FT Alphaville " Britain, still doomed We promised you the second part of Hinde Capital's "Britain is doomed" analysis... ... so here are some choice extracts from the report (which is now up in its entirety on their website): There is a limit to the amount of tax revenues as a share of GDP that any government can extract from the economy. Given the level of expenditure by the UK government, it means that even the maximum level of tax revenues that can realistically be collected cannot cover current expenditure. As a result, significant reductions in government spending are necessary. On the UK housing market: No more so is this true than in the UK. According to the ONS Blue Book, residential property in the UK is valued at some £3.915 trn, of which £3.696 trn is in the household sector, £117 billion in the public sector and £102 billion in the private sector. The substantial value of the residential sector is inextricably linked with successive government policies, which have fostered a culture of home ownership over many decades. Nevertheless, like commercial property markets, housing markets are prone to volatility, and since the 1970s there have been four periods of boom and three periods of bust, excluding the present downturn. The composition of the mortgage market in the UK represents an increasing fragility in UK property. Borrowers are becoming more tied to variable rates, leaving them exposed to base rate rises from the Bank of England, or rate rises independent of the BoE from still beleaguered banks looking to bolster their capital ratios. Both fixed and variable rates look to have bottomed and are turning up even though the base rate remains anchored. Forbearance by lenders only defers the problem and, in the case of interest-only mortgages, could exacerbate the problem as borrowers are more sensitive to rate rises. These structural changes to the mortgage market leave UK property vulnerable to another correction. On the demographic issues Britain faces: Will demographics provide tail- or headwinds to the housing market and how will future generations" total wealth be affected by housing? In the specific context of the UK, ageing will move more slowly than in the rest of Europe mainly due to higher fertility rates in the UK . This is a plus for housing in the long run. However, as the UK economy ages and as the workforce matures, the demand for additional housing will inevitably wane. The best way to think about this that the velocity of housing demand will go down with population ageing; in the future, there will be more households in the UK who already own a house (and who are likely to stay) than there will be new households with a demand for new (and bigger) houses. An interesting observation about the velocity of change in the housing market: The chart shows the share of UK households reporting the same address as a year ago as a function of age. The data is taken from the 2001 census and clearly shows that once the household reaches the 35-49 age bracket (based on household head) more than 80% reports the same address as a year ago. This does not mean, obviously, that such households are inherently immobile, but this chart shows the logical consequence of households making their main housing investment while they are in the 30-45 age bracket (roughly speaking). How Britons are using bricks and mortar as a store of value: A fascinating data point comes from looking at the figures for identified net personal wealth of persons aged 65 or more who died in 2003 (data collected by the HMRC Inland Revenue Statistics). The average value of net wealth of all people surveyed was £213,060 of which 67% (£143,970) was made up of real estate wealth/equity at time of death. The remaining 33% (£69,090) was financial assets. Still the key point is that for all but the most affluent persons in the UK aged more than 65 (who died in 2003) more than 50% of their net wealth was made up of housing at time of death. This is a staggering figure and shows how the old generation has benefitted hugely from the run-up in house prices in the past 3 decades. The key premise we have for this report is that the young generation cannot expect their net wealth to be buoyed by housing to anywhere near the same extent. In general, in the UK the wealth effect from equity in one's house is significant as we have a nearly 70% ownership of housing and almost 50% of a household's assets are in their house. So if housing falls so does both the equity and potentially the income of UK households. And how it's Hinde's opinion that the UK housing market could be uniquely exposed to a flight from gilts: If there is a flight from gilts, then the impact on mortgage rates could be catastrophic banks would be under severe duress and need of capital, so lending conditions will tighten and mortgage rates would rise. Individuals would not be able to service their debt and defaults would rise. Now clearly a collapse in bond prices would also undermine bank equity as their capital base would be destroyed by falling gilt prices which help capitalise them and the double whammy of loan impairments from the housing sector. Overall, the doom scenario seems to be connected to gilts eventually losing their safe haven status and to the fact that - try as they might - policymakers will never be able to rein in debt-to-GDP, which will soon become unsustainable. And when sentiment changes... Reality or cynicism - in the near term we do not believe there are any quick or sure fire remedies that would prevent the UK from coming under greater fiscal scrutiny. The free markets, if we can call them that, will likely execute a damning appraisal of the UK debt dynamics as we outlined. So it is most likely that long lasting reform cannot be implemented soon enough to effect change in the next few years. A question of when rather than if, supposedly. P.S. They advise reducing the welfare state as a solution. And, naturally, buying gold. Related links: Britain doomed, apparently - FT Alphaville Beyond scarcity series - FT Alphaville Britain isn't just in very deep trouble. It's doomed - FT Alphavile The strange case of "funding-for-lending" confusion - FT Alphaville This entry was posted by Izabella Kaminska on Friday, June 22nd, 2012 at 11:55 and is filed under Capital markets. Tagged with britain, gilts, housing.