London house prices face perfect storm as Brexit risks rise

London houses May17The UK goes to the polls on 8 June in a surprise General Election.  And premier Theresa May has clearly decided to base her campaign on a ”Who governs Britain?” platform, as she highlighted when launching her campaign last week:

“Britain’s negotiating position in Europe has been misrepresented in the continental press, the European Commission’s stance has hardened and threats against Britain have been issued by European politicians and officials. All of these acts have been deliberately timed to affect the result of the general election that will take place on June 8….there are some in Brussels who do not want these talks to succeed. Who do not want Britain to prosper.”

In reality, of course, all that has happened is that Brussels is behaving exactly at Theresa May herself forecast, when campaigning a year ago for the UK to Remain in the EU:

“In a stand-off between Britain and the EU, 44% of our exports is more important to us than 8% of the EU’s exports is to them….The reality is that we do not know on what terms we would win access to the single market…It is not clear why other EU member states would give Britain a better deal than they themselves enjoy. 

May’s rhetoric will no doubt give her a large majority, given the weakness of the Labour opposition.  She has also promised to be “a bloody difficult woman” during the Brexit negotiations that follow the election. But what is good for an election win, may not be such good news for London house prices.  These are at all-time record levels in terms of the critical price/earnings ratio, and were already heading into an inevitable downturn as the City AM chart shows:

  Massive over-building at the top end of the market means there are now 59k high-end apartments under construction in London, yet annual sales of new-build flats are just 6k
  Sales have also been hit by the hike in purchase tax (stamp duty) to 10% above £925k ($1.2m) and 12% on purchases over £1.5m
  The UK’s 2 million ‘buy-to-let’ landlords, most of whom are in London, have also been hit by a combination of a higher tax take on their income and tighter borrowing criteria for mortgages
  China’s capital controls means its buyers have had to pull back, as it becomes more difficult to move money overseas.  They have been the largest buyers of residential property in central London

Now this downturn could well become a perfect storm, as May’s “battle with Brussels” risks an exodus of highly-paid finance and other professionals from London.  As the BBC reports: “More than one million people work in the financial services sector in the UK and it pays over £70bn a year in taxes to the government, 11.5% of all receipts.

FINANCIAL SERVICES ARE PREPARING TO LEAVE LONDON 
The CEOs of the world’s 2 largest investment banks have already warned of difficult times ahead.

  JP Morgan CEO, Jamie Dimon, has warned:  “The clustering of financials in London is hugely efficient for all of Europe. Now you’re going to have a declustering which creates huge duplicate costs which is expensive to clients, but we have no choice.”
  Goldman Sachs CEO, Lloyd Blankfein, has highlighted the risks caused by uncertainty over the terms of the UK’s exit: ”Without knowing how things will turn out we have to plan for a number of contingencies,” Mr Blankfein said about possible job losses. “If there is no period of time to implement whatever changes are brought about in a negotiation, we may have to do things prematurely and we may have to do a range of things as a precaution and take steps.”

Unsurprisingly, buyers are starting to sit on their hands and waiting to see what happens, as The Guardian reports:

“London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a “burnt-out core.”

How much will prices fall, and how long will it take for prices to bottom?  These are now set to become the key questions at London dinner-parties.  Logic suggests prices will need to fall at least 50% to bring them back to more affordable levels.  And the pain is likely to stretch out over years, as leading buying agent, Henry Pryor, has warned:

In my 28 years in the property business, we have done this twice before, and each time it takes around five to seven years before things recover.”

We must all hope that May will use her potential landslide election win to quickly reverse her recent rhetoric, and return to the common sense positions she staked out before the Referendum.  It is not too late for her to agree to remain in the Single Market, the Customs Union and accept the jurisdiction of the European Court of Justice.

Without such a move, London home owners will face a perfect storm as the financial services industry “de-clusters” to Frankfurt, Paris, Brussels, Dublin and Amsterdam next year.

 

UK consumers face difficult times as Brexit unwinds the housing bubble, and financial services de-cluster out of London

UK savings Apr17Brexit negotiations are likely to prove a very uncomfortable ride for UK consumers as Russell Napier of Eric, the online research platform, warned last week:

 ”Public sector debt remains at near-historic highs (in peace time!) and for the first time this public sector debt comes with a private sector bubble
□  Credit card debt is rising at its fastest rate in a decade — 9.3% in the year to February
□  Unsecured debt as a whole is rising at more than 10% and some 6,300 new cars are bought on credit in the UK every day

Companies and investors already face growing uncertainty as March 2019 approaches, as discussed on Monday.  UK consumers now face similar challenges as their spending power is further squeezed by the pound’s fall in value since June, as the chart confirms, based on official data:

   UK earnings for men and women have been falling in real terms since the financial crisis began in 2008
   Male earnings are down 5% in £2016, and female earnings down 2%
   Since June, unsurprisingly, cash-strapped families have had to raid their savings to fund consumption
   New data shows the UK savings ratio hit an all-time low of just 5.2% last year – and was only 3.3% in Q4

One key issue is that monetary policy has reached its sell-by date, with Retail Price Inflation hitting 3.2% in February as a result of the pound’s fall.  Interest rates may well have to rise to defend the currency and attract foreign buyers for government bonds.  Foreigners currently fund more than a quarter of the government’s £2tn ($2.5tn) borrowing, and cannot easily be replaced.

Unfortunately, these are not the only risks facing the UK consumer.  As I feared in June:

   Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
   There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
   This will also undermine the London housing market by removing the support provided by these high-earners
   In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven

Lloyds, the global insurance insurance market, has just announced plans to move an initial 100 out of 600 jobs to Brussels, so that it can continue to serve EU clients.  Frankfurt, Paris, Amsterdam, Dublin and Copenhagen are also lining up to offer attractive deals to companies wishing to maintain their EU passports to trade.  And last month saw an ominous warning from JP Morgan Chase CEO, Jamie Dimon:

“The clustering of financial services in London is hugely efficient for all of Europe.  Now you’re going to have a de-clustering, which creates huge duplicative cost which is expensive to clients. Nevertheless, we have no choice.”

Dimon’s warning was reinforced on Tuesday by the leader of the powerful European People’s Party in the European Parliament, who told reporters 100k financial services jobs would likely relocate from London due to Brexit:

EU citizens decide on their own money. When the UK is leaving the EU it is not thinkable that at the end the whole euro business is managed in London. This is an external place, this is not an EU place any more. The euro business should be managed on EU soil.

Until now, many consumers have been cushioned from the fall in real incomes by the housing bubble.  But as I discussed in December, the end of such bubbles is normally quite sudden, and sharp:

 Worryingly, UK house prices fell in March for the first time in 2 years
  The Bank of England also reported that mortgage approvals are falling
  And normally, lower mortgage volume leads to lower house prices

Certainly it would be no surprise if prices did now start their long-overdue collapse, as highly-paid financial professionals start to leave the UK.  One key indicator – the vastly over-priced 9 Elms development – now has an astonishing 1100 apartments for sale.  And if the housing market does collapse, then recession is inevitable.

The key problem is that consumers do not have many options when the economy moves into a downturn. New sources of income are hard to find if mortgage costs start to rise.  All they can do is to cut back on spending, and boost their savings – to help them cope with any future “rainy days”.  This in turn creates a vicious circle as consumption – over 60% of the economy – starts to fall.

There are therefore no easy answers when trying to plan ahead for likely storms.  But being prepared for a downturn is better than suddenly finding oneself in the middle of one.

The unacceptable face of banking

Dimon, Diamond.pngBanks are essential in any modern society. Their role is two-fold:

• To take in deposits from companies and individuals
• To lend out this money prudently to other companies and individuals

Both are difficult roles to fulfil. Banking therefore requires employees who have both talent and integrity. They must be able to look after people’s money safely, and they must have the ability to manage financial risk.

Most bankers conscientiously aim to fulfil these challenging roles. But the examples of JP Morgan and Barclays highlight how the top leadership of many banks now appears to have a completely different agenda.

JP MORGAN CHASE
CEO Jamie Dimon apparently either never knew that one of his key units was taking vast trading bets, or he didn’t care to ask. He even denied the first rumours of major trading losses, when the story began to emerge in the financial press, calling them ‘a storm in a teacup’.

Today, the size of the eventual losses is still not known. But they are now expected to be at least $5bn.

BARCLAYS
CEO Bob Diamond is the head of a bank that has paid a $450m fine for systematically abusing the process by which LIBOR (London InterBank Offered Rate) was set over many years. This is no small issue.

The LIBOR rate is used to price an estimated $350tn of derivatives. Lenders and borrowers all over the world have potentially been affected.

Astonishingly, both Dimon and Diamond are still in their jobs today. No executve director of either bank has taken responsibility for these scandals and resigned*. This single fact shows the depths of the problem at the top of many banks.

The root cause of this problem was Congress’ 1999 repeal of the Depression era Glass-Steagall Act, which separated commercial and investment banking. Top bank executives abandoned their role as prudent lenders. Instead, they focused on increasing their profits as fast as possible via the use of maximum leverage.

In the process, as we argue in chapter 12 of Boom, Gloom and the New Normal, they encouraged the short-termism that has destroyed many companies. One casualty was the blog’s own former employer, ICI – once the largest chemical company in the world.

As the Financial Times notes:

If, as now seems likely, many banks were involved in fiddling rates, this raises questions not just about the leadership of one bank but that of the whole industry. For there to be a real change of heart and expectation, it may therefore be necessary to retire this generation of flawed leaders. This newspaper does not endorse banker-bashing for its own sake. But if the bashing is to stop, the banks themselves must change.

* The only resignation so far is of 65 year-old Marcus Agius, Barclays’ non-executive chairman. He had been chairman since January 2007, and was presumably coming up to retirement shortly.