rises, everyone will be safe. If your house is worth more
than your mortgage, you will be desperate to hold on to it. If you get into trouble, you can always sell it, repay the loan,
and move somewhere cheaper.
Yet, as the U.S. has discovered, if house prices start to fall, that arithmetic changes.
If you are in trouble with your mortgage, you can't pay it off by selling. There is little incentive to keep up the payments.
Why not just walk away, and hand the keys and the problems over to the mortgage company?
Britain hasn't reached that
point yet. But if it does, the mess could be even worse than in the U.S.
To contact the writer of this column: Matthew
Lynn in London at email@example.com .
Last Updated: August 7, 2007 19:17 EDT http://www.bloomberg.com/apps/news?pid=206...id=axWmsMHJDjiQ