Friday, 12 September 2008

Thoughts on Eastenders and the Credit Crunch

As I was watching television the other day, it occurred to me that there was one part of the United Kingdom which had been completely unaffected by the Credit Crunch. In this place, the two vexed words had never ever been mentioned, let alone caused difficulties. Where was this utopian land which had so entirely shrugged off the economic hardships plaguing the rest of the country? None other than Eastenders’ “keeping it real” Walford.

It’s amusing to speculate what could have happened in Walford in the last year should the tedious scriptwriters been given a free hand to reflect the economic reality. There might have been a run on the Walford Bank; Bradley Branning’s former boss, the admirably complacent housing developer, would have been made redundant after a monumental drop in her company’s share prices, repossessions in Walford would have dramatically increased, Walford market would have suffered a sharp downturn in business and – well, anyway, you get the idea.

From a jobbing commercial property solicitor’s point of view, such stories are all too familiar. The main problem for my clients, who are in any way reliant on finance, is that the banks have not only metaphorically shut up shop but also gone away on indefinite leave without leaving a forwarding address. I can imagine, in a few months time, lawyers reflecting on the good old days when banks used to issue “offers” as opposing to folding or desperately trying to offload huge amounts of debt for a fraction of their value.

Those clients who have long excellent standing relationships with their banks, may find their bank’s lending criteria change bewilderingly on a weekly basis or they may discover that previously reliable lines of credit simply discontinued. Theoretically, this means that cash rich investors are in a good predicament if they want to pick up cheap deals. However, although there is certainly some truth to this, it is not necessarily always the case.

A seller will not wish to be saddled with negative equity and so their asking price will be above their mortgage redemption value. Frequently, this figure will be substantially above current market value. Indeed, I have personally seen this happen time and time again. The seller is then forced to just “tough it out” and hope that the market will turn shortly. But will it?

According to Newton’s laws of gravity, what goes up must surely come down. But if you flip this on its head, does what goes down surely come up?

Generally accepted wisdom is that things will continue to get worse for another couple of years before starting to improve. But this may be akin to the historic prediction that the First World War would be over by Christmas.

“Expert” predictions in newspapers are ten a penny and usually completely worthless. The truth is absolutely no one knows how long this unholy mess will drag on for. Indeed, for all we know, it could continue for at least another decade. Accurate forecasts are virtually impossible due to the complexity of the issues involved and the consistent possibility of unforeseen random events that can powerfully affect the economy. The later factor has been termed the “Black Swan” by Naseem Nicholas Taleeb who has repeatedly shown, in his book of the same name, how unforeseeable events, such as war or 9/11 can have extremely wide-ranging economic consequences

However, one indicator is worth paying attention to: the stock market. In his fascinating book “Wealth, War and Wisdom” published by Hoboken this year, Barton Biggs showed the “wisdom of the market” was repeatedly proved during the Second World War. Financial markets aggregate the knowledge and expectations of their multitude of participants and have an uncanny way of “knowing” what the future holds. In retrospect, one can often look at a chart of broad-market indices and see that the market “called” important turning points by putting in a long term bottom or top, even when those turning points were perceived by few.

For example, in the United States, the Dow Jones Industrial Average declined throughout 1941 as the threat of war increased, fell further after Pearl Harbour and the fall of the Philippines, but put in all-time bottom at the same time as the Battle of Midway which, in retrospect (but crucially not at the time), was seen as the key inflection point of the Pacific War. Even though the U.S. was also at war with Germany and Italy but had not engaged either in a land battle, the market somehow still “knew” that whatever the sacrifices to come, the darkest days were behind.

Notwithstanding all the caveats above, there is a good argument to be optimistic as to the long-term future. If the population continues to increase, there may be a resulting shortage of properties and this can only ultimately force prices up. Furthermore, there is a generally an upward trend in the value of properties in prime areas. Indeed, “trophy” properties are nearly always resilient in a poor economic climate.

The current situation is not particularly helped by the government response. Increasing the stamp duty nil-rate band by £50,000 is largely cosmetic and will have minimal effect in effect in London. It may have more effect outside London but sensible residential purchasers are far more likely to adopt a “wait and see” attitude.

It is worth recalling that the previous stamp duty holiday brought in by John Major’s government for the first eight months of 1992 completely backfired. The threshold for stamp duty was raised from £30,000 to £250,000 (plenty of money in those days!). However, as UK property consultant King Sturges said the effect was “a sharp temporary squeeze in the time taken to complete the average sale as buyers rushed in to complete before the holiday ended.” Prices actually fell in 1992 by 8.3% - the single biggest annual decline in prices ever recorded – and transactions were lower at any other time in the last 34 years at 1.1m.

However, the Government “free” five-year loans opens up an opportunity for potentially lucrative private investment. This is reminiscent of the opportunities produced by the Conservatives’ “right to buy” schemes in the 1980s.

As almost every newspaper headline will remind you, we are living in a difficult, unpredictable era. However, remember, those who bought property in the darkest days of 1992 and then kept that property would have been wealthy fifteen years later. Similar opportunities are arising again for those with foresight and a little courage. Now, what time is Eastenders on?


Jonny Gould said...

A very accurate analysis and your summary about those with courage investing now, will prove the very definition of Risk v Reward in the long-term.

Factors which drive the econonmy are changing so swiftly that it's creating a multitude of new local and global opportunities.

Those that seize the day in this unseasonal period will reap the rewards.

Jeremy Jacobs said...

"As almost every newspaper headline will remind you, we are living in a difficult, unpredictable era".

Isn't it always?

Nice to see the family increasing in numbers on the Blogosphere.