KEY POINTS:
We are now all familiar with the damage that can be done to financial markets by a sub-prime lending crisis. Global equity markets have taken a battering recently because of concerns about home mortgages in the United States.
So which country is next? The United Kingdom has had
a property bubble every bit as unusual as that in the US. Valuations were stretched and lending criteria loosened. And now arrears are starting to rocket, even while the economy remains healthy.
Not only does the UK face its own sub-prime crisis, it could be much worse than in the US.
The latest figures on debts and mortgage arrears in the UK make grim reading. Households "are getting into more trouble when it comes to their mortgages", said London-based consulting firm Capital Economics.
"With higher interest rates yet to have their full effect, mortgage arrears are likely to rise further, while unsecured bad debt might start to rise again too."
According to the Council of Mortgage Lenders, lenders foreclosed on 14,000 properties in the first six months of the year, 30 per cent more than in the year-earlier period.
That reflected "the impact of an increasing amount of sub-prime lending within the overall market", the council said..
In addition, an estimated 125,100 households are behind with their mortgage payments, about 1 per cent of the total, says the council. Home owners behind with payments will have their homes repossessed a few months down the line, unless their finances improve.
Generally, Britain is deeper in the red than any other major economy. The National Institute of Economic and Social Research in London says the ratio of household debt to personal income is 1.62 in the UK, compared with 1.42 in the US, 1.36 in Japan and 1.09 in Germany.
The UK is now facing a sub-prime crisis on a similar scale to the US. A review by the UK's Financial Services Authority last month criticised reckless lending in the sub-prime sector, which had, it said, "resulted in the approval of potentially unaffordable mortgages".
The British market doesn't fall neatly into "prime" and "sub-prime" categories. Most of the mainstream lenders offer so-called self-certified mortgages, which require no proof of income. Plenty of prime borrowers - meaning people who haven't defaulted on a loan yet - are likely to take out mortgages that will be difficult to pay.
The UK sub-prime crisis may be nastier than that in US.
Despite the mounting evidence that people can't afford them, house prices continue to soar. The National Housing Federation predicted this week that British house prices would rise 40 per cent in the next five years, taking the average value of a home to £302,400 by 2012.
The average British home already costs 11 times the average salary and continues to increase. It is driven mainly by the UK's small geographic size, high levels of immigration and low levels of house building.
The net result is that even as payment problems mount, people will carry on taking out bigger mortgages. In the US, interest rates may have reached their peak and could soon fall. In the UK, that isn't the case.
The Bank of England is likely to raise borrowing costs, at least, once more, to 6 per cent. If the housing market and general inflation don't show any sign of responding to that, interest rates could go higher still. That won't help borrowers already hard-pressed to make their payments.
There should be two self-correcting mechanisms to correct a sub-prime crisis in the housing market. House prices should gently fall, making properties more affordable and reducing the size of loans. And interest rates should stabilise or fall, making loan repayments easier.
Neither seems to apply in the UK Instead, interest rates are rising and so are house prices.
The result is that thousands of families are left in a vulnerable position - and so are the banks that have lent them money (not to mention the investors who have bought those loans as they have been sold on).
While the property market rises, everyone will be safe.
If your house is worth more than your mortgage, you will be desperate to hold on to it.
If you get into trouble, you can always sell it, repay the loan, and move somewhere cheaper.
Yet, as the US has discovered, if house prices start to fall, that arithmetic changes.
If you are in trouble with your mortgage, you can't pay it off by selling. There is little incentive to keep up the payments. Why not just walk away and hand the keys and the problems over to the mortgage company?
Britain hasn't reached that point yet. But if it does, the mess could be even worse than in the US.
- Bloomberg
