Don Murray
The bursting of Britain's housing bubble
February 15, 2008
In Paris, a bank tottered. In London, a government felt secret relief.
While much of the world was taking in the spectacle of the young man who literally bet the bank — the one he worked for — on European stock movements, losing a cool $7.1 billion for his employer, the Société Générale, the British prime minister and his chief lieutenant, the chancellor of the exchequer (a very grand spelling for minister of finance), welcomed the headlines as a distraction from their own woes.
The distraction was short-lived.
Homegrown banking woes would soon envelop them again. The bank on this side of the channel is called Northern Rock. It, too, had bet its capital but not on stocks. Northern Rock sank in the swamp of subprime mortgages.
It had borrowed vast amounts of this cheap money, much of it from U.S. banks. Then it turned around and offered cheap mortgages to its customers in the north of England. They flocked to take them.
Britain, just a few years ago, was in the midst of a huge housing bubble. Prices were rising by 10 and 20 per cent a year. Some properties doubled, then tripled in value. Everyone wanted a piece of the action. Safe as houses, it all seemed risk-free.
It was not.
At the beginning of 2007, the average American was spending more than he earned on mortgage payments (103 per cent of disposable income). The average Brit was spending more still (125 per cent).
It could not last and it didn't. When the subprime crunch began to bite across the Atlantic, banks began calling in their loans. Britain's Northern Rock was cruelly overexposed. Its entire fast-growth strategy was based on low-cost mortgages and it didn't have a big enough war chest of deposits to pay the other banks.
The run is on
Faced with this dilemma, Northern Rock begged for time and help. But its customers panicked and began lining up to take out their money.
This was the first time in 140 years there had been a run on a British bank. To make matters worse for the government, it was taking place just a couple of months after the former minister of finance, Gordon Brown, had moved next door to become the prime minister and principal resident of 10 Downing St. in June of last year.
Brown had built his reputation on the pillars of economic prudence and fiscal farsightedness. A bank run was not supposed to happen on his watch.
His first reaction was to try to finesse the situation. There was an obvious solution that he probably contemplated: Take the bank over, and either close it or pump in money and sell it back to the private sector while hopefully recouping the public investment.
But though a Labour prime minister, Brown was nonetheless terrified of being tagged as a statist and a nationalizer and so decided to leave the bank private and feed it money, with the government announcing it would guarantee all the deposits.
The problem there, however, was that the state's money bled away, first $20 billion, then $40 billion, and still the bank needed more.
Virgin territory
Then, last month, the British government announced its long-term solution. Northern Rock would be sold to private interests, the likely candidate being Sir Richard Branson, owner of the Virgin brand.
"Sold" here has a special connotation. Branson would actually put up very little money. The government would continue to be responsible for the bank's debt. And estimates of that debt are now up in the $200-billion range.
One opposition MP, an economist by training, summed it all up in one devastating sentence. This was "nationalization of risks and losses, and privatization of gains." No one in the government even tried to contradict him.
For the government, having a wounded bank on its hands is bad enough, but there may be worse news on the horizon. The great housing bubble is bursting.
Prices have been dropping in Britain for several months. This is a good thing for many people, given that the average price for a dwelling in the London area is now well over $400,000.
But the number of new mortgages has dropped drastically as well, presaging a slowing of the economy. The credit crunch is truly beginning to bite, six months after it started chewing through America's financial sector.
George W. Bush's response was to go even deeper into debt, to try to jumpstart the American economy with more tax cuts and consumer spending. Brown may not have that option.
When he first became chancellor of the exchequer, he made much of his so-called golden rule that government borrowing would, on average, not rise above 40 per cent of national income. It is now in the 45 per cent range and creeping north because of adventures such as Northern Rock.
There is little talk from the prime minister these days of rules, golden or otherwise.
As finance minister, Brown repeated endlessly that he had broken the cycle of boom and bust in Britain. It may be that he merely postponed the bust and when it arrives, it will be a double or even a triple whammy. First the economy, then his reputation, and finally his job.
ABOUT THIS AUTHOR
Biography
During his 30 years at CBC, Don Murray has filed hundreds of reports in French and English from China, Europe, the Middle East and the Soviet Union. He is currently based in London. He wrote A Democracy of Despots, documenting the collapse and rebirth of Russia. From Berlin, he reported the Bosnia peace agreement talks and, based in London, the death of Diana and Northern Ireland peace talks. He authored Family Wars for the International Journal, paralleling Northern Ireland and Bosnia. He has covered wars in Kosovo, Afghanistan and Iraq.