Thursday, February 7, 2008

Credit Crunch Pounds UK Economy

--The global credit crunch is threatening to claim a new casualty: The United Kingdom, a country that has staked its economic success on attracting other people's money. --For more than a decade, the U.K. has reaped vast benefits from its role as a hub for the world's capital, building London into a financial center to rival New York. No large country is more dependent on the movement of foreign money through its banks: Some $2.4 trillion flowed in and out of the U.K. in 2006, an amount equivalent to the country's entire annual economic output, the most recent data indicate. The financial sector accounts for more than one-fifth of all U.K. jobs, compared with only 6% of jobs in the U.S., and contributed about one-quarter of the nation's economic growth over the past five years. --But now, amid the deepening credit-market turmoil, the U.K.'s embrace of financial globalization is becoming a liability. The investment-banking business is already stalling, potentially eliminating thousands of high-paid jobs and demand for everything from tailored suits to high-end hunting trips. As mortgage credit dries up, house prices are sliding at the fastest rate since 1995. And retailers are facing a tough time as consumers, coming down from years of credit-fueled spending, turn decidedly gloomy. --Bank of England officials, in a crucial policy-making meeting today, will decide what, if anything, to do to ease the pain. Economists expect the central bank to take out some insurance against a recession, cutting its short-term interest-rate target by one-quarter percentage point, or perhaps one-half point, from the current 5.5%. But with inflation running above the desired level of 2%, the bank may have little leeway to ease further. Meanwhile, the government, hobbled by a large budget deficit, will be hard pressed to come up with a stimulus package like the one being considered in the U.S. --Much of the prosperity, though, depended on the global boom in credit of the past several years. The pulse of London's financial center, known as "the City," quickened as its bankers invented increasingly complex ways to package and resell all kinds of assets, from high-risk U.S. home loans to European corporate bonds. Over the five years ended September 2007, the financial-services sector grew at an average, inflation-adjusted rate of just over 8%, its most intense stretch of growth in almost two decades. --Locally oriented retail banks, such as mortgage lender Northern Rock PLC, also tapped global capital markets for cash, which they made available to British consumers. The abundance of easy money catalyzed a sharp rise in home prices and boosted consumer spending. But it also drove people deeper into debt as they stretched to buy homes and live large. According to the most recent data from Paris-based Organization for Economic Cooperation and Development, total consumer debt in the U.K. stood at 164% of annual disposable income at the end of 2006, by far the highest level of any developed country. In the U.S., that number was 138%. --As the credit cycle takes a sharp turn downward, many of the businesses that fed the U.K.'s financial sector, from taking companies public to issuing corporate debt, are set for a fall. Among the hardest hit so far have been the complex products in which London-based bankers and traders specialize, such as the collateralized debt obligations and structured investment vehicles, or CDOs and SIVs, that are at the center of the current crisis. "You've got certain sectors that are out to lunch and are likely to be out to lunch for the rest of their lives, or at least for the foreseeable future," says Mr. Kirkwood of Citigroup.

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