Comments: Sunday reading

Hi David,

Hope you are away from a PC due to being in some nice sunny holiday destination :-)

Back in December I posted some responses

We were speculating that controlling inflation via IRs is becoming harder because of the uneven distribution of debt.

Your latest article extends on this theme.

It would be interesting to back up your observations on the "Golden Generation" with some stats.

I wonder what the net effect on spending really is of increases in IR?
And more interestingly what the trend in the relationship is ?
It may be that using IRs to control inflation will not be possible in future. (It will also be affected by the shift away from property ownership towards long term rental.)


Posted by Nick Thorne at August 12, 2007 09:42 AM

David, in December, and in response to Nick Thorne's replies at that time, in with reference to property markets, you said: "My central point has always been that you don't get a crash unless there are extentuating economic circumstances - a loss of control of monetary policy (very sharp rises in interest rates), a big increase in unemployment and a wave of business failures".

Do you still hold that view given that the US housing market is unravelling in the absence of any of the three factors you highlight?

Posted by t tgumbrell at August 12, 2007 10:18 AM

How does it feel to have been proven so utterly wrong by all of your past critics?

Posted by Jake Hywell at August 12, 2007 06:22 PM

o.k. back again, but I could help but notice this; Such a problem, as to cause our new Chancellor to cancel his holiday!.

How severe is this story, Mr Smith?. Even with my limited Knowledge, it appears rather shockingingly bad news.....

Posted by matthew at August 12, 2007 10:02 PM

Your blog needs an edit function for posts Mr smith. Even I can see that I've put an extra "ing" where it shouldn't be!.

I've noticed the source of the article in the link is from "The Mail on sunday" !!!. Sorry about that, thought it was a "This is Money" piece.

Posted by matthew at August 12, 2007 10:45 PM

Hi tgumbrell

I think David is right and the US has had a very sharp rise in interest rates, ie from 1% to 5.25% , over two years.

This is the reason the sub prime is going into collapse, many people were on 2/28 or 3/27, and are seeing their rates rise from 1% to 2% to 7% to 8% at the reset. Therefore they can't afford the new repayments (the same as when the UK rates rose from 7.5% to 15% over 16 months)

Posted by kingofnowhere at August 13, 2007 08:22 AM

Hello Kingof - I can not agree: Interest rates in the US are still low by historical standards. The Fed most cetainly did not lose control of monetary policy; there has been an absence of exogeneous shocks, and no unexpected transformation of the monetary landscape. The rate increases were measured, cautiously implemented, and predictable (by the lending institutions if not by the sub prime borrowers).

The crash was due to sub-prime as you correctly point out. To put it another way: the crash was due to the banks throwing credit around indescriminately. It was a classic credit bubble. It took the normalisation of interest rates to prick it. There was no loss of control of policy.

Also, the wording of David's statement suggests that he believes that the loss of control of monetary policy alone was a necessary, but not sufficent condition. Please note the 'and' joining the last condition to the first two. Note: the 'and', not the 'or'.

Posted by t tgumbrell at August 13, 2007 10:30 AM


We'll personally I would say having to raise rates at every meeting for two years, from 1% to 5.25% indicated some sort of loss of control of monetary policy. No Gentle hand on the interest rate tiller there, more like hard to port!

Basically the Fed had interest rates too low for too long (as Merve King said in June 2006) and they had to rush to push rates up sharply.

Nope, DS still get my vote, because I think he realises that interest rates are very large part of housing affordabilty. If affordabilty is push of the scale then house prices crash,

Re And, What would you say about a sign that said "Smoking and Spitting not allowed". Does that mean you can smoke or spit, but as long as you are not doing it at the same time, then that's OK?

Posted by Kingofnowhere at August 13, 2007 11:22 AM

There was no loss of control that I can see. Greenspan knowingly and intentionally set the IR at a silly level in order to avoid a deep recession. He and the fed knew that this tactic would minimise the chance of a deflationary spiral taking hold, but would cause asset price bubbles in unforeseen places. The Fed also knew that rates would have to be normalised eventually to avoid an inflationary spiral. I can not see that the incremental increase of rates upto 5.25%, which represents a low cycle peak, in anyway represents the loss of control of monetary policy. In sum - yes, a big increase in rates from a very low base, but an increase that was gradual and expected. No loss of control. No unexpected shock. Just an economy returning to normality.......precipitating a property market crash.

Posted by t tgumbrell at August 13, 2007 01:31 PM

I think Bernake and King will be forced to let Ir's fall and then unleash inflation, albeit for what they believe will be a short period..........

Posted by Pete Balchin, Solicitor at August 13, 2007 01:42 PM


Last week you were saying rates would have to be 6.5% by year end to control inflation, and now you are saying King will be forced to cut rates, and unleash inflation.

Scooby Doo is less confused than you !

Firstly, it would be the MPC and not just King that would have to vote for a rate cut.
Besides that, we will have to see a significant knock-on effect, from the current credit crunch, feed through into business/consumer confidence and hence spending/inflation before the bank considered cutting.

As they have re-iterated their "lender of last resort" status at Bank Rate + 100bp, the mechanism is already in place to react to the current situation.

Posted by Simon at August 13, 2007 02:39 PM

I mean in the sense that they 'control' the potential respective remit to reduce IR's (and I know you will say that King voted against not putting them up etc., but I mean political pressure is brought to bear...).

I think that in view of the way that the financial institutions (and the BOE must also be held partly culpable in this), have created this debt monster, they may have to keep feeding it and/or encouraging others to do the same.

You know that Mervyn King said that the financial institutions don't know the true value of these CDO's or whether they have any security/collateral, this of course was before Bear Sterns went under, before American Home Mortgage Investment Corpn. filed for bankrputcy and before the apparent problems with BNP Paribis and Goldman Sachs' hedge funds. Regulation is questionable, and as such better to let sleeping dogs lie one might think and presumably before a serious risk transpires over here...

Now, the City is (or was in May/June) pricing in IR's at 6.25% to their deals 2 years hence. The presupposes that the BOE have been woefully dialtory in raising the rates. I tell you (with all candour/certainty, as Callaghan...(sic)?) that real experienced inflation on the street is 4.5 - 7%.

Actually the financial institutions are conservative in measuring the top of IR peaks, by about 20%. Therefore I would tenatively suggets IR's may have to (or even will) rise to 120% of that figure, hence 7.5%.

A taxi driver I used the other day told me that he said the BOE were really worried about inflation now and IR's could rise to 8%. We have of course had higher rates but I take such predictions with the gravity necessary, however you know what they say about taxi drivers and economics...

I think that they are too low. They should be higher now. We may get 6.0 % before xmas (or even 6.25%). Remeber also that they prdicted the current peak of IR's to be much lower and this prediciton was based on growth of 2.5%. However, the debt monster is obviously well and truly out of the closet and what will the BOE do faced with a potential credit crunch of this magnitude? Presumably as no one has learnt the lesson from LTCM Bank and the BOE have cut before, don't bank on the BOE doing what they should sensibly be doing which is raising rates. They may cut.

So not confused, no. I rather think they should have acted much earlier to raise them but then...

Oh and by the way the BOE may say they will set aside this reserve fund, but even they have finite resources and so the best course of diplomatice policy may be the inflation out of this bubble.

Posted by Pete Balchin, Solicitor at August 13, 2007 03:45 PM

...and on the ever popular theme of sub prime and its discontents... looks like some admissions are starting to be felt necessary in the context of the current market turmoil.

Followingly nicely on from the FSA's bit of tokenism re the UK's sub prime lenders, this appeared in today's telegraph:
"Ms Earley [Nationwide's chief Economist] said as the US has greater exposure than the UK to the sub-prime mortgage market, it was experiencing "more extreme" difficulties. She estimated that sub-prime mortgages account for "no more than 10pc" of the UK market."

What a bizarre statement - It wasn't long ago that such a public figure would have denied that a SP market really even existed in the UK.

Now it's suddenly 10% of the market! That's a much higher figure than I expected to hear from such a deeply dug in defender of the trench.

With our massive, self-certified BTL market (not extant in the US) on top of this standard SP market, we could conceivably have a larger effective SP market than the US.

Does anyone (David?) actually know the whereabouts of, or have access to, reliable, independent stats on this market sector? Or are we all just putting fingers in the wind?

Posted by t tgumbrell at August 13, 2007 06:06 PM


Why do you say the USA has no self certs or BTL mortgages.

The problems they have are because on on income verified (in fact there is now talk to outlaw these in the USA), and they have had rental mortgages for longer than us, although they don't call them BTL

FWIW USA sub prime is 20% of Market UK is estimated between 5% to 10% (Depending on how you define sub prime)

Any way Just some examples, of non income and BTL mortgages in the USA

Non Doc


Investors Pay More

Rental property mortgages have historically been higher risk loans, so mortgage insurance underwriters limit the number of non-owner occupied mortgages they will insure for individual borrowers to five. Additionally, real estate investors do not have the interest rates, terms or down payment options that are advertised and available to home buyers.

And Here

Posted by Kingofnowhere at August 13, 2007 09:20 PM

Some responses:

Nick. Well the piece did include some stats. But as I said, monetary policy still works, though this may be another reason why it's been a bit slower than was expected.

Matthew shows an unerring gift for getting things wrong --- where did it say in the piece that the chancellor had cancelled his holiday? Flying back from holiday is very different from cutting it short.

So does Kevin. Of course indirect taxes are included in the CPI. And if things have gone up a lot in price their weighting will increase, not decrease. Why don't you look at the index and its construction?

Did the Fed lose control of monetary policy? I think 1% was too much of a relaxation, but the return to 5.25% represents, as has been said, a normalisation of rates, not a loss of control. And we haven't yet seen a house price crash in the US.

As for UK sub-prime, people are sensing conspiracies where they don't exist. This link will take you to CML research, which includes their article on UK sub-prime (or adverse credit) mortgages, from November of last year:

Posted by David Smith at August 13, 2007 09:59 PM


You are a wind-up merchant clearly. So I will only rise to your bait one last time.
In the same paragraph you say we may get rates at 6.0% or 6.25% by XMAS, or they may cut. I would say that means you are slightly confused, or basically have no opinion.

And as for taking predictions from taxi drivers with the necessary gravity, what are you talking about?

I appreciate everyone should have an opinion, but IF you are a solicitor surely you must be capable of making more considered judgements and comments.

Last I remember, the BoE has infinite resources to pump money. They own the printing presses. They have their finger hovering over the "ON" button. They can pump as much money into the system as needed. It is NOT a fixed amount at their disposal.

Posted by Simon at August 14, 2007 08:38 AM


Within the remit of the expansion of money supply ...

I suppose you do know waht inflation is don't you?

Posted by Pete Balchin, Solicitor at August 14, 2007 08:57 AM

Don't rise to the bait.

Posted by David Smith at August 14, 2007 10:16 AM

David - thanks for your reference to the CML document. I think the discussion about sub-prime in the UK is extremely pertinent now given what has happened in the US (and its consequences).

Previously I had thought that 'sub-prime' denoted a bundle of mortgage types including self-cert mortgages, but now I understand that the definition only includes loans to people with dodgy or non-existent credit histories.

So, if Nationwide's chief economist is correct, and around 10% of mortages in the UK are sub-prime, then what are the statistics for the other types of exotic loans? Does anybody know?

I am thinking of: i) self-cert loans, a significant percentage of which will obviously be based on lies; ii) loans granted on unusually high multiples of verified income (4.5X or more); iii) loans that represent 100% of the value of the property they are secured upon, whether they are FTB loans, BTL loans, or combined loans including equity release where the end result is that the equity has been fully released.

I get the feeling that when you start to add up all of the 'specialist' loan categories in the UK, we might have something to worry about.

Has anyone bothered to conduct a reliable comparative survey of the UK and US home loans market? David - Have you written anything on this?

Any info and/or links appreciated.

Posted by t gumbrell at August 14, 2007 10:11 PM

I'm a loan officer in the US - and I would like to explain a couple of things are unclear in the press in the US. Note: I don't think the press is purposely misleading the public, I believe, after 20 years in the mortgage business that it is a complicated business and one doesn't learn it from the outside looking in . . .

That said, 1) interest rates here were never 1% - PAYMENT RATES on some loans were 1%, but the actual interest rate was much higher. The unpaid interest was deferred, as it now called. Heretofore it was known as negative amortization. Managing a mortgage in this fashion is akin to making the minimum monthly payment on a credit card - except that in this case there is an end to the easy ride, and the payments revert to the actual interest rate.

These loans are being talked about a great deal, and are referred to as sub-prime loans. They are not sub-prime, which is accurately described above as "dodgy credit". To qualify for these loans one's credit had to be very good. They were designed for people with substantial resources, who could afford the increase to their mortgage balance and who would use the money not spent on their monthly house payments to invest in something else . . . two uses for their money, if you will. The first being assumed appreciation of a house they weren't paying much out for and the income they would derive from the extra investment funds.

They were also used speculatively by people who were, in some cases, living above their means, and by some owners of rental properties to improve their cash flow. All based on the remarkable appreciation of real estate we were experiencing when the loans were taken out.

And, there were many of these loans that were done with no verification of income, based on credit criteria. Very good credit criteria.

2) Sub-prime loans - for those with "dodgy credit" were the arms that were fixed for two years and adjustable for 28, or fixed for three years and adjustable for 27. These loans were thought to provide these borrowers with a window of two to three years to repair their credit, and qualify for a lower rate at the end of the fixed period, so they wouldn't actually pay the higher rate.

The real estate market came to a halt, and people couldn't refinance a house that was worth less than the mortgage. There were the ones who had presumed (wrongly) that appreciation would take care of the unpaid interest, and that they would refinance before they had to make the entire payment, not the ridiculously reduced one; and those sub-prime borrowers who had not taken care of their credit issues, and now found they couldn't possibly refinance, and couldn't make the higher payments.

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