Monday, December 1, 2008

Justifications Of Ever-Falling Mortgage Approvals In UK

It seems that the worst from property market woes in UK are far from over. In the latest data released by Bank of England, mortgage approvals have again fallen in October, standing at around 32, 000 which 1,000 lower than previous. Overall mortgage approvals have slumped 74% in just one year owing to the global credit crunch

What all this has to say?

(1) Banks more frugal in lending. The financial mess originated from US. High mortgage default rates there had caused the bank to seriously lose lots of money. Therefore this leads to liquidity problem. Banks are now more frugal to lend to each other, internally & externally. Unfortunately, British banks also raise money through money markets. Difficulty to extend cash caused them to cut mortgage lending. Homeowners in UK find it difficult to borrow money, & this automatically translates to fall in demand for housing. As such prices of house began to crash creating a negative wealth effect

(2) More banks will be nationalised. I argue that this problem is inflicted by the bank itself. It can’t be denied that initially banks do have serious balance sheet problems. But since the UK government is willing to pump in more money to increase liquidity, stabilise the financial system & slashed base rates to 3%, many banks remain stubborn in giving out mortgage financing. Some even increase the interest rate charge on credit cards. Part of the reason is that the bankers now would like to seize the opportunity to improve their financial standing.

But doing so will bring them more harm than good. Charging higher rates will further discourage spending in a dying economy. By not passing on the lower lending rates will witness more people to go defaults in environment where unemployment is increasing everyday. More will soon follow the footsteps of Northern Rock, Halifax, RBS & Bradford and Bingley

(3) UK economy will be in long recession. On average house prices had fallen between 10%-15%. Some other areas fell even more. With the current ongoing situation, there is no sign when the property market slump will be over. Since traditionally large proportion of Britons store their wealth in the property market, this translates to falling wealth which will negatively feed into the whole economy. As people feel poorer, they will spend lesser. Fall in consumption will cause a fall in AD. Real output will fall. This problem will be exacerbated by the negative multiplier effect

(4) Possibly another rate cut. The monetary authority will likely slash interest rates in the coming meeting in December (in fact they have. Now base rate is at 2%, the lowest in 57 years). Given the worsening UK economy outlook in 2009, the threat of inflation had been taken place by deflation. As such, MPC will have more flexibility to adjust the rate downward. Economic growth is the major concern now

(5) More fiscal stimulus. It is very normal to witness the government to spend more money into the economy during recession. Monies will be spent onto building motorways, construct schools, infrastructures etc that can potentially absorb several hundred thousands of redundant workers. The aim is to create consumption into the economy. But more often that not, national debt as % of GDP will increase. This is because government will need to borrow more to finance all those development projects, while at the same time GDP is shrinking. Do the math & you will understand

No comments: