the dollar will rock your mortgage
By Selwyn Parker
The crisis at the Northern Rock building society, which prompted the Bank of England to rush to the rescue, is symptomatic of a greater turmoil – the decline of the world’s most important currency
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IN THE global money markets of today, no financial institution is an island. Not even mortgage lender Northern Rock. Friday's bail-out of the Newcastle-based institution by the Bank of England provides a sobering example of how the dollar-generated turmoil in the money markets can threaten the financial integrity of a long-established building society on the other side of the Atlantic.
The hopefully temporary rescue of the mortgage lender, Britain's fifth-largest, also illustrates the dilemma facing commerce in general because of the long-term decline of the dollar and a weakening US economy.
So far the turmoil has hit mainly those companies that deal in financial instruments. The Northern Rock emergency brings it all much closer to home.
Surely going very much against the grain of Bank of England governor Mervyn King, who firmly believes banks must be allowed to suffer the consequences of their own mistakes, Northern Rock was the recipient of the biggest bail-out of a British financial institution in 30 years. The loan - effectively an authorised overdraft - was made in a similar way to the US Fed's current and controversial support for institutions in trouble. It was backed by Northern Rock's collateral in the form of packages of prime residential mortgages, though at penalty rates.
It should not, however, be forgotten that the last time this happened was in 1973, when another major UK lender, Cedar Holdings, a pioneer second mortgage company, got into trouble and threatened to take a good percentage of the banking system with it.
Finally, Northern Rock's predicament provides a nasty reminder of the higher interest rates over the horizon. Just as residential mortgage rates have already started going up - Northern Rock was lending at a loss on some business - so inevitably will commercial rates as the turmoil translates into higher borrowing costs all round. Last week, the cost of funds in the inter-bank market - the prime one that, ultimately, ensures money keeps coming out of ATMs and finances factories - hit a 10-year peak.
According to corporate broker Panmure Gordon, commercial finance deals are already on hold. And although it is only relevant to the US for now, Moody's Investor Services has warned of a sharp jump in company defaults. Unlike Northern Rock, these unfortunates have no chance of a rescue. Although Northern Rock is not apparently a sub-prime lender and has, according to a careful joint statement from the Treasury, Bank of England and the Financial Services Authority, "a good quality loan book", it is ironically a victim of sloppy mortgage-lending practices by similar institutions in Detroit, Tampa and other US cities. This could not have happened even five years ago.
It was no accident that, one after another, the economists who took the lectern at last week's monetary symposium at Jackson Hole, Wyoming, devoted themselves to the sub-prime debacle facing the American economy. There is the likelihood of plummeting house prices - one eminent professor talked of 40% declines, and their long-term effect on the dollar.
The almighty dollar, as it was dubbed by a US paper in 1836, is on the skids.
HOW low can the dollar go? The short answer is that nobody knows but expert opinion generally agrees the greenback still has some way to fall, if only because of the outlook for America. "Currency investors continue to fear the implications of a worldwide credit squeeze on the US economy," dollar guru Stewart Douglas observed this week.
The situation will become clearer later this month when the Federal Reserve, whose every pronouncement used to shift the world currency markets, votes whether to cut official rates. If it does, "this will come ultimately at the expense of the value of the dollar", Douglas adds. Everybody is just hoping the greenback does not fall off a cliff and drag Britain and Europe with it.
Meantime, it says a lot about the loss in the dollar's pre-eminence over the past few years that it dropped to a record low against the euro last week - a slump of more than 2%- without sowing panic into the money markets. It dumped the dollar index - the greenback measured against a basket of other currencies including the pound - to a 15-year low. It has breached the historic $2 barrier against sterling.
Need medium-term proof?
Since the start of 2006, the dollar has collapsed 12.5% against the admittedly high-flying euro and nearly 15% against the pound. President George W Bush has presided over the transformation of the dollar from a deity among currencies to merely mortal.
Longer-term proof? The dollar has lost value on average against a basket of other currencies since 1970, in fact since the resignation of President Nixon. It has jumped once or twice, notably in the high-tech bubble in the late 1990s, but then resumed its descent. Even once-despised Asian currencies such as Thailand's baht appreciated 15% against the greenback over 2006.
The reason? As practically everybody agrees, the dollar's misfortunes are the result of the biggest spending spree since the "Roaring Twenties" which ended, some will remember from their history books, in the Wall Street crash of 1929 and the consequent Great Depression.
Trillions of dollars of Treasury bills were issued to fund the Big Spend and a vast percentage of them have, for the first time in history, ended up in foreign hands. Thus the US has fallen hostage to creditors such as China, an unthinkable position even a decade ago. It was not that long ago that $2 billion flowed into America every single day. Now the position has reversed.
Pending further startling developments, for now though the pressing issue is how the dollar's hopefully orderly descent will affect the UK economy.
The best way to look at it is to reverse Britain's experience with the sick pound over a 30-year period. In short, the boot is on the other foot.
Anybody alive in 1967 will remember the infamous observation of prime minister Harold Wilson who comforted Britain after the November devaluation of sterling by saying: "It does not mean, of course, that the pound here in Britain, in your pocket or purse or in your bank, has been devalued."
As far as it went, the statement was correct. Wilson, who had studied economics, was only saying that the quid in the pocket lost 14% - the amount of the devaluation - when it was taken abroad.
However, he neglected to explain that the value of the domestic quid was directly affected by a devaluation, even in the purse of somebody who never went beyond Gretna. Even 40 years ago, before currencies became globalised and traded around the world 24 hours a day, the buying power of sterling was influenced for good or ill by outside forces.
On the minus side of the ledger, Wilson's devalued pound made imported goods 14% more expensive to buy, at least from those mainly non-Commonwealth countries that did not devalue in tandem.
At the time that meant everything from oil to wool. Thus it cost more to drive a vehicle, pushing up the cost of distribution, and to heat factories and homes. Certain clothes became more expensive. Imported luxury goods were hard to come by in Britain and products that had not been luxuries soon became so. Britons travelled abroad less, unless it was to countries that also had low-rated currencies. And because sterling was weak and the debt markets nervous, commercial loans became more expensive, slowing growth and general prosperity.
But it also made exports easier to sell, boosting Britain's manufacturing industries and any other sector doing business abroad. It also made British assets cheaper to buy and there was a rush of foreign capital into Britain to snap them up. The tourism industry benefited because hotels, transport and package deals were more affordable for dollar-denominated visitors. Those few Britons with US investments banked dividends up by 14%.
It is now a different world for currencies. It is markets, not governments, that set the price of their sovereign coin.
SO where do we stand? Oil prices, which are denominated in dollars and have skyrocketed since 2004 from US$37 to US$78 a barrel, should fall in sterling terms. Heavy machinery, Chrysler cars and other goods imported from the US will become more affordable.
Holidays in the States will become even cheaper than they already are, to the benefit of British Airways and other UK-based carriers. Indeed one of the reasons Ryanair and other airlines have trans-Atlantic plans is because they expect the dollar to continue to fall.
However, exports should suffer and dollar-denominated earnings fall. Ditto for those on the receiving end of dividends from such London-listed companies such as BP which pay them in dollars. The crystal ball is cloudy for Scotland's whisky industry. Although the US is its biggest market, spending £400 million a year on our blends and malts, it is a premium sector that, if not immune to the lower buying power of the dollar, is in a better position to ignore it.
It is hoped the same applies to tourism. Nearly a quarter of all visitors to Scotland hail from the US and two thirds of them come to play golf; the biggest spenders of all tourists in an industry worth over £4.4bn a year, Americans leave on average nearly twice as many pounds behind as everybody else.
However, in Britain at large, it is pretty much certain that tourism and its infrastructure will suffer. For instance, Americans flying to Britain will be more likely to buy seats on their own carriers. The airlines can only hope to make it up through UK bookings.
But what are the prospects for Northern Rock and its thousands of mortgagees? Having examined the books, the government seems happy enough that its business is sound and will recover. However, it serves as a useful example of what has gone wrong in the money markets over the last three weeks. Unlike historic building societies, it does not have a big base of deposits and itself borrows some 70% of its financial resources at relatively short-term rates. Thus it lends long but borrows short, classically dangerous banking practices.
All up, it means that Northern Rock is not the place to go for a mortgage for a while - it has practically shut up shop until it gets liquid again. And that will depend on how long it takes for the dollar-denominated ruckus in the money markets to settle down.
sundayherald.com
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