Credit Crunch Pounds U.K. Economy
By ALISTAIR MACDONALD and MARK WHITEHOUSE
The Wall Street Journal February 7, 2008; Page A1
LONDON -- The global credit crunch is threatening to claim a new casualty: The United Kingdom, a country that has staked its economic success on attracting other people's money.
For more than a decade, the U.K. has reaped vast benefits from its role as a hub for the world's capital, building London into a financial center to rival New York. No large country is more dependent on the movement of foreign money through its banks: Some $2.4 trillion flowed in and out of the U.K. in 2006, an amount equivalent to the country's entire annual economic output, the most recent data indicate. The financial sector accounts for more than one-fifth of all U.K. jobs, compared with only 6% of jobs in the U.S., and contributed about one-quarter of the nation's economic growth over the past five years.
But now, amid the deepening credit-market turmoil, the U.K.'s embrace of financial globalization is becoming a liability. The investment-banking business is already stalling, potentially eliminating thousands of high-paid jobs and demand for everything from tailored suits to high-end hunting trips. As mortgage credit dries up, house prices are sliding at the fastest rate since 1995. And retailers are facing a tough time as consumers, coming down from years of credit-fueled spending, turn decidedly gloomy.
Bank of England officials, in a crucial policy-making meeting today, will decide what, if anything, to do to ease the pain. Economists expect the central bank to take out some insurance against a recession, cutting its short-term interest-rate target by one-quarter percentage point, or perhaps one-half point, from the current 5.5%. But with inflation running above the desired level of 2%, the bank may have little leeway to ease further. Meanwhile, the government, hobbled by a large budget deficit, will be hard pressed to come up with a stimulus package like the one being considered in the U.S.
"Neither I, nor people who are much better trained economists than I, see anything that we feel would mitigate the gloomy outlook for 2008 in the U.K.," says Michael Kirkwood, chief country officer for the U.K. at Citigroup Inc.
On average, economists see the country's economy growing at an inflation-adjusted rate of 1.8% this year, down from the 2.4% they forecast a year ago, according to London-based economic research firm Consensus Economics. But many see those forecasts as tentative at best. "There are very real risks," says Howard Archer, chief U.K. economist for consulting firm Global Insight in London. "Maybe we are being too complacent."
Only a year ago, few guessed the nation's prospects could turn quite so bleak. The country shrugged off the U.S. recession of 2001 to grow at an annual inflation-adjusted rate of 2.6% over the five years ending in 2006, a full percentage point higher than the neighboring euro area. In all, the U.K., the world's fifth-largest economy, has experienced 15 years of uninterrupted growth. That rare achievement helped propel Gordon Brown, who oversaw the economy for 10 of those years as Chancellor of the Exchequer, into the post of prime minister last June.
Much of the prosperity, though, depended on the global boom in credit of the past several years. The pulse of London's financial center, known as "the City," quickened as its bankers invented increasingly complex ways to package and resell all kinds of assets, from high-risk U.S. home loans to European corporate bonds. Over the five years ended September 2007, the financial-services sector grew at an average, inflation-adjusted rate of just over 8%, its most intense stretch of growth in almost two decades.
Locally oriented retail banks, such as mortgage lender Northern Rock PLC, also tapped global capital markets for cash, which they made available to British consumers. The abundance of easy money catalyzed a sharp rise in home prices and boosted consumer spending. But it also drove people deeper into debt as they stretched to buy homes and live large. According to the most recent data from Paris-based Organization for Economic Cooperation and Development, total consumer debt in the U.K. stood at 164% of annual disposable income at the end of 2006, by far the highest level of any developed country. In the U.S., that number was 138%.
Ann Taylor, a student nurse in the town of Hornchurch just east of London, is one of the consumers who went along for the ride. Over a period of almost three years, she racked up £18,000 in debt, about $35,000, on four credit cards -- mainly, she says, on small clothing items and a holiday trip to Spain. She managed to keep up the interest payments for two years, but in December, she gave up and declared bankruptcy.
'My Own Fault'
"It's my own fault," she says. "But everywhere you are offered credit cards, and it is so easy to pay for things once you've got one."
Some 22% of Britons with mortgages and other debts -- nearly seven million people -- say they are struggling to make their payments, according to a survey released yesterday by professional services firm KPMG.
As the credit cycle takes a sharp turn downward, many of the businesses that fed the U.K.'s financial sector, from taking companies public to issuing corporate debt, are set for a fall. Among the hardest hit so far have been the complex products in which London-based bankers and traders specialize, such as the collateralized debt obligations and structured investment vehicles, or CDOs and SIVs, that are at the center of the current crisis. "You've got certain sectors that are out to lunch and are likely to be out to lunch for the rest of their lives, or at least for the foreseeable future," says Mr. Kirkwood of Citigroup.
Over the next 18 months, as many as 20,000 of the 350,000 people who work in London's financial-services sector could lose their jobs, according to information-services company Experian Group. Many major banks have already made some cuts. UBS AG said in October that its investment-banking unit, which has about one-third of its staff in London, will cut around 1,500 jobs. Among the banks that have also made cuts in London are Credit Suisse Group, Deutsche Bank AG, Morgan Stanley and Merrill Lynch & Co.
Shrinking Bonus Pool
In October, the Centre for Economics and Business Research, a London-based consulting firm, estimated that the bonus pool in the city's financial district in 2007 would be £7.4 billion, or $14.5 billion, down 16% from the year earlier. With market conditions no better and in many cases worse, the actual drop is likely to have been greater.
Jason Kennedy, chief executive officer of financial-services recruitment firm Kennedy Associates, says he has seen a big increase in the number of people in banking saying they are "available," either because they were disappointed with their bonuses or are preparing for layoffs. "It is hard to find people jobs," particularly in credit-related areas, he says. "The whole market is contracting. I suggest for them to sit it out and wait."
Troubles in London's financial center have already triggered a sharp drop in the market for commercial real estate. Sales of office buildings in the district fell to £712 million in the last quarter of 2007, from £1.9 billion in the year-earlier period. Real-estate agents say prices in the district have plunged by 15% or more in the past few months, and futures markets suggest they could have another 15% or so to go. Spooked by splashy headlines about the troubles in the commercial-property market, Britons have rushed to pull money out of investment funds that specialize in commercial real estate, forcing some to freeze withdrawals.
Taken by Surprise
"I think everyone's been taken by surprise at how quickly the market has fallen," says Graham Browning, a partner at commercial-property agents Allsop LLP.
Businesses that cater to bankers are feeling the pinch. Andrew Richardson, who runs a hunting business called Safari in Scotland, says he has seen bookings from London fall off a cliff this year. Most years, he says, he would expect to sign up at least 10 groups from the capital's financial community to hunt game such as pigeons, geese, rabbits and woodcock. This year, though, he has only two bookings, and he says his clients have become noticeably more cost-conscious.
They're "quibbling with us more," he says. "In the past, it was name your price and you got it."
Regular consumers, too, are facing new constraints as banks, nursing wounds inflicted by mortgage losses, pull back on all kinds of lending. In one of the most drastic moves yet, Citigroup said last week that it would be canceling the credit cards of some 161,000 U.K. customers it deemed too risky. U.K. mortgage lenders are tightening their lending standards as they find themselves unable to tap global capital markets for cash. According to the Bank of England, new mortgage approvals stood at 73,000 in December, the lowest level since May 1995.
The downturn in credit has cast a pall over the nation's once-hot housing market. According to U.K. lender Nationwide Building Society, house prices fell nationally at an annualized rate of 5.6% in the three months that ended in January, the fastest rate of decline since 1995. Analysts are also expecting a rise in mortgage defaults, as some 1.4 million homeowners see payments on their mortgages reset to higher levels this year, 52% more resets than last year.
Yesterday the U.K. Chancellor of the Exchequer said he was set to propose ways that could help lower the cost of financing for mortgage lenders, which in turn would make mortgages cheaper.
Economists don't expect a housing bust as bad as the one now unfolding in the U.S. For one, the U.K. never experienced the same building boom, so there will be fewer unsold houses to weigh on prices. Also, U.K. mortgage lenders have made fewer high-risk "subprime" home loans. U.S. research firm Sanford Bernstein estimates that subprime loans accounted for 6% of all mortgage loans outstanding in the U.K., compared with 14% in the U.S.
Even if they don't trigger a housing-market disaster, falling home prices and rising mortgage payments are having an impact on consumer spending, which accounts for more than two-thirds of the U.K. economy. According to the nation's financial-market regulator, the Financial Services Authority, homeowners whose monthly mortgage payments are resetting this year face an average increase of £210, or $411, at a time when they are already digesting a sharp rise in energy and food costs.
Judging from the latest data on retail sales, consumers already are rethinking their spending habits. Last month, U.K. retailer Marks & Spencer PLC reported its worst quarterly sales performance in two years, and warned the pain could extend into 2009. Tesco PLC, the nation's largest retailer by sales and typically the sector's star performer, missed its sales forecasts for the holiday season. Overall, U.K. retail sales dropped 0.4% in December from November.
Dancing Slowdown
The British are even dancing less. In January, nightclub operator Luminar Group Holdings PLC reported lower sales from mid-November to December, partly a result of the consumer slowdown.
Claire Felton, a 35-year-old manager of government contracts, has become more careful. She says she can handle the mortgage payments on her East London apartment, which will rise by £270 a month as of May, when the rate on her interest-only mortgage resets to about 7% from the current 4.45%. But she's put off plans to redecorate her bathroom, and even smaller purchases such as clothes are on hold.
"I'm making do," she says. "Usually I'd buy new clothes at the start of every season, but I didn't for the winter and won't for the spring."
URL for this article: