With the election of Labour government in May 1997, Gordon Brown became Chancellor of the Exchequer, a position that he held for the next decade. As Chancellor Brown promised the "end of boom and bust" and that he would steer the British economy on a path that would lead to prosperity for all. Indeed in later years, when faced with any criticism of his record on any topic whatsoever, he would respond by claiming that he was responsible for "the longest period of growth" in the United Kingdom's history, a period of ten years during which GDP consistently rose year on year. This was the British Economic Miracle, a period of unprecedented economic growth.

The Great British Housing Bubble

During his first Budget speech as Chancellor of the Exchequer Gordon Brown promised the nation that "I will not allow house prices to get out of control and put at risk the sustainability of the future". We shall see how successful Chancellor Brown was in delivering on this promise.

When the Labour government took office in 1997 the average price of a house was around £58,000. Over the next decade house prices pursued a steadily upward trend, with annual price rises that varied between the 25% experienced in 2002 to the meagre increase of 3.2% achieved in 2005. In fact the over the ten years between 1997 and 2007, the growth in house prices far outpaced the growth in earnings; by October 2007 the average house price was slightly in excess of £186,000 and had therefore had increased by some 200% over the decade, whereas average earnings had increased by a mere 60% or so. Concerns began to be expressed over the so-called affordability of housing, which was generally measured by the ratio of average house prices to average earnings. Over the long term the ratio had the average was between three and a half and four, however by October 2007 the ratio was approaching six, an almost unheard of level.

Naturally there were those who believed that British house prices had become 'over-valued', whilst a few brave souls even pointed at the situation in the United States were house prices were indeed falling after a continuous period of growth stretching back to the 1930s. The consensus however was that Britain was different. It was a small overcrowded island with a growing population where housing was apparently in short supply, and house prices could therefore only increase.

Indeed even as the Americans bemoaned their own Mortgage Meltdown, the British consensus was that it couldn't happen here. Anyone who doubted such a conclusion would have found their concerns allayed by a report from the "Government-backed housing body" known as the National Housing and Planning Advice Unit, who announced in June 2007 that the next generation of homebuyers would be facing average house prices that were ten times their salaries. This body was chaired by Stephen Nickell, a former member of the Bank of England Monetary Policy Committee, and a former professor of economics at both the University of Oxford and the London School of Economics. He was on hand to offer his expert opinion that house prices would grow "inexorably", and that he did not believe a property crash was at all likely, as there would not be a recession to spark it.

Again in August 2007 the Guardian was reporting on how the National Housing Federation had commissioned research from Oxford Economics, who were confidently predicting that the "average English house price will top £300,000 in five years". Buying a house in Britain was therefore clearly a one-way bet. No matter that the talk in the nation's tea shops and public houses was of how "this can't go on forever" and about how "house prices were now ridiculous"; the experts had pronounced, the housing boom would go on forever.

The Recession starts here

Once upon a time mortgages were provided by Building Societies who collectively organised themselves into a cartel and charged more or less the same rate for mortgages and paid the same rate for deposits. Would-be borrowers would dutifully save with the society of their choice in order to win a place in the mortgage queue and thus be able to purchase their own home.

In those days building society managers regarded it as something approaching a mortal sin to lend money for anything other than investment in property, and borrowers were obliged to jump through a number of hoops to prove that the funds advanced had indeed been spent on buying or improving a home. (Although it was often said that there were people who were driving around in their new conservatories.) It all began to change during the early 1980s when the Banks began moving into the mortgage market. This eventually led to the collapse of the Building Society Cartel in 1983, after which the whole market became far more competitive. No longer were anxious borrowers forced to wait months, sometimes years, to qualify for a mortgage, as now there were a range of various institutions all vying for their business. In this new competitive environment lenders became less particular about what their borrowers intended doing with the money once they'd got their hands on it.

The nature of the market also changed once more in the 1990s, as instead of paying what was commonly known as the standard variable rate on their mortgages, borrowers began taking advantage of all the 'special deals; the banks and building societies were offering. Lending institutions began offering mortgages at fixed rates over a period of two, three or perhaps five years, or ones that tracked the Bank of England's base rate, or even ones that offered a discounted rate for a certain period of time.

Therefore whereas in the past someone would have taken out a mortgage with their local Building Society and simply kept up the payments for the life of the loan, now they were taking out a two year deal with one lender, and then often remortgaging with a new lender once the deal had expired. Of course, there were costs to pay in remortgaging, so why not borrow a little more to cover the fees, and while you're about it, why not borrow an extra £5,000 or £10,000 to pay off that annoying credit card bill, buy a new car, or relax on that well deserved holiday in foreign climes? After all that house that was bought for £100,000 four years ago was now worth £200,000. Why shouldn't you feel richer? Why shouldn't you spend some of that profit now rather than later?

Research conducted by the University of Durham on data for the years between 2001 and 2005 showed that some 40% of homeowners were habitually borrowing between an extra £5,000 and £7,500 each year to fund their day-to-day spending which, if nothing else, explained how by the beginning of 2008 around one in ten of the population were indeed spending more than they earned on a monthly basis. The British, it seemed, no longer regarded their houses as simply somewhere to live, but rather as cash machines that generated profits that could be spent on enjoying the good life.

This is the phenomenon known as Housing Equity Withdrawal, being the measure of "new borrowing secured on dwellings that is not invested in the housing market", and which had been dutifully measured, or at least estimated with the kind of accuracy that generally applies to such things, by the Bank of England since at least 1971. In 1998 the Bank of England reported that housing equity withdrawal amounted to a mere £212 million. In the following year the total was £2,472 million and the year after that it was £12,045 million. The total peaked at £57 billion for 2003, but was still running at £42 billion for 2007. Indeed over the decade 1998 to 2007 housing equity withdrawal totalled almost £391 billion, which given that total mortgage debt amounted to some £1.1 trillion in the summer of 2007, meant that around £1 in every £3 that had been borrowed had been used to finance consumption rather than investment in housing.

Indeed the scale of housing equity withdrawal during the Brown decade was of profound significance in the overall picture of the British economy, as the £42 billion borrowed in 2007 amounted to something like 3% of GDP or 4.5% of post tax income. Given that only around 45% of British households had a mortgage (and some who did would never have even considered borrowing extra money for anything other than spending on their home) this provided an indication of the extent to which some people were truly living beyond their means. And of course all these billions of extra spending generated billions of profits for the businesses who provided all the goods and services, as well as billions of extra tax revenue for the Treasury which Chancellor Brown was able to spend on whatever causes he felt were worthwhile.

Everything changed when events in a far away country triggered a chain of events that led to the collapse of the Northern Rock bank in September 2007. The words 'credit crunch' entered the public consciousness, and at one stroke the nation began to consider the notion that house prices might not pursue a forever upwards course. With the prospect of falling house prices now on the horizon, it no longer seemed a good idea to borrow money against the strength of the value of property and spend the proceeds. During the first quarter of 2008 housing equity withdrawal fell to a £5.6 billion; in the second quarter it fell to nothing, and by the third quarter of 2008 stood at a negative £5.6 billion, as British consumers now began injecting funds into rather than out of housing equity. Suddenly the British economy was going to have to survive without the regular injection of £40 to £50 billion's worth of debt financed spending. At a stroke growth disappeared and the economy slammed into reverse gear during 2008.

Professor Nickell's error was to believe that you needed a recession to trigger a fall in house prices, whereas in truth it was the fall in house prices that would trigger a recession.

Debt is Good

Once upon a time people used to worry that at 10% the British household savings ratio was worryingly low compared to the Germans and Japanese who were managing to save in excess of 20% of their income. Not so in Gordon Brown's Britain when we learned to stop worrying about such trivialities. Indeed Brown set the tone for his administration of the nation's finances by launching his now infamous Pensions Raid in 1997 when he raised an extra £5 billion a year in taxes on pension funds. At the time Brown justified this act by calming that it would encourage British companies to invest their profits, rather than distribute them to shareholders. This caused some head scratching amongst those who wondered how increasing taxation on saving would encourage investment. But never mind, in Gordon Brown's world spending was the key to economic prosperity, and saving was of little consequence.

No surprise therefore that the household savings ratio steadily declined throughout the period of Brown's stewardship, and by the beginning of 2008 had shrunk to practically nothing. And whenever anyone sought to question this decline in the nation's willingness to save and suggest that this was a problem that needed attention, they found their concerns brushed aside as being irrelevant. Such as on the 14th June 2007 when John Healey, the Financial Secretary to the Treasury, spoke approvingly of how households now had the "confidence to reduce their contingency savings". The official government line was that the willingness of consumers to reduce their savings and take on debt was unquestionably a 'good thing', as it showed that people were confident about their futures under Gordon Brown's wise economic guidance. After all, the days of "boom and bust" were over, as Brown's fiscal alchemy had apparently abolished economic cycles.

Banking was once a simple business. Banks accepted deposits, and then lent the deposited funds to someone else. By the simple expedient of charging the latter more than they paid the former they duly made a profit. A bank's balance sheet was therefore a relatively straightforward document where the amount of lending on one side was roughly matched by the total of retail deposits they had raised on the other. This was indeed the case for British banks up until the year 2001 when the propensity of the British to borrow coupled with their reluctance to save was such that the banks rather ran out of money to lend. Never fear, the American banks had showed the way by securitising their lending, and transforming loans into bonds that could be parcelled up and sold to investors in the global hot money market.

By the application of this magic formula the British banking system could keep the loans flowing without worrying about having to balance the books, and billions of mortgage backed securities and other instruments were duly sold off to those who had the money to spare. Such as the likes of the sovereign wealth funds of oil-rich states and sundry hedge funds, as well as the Chinese who were piling up the cash accumulated by actually manufacturing the consumer goods the British were eagerly buying on their borrowed money. By 2008 this 'funding gap' was in the order of £600 billion to £700 billion; a truly colossal sum of money in the context of an economy producing some £1400 billion a year.

The crunch came on the 9th August 2007 when BNP Paribas announced that it could no longer place a valuation on certain assets because the market in them had disappeared. Naturally investors became somewhat reluctant to acquire assets whose valuation was uncertain and could not be traded, and so almost at a stroke banks found themselves unable to sell new securities. Suddenly British banks were faced with the problem of how to fund their lending programmes and, even worse, how to refinance their existing loan portfolios as previous issues of securitised debt matured and holders demanded repayment rather than roll their investment on into new issues. This is what killed the Northern Rock, holed the Royal Bank of Scotland, and brought Britain's largest mortgage lender HBOS to its knees, and into a forced marriage with Lloyds TSB.

Welcome to Reykjavik-on-Thames

And so it turned out that the British Economic Miracle was nothing more than one enormous debt-supported spending spree which depended on the willingness of successive waves of home buyers to borrow ever increasing amounts of money to buy ever more expensive housing. It was, in effect, simply one gigantic Ponzi scheme, by which debt was to be handed down over the generations.

What was worse, not only was there billions of mortgage debt, but there were also billions of unsecured personal debt, billions of corporate debt, and billions of government debt. Indeed according to the CIA World Factbook, the United Kingdom had $10,450 trillion of external debt as of June 2007, second in the world only to the United States with $12,250 trillion of external debt and a population five times that of Britain's. Of course there are those who argued that this was not a problem, since the United Kingdom also possesed the odd trillion or two in overseas assets. But then again the same was true of Iceland; the problem being that when the going gets tough, assets become hard to sell but debt abides.

With the great housing merry-go-round at a standstill, and the banking system frozen by a shortage of ready funds, the government's response to the oncoming recession was revealed in the autumn 2008 Budget. It cut the rate of VAT from 17.5% to 15% in an attempt to get the "British consumer spending again", whilst it made repeated, and ultimately futile, calls on the banks to start lending again, as if the only solution was to try and restart the whole merry-go-round and hope that no one noticed. It blamed the Americans or the banks for the nation's predicament, anything other than admit the stark truth that the economic growth supposedly generated during Brown's stewardship of the economy was nothing more than debt piled upon debt.

Indeed, according to one government minister named Paul Myners, matters became so serious that on Black Friday, the 10th October 2008, the nation was three hours away from complete financial meltdown, with the Treasury poised to hoist a 'closed' sign over the entire British banking system. The nation was left to endure steady tide of redundancies and tales of employees accepting wage cuts of 10%, 15%, or even 20%, just to retain their jobs, as companies across the land feared for their very survival, and the Bank of England prepared to deploy its ultimate weapon of firing up the printing presses and simply printing more money.

Let us not even mention the balance of trade, and consider how Gordon Brown turned a trade surplus of £4,459 million into a trade deficit currently running at over £40 billion a year, but such is Gordon Brown's legacy to the nation.

"House prices are a matter of opinion whereas debt is real."
Mervyn King, 2008 AD

"The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance."
Cicero, 55 BC


  • Housing Equity Withdrawal (HEW) Bank of England 29 December 2008
  • House Prices from the Nationwide Building Society
  • Office for National Statistics http://www.statistics.gov.uk/default.asp
  • John Stepek, The truth behind the British economic miracle, MoneyWeek, Oct 24 2007
  • Gill Montia, Mortgage equity withdrawal kept families afloat, FinanceMarkets, December 12, 2008
  • Millions 'spend more than income' 22 January 2008
  • The 10 people most reponsible for the recession, The Times, January 30, 2009

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