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Sep 23, 2007

DISPATCHES

Britons get a nasty but timely reality cheque

By Mark Rice-Oxley, FOR THE SUNDAY TIMES

KINGSTON, ENGLAND - HARRY Wilson has lived long enough to know a financial crisis when he sees one.

He was born into the era of global depression in the 1920s. He remembers the rampant inflation of the post-war years and the 1970s.

But even he has never seen anything quite like the panic on the streets that gripped Britain over the past week.

'Money's a funny old thing,' he confides outside the besieged local branch of the Northern Rock bank in this town in southern England.

'It's the first time in my memory I've seen an actual run on a bank.'

For me, it wasn't the first time. Nine years ago, I huddled with angry crowds massed outside my local bank and listened to those at the front pounding on the barricaded doors.

But that was Moscow in 1998, a developing economy in freefall and a nascent retail bank in the throes of collapse.

On that occasion the solution was simple: I flew to London, a city with a proper, mature banking sector, and started pulling money out of ATM machines as fast as they would allow.

Alas, for customers of Northern Rock, it wasn't so simple.

Some queued for two days to get their money. Many were senior citizens who had been enticed by specialised products targeted at the over-50s.

In all, there was £24 billion (S$72.4 billion) of savings at stake.

Mr Wilson refused to stand for days to get his hands on his money. The Brits, he remarked drily, may be good at queuing, but at 79 he was too old.

So there he was sitting on a bench outside the bank, pondering what to do.

Ironically, he noted that the Northern Rock branch in Kingston is right next to a bookmaker.

Some people might be wondering if they would have been better off taking their money there instead, he said.

Ultimately, Northern Rock was saved. After dithering for three days, the authorities finally stepped in with the controversial offer of promising to underwrite all deposits. The queues evaporated, the panic blew over.

'We've decided to leave our money there on the basis of the government's guarantee,' said Mr Reg Harding, who admitted to mild panic last weekend over the fate of his £50,000 savings. He is in his 50s and works in travel insurance.

'We would have lost £5,000 if it had gone under,' chipped in his wife, Nora, who is in her 50s and retired. Bank deposits are protected by a guarantee system so the Hardings would not have lost their entire savings.

'It just goes to show how badly this country is being run. We haven't played the stock market, we haven't done anything risky, just put our money in a bank,' she added.

There's nothing like a financial crisis to remind you that reward comes only with risk.

Banks may declare they are safe as houses, but on this occasion, the houses were financed by subprime mortgages in the United States - mortgages given to people with poor credit history who can ill afford to buy homes.

The bad debt crisis fanning out from the US subprime mortgage meltdown has made banks extremely reluctant to lend to each other, as no one knew who was exposed to what losses.

Northern Rock relies heavily on such interbank lending to fund short-term commitments, so when the money markets dried up, it was deprived of its lifeblood.

The supreme irony is that in a nation of big spenders, where private debts now total £1.3 trillion, it was savers who almost got caught out.

But the Northern Rock troubles hint at a deeper insecurity that is nagging away at Britain. The same conditions of low interest rates that led to the US subprime crisis have encouraged British housing prices to soar well beyond traditional ratios of affordability.

To get a roof over his head, a Briton must now pay 10 times the average wage of around £20,000. Thousands have been able to do so only by borrowing deeply. And five interest rate rises in the last year have suddenly done nasty things to the monthly repayment schedule.

One family close to my own may be fairly typical.

They needed a larger house for a growing family. They bought a three-bedroom suburban home at a stretch, but didn't fix the mortgage rate. Five interest rate hikes later, their repayments have almost doubled.

They have barely decorated the place and are now wondering if they can afford to remain there.

'A couple more rate rises and we'll really be feeling it,' said the mother.

Of course, mortgage pain does not become a full-blown property crisis unless people start losing their jobs as well, as they did in the early 1990s.

Repossessions are increasing, but from a very low base.

Experts are predicting that the housing market will flatline, with activity slowing to a crawl over the next year. But no collapse just yet.

'There will be foreclosures on a large scale,' predicts Mr Willem Buiter, a former member of the Bank of England's rate-setting monetary policy committee.

'There is a lot of unsecured debt, credit card debt, some of which has already gone belly up. There will be pain both in households and in businesses exposed to them, but it should be manageable without a major slump.'

Instead, many people have decided that rather than buy a bigger house they can't afford, they'll upgrade the one they have.

My neighbourhood is like a giant construction site. Loft conversions are popping out all over; conservatories litter the landscape; scaffolding hugs the facades of Victorian semis; dinner party guests burble about the planning regulations that govern house extensions. Reliable builders are hard to come by, despite the recent influx of Polish craftsmen.

As for the high street, the queues of anxious savers may have dispersed, but don't expect them to get back to the energetic shopping that has fuelled the British boom.

Economists believe that the powerful images of panic on the streets might just persuade the masses to tighten their belts and balance the books in the coming weeks. In short, shopping may be an easier experience, with fewer crowds to muscle through.

'Although you probably have less money to spend,' quips Mr Buiter.

Credit crunch

Economists believe that the powerful images of panic on the streets might just persuade the masses to tighten their belts and balance the books in the coming weeks.