The UK government and Bank of England have today announced plans to inject some £50 billion of capital into the money markets by way of an asset swap with the clearing banks of the UK. Under the arrangement the banks will be able to swap a portfolio of their more risky mortgage investments in return for government bonds – with a total of £50 billion on offer during the 3 years scheme. Surely £50 billion will be enough?

On the surface you would surely hope that £50 billion would be enough to bail out the markets and increase liquidity again, but there are some who have their reservations. For many observers the “fix” has come too late to save many leading financials from disastrous losses, but on the other hand why should the taxpayer affectively bail out the banks for what has been a sustained period of greed within the financial sector?

There should be little risk to taxpayer’s money because the banks will be asked to swap assets with a much greater book value that the bonds which they receive in return. The commercial banks have also agreed to underwrite any losses on these asset swaps, thereby ensuring no loss for the taxpayer – in theory!

This type of move has never been seen before in UK markets, then again we have never quite been in a situation like we are today. By affectively switching their more risky assets off balance sheet and bringing onboard bonds which are guaranteed by the government, this should free up a large amount of liquidity. Not only will this liquidity benefit the clearing banks, but it will also allow the smaller financial institutions to borrow in the markets to get their business wheels in motion again.

This is a final throw of the dice by the government and if there is even the slightest hint of failure with this they will lose all face with the markets and voters. The fact that it has actually taken so long to decide upon this action has surprised many, because for the price of the taxpayer’s investment into Northern Rock they could already have had a similar scheme in place.

Many market observers are expecting to see a short term upturn in sentiment and then it will be down to the markets to find a level of risk and reward at which they are most comfortable. This £50 billion is no quick fix, it will not put right the wrongs of the market overnight but it has a great chance of setting the wheels of the economy moving again.

While the current government can afford to wait until 2010 to call the next election, it really will take some time to get the economy back on an even keel. Even though the money markets may start to show more signs of life, and a certain degree of confidence will return, many in the UK will still have to go through the pain of financial losses, employment worries and housing repossessions – which is all part of the boom and bust culture which all developed economies go through at regular intervals.

The news of an impending summit between the government and the Council of UK Mortgage Lenders is rumoured to be taking place this week, but what will they decide? Will it make a difference to the person in the street?

At the same time as Chancellor Alistair Darling was dishing out words of wisdom to the mortgage industry which he has very much helped to destroy of late, it was announced that State owned Northern Rock were not even following the governments lead. Northern Rock have yet to decide whether their variable mortgage interest rate will be changed after last weeks base rate reduction, in direct to contrast to Darling’s call. So is this a case of do as I say, not as I do?

While the government will argue that this truly reflects the independent nature of the Northern Rock, which is supposed to be run at arms length from the authorities, how can they then criticise the rest of the industry?

The mortgage industry in the UK is literally on its knees with increased funding costs, a falling housing market and a government which seem keen to squeeze them as hard as they can in order to curry favour with the public. It is difficult to argue with some of the points which the government have made, but does this latest outburst not deflect the attention from the Treasury at a time when public spending is under pressure, government debt is rising and the economy is stalling?

It will be interesting to see if the minutes of the summit are released, showing the arguments from both sides, because from an outsider’s point of view it would be interesting to see what was said and any changes agreed for the future. However, is it not ironic that all talk of a one off banking sector tax charge (suggested when they were all doing well) has now been replaced by an atmosphere of “let us work together”.

The bottom line is that while the mortgage companies of the UK could no doubt reduce their rates a little further, there is still massive pressure on funding. Many have been critical of the Bank of England who have injected just a fraction of the liquidity which their US and European counterparts have, despite the obvious deterioration in the financial sector. But is this the fault of the Bank of England, the consumer or even the government?

Let is not forget that this is a government who have bragged about the increasingly bright economic future of the UK for some time, the fact that the boom and bust scenario had gone for good and kept wage inflation in the public sector to a minimal. Now the economy is failing quickly, the bust scenario is returning and we are seeing more and more strike action in the public sector, and all in just a couple of years.

Will Gordon Brown get the chance to breathe new life into the economy, will the mortgage lenders play ball or has the Prime Minister lost his iron tight grip on the UK economy?

As if to highlight the limited affect that interest rate reductions are having on the economy, today’s quarter point up in UK base rates by the Bank of England has hardly registered in the financial services sector. While it seems likely that more will follow, possibly in July and September, the difficult situation in the UK financial sector is far from over.

The rate announcement was followed by a wall of silence from the main lenders in the UK with many insisting that they would only pass on rate cuts “where possible”, and some actually reacting by putting up their mortgage rates (and taking away many of their reduced rate offers). The reason for the lack of action can be explained by what is happening with the LIBOR rate (the London Inter Bank Offer Rate) which is the rate at which financial institutions will lend and borrow money between each other. Normally the LIBOR rate is about 0.25% higher than the UK base rate, but at the moment it is about 0.75% higher (reflecting the increased risk and lack of capital), although it did reach a high of 1.15% greater than base rates back in September when the credit crunch really began to register.

In the press we will no doubt see claims that the banks are making extra margin while the rest of us struggle but the fact is that lending and borrowing is a risk related action, and the greater the risk of default, the higher the rate will be compared to the base rate. As we have covered on this blog on a number of occasions, the credit crunch is far from over and slowly but surely it will need to work its way through the system. The main turning point will come when the affects start to diminish and the position of both the UK economy and base rates are at that time, as well as the worldwide picture, will be vital. So what happens in the meantime?

The situation for at least the next 12 months looks very bleak, and while we will see speculation of further rate cuts and assistance from the authorities, as today has shown, the affect of base rates on this current situation is limited. More people will go bankrupt, more people will lose their homes and while there are savings that many of us can make in our daily lives, these may not be enough to save many from hardship.

More and more people are comparing the current situation to the depression of the early 1900s when economies around the world fell for a sustained period of time and people struggled under mountains of debt. Whether the world economy will actually fall into a depression is very unlikely but if we were to receive any more bad news, e.g. another large hike in the oil price, then there is the potential for things to get much worse before they get better.

We all need to tighten our belts and ride out this difficult situation until we start to see the light at the end of the tunnel, although it may be a case of easier said than done for many of us.

They may have been quiet for a while, but the International Monetary Fund (IMF) have now stepped in to deliver a highly critical verdict on the current UK economy, outlook and the problems which lie ahead. While in the recent budget the chancellor stood up and claimed that the UK was well positioned to fight the ongoing credit crunch, and we would not fall into recession, the IMF have delivered a stark counter to those claims.

The UK government have been shown as severely over optimistic with their forecast of growth for 2008 quoted at over 2%, while the IMF believe that the UK economy will only grow by 1.6% this year – so what does it all mean, and will it impact upon everyday life in the UK?

Apart from the fact that a slowing economy will mean less jobs, more unemployment and more strain on the benefits system, if the IMF are correct in their calculations then that will leave a black hole of some £3 billion in the government’s spending plans. This figure is expected to widen to between £6 billion and £7 billion in 2009/10, leaving Gordon Brown in a mess as he approaches the next election. So what can the government do?

Time and time again the government have had the opportunity to try to tackle the worsening position head on, but each time they have buried their heads in the sand. Firstly we need the government to take off their political cap and admit that the UK economy is set to slow sharply over the next couple of years, roll up their sleeves and try to soften the blow as much as possible. Voters would rather they cut back ambitious spending plans now rather than find they have no choice in 12 months time, at which point people have begun to depend on these spending plans. Like King Canute, Gordon Brown and his advisers are trying to hold back the sea knowing that at some time it will surround and engulf them. So how will these funding plans be funded in the event of falling tax revenues?

While the UK authorities have for some time been very vocal in their belief of strong fiscal controls and systems, it seems that slowly but surely these will be loosened as the Treasury are forced to take on more and more debt to fund ambitious funding plans. This will see more and more future tax income used to pay the interest on mounting debts, leaving less and less to spend on public services and the like. As and when the worldwide economy starts to pick up this will mean that the UK is not in a position of strength and we could see other countries power past us, snatching more and more business. It is a very tricky situation…..

It would be wrong to pile all of the blame onto the UK government, who have been as much a victim of circumstance as anything else, but they did not make sufficient provisions in the good times to cover the lean. Out of control spending on public services has left very little in the Treasury pot, at a time when it has never been more vital.

While news that UK base rates have been reduced by 0.25% has been greeted with relief in many areas of business, there are real fears that it is too little too late. In a week which saw the owners of the Egg credit card operation threaten to close down over 100,000 accounts, we are seeing yet further signs that the economy is set for a very tough 12 months to say the least. So what is actually happening?

The impact of the interest rate cut was reduced somewhat by the very fact that everyone in the financial markets knew that this was going to happen, on the back of recent US rate cuts. However, the concerns generated by the move by Egg have further highlighted the real problems underneath the surface, and the concerns that business growth will be severely dented in the short term by the economy and the lack of affordable finance. The Egg situation has been summarised as “house keeping”, but this is from a company who have been on of the leaders in the UK, a company who need to make the business pay and a company who appear to be genuinely concerned about the possible cases of default.

There will come a point whereby the continuous fall in interest rates will kick start the economy, although many believe that this is still some way off. What the markets really need at this moment in time is confidence in the British Government and the Bank of England. Many government figures are brushing off the Northern Rock situation as something unconnected, but the genuine lack of confidence in the skills of the government to handle this difficult financial situation is very much in the foreground.

Time will tell exactly how this current situation pans out, but the lack of confidence more than anything is causing as much trouble as “high” interest rates.

Over the last few weeks and months we have seen regular updates with regard to the amount of consumer debt which has been racked up through the “good times”.  It seems that the total consumer debt in the UK has now reached an unprecedented £216 billion, but is it quite as bad as it seems?

On reflection, the announcement from the Treasury that ISA (Individual Savings Accounts) investments have grown from £29 billion in April 2000 to more than £200 billion today, perhaps shows that things are not as bad as some may have you believe.  This figure has been boosted by the ability to make annual contributions to funds as well as the recent rise in the stock market.

So while credit card, loan and mortgage debts are spiralling higher in the UK, there is some support for those who also have “other investments”. However, it is those who have debts without investments to back them up who will probably be hit hardest over the months ahead.   There is no doubt that the UK economy is slowing and house prices are deflating a little, but it is the possible threat to consumer spending and ultimately employment prospects which is most worrying.

Recent events across the Atlantic have highlighted the fact that after enjoying prosperous times over the last few years the world economy is under pressure.  Overnight these worries were realised n the Far East where markets fell on US considerations. 
Even though we can expect rocky times in the short to medium term, the situation is not likely to be as prolonged as more recent worldwide slowdowns.

It has been confirmed today that according to Treasury figures, the UK housing market is heading for a slowdown rather than a crash as many had feared.  This will be much appreciated news to the stock market, as the housing market can often lead the economy in either direction.  So what is happening?

While the signs in the housing market are mixed at the moment, the general trend is one of reduced demand and softening prices. Probably caused by both the recent credit crunch and ongoing concerns about the future of the UK economy, it seems that some house buyers are holding off for the moment.

The trend at the moment has rubber stamped the Bank of England approach which has been criticised by many economists.  It seems that retaining interest rates at current levels has served to squeeze the mortgage market, and the credit crunch recently added to the pressure (with some mortgage rates being pushed higher). Not for the first time it seems that the Bank of England have been proved correct in their focused approach to the long term situation, and have avoided short term policy changes which may come back to haunt some Central banks around the world.

It will be interesting to see if this steady reduction in house prices continues, and at what point (if any) those with substantial paper profits will look to crystallise their positions.  If the property market does not fall back too far, then there is every chance that the UK economy will avoid a marked slowdown, and we may just experience a period of consolidation - which will hopefully take out much of the “froth” in the market.

While the clamour for a reduction in UK base rates has been growing over the last few days, it seems that the Bank of England are taking a firmer, longer term approach than their US and to a lesser extent European colleagues.  Despite massive pressure to reduce rates, they have held firm in the belief that a reduction now may be seen as fool hardy when the mist clears over the Northern Rock debacle.  So what are the prospects for the UK economy, and is a rate reduction inevitable?

At the moment the economic indicators are suggesting at best a softening of the UK economy, with spending under pressure and mixed signals from the housing market.  This all leads to the general opinion that the UK economy is slowing, a view which would seem sensible bearing in mind the recent credit crunch and the shock many consumers received  from the Northern Rock crisis.  But is a recession around the corner, or should a strengthening of the rate of inflation be our main worry?

Unless we see a drastic worsening of the credit crunch there seems little likelihood of the UK economy actually falling into a recession, although a slow down would seem a distinct possibility.  While the US and European banking authorities have signalled their intentions to reduce rates (with the US having already done so), many are seeing this as a panic reaction.  The Bank of England have always dealt with matters in a methodical fashion, and even in the worst days of the credit crunch there were no panic reactions. 

While some commend this type of strategy, there are many who are calling for the Bank to be more pro-active and reactionary - but this is the Bank of England we are talking about, a banking giant which has seen it all over the years.  The “Old Lady of Threadneedle Street” lives on……

It has emerged since the crash of Northern Rock that many UK financial establishments are actually turning down new business which they would normally have taken on at a seconds notice.  They seem to be under strict orders to keep assets as fully intact as possible, and not open themselves up to over stretching, such as in the case of Northern Rock.  So when will this change?

The credit crunch has not only effected the borrowing financials, it has effected the lending companies who are not as keen to let go of their money at the moment. Unless there is as near to zero risk as possible they have been seriously considering their positions, which will ultimately improve their bad debt situations but possibly reduce their short term profitability.

Those who thought that Northern Rock marked a turning point in the crisis are set to be sorely mistaken, with many analysts forecasting further sector difficulties in the short to medium term - indeed there are even reports that the industry may well let Northern Rock “die a sad death”.  None have been forthcoming to bail the company out, and the longer this goes on the less chance of the company making any kind of revival. 

There is even talk of the authorities stepping in again to finance the company, but this will never happen as that would mean crossing the line to the free market.  Sadly the days of Northern Rock are numbered, unless a bidder comes up very soon!

The credit crunch is set to claim more scalps in the States, with rumours that some of the big players may be experiencing difficulties.  Until the credit crunch has run its course, and no amount of State aid or extra liquidity will effect this, the system will still be on red alert for difficult situations.

Recent events in the money markets have shown that once you sign that mortgage / loan deal, do you really know what happens, and where your liability may end up? Unless you have done some major research into the sector, you will probably not be aware about what goes on behind the scenes.  Let us tell you what happens…….

Once you sign that mortgage or loan deal, there is every chance that your agreement could be split up into many pieces and sold to a number of financial companies around the world.  But how is this done?

Simple!

When you sign a financial agreement you will create two separate income streams, interest and capital, which will be stripped and bundled up with a variety of other financial elements.  By bundling many different qualities of income stream into a new financial instrument, it is possible to create a customised vehicle for any requirement.  Risks and the duration of the instrument can be varied simply by taking on different “strips” of any other agreement.

So in effect you take your mortgage out in the UK and within a matter of days your agreement could be scattered to all areas of the world.  This is part of the problem with the ongoing credit crunch in that nobody really knows who is at risk until the pack of cards start to fall, then A cannot pay B who cannot then pay C, and so on.  After a short period of time, liquidity dries up, finical institutions need to retain their funds, and the internal money market is dead.  Step forward Northern Rock for 75% of that last mortgage they agreed, in the form of a commercial loan, but the funding is not there!

While the above description may sound a little simplistic , it really is that simple.  A lack of confidence in the money markets can lead to banks withdrawing their finance from the markets, which results in other companies not being able to function normally, which results in Northern Rock like situations.

Northern rock is a little different than most banks as it borrows a large amount of mortgage funding from the market, rather than being in a position to use its own assets.  The likes of Barclays, Lloyds, etc are total different in that they are more likely to use their own asset to back 75% of a mortgage agreement, and borrow 25% from the money markets.