Sunday Thoughts: When will the economy recover? When both a family in Florida and you know what your house will sell for

Sunday, November 16th, 2008 - Uncategorized

There is much talk in the Sunday newspapers about the economy, and the comments of UK Shadow Chancellor George Osbourne. The question is – how long will the recession be?

Simply, at present I don’t know anyone who knows the answer to that question. The answer to part of that question is: do you know what value your house would sell for tomorrow? OK, November is not a great time to be selling a house, so what would it sell for say next April, as Easter is traditionally a high spot for the home sales market?

You may think “well its worth X,” and there are many people still believing that – just take a quick look at UK house marketing website RightMove, and see how many properties have the words “Offers in Excess of” tagged before the price. But really, all that is a view of hope over economic reality.

When I was in college, there was an argument between the electronics lecturers and the business lecturers over a project they lead us through, to design and market a product. The electronics lecturers said that the price of the product was cost plus fair margin; the business lecturers said it was whatever the market was prepared to pay. Siding with the business lecturers was what eventually made me end up going into business – its economic and market reality, as in theory the value could go to zero.

My view is that those who put “Offers in excess of” would have sided with the business lecturers – but then, watching those properties, they have now been on the market on average in excess of six months; and those that don’t have those words are starting to – slowly – turnover and sell. These are either fire sales by mainly what seems like buy-2-let owners, or repossession resales by mortgage companies – of buy-2let flats. I have said to friends now for a while, that this recession could well be a middle-class one, where by the buy-2-let dream becomes a reality of “prices can go up as well as down.”

But fire sales always happen in markets, as do repossessions – it’s the growing volume which is concerning, and those growths are not signs of a stable market. It’s the sales price of the average family home which is where the problem of valuing assets is currently the part answer to the recession question.

On Friday, various mortgage lenders re-entered the tracker-mortgage market. The products though, as economists had predicted were changed. The changes were in the form of: a larger “gap” between the Bank of England base rate and the mortgage rate – with some predicting new products may well be based soon on LIBOR as opposed to BoE rates; and the amount of deposit required – there are now less than 50 mortgage products on the entire UK market which require a 10% deposit, and nothing below this level.

What does this data say? It says that most mortgage lenders, already short of cash, can’t take a bet at present on house prices dipping by a further 10% in the next two years. In fact what it is saying, is that that is what is going to at least happen. In most stable markets, a 10% deposit would be enough to take care of most economic changes – at present it is not, and until it is this recession will not find a bottom.

The hailed for and resultant stock market rallying – possibly Gordon Brown lead, I think so – injection of capital into the banks together with buying of so called “toxic” debts has still not occurred. In the United States, Henry Paulson stated that the US Treasury had so far with its $700Bn cash pile only bought shares in banks, not the toxic debt – which resulted in more turmoil on the global stock markets; while new RBoS CEO Stephen Hestor still debates the how and when of the proposed BoE cash injections. All this means that the lack of trust between banks continues, resulting in the continuing instability of the interbank markets reflected in LIBOR, resulting in less lending, and hence to the stock markets falling and climb like the Red Arrows – the whole problem that the Gordon Brown solution was supposed to solve.

The economic storm was started by: over lending in the United States mortgage market; and packaging of these debts in to the world finance market, and purchase by global bankers who didn’t know what they were holding. This storm will continue until the banks can trust each other, and know that either they have sufficient cash to pay back debts, or can sell assets to pay these debts, and know the value of those assets. While the lack of cash-injection continues, and a resultant lack of lending, the value of those assets will fall, and hence the cycle will continue downwards.

What about specifically the UK? Downturns are when Governments should spend, and that what Gordon Brown is proposing – from listening to the media, a tax cut in a pre-Christmas budget. However, as one commentator said yesterday, even a 10% tax cut putting in £30 a week in the average pay packet will be swallowed up by rising fuel prices rather than high street spending – so I don’t like that idea.

My view is – if you don’t have any savings in the cupboard (which the UK doesn’t), and you need to spend (which we ought to), then spend on long term projects, which you would have had to have borrowed for anyway. Transport is a good sector for such projects – which creates many jobs in the construction and operations phase – so why not revive plans for a high-speed link in the UK? Virgin had plans in their bid for the East Coast mainline a few years back, and there is always the old “rebuild the Great Central Railway” which is still relatively untouched post-Beeching; and I can’t see why electrification of the old GWR can’t be undertaken, or a review of the long term location of London’s main airport can’t be undertaken – there are far fewer homes in the Thames than the M4 corridor.

So, when will the recession end? It will bottom after Mr Paulson and Mr Dowling get on and inject their cash into the banks; after Barack Obama gets into the White House; and once you know the price of what your house will sell at next Easter, and the banks will give the buyer of your house a mortgage on a 10% deposit from a choice of more than 250 products, knowing that it provides a fair risk/return. Until that point, and no matter what Gordon Brown spends on or George Osbourne says will make little or no long term difference – it will only add to the peaks and troughs which say: neither I, nor you, nor the bank know what your house is worth.

Good Luck!

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