U.S. credit crunch ensnares Britain
LONDON -- As she waited in line here this week to pull her money out of Britain's Northern Rock bank, Helen Levenson asked, "What's the saying? If the U.S. sneezes, Britain catches a cold?"
Levenson, 71, a retired London secretary who once worked on New York's Wall Street, is proof that the crisis in the USA's subprime home-lending business has turned out to be highly contagious.
A credit crunch, sparked by the subprime crisis, prompted depositors such as Levenson to make the first run on a British bank in a generation, developers of London's tallest skyscraper to postpone construction plans and economists to warn that economic growth will shrink.
Effects of the credit crunch are being felt elsewhere on this side of the Atlantic.
The Dutch government says it could knock 0.75 of a percentage point off its economic output next year. And the governor of the Bank of Spain, Miguel Ángel Ordóñez, has had to reassure Parliament that the nation's financial system is "immensely solid," despite a drop in the share prices of banks and construction firms tied to a deflating property bubble.
But Britain appears more susceptible than most of Europe to the crunch, many economists warn. And some, including former U.S. Fed chairman Alan Greenspan, say that Britons could be more vulnerable than Americans.
"It might be fair to argue that Britain is in a worse position than the U.S.," says Adam Slater of Oxford Economics, a British consulting and forecasting firm.
Like the USA, access to cheap credit has fueled Britain's economic growth, which has been unprecedented in the last decade. It's run at a 3% clip in recent years.
Capital from the developing world has poured into London's banks. London's exchanges have become a favorite place for many of the globe's start-up businesses to raise money.
The city's financial sector accounted for a third of the rise in economic growth in the first half of this year.
Financiers pocketed $18 billion in bonuses from March to November, the economics firm Centre for Economics and Business Research estimates.
Consumer spending also has risen. Britain's housing market has boomed, and at a higher rate than in the USA. Prices have soared in the last 10 years.
Now, those pillars of growth are threatened.
Banks are still tallying their losses from the U.S. subprime market, says Jonathan Said, senior economist at the Centre for Economics and Business Research.
British banks, as did others around the world, bought U.S. subprime mortgages. Those are mortgages U.S. lenders sold to borrowers with poor credit histories who didn't qualify for conventional home loans. Rather than keep the loans on their books, U.S. banks bundled the mortgages into securities and sold them.
As U.S. homeowners have defaulted, banks around the world have had to assess how much of a loss they have suffered from the loans they bought.
The tally isn't in yet here.
In the meantime, the banks have less cash for mergers and acquisitions, and are raising borrowing costs to offset losses and their own higher borrowing costs. Said says profits and hefty bonuses are likely to drop, although it's uncertain how far.
"This has been a dominant, driving force in economic growth," Slater says of Britain's financial sector. "Even a relatively modest slowdown is going to have quite a big effect on GDP."
Signs are emerging that the crunch already has spread into the broader economy, hitting businesses and consumers:
•Plans to start building London's tallest skyscraper, "The Shard," near London Bridge next month were put on hold on Monday. Sten Mortstedt, chairman of CLS Holdings, which has a one-third stake in the 72-story building, said it had failed to secure funding for the $2 billion tower because of the crunch.
•New home-buyer inquiries dropped at their fastest rate in three years last month, the Royal Institution of Chartered Surveyors reported last week. And a survey by Rightmove, a property website, showed the average asking price had dropped almost $14,000 since August.
•Home mortgage rates hit their highest point in nine years, the Bank of England reported last week. Although the central bank's official interest rate is 5.75%, many of Britain's 11.7 million mortgage holders were paying as much as 7.69% as their variable rates have increased.
Because of housing, Greenspan says that Britain is more vulnerable to the effects of the credit crunch than the USA.
"Britain is more exposed than we are — in the sense that you have a good deal more adjustable-rate mortgages," he told The Telegraph newspaper in London on Monday. "In Britain, the housing thing hasn't turned yet, and the consumer households are more subject to interest rate changes than in the United States."
Roughly 800,000 British homeowners are due to refinance their mortgages before the end of the year.
Higher rates are arriving at the same time personal debt among Britons is at an all-time high. Consumer debt has surpassed Britain's gross economic output, the accounting firm Grant Thornton reported last month.
Credit Action, a consumer group, says personal debt is rising at $2 million every four minutes. Aside from mortgages, the average British adult is carrying more than $9,000 in unsecured debt via credit cards and bank loans.
Long lines at bank offices
The most visible sign of economic jitters were the Depression era-like lines that formed outside Northern Rock's bank branches Friday morning after Northern Rock had gone to the Bank of England for an emergency loan to meet its obligations.
Although the origins of Northern Rock's problems lie in the U.S. subprime crisis, the bank held little of the American mortgage paper.
Instead, Northern Rock, Britain's fifth-largest home lender, was the victim of the global credit crunch that emerged from the subprime crisis.
Like others, British banks began closing off or raising rates on credit among themselves. That exposed weaknesses in Northern Rock's business model.
Northern Rock relied heavily on raising money in the capital markets to finance its mortgage lending rather than on consumer deposits, as do most other banks. It extended a large volume of loans and lived off a thinner margin from what it charged borrowers and what it paid for capital.
When the crunch hit, Northern Rock couldn't meet its obligations without going to the Bank of England.
Once word on the emergency loan emerged, the run to pull money out began. Unlike in the USA, where deposits up to $100,000 are guaranteed 100%, only the first $4,000 of British deposits are fully backed. After that, only 90% of deposits are protected up to a $66,000 limit.
Levenson says she had no choice but to withdraw her money for fear that she could lose almost 10% of it if Northern Rock went under.
The lines didn't begin to disappear until Tuesday, after the government announced it would stand behind depositors' savings 100%. Even that guarantee from Alistair Darling, chancellor of the exchequer, wasn't good enough for Levenson.
"I don't trust the government," she said before withdrawing her money. "I've put too much in this bank."
Economic conditions worsen
Even before Levenson and other customers put a run on Northern Rock, economic forecasting firms such as Global Insight had cut Britain's growth outlook by almost a third because of the crunch.
Early this month, Global Insight pegged Britain's economic growth for next year at 2.1%, down from this year's 2.9%.
After Northern Rock, forecasts could go lower.
"There is now a very real possibility that growth will be significantly below 2% in 2008, which would be the weakest performance since 1992," says Howard Archer, Global Insight's chief economist for Britain and Europe.
If that seems likely, Archer says, pressure will grow on the Bank of England to follow the U.S. Federal Reserve's lead and cut its benchmark short-term rate, which stands at 5.75%.
If it doesn't, Britain's economic conditions could worsen, some economists say, and end up being worse than in the USA, where it all began.
"We (the United States and Britain) are both catching colds. It's just too early to say whose cold is worse," Slater of Oxford Economics says.