Outlook: What a mess as pain deepens for Equitable policyholders

France Telecom; Housing blues

Every time you look, the situation at Equitable Life seems to have just got a great deal worse. Lots of life companies have been raising the penalty for early encashment – the so called market value adjuster – in response to falling stock markets but few of them have raised the punishment to as much as a fifth of your money. Anyone with a decent wodge in Equitable is essentially locked in. We all know the reason. Equitable is within a whisker of technical insolvency, and it cannot afford for more members to leave at the old rate. Never mind the veritable army of them who were sensible enough to cut their losses and get out while the adjuster was still set at 10 per cent. Even at 20 per cent there is a danger that members would be leaving with more than their fair share.

Look at the numbers and you can see what's happened. Only 15 per cent, or £3.6bn, of Equitable's £24bn under management is held in equities. Since Equitable last increased the exit penalty, the stock market has fallen 10 per cent, wiping £360m off the value of those equities. When the company last filed a solvency return it had reserves of only £565m in excess of the legal minimum, and that was after taking account of £500m of forward profits. The stock market would only need to fall 5 or 6 per cent, and Equitable would breach the solvency limit.

The rules are designed to prevent this from happening, by requiring the life company either to recapitalise or to dump equities before this position is reached. With no outside shareholders, Equitable cannot raise more capital, so quietly it will have been liquidating the rest of its equity portfolio to safeguard its capital against further falls in the market. It's a terrible position for a life company to be in, because it means there will be virtually no upside left in the fund when stock markets eventually recover.

Last week, the Financial Services Authority loosened some of the solvency rules in an attempt to ease the plight of distressed life companies, but it won't have done Equitable any good. Equitable ticked us off for being irresponsible when we advised policy-holders to take their money and run when the penalty was only 10 per cent. It obviously wasn't such irresponsible advice after all.

France Telecom

The French Government was quick formally to deny reports yesterday that it might be prepared to renationalise France Telecom in response to the beleaguered telecom giant's now desperate financial straits. True enough, everyone's faith in the sanity of free market economics has been shaken to the core by the spectacle of the telecoms boom to bust. No government could surely have been as stupid as the capital markets were in backing Michel Bon's debt fuelled bid for global domination. Then again, even dirigiste France has learned that state control has got its drawbacks, and even if it could afford to compensate France Telecom's army of small private investors as well as take its mountain of debt back onto its own balance sheet, it would surely hesitate before doing so.

None the less, there's rarely smoke without fire and the reported mutterings of various French Government officials to the effect that maybe France Telecom will be taken back into state ownership almost certainly mean something: if nothing else, the French Government, which still has a majority shareholding in FT, wants it to be known that it is fed up with the way the markets keep trouncing the company and interfering with its ability to refinance itself.

Somehow or other, it is going to give all those Anglo Saxon speculators and hedge fund operators a good beating in return. But how? Even if Mr Bon, the FT chairman, or his political masters in the Government, were prepared to contemplate a rescue rights issue, it probably wouldn't be possible in these markets. To raise anything worthwhile would in any case require an unacceptably high level of dilution.

But there are lots of other things the French Government could do which stop short of complete renationalisation. One would be to guarantee a France Telecom bond issue. This might be regarded by Brussels as unfair state aid, but since when has the French Government cared a damn about what Brussels has to say, and in any case, there is the precedent of the British Government's guarantee of the bond issue used to finance the high speed rail link to point to, not to mention the implicit guarantee of Network Rail borrowings. The French Government may not be about to renationalise France Telecom, but something is afoot. The perceived interests of La France are not about to be defeated by the will of the markets.

Housing blues

Perhaps because it is such an illiquid form of investment, the British housing market doesn't seem to obey the normal rules of supply and demand. These would dictate that with prices continuing to rocket at nearly 20 per cent a year, more houses would get built and more would get sold until eventually supply comes back into balance with demand. Not so. In fact fewer houses are being built today than at any time since the 1920s. The builders blame planning restrictions, but they are by no means the whole problem. In fact, house builders may gain more by restricting supply than by satisfying demand, because of the big fat profits that derive from ever rising prices for an asset built at a barely inflating cost. The fast appreciating nature of the market also means that fewer existing houses are being put up for sale, so that those that are become hotter properties still.

Add to that cocktail the lowest interest rates in a generation, which has hugely decreased the cost of borrowing to buy a house, a seemingly endless supply of money to finance such borrowing, and the absence of any high return investment alternatives, and it is hardly surprising that prices are still soaring. So when will it come to an end? It's as plain as a pike staff that the housing boom is a bubble fed by cheap, easy money waiting to burst, but as with all bubbles, it's impossible to predict when. In the very long term the demographics would seem to point to sharply deflating prices, as the current generation of baby boomers dumps property to finance retirement and then dies out altogether. But that's a long way off, and there is easily time for at least another bubble or two after this one before that happens.

What will bring this one to an end is tougher times economically and higher interest rates. The collapse of confidence in corporate America, and indeed business confidence more generally, makes the first of these things look all too possible. As a result, the Monetary Policy Committee, which meets this week to vote on interest rates, won't want to raise rates until it is sure there will be no damage to the rest of the economy, which needs an interest rate rise like a hole. In any case, a quarter point on interest rates, or even a half point, would do little to damp down such a roaring bonfire as the British housing market. That requires much firmer action. Eventually, more general inflationary pressures will return and interest rates will indeed rise steeply. For many, the result is going to be painful in the extreme.

jeremy.warner@independent.co.uk