Wednesday, March 3, 2010

Fiscal Troubles in the UK

The fiscal and debt problems in the UK have been discussed and analyzed for a number of months. Just like the US, the Brits took on huge amounts of debt over the past decade to fund, among other things, investments in housing.

And while we've all known the problems would eventually have to be addressed, the day of reckoning always seemed to be far away.

More attention was paid to the problems of the so-called "PIIGS" (Portugal, Ireland, Italy, Greece and Spain) than the UK, but now this seems to be changing.

Today's article in the New York Times provides a good update (I have shortened the piece slightly; full link below):

Britain Grapples With Debt of Greek Proportions

Published: March 2, 2010

LONDON — As Greece’s debt troubles batter the euro, Britain has done its utmost to stay above the fray.

Mervyn King is governor of the Bank of England. The bank's bond-buying program has kept mortgage rates at low levels.

Shaun Curry/Agence France-Presse — Getty Images

The pound fell to $1.4954 on Tuesday, its lowest level against the dollar in months.

Until now, that is. Suddenly, investors are asking if Britain may soon face its own sovereign debt crisis if the government fails to slash its growing budget deficits quickly enough to escape the contagious fears of financial markets.

The pound fell to $1.4954 on Tuesday, its lowest level against the dollar in nearly 10 months. The yield on 10-year government bonds, known as gilts, slid as investors fretted that Parliament would be too fragmented after a crucial election in May to whip Britain’s messy finances back into shape.

The slide in the pound followed a sharper decline on Monday after polls released over the weekend indicated that the opposition Conservatives had lost their clear lead in the election race.

Without a strong political majority to tackle Britain’s lumbering fiscal problems, investors could start to make it greatly more expensive for the government to raise funds, setting the stage for a potential double-dip recession, if not worse.

“If you really want a fiscal problem, look at the U.K.,” said Mark Schofield, a fixed-income strategist at Citigroup. “In Europe, the average deficit is about 6 percent of G.D.P. and in the U.K. it’s 12 percent. It is only just beginning.”

Since the Labour government’s intense fiscal intervention in 2008 and 2009, yields on British government debt have soared to among the highest in Europe. And on a broader scale, which includes the borrowing of households and companies, the overall level of debt in Britain is the second-largest in the world, after Japan’s, at 380 percent of the country’s gross domestic product, according to a recent report by the consulting company McKinsey.


Indeed, the increase in private and government debt here contrasts sharply with the deleveraging that has been going on in the United States.

British household debt is now 170 percent of overall annual income, compared with 130 percent in the United States. In an echo of the United States’ rush into subprime mortgages with low teaser rates, millions of homeowners in Britain have piled into variable-rate mortgages that are linked to the rock-bottom base rate.

As for the British government, it has been able to finance a budget deficit of 12.5 percent of G.D.P. — equal to Greece’s — at an interest rate more than two full percentage points lower only because the Bank of England bought the majority of the bonds it issued last year.


Despite its borrowing and spending excesses, Britain still maintains a triple-A credit rating and much of its debt is long term. But with 29 percent of British bonds held by foreigners, Britain, like Greece, remains highly vulnerable to the vicissitudes of outside investors.

Since early this year, foreign holdings of British bonds have fallen from 35 percent, a trend that has tracked the pound’s decline and contributed to the increase in the yield on its 10-year gilts.