Hamish McRae: After the £50bn bail-out, how are we placed?

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The Independent Online

So what happens next? We have just had a £50bn bail-out for the banks under the Bank of England's "special liquidity scheme" to free-up the mortgage debt they cannot sell and so start to tackle the mortgage famine. We will have further interest rate cuts, though these may take some time to come through. But will these measures succeed in reviving the housing market? And, more broadly, how well placed is the UK to cope with a general global economic slowdown?

To be clear: this £50bn of help for the banks is not because the Government wanted to be their new best friend. It is because it was seriously worried about the mortgage famine that is already evidently getting much worse. Without it the banks would not go bust; they would merely have been unable to make new mortgages, or at least hardly any, because they are so full of existing ones. The scheme enables them to clear their books of some of these old mortgages which, in theory, should enable them to make more new ones. It unblocks the pipeline but that is all it does. The core of the problem – that there are not enough savings in the country to fund the demand for mortgages – remains.

So what will probably happen is that the flow of mortgages will improve a bit through the next few months but terms will be tight for the foreseeable future. We are talking at least a couple of years, maybe a decade, conceivably a generation. So there will be no early return to 125 per cent mortgages, 100 per cent ones will be hard to come by, and there will be an end to loans of six or more times salary.

That will have two effects – a direct one on the housing market and an indirect one on our spending patterns and hence on the economy as a whole. The housing market will be subdued for some time, maybe several years. The economists have come up with various forecasts about what will happen to house prices, ranging from broad stability to an average fall of 20 per cent over the next two years. The truth is we don't know.

What we do know is it would be much better for everyone – for individuals, for businesses, for the banks and especially for the economy as a whole – for there to be a gradual adjustment in prices rather than a crash. Inflation will gradually reduce the real price of a home, even if the money price stays the same. We also can be pretty sure that next housing boom is a long, long way off.

This subdued housing market will change how we run our finances. Last year, we took out £40bn in housing equity withdrawal: we borrowed an extra £40bn, yes, billion, against the security of our homes that we did not actually need to buy the homes themselves. That typically happens when people move house and borrow more to give themselves a cushion but some are straightforward second mortgages. Not all that money was spent, but quite a lot was. By the end of last year, that flow was coming down and it may disappear altogether. It did in the early 1990s. That will hit spending.

But spending is already being squeezed by inflation. If you look at what we have to spend money on, such as food, fuel and council tax, rather than what we choose to spend on, such as a new TV or clothes, inflation is far higher than the official figures show. So there is a double whammy. I think this squeeze from both sides explains why there has been such a strong protest against the abolition of the 10 per cent starting tax rate.

At any rate, the result will be a squeeze on spending. This will have a profound effect on the economy because consumption accounts for two-thirds of demand. How quickly this happens is not clear. There is very little sign in the jobs market of companies stopping hiring. At the moment, stores are maintaining sales by price-cutting: volume is all right but profits are not. So it seems the squeeze is really only just beginning and it will take several months to tighten. But tighten it will: my own concern is for next year more than this one.

So are there any rays of light to brighten this gloom? Well yes. One is that the present surge in the price of oil, commodities and food may peter out later this year. We should desperately hope they do, for they tend to hit the most vulnerable people and countries. Households in Britain spend a bit more than 10 per cent of their income buying food in the shops, but in India that figure is 60 per cent. Any shading down of food and energy prices would be hugely helpful in social as well as economic terms.

Another ray of light is lower interest rates. As a result of the problems of the money markets the full effect of the cut in rates by the Bank of England has yet to move through the system. The Bank can cut its rates by the actual money market rates that the banks have to pay may not fall in proportion. Eventually they will – and one of the aims of that £50bn was to nudge money market rates downwards – but meanwhile the Bank clearly has to do more to its own rates.

However, there are limits to the speed at which these can decline, for the last thing the Bank of England wants to do is to stoke up existing inflationary forces. Besides, we need more savers and those savers need to be rewarded.

The pound has recently fallen as far against the euro as it did when we were expelled from the ERM. That lower pound will also help exports, for which there is still strong global demand. As a result of all this, the economy is still growing. Whether or not it reaches the 2 per cent growth the Treasury expects this year, that is the rate at which it seems to be growing at the moment.

I would throw in a further cause of hope. We have an economy that has shown itself to be flexible, to be able to adapt to changing international circumstances. It will have to do that over the next few years.

Against this have to be set three concerns. One is that we have a large international financial sector and, while that has been successful and profitable, it is obviously vulnerable right now. There will be job losses in financial services – indeed, they have already begun. Next, we carry a huge burden of housing and consumer debt, larger proportionately to the economy than even the Americans. Finally, there is not much the Government can do about it because the fiscal deficit at about 3 per cent of GDP gives no room for tax cuts – in fact rather the reverse, as we can see right now.

So you have to see this £50bn as part of a continuing package of special measures to cope with a special situation: a gumming-up of the credit markets leading to a mortgage famine. It should prevent a difficult situation from getting worse but it does not solve the long-term problem, which is that we will all simply have to save more. But we must not switch from being spenders to savers too fast. Or as St Augustine is quoted as saying: "Give me chastity and continence, but not yet."

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