Battening down the hatches - what a Greek exit would mean for the UK mortgage market

At the beginning of the year, I wrote a blog predicting a Greek departure from the euro. I suggested that this was the inevitable scenario given that Greece has debt at 144 per cent of GDP and its economy was and is in a downward spiral of contraction and austerity. Well, now most analysts have come out of the woodwork and seem to agree with my view.

In my posting, I also suggested that although Greece would take a massive hit, optimistically its departure could be manageable if the markets were convinced that no other countries would follow, particularly vulnerable countries such as Spain and Italy. I said that it would need international officials to put a firewall around Greece to avoid the markets getting spooked. Of course all this holds true today although thus far I’m not sure if European officials are doing enough to reassure the markets as witnessed last week. Confusion reigns supreme with Angela Merkel and President Hollande saying that they want to keep Greece in the euro but Christine Lagarde, head of the International Monetary Fund raising the possibility of orchestrating an ‘orderly exit’ for Greece from the eurozone.

So there you have it, although I still predict a Greek exit sooner rather than later, I guess much hangs on how the Greek elections in June turn out.

So what would a return to the drachma mean and how would the UK, in particular the housing market, be affected? It all comes back to my earlier point and how the exit is handled. Worst case scenario it will be complete chaos. In the words of Charles Dallara, the International Institute of Finance chief,  the damage to the rest of Europe from a Greek exit would be ‘somewhere between catastrophic and Armageddon’. Therefore potentially a complete temporary collapse of the banking system although from a UK perspective, Mervyn King, Governor of the Bank of England has suggested that contingency plans are in place were this to happen after warning that the eurozone was showing signs of ‘tearing itself apart’.

Even in the best case scenario, the UK would inevitably be affected by this scenario. Already there are signs that investors are spooked as customers withdrew their monies from Santander UK in the wake of the downgrading of the bank’s credit rating. And we should expect more of this jittery behaviour.

On a national level, certainly economic growth would collapse as our export market would nose dive bearing in mind half our market is in the eurozone. Plus our goods would be that much more expensive to buy as our currency increases in value being perceived as a (relatively) safe haven.

As for the mortgage market, I foresee banks resorting to behaviour last seen at the outset of the Credit Crisis, storing up capital and abandoning aspirations of market share. This is evident already to some extent and with more stringent regulation on the horizon, in the form of Basle III which will have a wide ranging impact on bank’s capital holdings, this behaviour is set to continue.  With total disruption to banking capital markets, it will prove harder for banks to raise new debt and significantly more expensive. So the cost of funding would inevitably rocket and homeowners would be hit by increases in mortgage rates. Banks would be keen to pass on costs to the consumer so upward pricing of mortgages would persist. On top of this mortgage availability would dry up and the possibility of obtaining credit would dwindle. This will inevitably have a knock-on effect to house prices which will fall significantly as consumer confidence is dented further. The exception to this would be the London market where luxury houses in particular will rise exponentially. Already Savills reports that homes costing more than £1.5m jumped by 39% in April as investors from Greece and Spain in particular seek a safe haven for their monies.

All in all, not a rosy picture then. But going full circle, back to my blog again, it all comes down to how orderly our plans are to resolve the situation. Because resolve it we must before we, and our EU partners, can move forward. 

The Chinese Way

What a contrast. Let’s stop for a moment and look at how the UK is dealing with an economic downturn as opposed to China and we will see that we are literally worlds apart.

Just to recap. The UK has gone into a technical recession with GDP shrinking by 0.2% in the first quarter of 2012. Deleveraging is the order of the day. Banks are looking to shore up their capital in light of new regulation which is starting to kick in. Plus they have MMR shadowing them and the impending restrictions on capital requirements resulting from Basle III requiring banks to increase levels of highest quality capital to 7% by 2019.

And Mervyn King is putting in his two pennies worth stating that banks haven’t gone nearly far enough and need to improve their ratios considerably from 20:1. So the resulting impact is that banks are choosing to lend less, both to businesses and consumers. Lloyds Banking Group announced recently that it is planning to cut its share of the UK mortgage market from 28% to 25% and no doubt other lenders will follow. Inevitably credit will dry up or only be available to the less risky elements of society and will be risk priced accordingly.

Sadly of course this will have a knock on impact to the economy with mortgage lending faltering and a subsequent knock on effect to house prices. Thus potentially dampening the economy still further. But let’s wait and see.

And what of China? Well China’s manufacturing activity seems to have turned a corner expanding for the fifth month in a row, easing concerns about a sharp slowdown. The worries about a global slowdown and its impact on China’s economy had seen the country take steps to ease monetary policy in order to boost growth. China’s central bank has cut the amount of money banks need to hold in reserves twice in the past few months to try and stimulate lending in the country. The move saw Chinese banks extend new loans in March, much more than forecast. Analysts said the increased availability of credit had started to have a positive impact on the economy. And subsequently, China’s economy is likely to grow at an annual rate of 8.5% in the second quarter, up from 8.1% in the first three months of the year. So good news for the Chinese.

Of course we have to put in some caveats. The UK economy is vastly different to that of China with different concerns and pressure points. The government, Bank of England and FSA are hugely worried that unless we take these measures we are vastly exposed to a potential second banking crisis. I take on board these points. Still, maybe, just maybe, there are some lessons to be learnt from the Chinese approach?