Bill Jamieson: Mystery of the hide and seek recession

LAST week, a friend in America received a lovely letter from the government. Since these are rare events, and it was such a lovely letter, let me quote it in full:

"Dear Taxpayer, We are pleased to inform you that the United States Congress passed and President George W Bush signed into law the Economic Stimulus Act of 2008, which provides for economic stimulus payments to be made to over 130 million American households. Under this new law, you may be entitled to a payment of up to $600 ($1,200 if filing a joint return), plus additional amounts for each qualifying child. We are sending this notice to let you know that based on this new law the IRS will begin sending the one-time payments starting in May."

Could you ever imagine receiving such a letter here? I thought not. But the aggregate effect of a $160bn stimulus, together with that from interest rate cuts totalling three percentage points and set to have maximum impact six to 12 months out from now, does suggest a disconcerting scenario for us here in Britain. Might it just be that we will be going into a sharp downturn as America is pulling out?

No one knows how the crisis in financial markets is going to play out. But three significant differences have now emerged in the approach to the crisis adopted in the United States and that adopted here.

First, interest rate cutting in America has been speedy and radical, while our response here has been slow and tentative. Second, the US government has announced – and is soon to deliver – a significant one-off tax-cutting boost for the economy. No such luck here.

And third, the US Federal Reserve has made clear, both by word and deed, that it will throw everything at the crisis in markets – including the kitchen sink if necessary – to beat this crisis. Here, the Bank of England has responded timidly, with relatively modest measures to thaw the liquidity freeze. More accommodating support is promised. But neither the scope nor the details have been revealed – as near to a perfect breeding ground as it is possible to get for destabilising speculation and rumour.

I do not doubt that America is now in recession. Nor do I doubt that more measures may be needed – Congress is already working on a proposal to enable the government to buy in some of the sub-prime debt to help put a floor under the fall in house prices. But I would be surprised, too, if the combination of measures announced in recent months will not have an effect on the financial sector, the housing market and the broader economy by the late summer.



But by then, a slowdown here will be unfolding. Citigroup economists have cut their forecasts for UK growth in 2008 and 2009, to 1.4% and 1.3% respectively, well south of the official predictions in Chancellor Alistair Darling's Budget just over a week ago, and representing the sharpest slowdown in any Group of Seven major economy. Of particular note is that 2009 is now forecast to be worse than 2008, suggesting that no real recovery will be underway until 2010.



So far, we have escaped lightly. Indeed, eight months into the global credit crisis, we seem to be in a phoney war with the forecasters. Where is the slowdown exactly? Last week brought news that unemployment UK-wide fell by 32,000 in the three months to January and that the number of people in work reached a record high of almost 30 million. Scotland's unemployment rate hit its lowest level in nearly 34 years, after a further fall last month.

Retail sales showed an unexpectedly buoyant 1% month-on-month rise in sales in February. Total sales volume was 4.7% higher than for the same period a year ago, while sales for predominantly non-food shops rose by 5.3%.

And as for heartland manufacturing, the CBI industrial trends survey for March released last week was markedly firmer than expected, showing order book growth picking up from a four-month high and output expectations hitting a nine-month high. Export orders showed a strong improvement in March, probably benefiting from the fall in the pound in recent months.

So this is a spooky period as we wait for the storm to break. Where is this hide-and-seek recession, exactly?

A slowdown is almost certainly on the way – and it may last longer than that in the US because of the paucity of policy response to date. The advance signs are a slowing down in job recruitment, weakness in durable goods sales and a slowdown in business investment.

But the most worrying linkage is that between the financial crisis and the real economy – bank lending, and in particular lending on mortgages. This in turn impacts on housing market turnover and house prices.

Much of the buoyancy in consumer spending over the past six years has been due to record levels of mortgage lending and a continuing rise in house prices which encouraged households to take on more borrowing and to 'trade up'. This boosted household spending in new furnishings and household items. The banking crisis has brought a sharp and severe curtailment in mortgage products. Not only has the range of such products been dramatically reduced – 100%-plus loan-to-value mortgages have all but disappeared – but supply from wholesale funds, which accounted for some 30% of all mortgage lending, has virtually dried up.

The result is that mortgage lending is now falling sharply. Last week the Council of Mortgage Lenders (CML) reported that gross mortgage lending fell 6.2% year-on-year to £24bn in February. Stretched affordability and tighter lending practices are already taking effect even before the recent escalation of the credit crunch.

Household budgets are under pressure from rising utility, energy and food bills and only modest real disposable income growth since August 2006. On top of the rise in mortgage interest payments since then, many home owners are now having to re-fix their mortgages at significantly higher rates.

Although rates were trimmed in December and February, the overall downward impact on mortgage repayments has been nullified by a lack of funds for lenders and high money market interest rates, as well as lenders wanting higher margins due to increased risks. In addition, the credit crunch and sub-prime mortgage concerns have made lenders much more careful about whom they lend to, and on what terms. The escalating credit crunch is deepening these problems. There were reports this weekend of some of the smaller mutual building societies withdrawing all their home loan offers after it became impossible to secure funding for lending.



As a result there is now a greater risk that a significantly sharper housing market correction could occur. Housing demand will be hit by fewer and more expensive mortgages being available. Furthermore, there is a growing danger that the UK economy will suffer recession, or extended weak growth, and that unemployment will increase significantly. This would be liable to lead to a marked increase in the number of people having to sell houses for distressed reasons, particularly given the extent to which many households have had to stretch themselves to the limit.

Citigroup believes the lack of early stimulus will mean a longer period of interest rate easing. It sees rates down to 4.25% by the year-end, but now predicts a further fall of 50 basis points to 3.75% in the first half of 2009 to restore growth to trend, putting recovery back to 2010.

That long? Remember that we entered the credit crunch with a record level of personal indebtedness, near record lows in household saving and an unsustainable pace of house price inflation. Unwinding this will be all the more extended for the lack of those lovely "Dear Taxpayer" letters.

Northern Rock shareholders draw up their battle plan

WHILE the markets were melting over misplaced rumours of a credit crisis at HBOS, a small room in the historic offices of law firm Edwin Coe was bursting with media folk straining to hear about the latest episode in Britain's other banking crisis.

The room, overlooking one of the green squares dotted around Lincoln's Inn in central London, buzzed with accusations of confiscation, a rigged valuation and a battle for compensation. All of this around the nationalisation of Northern Rock.

Roger Lawson, communications director for the UK Shareholders Association, held court for the best part of an hour as the group, which is backed by 7,000 shareholders, launched its legal campaign for fair compensation for the compulsory purchase of their shares by the Government.

"They have promised to pay some compensation but have rigged the basis of the valuation of the shares so that shareholders are likely to get very little or nothing," said Lawson. Some have suggested this could be as little as 5p a share, "and we also believe it will be a negligible figure", he added.

Lawson, flanked by David Greene, the Edwin Coe lawyer representing the group, accused the Government of making two false assumptions: that the company could not continue as a going concern and that it was in administration.

"Such terms of reference for the valuation of any company are likely to result in a negligible valuation," said Lawson. "In addition the selection of the valuers is solely at the discretion of the Treasury and there is no guarantee that they will be unbiased and impartial."

The group has lodged a letter with the Treasury giving ministers 21 days to respond, after which it would seek a judicial review of the compensation process. It is likely that one of the big institutional shareholders, the hedge fund SRM Global, will join the action. It has already written separately to the Treasury to complain about the valuation process.

The Government is claiming that the company was in effect bust and only survived due to the £25bn of taxpayers' money used to support it. It is likely that it would therefore fight the claim in court.

But ministers are facing a group of determined and well-informed private shareholders who have experience from previous battles, notably concerning Railtrack, the former rail network company.

Apart from this experience, the shareholding group has the means to raise sufficient funds to fight their case which could take 18 months and prove a further embarrassment to Chancellor Alistair Darling and the Government in the run-up to a general election. Politics do not worry Lawson.

He is determined to get a fair deal, and his group is ready to swing into action. He said: "If you look at Railtrack you will see that if shareholders are angry enough they can raise a lot of money: £3m in that case."

He stressed that the action is concerned with achieving a fair valuation though the association's view that an independent valuation might produce a figure closer to £5 than 5p per share.

"This gives you a measure of how much compensation we believe shareholders should be asking for as opposed to what the Government proposes to pay," he said. "But we are not asking for a specific sum of money. We want a fair and independent valuation using normal commercial principles.

"We consider the valuation approach to be unlawful, immoral and unethical and we believe that the Government should not gain by being able to purchase the company cheaply as a result of its own actions."

After taking legal advice the group believes shareholders' human rights have been violated under two pieces of legislation. "Shareholders have been ignored all the way along in this process. They should have some reasonable and equitable protection," said Lawson whose hostility is geared wholly at the Treasury. "The problems at Northern Rock were the run (withdrawal of funds] and what caused that? The Government.

"In our view the Government has confiscated the shares even though there was a good private sector solution on the table that would have enabled the company to recover and repay the debts owed to the Bank of England."