News in Charts: UK Chancellor Fires Up the Doomsday UK Debt Machine

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Excessive public borrowing bad. Excessive private borrowing good.

The UK government unveiled its 2013 Budget against a backdrop of flat to falling growth. Since its election in 2010, its focus has been to reduce government borrowing with the aim ultimately of stabilising the public sector UK debt as a share of GDP. The basic narrative being that past mistakes had left the economy burdened with excessive government debt, and that is something that must be dealt with, and not avoided. Fathom has consistently agreed with the broad thrust of this argument – the UK still has the largest structural deficit among its peers, after all.

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However, the same logic has bizarrely not been applied to private sector debt – even though as a proportion of income, it far exceeds public sector debt. Indeed, the most eye-catching proposal in the Budget is the Help-to-Buy scheme. Its main aim is to increase the availability of mortgages, on new or existing properties, for those unable to raise the deposit of 20% or so now required by a more cautious banking sector. It does this by using the Public Sector’s balance sheet to guarantee up to £130 billion of high Loan-To-Value (LTV) mortgages. Specifically, the government will:

• Increase the supply of high LTV mortgages by offering a government guarantee to lenders who offer mortgages to people with a deposit of between 5% and 20%
• Be open to existing homeowners and first time buyers.
• Have no income cap constraint
• Be available on homes with a value up to £600,000

Dash for debt

If you think you might have seen this before, you have. It was called sub-prime lending. By calling it sub-prime, we are not making a moral value judgement. We are simply pointing out that this measure is aimed directly at making credit available to borrowers that the banks would not otherwise lend to in the absence of a significant down-payment. There are good reasons why banks now sometimes require a 20% deposit before lending. First they are still encumbered with legacy mortgages made at a time when risk was a four letter word not to be used in polite financial circles. Second with house prices only sustainable at their current levels with exceptionally low interest rates, prices are vulnerable to a correction, which would leave these loans unsecured.

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It is hard to exaggerate how disappointed we are by this. Suffice to say that had we been asked to design a policy that would guarantee maximum damage to the UK’s long-term growth prospects and its fragile credit rating, this would be it. As we argued in our proposal ahead of the Budget, the UK already has its own version of the US sub-prime problem, called the Buy-To-Let (BTL) sector – (see: http://bit.ly/YqBJD1). But as if that were not enough, this measure could, if successful, unleash a whole new round of sub-prime lending.

New OBR forecast changes – same as the old ones

The OBR has again been forced to revise down its growth forecasts. Compared to the December Pre-Budget Report, the level of output in 2015 is now forecast to be 0.6% lower. Growth expectations for 2013 at least now appear realistic, with the OBR looking for 0.6% compared with 1.2% three months ago. A large part of this near-term downward growth revision is due to a lowering in its expectations for private consumption growth. The OBR now expects consumption growth of just 0.5% this year. However, the independent body is still expecting a quick return to growth of 2% or more over the next few years. The OBR, much like the Bank of England Monetary Policy Committee, has been ritually disappointed with the UK’s growth performance and there is little reason to suspect that this time will be different. There has still not been acceptance of the fact that the financial crisis has reduced the UK’s potential growth rate. Though thanks to the Help-to-Buy scheme, the OBR’s long-awaited increase in household debt might, unfortunately, come through at last.

Debt reduction timetable – further delays

The cyclically-adjusted current balance, which strips out capital expenditure and receipts, and provides an estimate of what the fiscal position would look like if output were in line with potential, is still expected to move into surplus in 2016-17. However, it has worsened by around half a percentage point since the December forecast. Moreover, debt as a share of GDP is not expected to fall until 2017-18, way after the next scheduled election, and even this is based on what in our view are unrealistic growth forecasts.