How bad will it get?

30 September 2008

The news that the US Congress has rejected plans to bailout Wall Street to the tune of $700 billion, may not immediately appear to have much impact on you and your finances.

But, in reality, the decision has already had repercussions that could continue to reverberate globally for some time.

The bailout aimed to rescue American banks, by using taxpayers’ money to buy “bad debt” off their balance sheets, thus reducing their likelihood of further write-downs and (hopefully) improving their liquidity.

Although not all experts believed the plan would be enough to solve the current economic problems, others (including President George Bush) previously argued that, without it, the US was to fall into a deep recession and banks would continue to struggle.

Now that the plan has failed, the fear is the current funding issues suffocating the banking sector will continue and other large firms will crash and burn as a result. However, this is by no means set in stone; Hank Paulson, the US treasury secretary who brought the plan before Congress, has stated that it is simply too important to let it fail completely. As such, the issue will be re-addressed later this week and experts hope that another version of the bailout can eventually be approved and introduced.

Worse case scenario

Without the bailout, it is bad news for banks and, therefore, bad news for consumers in the US and beyond.

With banks continuing to struggle in the current climate, and a recession surely just around the corner, the availability of mortgages, loans and other forms of credit to households will continue to remain limited and expensive.

Mortgage rates, which have fallen in recent months in the UK, are now set to increase again as banks attempt to preserve what little funding they have. And lending criteria – such as maximum amounts, deposit size and credit history – are only likely to tighten further.

Even if you already have a mortgage, you face potential problems ahead. For all those homeowners whose fixed or tracker deals are soon to expire, finding a new deal could be a problem. Many will find themselves paying considerably more whether they manage to remortgage onto another deal or simply stay on their current lender’s Standard Variable Rate.

Most people will deal with higher mortgage payments by cutting back in other areas – for example, spending on luxury items. This, of course, will in turn impact businesses and will only fuel the UK’s descent into a recession.

Others will find themselves unable to cope with higher payments, and could end up losing their home if they fall behind. Arrears and repossessions will rise.

With fewer lenders lending, fewer buyers buying, and increasing numbers of homes coming onto the market via repossessions, house prices can only suffer. We’ve already seen a full 12 months of house price falls, with many experts predicting another year of crashing prices.

Now that the US bailout has failed, the housing market downturn will continue for longer and - potentially - at a faster rate.

With the UK already believed to be in a recession, businesses will have to tighten their belts. Unemployment (already on the up) will rise as more job cuts are announced. Those unable to find new positions may well have little choice but to sell their homes – if they can.

Even those that bless the fact they have no financial commitments – such as renters – will feel the reverberations of yesterday’s decision by American politicians. Buy-to-let mortgages are rapidly vanishing from the shelves, and interest rates are increasing, leaving many landlords with little choice but to up rents.

Retirement savers and investors have also been left in anunpleasant position. Stockmarkets have been sent into turmoil as aresult of the bailout failing, putting peoples' retirement pots andother investment strategies at risk.

Simon Denham, managing director of Capital Spreads, says: “As long as banks continue to stop lending to each other, the longer this turmoil will go on. Without this deal, toxic assets remain on private balance sheets, it is most likely that further losses will be incurred, more banks will probably go under and ultimately everyone will get hit where it hurts most.

“The long-term damage is still being done, and it could be a great length of time before we see a revival in the banking sector, and the financial markets as a whole.”

In light of the nationalisation of Bradford & Bingley, borrowers saw the largest decline in mortgage products ever seen in one day, with 11.4% of products being culled. At the start of Monday, there were 3,914 mortgage products on the market, a day later there were just 3,469.

Michelle Slade, analyst at Moneyfacts, says: "This news will be another blow for mortgage borrowers, as not only do they now have a more restricted choice, but the insecurity in the money markets has caused many lenders to increase their mortgage rates.

"If more lenders decide to take the same stance and withdraw their range on a temporary basis, it is likely to cause a bottleneck for the remaining lenders. As the pressure on these lenders increases, service is likely to suffer. As a result we may see further lenders being forced temporarily to withdraw their range.

"Coupled with the liquidity problems in the markets, it may be that we see further increases with this phenomenon in other aspects of lending, such as loans and overdraft rates."

Of course, the chances are America will still bail out its banks in one way or another - it cannot risk the consequences of not doing so.  

But Paul Niven. head of asset allocation at F&C, says that even with a modified form of Paulson's bailout plan likely to be agreed upon in the coming days, a US recession is still on the cards.

He adds: "We are now entering panic territory and capitulation from investors. For all the hysteria over recent weeks this will be the first time that it has become clear that investors are really throwing in the towel on equity markets."

And he warns: "The impact on the global economy of recent events, traced back to last summer, will last for years. Credit will be expensive and constrained for some time. Consumers will not demand it as asset prices continue to decline and incomes are threatened and banks will be unwilling to supply it as efforts to rebuild capital base are ongoing.

"Authorities will pass resolutions to tackle the crisis, hopefully effectively, but the hangover from the banking crisis will be long lasting and profound."

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