Archive for the ‘Debt’ Category

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According to a Halifax report, new mortgages are at their cheapest level in 14 years. Mortgages taken out during Q1 accounted for just 27 per cent of borrowers’ net income. In 2007 the ratio was 48 per cent; over the last 30 years the ratio was 36 per cent. Yippee to that.

It is just that…

Remember interest rates are at a record low. They are hardly likely to fall, but they are likely to rise. The Bank of England tries to re-assure us by saying rates are unlikely to go up until 2016. Alas, most new borrowers will not be repaying their mortgage in full between now and 2016. Who knows what rates will be in five years’ time, in ten years’ time or in 20 years’ time? It is anyone’s guess.

Remember that the markets have concluded that rates are rising sooner rather than later. The yield on UK government bonds is now at a two year high. Mortgage costs may rise in their wake.

Above all remember this. Sure, over the last 30 years mortgages on average took a higher proportion of new borrowers’ salary than they do now. But over the last 30 years wage inflation was ever present. Who cares about high borrowing to income ratios when incomes are rising so fast?

It is not like that now. Incomes are no longer rising fast, real incomes are falling. Those who celebrate the low cost of mortgages seem to have forgotten this.

© Investment & Business News 2013

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The threat posed by debt just won’t die down. Last week we reported that the Bank of England’s figures suggest that the UK cannot afford much higher interest rates. New figures from the Resolution Foundation suggest that the situation is even worse than the Bank of England suggested.

“If interest rates rise 1 per cent,” said the Bank of England in its latest Financial Stability Report, “households accounting for 9 per cent of mortgage debt would need to take some kind of action — such as cut essential spending, earn more income (for example, by working longer hours), or change mortgage — in order to afford their debt payments if interest rates rise…If interest rates rise by 2 per cent,” continued the Bank, “ditto, except that that it will be households accounting for 20 per cent of mortgage debt who will be so cursed.”

The Resolution Foundation has also taken a look at the story of the UK’s household debt, and its conclusions are even more disturbing.

Before the crisis of 2008 household debt across much of the developed world was worryingly high. Some countries, such as Denmark, Ireland, the Netherlands and Norway had it worse. Nonetheless with a ratio of household debt to gross house disposable income of 174, it was worryingly high in the UK. The good news is that it has since fallen, and the ratio at the end of 2012 was 146.

Alas, according to estimates from the Office of Budget Responsibility (OBR) it is set to rise again – not by much, for sure, but any rise is worrying. The OBR does in fact project that there will be a household debt to disposable income ratio of 151 by 2017 . To put that in context the ratio was just 112 in the year 2000. In the US, at the end of 2012 the ratio was 106.

According to the Resolution Foundation, at the end of 2012 no less than 3.6 million households were spending more than a quarter of their disposable income on debt repayments. Debt levels, however, are expected to rise as the government attempts to kick life into the UK housing market by encouraging greater mortgage lending.

But in its most recent report the Resolution Foundation looked at households whose debt repayments make up more than half of disposable income, or those in so-called debt peril. Right now, around 2 per cent of all households are in this position. If things carry on the way they are supposed to, and rates rise in line with Bank of England projections and real wages increase in line with projections for GDP, the Resolution Foundation estimates that the percentage number of households in debt peril will rise to just under 3 per cent by 2017. This is similar to the level seen in 2007, in fact.

If rates rise by 2 percentage points more than expected, the foundation estimates that the percentage number of households in debt peril will rise to 4 per cent. If, in addition to this, wages fail to rise with GDP, but rather – as has been the case in recent years – increases in wages continue to be outstripped by inflation the Foundation estimates that the number of households in debt peril will rise to 5 per cent.

Okay, you might say, but if this is the case then the Bank of England may not let interest rates rise. Unfortunately, central banks may have less say over the matter than is generally thought. See: The Great Reset 
There are all sorts of combinations and permutations.

But the points to remember are these: as rates rise in the US, the Bank of England may be forced to either up rates, or let the pound fall. If rates rise, debt levels in the UK will increase. If the pound falls, inflation will pick up, real wages may fall, and once again debt to income may fall.

In short, we may be in big trouble whatever happens.

But just bear this in mind. Debt does not matter if the percentage interest on debt is less than the percentage increase in income. What the UK really needs is for incomes to rise, and for this to happen it needs improving productivity, which comes from more investment.

© Investment & Business News 2013

The rich get richer and the poor get poorer. It sucks, but that is the way of the world. At least that is what most of us assume, but data from the ONS out this week suggests this may be wrong.

Since the start of the economic downturn in 2007/8 the richest 20 per cent of households have seen disposable income fall by 6.8 per cent, the poorest 20 per cent have seen income rise by 6.9 per cent.

It is important that we point out what we mean by disposable income at this point – it’s after taxes and benefits. The ONS has included VAT in the equation, by the way.

In 2011/12 the richest 20 per cent – before taxes and benefits – enjoyed income of £78,300, which is 14 times greater than the poorest fifth, which had an average income of £5,400. That is a ratio of 14 to one.

But take into account taxes and benefits and things look different – very different. The top 20 per cent saw disposable income fall to £57,300, while the bottom 20 per cent saw it rise to £15,800. The ratio changes to just four to one.

So what a bunch of socialists the government of the last few years has been. Except they haven’t really.

For one thing, the data does not tell the full story. It does not tell us about average income in the top 1 per cent quartile.

Besides if you drill down, things look different. If you look over a much longer time period, say from 1977, a quite different picture emerges. Since 1977, disposable income for the bottom 20 per cent has risen by 1.93 per cent, and by 2.49 per cent for the top 20 per cent.

There is in any case a more noticeable gap between the top 20 per cent and the rest of the population.

Average disposable income for the second poorest 20 per cent was £21,373 in the last financial year, or 1.35 times more than the first 20 per cent. Average disposable income for the middle 20 per cent was £27,526, or 1.29 times the average for the second poorest. Average disposable income for the second richest 20 per cent was £34,437, or 1.25 times the average for the middle 20 per cent. And average disposable income for the richest 20 per cent was 1.66 times the second richest.

But then again, so what? Don’t the rules of numbers mean that the average of the top 20 per cent will always be much higher than everyone else for the simple reason there is no upper limit to the top 20 per cent. The lowest disposable income can be is zero, the highest is… well, it’s infinite. Instead let’s look at how things have changed.

Equivalised disposable income, by the way, means: “The total income of a household, after tax and other deductions, that is available for spending or saving, divided by the number of household members converted into equalised adults; household members are equalised or made equivalent by weighting each according to their age, using the so-called modified OECD equivalence scale.” See: Glossary: Equivalised disposable income

And by the way just one more point. The proportion of people in the bottom 20 per cent who are retired has fallen over this time period. . This is because retired households have seen incomes growing at a faster rate than those of non-retired households.

© Investment & Business News 2013

In 1994, the US Federal Reserve increased interest rates. The eventual effect of this was the Asian crisis of 1997, then the Russian crisis of 1998 and the collapse of LTCM.

History does not repeat itself, once said Mark Twain, but it does rhyme.

Did you hear that? It is the markets rhyming again.

This week the OECD said: “In East Asia…combined nonfinancial corporate and household debt has increased in several countries, reaching 130 per cent of GDP in China and Malaysia in 2012. For the East Asia region as a whole, private debt has increased by 19 percentage points of GDP since 2007, while in Latin America it has increased by 9 percentage points.

Household debt (only by deposit-taking corporations) in Thailand has risen 15 percentage points since 2007 and now stands at 63.4 per cent of GDP. Total household debt is estimated to be about 77 per cent of GDP in Thailand and almost 80 per cent of GDP in Malaysia.”

Countries across the emerging world where private debt is either around 100 per cent of GDP or even greater than this amount – and listed in order of size of debt to GDP – include: Thailand, Panama, St Lucia, Vietnam, Malaysia, South Africa and China.

Three countries stand out with excessive level of foreign debt. They are Papua New Guinea, Latvia and the Seychelles.

The World Bank said: “Public debt levels are high and proving difficult to manage in countries such as Cape Verde, Egypt, Eritrea, Jamaica, Jordan, Lebanon, Pakistan, and Sudan.”

But as markets panic, and emerging market debt becomes the thing they fear most, expect fundamentally strong economies to be punished too. The markets are like that. In times of either euphoria or panic they don’t tend to discriminate between sectors or regions.

That means opportunities may emerge. Watch out for the countries that make up the Pacific Alliance Trade Bloc, some countries within South East Asia, and the so-called TIMPs – Turkey, Indonesia, Mexico, and the Philippines – in particular.

© Investment & Business News 2013

Uk Population

Here’s a chart for the UK population as of now with a line for the official projections 10 years hence.

As a tool for prediction this chart can be quite powerful; pictures speak a lot louder than words.  The way to use the chart is to imagine the blue and red lines being pulled across the page as we all move inexorably towards God’s waiting room on the right.

We’ll be pulled past 2 marks on the way. The left block shows where young people (16 – 24) might find themselves becoming employed and paying taxes – remember that 20% don’t though so the ‘new workers’ line is copied and shifted lower.

The next mark, for the retiring age for men, shows an ever increasing rate of retirees, after a very steep previous 10 years there will be another 7 million arriving during our 10 year look into the future. You might notice an almost mirror image of the lowered ‘new workers’ line but the unemployed are living off the state too, so there is another 1 million to be added to the line on the right if we want to balance workers vs. state supported.

Unfortunately, because the leading edge of retirees points up and the leading edge of new workers points down, things just get worse. While this demonstrates the ex-growth nature of the economy it is reassuring to compare the huge block of substantially employed people and the much smaller wedge shaped block of the already retired.

So it looks a lot less gloomy right now but as our 10 year view unfolds it builds to uncomfortable levels all the way up to and past the baby boomer’s peak in 15 years.

Note how the red projection line slumps after the retirement age. I’d like to think that this is not an early death syndrome but rather an indication that retired people like to head off to countries with blue skies and sunshine. As we have seen, the retiree level is really lower than the new workers level and that’s a significant first; it just gets progressively worse after this as the retirees line builds even steeper and the workers line pulls across a dip. Incidentally there are dips because WW1 and WW2 were one breeding cycle apart (27 years) and the resulting post war pulses have yet to die down.

If you are about 50 now you are at the population peak age. Births subsequently declined for 13 consecutive years, and that was another first, signalling the end of centuries of perpetual population growth. Because accounting practices, pension arrangements, government finance, and much more, all worked because growth conveniently forgave all sorts of silly thinking, there were, and still are, bound to be some serious consequences.  The way the world works has changed forever.

The workings of pension schemes are of particular interest. With perpetual growth there was always a bigger pool of funds to pay out the liabilities so nobody needed to be particularly efficient. That is no longer the case and you can be sure there will be a raft of pension scheme failures.

With such a huge pension liability arriving over the next 15 years the pension funds have to prepare by switching out of equities and into bonds and then progressively the bonds are then sold as net payouts increase. Logically we might expect weak equities and strong bonds eventually followed by weak bonds.  When the bond sell-off stage arrives one wonders how the Government finances will work – who will they sell bonds to then?

An ex growth world has some implications for equities. Shareholders have got used to accepting lower yields in exchange for corporate growth. As soon as the growth stops then a proper yield will be required. As an example a company yielding 2% and going ex-growth might have to yield 4% to remain attractive. So that means the share price would have to halve!  How likely is this scenario?

Well take a supermarket for example. As a footfall company, whose profits are directly linked to the traffic through the door, the impact of an ex-growth population will be severe. Actually the population is not quite ex-growth, it is just slowing down, but even so companies in this category are subject to massive falls as soon as their growth is seen to end. Just to be safe, sell all your growth stocks?

You can see why there was a property boom over recent decades as the only way the available housing stock grew was via owners dying or new houses being built. Looking back it seems so obvious that fewer old people (from a previously smaller population) supplying demand from a much bigger block of house seekers would result in big price rises.

The chart is giving a strong indication of a repeat performance. Note how there is a bulge moving into the first time buyers age groups and then compare that to the lower height of the chart where old people might shuffle off. Demand will clearly outstrip supply for a while and looking forward 10 years this is increased by immigration as can be seen by the way the bulge actually grows as it moves across. The low end of the housing market looks like a good bet and you can expect a rally in the house builders too.

All this is good for the economy with an added twist. The baby boomers already have a house and yet they are about to inherit their parents houses which can easily be sold on at today’s fairly substantial prices; an added boost to the economy for several years to come.

This last point reinforces the idea that retiring couples with windfall cash will head for the sun. That’s bullish for overseas holiday homes so get in while they are depressed.

Any negatives? Well the way the dotted red line sits above the blue line has implications for NHS services over the next 10 years. It doesn’t look much but in percentage terms there is a significant increase with a detrimental age bias to account for too. An already stretched service has a crisis looming.

The big bulge in the new adults group will all be driving cars for the first time; good for the motor industry but bad for traffic jams.

Conclusions:  No great dramas for the next 10 years but this is the lull before the storm. After 15 years the peak of the baby boomers will be at retirement age and from then on it is hard to see how the books stack up unless the, already brimming, country is filled with more foreigners.

The houses to buyers ratio is likely to top out, leading to a sustained bear market in house prices. The stock market will slump horribly as it goes absolutely ex-growth and the pension funds go into net draw down.  The Government will find it hard to fund the state pension burden and increased demands on public services. Borrowing to bridge the gap will be hard as traditional lenders, in the net draw-down scenario, have no need to buy bonds. Interest rates may well climb as a result and then the National debt financing costs spiral up. Pay more, borrow more, pay higher; sounds familiar.

A UK Government default before 2028?  Not so hard to imagine is it?

Data – The Office for National Statistics

Opinion – Patrick O’Connormist

Let’s hope you are sitting down because this may come as a shock. It turns out that a lot of Brits are not saving enough.

According to Prudential: “One in seven (14 per cent) people planning to retire this year will depend on the State Pension as they have no other pension.”

The Prudential analysis also reveals that nearly one in five (18 per cent) of those planning to retire this year will be below the poverty line. The Joseph Rowntree Foundation estimates that to be above the poverty line a single pensioner in the UK needs an income of at least £8,254 a year, yet 18 per cent of those retiring in 2013 expect to retire on less than this.

The findings also highlight a significant gender divide, with 21 per cent of women expected to retire below the poverty line in 2013 compared with 14 per cent of men. In addition, women are nearly three times more likely than men to have no other pension – 23 per cent of women retiring in 2013 will retire without a private pension, compared with just 8 per cent of men.

The truth is that the retirement of the baby boomers, something we are only just beginning to experience, will provide the single biggest challenge to the UK economy over the next few decades. Indeed the US and much of Europe face a similar challenge.

You could say that what is happening in the UK now happened in Japan 20 years ago.

What is the answer?

From a micro point of view it is for us all to save more. But if we all save more, the result may be recession and falling wages, which in turn may make it harder to save.

From a macro point of view we need investment into innovation, infrastructure and just in trying to create a more dynamic and stronger economy. Or we need more immigrants, which is not an idea that is likely to prove very popular.

© Investment & Business News 2013

Last year I did a list of each country’s national debt divided by population to see what the next generation might either pay interest on or pay back.

Examples in $1000 per head:

UK 26.5

Ireland 35

Germany 28

France 31

Spain 17.5

Italy 38

Japan 83

USA 29

Canada 37

Norway 39

Australia 11.5

So what you might say? As a percentage of GDP it’s not so much … well that’s got naff all to do with it too unless there is a current a/c surplus … if you cut someone’s hair it adds to GDP but it hardly pays the £26,500 you owe on top of the £10,000 on your credit card.

Obviously, in the UK, with the old folks about to fund the out of work young folks as well as the civil servants, NHS etc (biggest GDP earners presumably and therefore the biggest ‘so what’ in this whole sad tale) this black hole is here to stay for a long time.

To get away from the obvious side of the story let’s have a look at the other side of the loans – the £26,500 each and every one of us had borrowed on their behalf… someone is the lender and so they will either ask for it back one day or extend the loan forever and the borrowers (you) will pay the interest. As the banks already went bust then presumably the debt is met by bond issuance from each government … “wow government – must be safe” bonds of course.

So who owns the bonds? i.e who is hoping to get paid back?  As it’s not countries per se nor banks so much, it must be the pension funds and the pension funds have your money in trust for when you retire. So the money they are going to give to you one day is indirectly the money you already owe ? And in order to realise that money, the pension funds have to redeem the bonds so the government has to find the money to give the pension providers to give to you….. enough of that … the real truth is that the government bought votes by indirectly spending your pension fund over the past few decades. The government borrowed from the very people it was robbing at the time. Many pension plans will have to go pear-shaped… whose will be first?  Do you doubt this? In that case just tell me who is going to produce your £26,500?

Any thoughts out there?

Patrick O’Connormist is this week’s guest contributor to The Money Spy blog