Simple Pound

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I was just watching one episode of Channel 4’s documentary “Dispatches” that examines the root causes of the subprime crisis and the financial meltdown that followed.

Close to the message the documentary was supposed to bring across, it was called “How the banks bet your money” and I somehow knew there were going to be a number of things I would disagree with.

In one way or another, the documentary blames banks, credit rating agencies, regulators, governments and banks again for what has been an enduring theme across the public press for the last 6 months. The banks are blamed for creating the product that made the crisis possible and for becoming a victim of their own greed for higher and higher margins and the profits that were hoped to follow. The credit rating agencies are criticised for rating these financial products with one of their best ratings available in the market (S&P’s AAA-rating) and hence creating the fallacy that those products were inherently low-risk while at the same time understanding little of how they operated and apparently receiving payments from banks for these individual ratings. Gordon Brown is reproached with decoupling the financial regulation from governmental interference and thus having created a tripod of financial supervision. The FSA is accused of not acting in a way it was expected to when Northern Rock became a problem. And the list goes on…

Overall, I’m not disagreeing with many of the rational arguments that are being made in this documentary. I am, however, disagreeing with how it is presented and what misconceptions it will cause with people who don’t have a thorough understanding of how financial markets really operate (i.e. the majority of the population).

The suggestion that the invention of collateralised-debt-obligations (CDOs) was purely evil and driven exclusively by the bank’s greed is an immense exaggeration that fails to own up to the positive effects that financial innovation brings. The banks merely created the vehicle that was subsequently abused - and I’m not disputing that greed led to this abuse. Without financial innovation we wouldn’t be as developed a nation as we are. We wouldn’t have access to all the financial products we take for granted if it wasn’t for banks’ natural strive to create newer, better and ultimately more profitable products.

Credit cards are the best example - they’re not inherently evil. It’s just people’s misjudgement of their own abilities that can turn them into a harmful invention. Technically speaking, credit cards provide you with a 50-day interest free loan every month. It is not their fault that you think your cash supply is limitless.

Similarly, nobody forced people to take out mortgages they couldn’t afford. Of course the bank will try to sell you something they’ll eventually make a profit of. That doesn’t mean you’re supposed to blindly trust everything your banker is telling you. If you don’t feel you fully understand what you’re signing, then just don’t sign it.

The important side effect that people seem to ignore is that it also gave those people that didn’t have a long credit history the opportunity to own property while a few years back no bank would have even bothered to see that they might be eligible for a mortgage. It gave people who understood their limitations (!) the opportunity to buy their own place despite never having owned a credit card or never having taken out a loan. It’s not a flaw of the product that made people take out mortgages that were far to expensive for them in the first place. It’s also not the product’s fault that people wanted to own properties that were way out of their realistic budget.

If you expect that your bank will lecture you about what you can and cannot afford, then you’ve missed the fundamental principle of capitalism. At the end of the day, a bank is a company like any other that can only exist if it returns a profit at the end of the year. After all, Walkers doesn’t tell you to stop eating their crisps because they’re bad for you either. Don’t expect banks to operate as a super-human institution that would rather see it’s customers be happy than return a profit.

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It has been all over the news since August this year - credit squeeze here, liquidity crisis there. So we certainly can’t claim that we haven’t had enough press and media coverage on the topic, but - if someone walked up to you and asked you to explain the credit crisis to them, would you be able to?

To come to your (and most likely my own) rescue, I luckily discovered a really good video on the FT website that explains this rather complex economic phenomenon in fairly simple, easy to follow animations. It’s definitely a must read/watch if you want to understand how the world’s largest and most stable economies were forced to their knees.

Check it out here. Don’t disregard the suggested further reading either as it will provide you with a deeper understanding of the dependencies between the different players in the market, their role in the crisis and the wider macro-economic impact the current situation is likely to have.

If any questions remain unanswered, you’re welcome to post them in the comments and I will do my best to shed some more light!

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The FT reports that within the last two months a whopping total of 125 credit card related charges have increased. You could argue that this is clearly a symptom of the credit crunch as financial institutions scrape for liquidity, i.e. good old plain cash.

The trouble is that competition in the credit cards market is strong with hundreds of providers and cards to choose from. This means that increasing the annual percentage rates (the APR you see quoted) is dangerous and would potentially drive away many (existing) customers as well as decrease the number of new issuances. Hence the plan to increase liquidity would result in exactly the opposite - as less customers translate into lower revenues, profits and thus less of the much desired cash.

Look at these statistics:

• 69 cards have seen an increase in the charges for cash withdrawals
• 18 cards are now more expensive to use abroad
• 10 cards have increased balance transfer fees

Banks belonging to the first category include for instance Halifax, Bank of Scotland and Smile, so beware of the fine print before signing a new application with them. This obviously applies for any new credit card application you make as these increased charges might be hidden in lengthy terms and conditions and will thus not be immediately obvious.

Let us know whether you have encountered any other cards other than the ones issued by the banks named above. It would be fantastic to have a detailed list of cards affected by these rate rises.

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I’ve been eagerly watching the house price inflation and several house price indices for the past months. I strongly belive that the market is currently immensely overvalued and will have to face a correction at some point in the near future. How soon this will happen is not necessarily clear and for the sake of stability I’m hoping that we won’t see an actual crash but a slow downturn.

According to some sources we would have to see a 50% fall in house prices over the next few years to restore the long term average. This figure even exceeds the 30% decrease in property value the UK experienced in the early nineties and hence seems a little too pessimistic. On the other hand, countries like Japan have shown how easily a bubble like this can burst - after years of recession house prices are still below their 1990 average! If the same scenario was to happen to the UK the average house would cost £70,000 instead of £180,000 (£340,000 in London).

According to the latest figures released by the Landregistry we are certainly seeing a slow-down in growth - which is hopefully a start for more reasonable and hence affordable property prices. With an increase of only 0.1% in July it is not entirely unreasonable to assume that we’ve reached a price plateau. In fact, London is probably the number one factor why we are still experiencing a positive house price inflation. While the countrywide annual inflation currently stands at 8.8%, London tops the list with a 15.5% inflation since July 2006.

This inevitably leads to first-time buyers struggling to get onto the property ladder and choosing to rent instead. According to the Royal Institution of Chartered Surveyors (RICS) first-time sales are tumbling at their fastest rate in more than three years. Countrywide the number of sales transactions has decreased by almost 10% in the last year only, but at the same time the price tags of the sales exceeded the £2,000,000 mark much more often. Sales of less than £250,000 decreased by nearly 25%, which is probably the first-time sales we’re looking for.

If you want to dig even further into the details, Cliff @ Fool.co.uk provides a good overview of the London boroughs that have experienced a decrease in house prices so far. He breaks it down by property type (flat vs. terraced vs. semi-detached etc.), which should give you a good idea of where to not buy at the moment if you know what you’re looking for.

Further, Ed @ Fool.co.uk supports my view that a fall in house prices is simply a matter of time by now. He discusses topics like the subprime mortgage crisis in the US and it’s likely impact on the UK market (a hypothesis supported by this ABN Amro paper) as well as some other macroeconomic points that are worth considering.

If you think this is all far too serious, you should definitely watch this.

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The average house in London now costs £313,000. Think about that number - three hundred and thirteen thousand pounds. That’s more than 600,000 US dollars and thus probably even exceeds the phenomenal house prices in Manhattan.

The latest statistics reveal that the average salary in London is around and about £30,000.

Now one can debate what exactly the term “average” really means, as you can presume different people judge different properties as “average”. But looking at the bigger picture it becomes obvious why it’s so difficult for first-time buyers to get on the property ladder and why people start taking out mortgages for longer than 25 years. Technically, the average worker requires 10 times her salary to buy a house in London.

What am I taking away from these statistics? Flat hunting just got a little more important, because I might find myself renting for longer than originally expected. I want a down payment of at least 20% which is currently roughly two times my salary (before tax!). That means I need an in-expensive but nice flat to be able to put as much money aside for a house as possible.

Watch me achieve the impossible!

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When you are interested in the stock market, one phrase you come across often is “Markets are efficient” - meaning that in most cases and most of the time (there are exceptions… think 2001 Internet hype!) the market rates accurately reflect underlying value. People who are advocating this feature will therefore tell you not to try to time the market (or even beat it) because you will fail in the long run. You might get lucky this year, but over a 10 year period you will be almost certain to underperform the market.

With this information in mind, I stumbled across the following headline on the BBC website:

“Graduate jobs rise, but pay down”

The article quotes a recent survey undertaken by the Association of Graduate Recruiters which reveals that starting salaries in London fell by 5%. East Anglia is even worse off with a fall of 14 percent!

Now, if you have been following the news in the last couple of months, shouldn’t you immediately think that’s odd? Inflation well above target, interest rates keep rising to tackle the problem but there doesn’t seem to be an end in sight (yet). Living costs in London are as high as (almost) nowhere else in Europe and the extraordinary house price inflation in the UK should be news to no one. Coupled with the high interest rates, mortgages are on the brink of becoming a luxury.

So can anyone explain to me why salaries are falling?

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