Interest rates won't stay low for much longer. When the cheap loans end the result will be red-letter bills and repossessions
‘This time the credit crunch will primarily affect ordinary consumers, rather than banks or businesses.’ Photograph: Dominic Lipinski/PA
Come with me into the near future, just two years from now. In spring 2016 things look much the same: another coalition government has been installed; the spending cuts first outlined at the beginning of the decade have begun again; and somewhere on the continent a newspaper is publishing grainy close-ups of Kate Middleton's elbow. Business as usual.
Except for one big difference. By early 2016, the era of record-low interest rates is over. Borrowing is getting steadily more expensive. And the result is starting to destabilise our entire economic model.
Such a vista is clearly visible from our vantage point today. Over the past couple of weeks, senior officials at the Bank of England have dropped hint after hint that it is simply a matter of time before interest rates go up. Few expect the Bank governor, Mark Carney, to lob anything as inconvenient as a rate rise at Chancellor George Osborne this side of a general election – but some of his colleagues are growing impatient. On the front of Thursday's FT, rate setter Martin Weale asked: "The question is: how close are we getting to 'soon'? Of course we can never be sure, but the economy has sustained fairly rapid growth in demand." Which sounds like the monetary-policy equivalent of the backseat child grumping, "Are we there yet?"
You can see why Weale is getting twitchy. House prices in London are rising at an annual rate of 17%. The unemployment rate has dropped below 7% – the point at which Carney initially committed himself to lifting the key rate off its 300-year low.
This narrow range of indicators doesn't amount to a recovery. Yet – and here's one oddity of Britain's economic situation – it does add up to a case for rate hikes. Rather than suddenly rocketing from 0.5%, rates are likely to go up in what the Bank's outgoing deputy head, Charlie Bean, recently described as "baby steps". He might as well have used the metaphor of a frog immersed in water that is slowly brought to the boil.
Which is what makes spring 2016 so important, because while likely to be still early in the slow uphill march of rates, that's the point identified by economist Matthew Whittaker as being "crunch time" for Britain's indebted households.
As chief economist at the well-regarded Resolution Foundation, Whittaker has probably spent more time than anyone else in the country analysing what higher borrowing costs could mean for Britons. His predictions are frightening. Should the key rate hit 3% in 2018, as the market and the Bank's Bean predicts, then about one in three of all mortgaged households will find themselves dangerously stretched.
Within that group, Whittaker identifies 770,000 "mortgage prisoners" – households who, perhaps because they're self-employed or have low equity in their homes, will find it very hard to remortgage on to a cheaper deal.
What he's describing is a second credit crunch – this time primarily affecting ordinary consumers, rather than banks or businesses, and kicking-in in just two years' time. The Resolution Foundation avoids sketching out what the human implications of this consumer credit crunch might be, but they're not hard to infer: red-letter bills, forced sales of homes, and a rise in repossessions. All this at a time when the bulk of Osborne's austerity programme will be pushed towards completion.
In its Financial Stability report last November, the Bank of England noted that 16% of mortgage debt is owed by households with less than £200 left over each month after paying their essential bills and groceries. Imagine such a household has a £100,000 mortgage on a 3.6% variable rate. As the rate goes up in line with the base rate, their monthly mortgage bills will rise from £506 to £644. Between now and Christmas 2018, they'll have paid something like an additional £4,400 solely on home loans. All that before you look at any other debts or financial mishaps they might have.
Looking at these figures, some might say this is the fault of the feckless, of those who wanted newly built flats, German kitchens and exotic holidays during the boom but couldn't afford them. That ain't necessarily so, for three main reasons.
First, as estate agents say, location matters. Look at Northern Ireland, where Whittaker thinks around 70,000 households face mortgage imprisonment. A lot of those people will have taken out perfectly prudent home loans in 2005, 2006 or 2007 – it's just that their properties have halved in value from their pre-Northern Rock peak. A London couple could have borrowed to the hilt in the boom – but they will have been kept afloat by the bubble in the capital.
Second, for each heedless debtor, there will have been a predatory lender. Even at the end of 2007, well after the credit crunch had begun, just under half of all mortgages were given without any proof being demanded of the borrower's income. This was a no-questions-asked market, and both lenders and politicians liked it that way.
Finally, your average cash-strapped Britons, with their wages lagging far behind rising prices, don't have the space to sort out their finances. The story of British households is simply told: we went into the crash with historic levels of debt; we cut back a bit, but are still burdened with debts worth about 140% of our income – higher than the eurozone and even credit-happy America. In cash terms, household debt is way above that racked up by the government – even though the right only bangs on about the latter.
Step back and the big picture isn't even of three-quarters of a million British households unable to pay their way, but an entire country unable to do so. As research from the TUC and others shows, Britons built up so much debt during the boom because they weren't getting paid enough. National income grew, sure enough, but it largely went to those at the top. For the rest of the country, the model was simple: let them eat credit. The result is summed up by former head of the Financial Services Authority Adair Turner in a speech this March: "We seem to need credit growth faster than GDP growth to achieve an optimally growing economy, but that leads inevitably to crisis and post-crisis recession."
During the long bust, the problem wasn't fixed – it was simply shoved under the carpet of ultra-low rates. The existential question facing post-crash Britain is this: if we now rely on cheap debt and tax credits to keep our heads above water, what happens in an era when neither loans nor benefits are so easy to come by?
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