I’ve watched the roller-coaster of the financial markets over the past days. What does it means for “normal” mortgage holders and pension holders.
Politically the Labour Party are playing up memories 1992 and the disasters of Black Wednesday. Alistair Darling has repeatedly said that the UK “economy is strong” and we should not worry.
I am worried. The financial world has changed a lot in the past decade and the risks we face are very different.
1. Borrowing, whether through mortgages or loans has ballooned. A small movement in interest rates takes more out of the pay packet than before. We are more “sensitive“ to ½ or even ¼ interest movements than we were a decade ago. Fixed rate mortgage deals mean for some there is a time lag before the pain bites. But it does bite. One of the results of the recent market volatility is that mortgage rates in the UK for higher risk (generally lower income) house-owners have climbed again.
2. Savings have also dropped from historic averages of around 8% of income to nearer 4% today. Savers have less put by to help withstand market fluctuations. The risks of investments are also very different. “Investment Funds” are now much more intra-invested across the globe, frequently in complex debt instruments as well as traditional shares. On one hand this has brought “diversity “ opportunites for savers on the other had means that domestic markets are more susceptible to crashes in other overseas markets than in the past.
The trigger for the current market turmoil was the crash in the US subprime mortgage market. People on low income were encouraged to borrow too much, had problems meeting their mortgage payments and that market has crashed. It’s easy to point the finger of blame - in reality many things could have tipped this turmoil. There has been a bull market, many fund managers have taken more risks in many different markets.
3. As we are seeing the markets can become highly volatile even when there are few underlying changes to companies’ business performance or the economy as a whole. As some markets started to drop, others also spiralled as highly complex investment funds chased “liquidity" and had to sell off other seemingly unrelated investments to meet requirements of their own investors and the ratings agencies.
The “Fed” (US central bank) and the European Central Bank have pushed liquidity into the system in the past days, and for now the markets are a bit better. There are still risks in weeks ahead as it becomes clear who has been hit by this volatility.
What does this mean for regulators and for government? Mud-slinging at hedge funds and rating agencies could appear tempting, as would weighing in with a clunking fist of regulation. However regulation and extra controls can also limit growth - remember lots of people, from different income spectrums, have benefited from the growth in the markets over the past few years, as has the whole economy of the South East of England. Pension funds desperately needed the chance re-grow and businesses have also benefited from increased availability of funds.
As the markets have grown in complexity so has a level of self-regulation through rating agencies and market forces. It would be inconceivable for any government to try to emulate that regulation today. Many of those who have lost out in hedge funds are highly sophisticated investors capable of understanding the risks they were undertaking. Just one of the suggestions in the Conservative Policy document “Freeing Britain to Compete” is that these investors should be free of regulatory interference to take their own decisions on risk.
At the other end of the spectrum, there is an increasing gap between those who are aware, educated, and connected to this complex market and its risks and those outsiders who are not. We must forget the low-income mortgage borrowers in the US who were encouraged to take on debts of 100%+ of their homes whose losses triggered this crisis. It is right that those on the outside (often those who can least afford to lose) should be properly informed about the risks they are taking on. Regulation of financial advisors, and mortgage lenders is important but, as in all sectors, regulation should be targeted towards helping to manage sensible risks without stifling opportunity or becoming overly burdensome. Redwood and Wolfson's report this week on competitiveness does not call for an end to all regulation - but to make sure that regulations are disciplined, costed, regularly reviewed and where practical phased out by competitive pressures and market awareness. It is this balance of regulation that is wrong in Britain today.