February 3, 2013

Chart of the Week: 2013: a fresh start for the UK?

by Fathom Consulting

After a welcome boost from the Olympics, the UK ended 2012 on a disappointing note, contracting by 0.3% in Q4. We expect the UK economy will return to positive, if weak growth in 2013. While a fresh approach to monetary policy offers hope, unless banks can be encouraged to write down their bad debts, and seek new capital, the UK economy will continue to bump along the bottom. We estimate that the failure of UK policymakers to introduce a version of the US TARP programme has, to date, cost the UK more than £120 billion in lost output.

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The UK economic recovery has been modest at best. From the third quarter of 2009, when the economy troughed, through to the final quarter of 2012, economic output expanded by just 3.2% – an average of 1% per year. In our view, this weak recovery can in large part be explained by a substantial debt overhang built up in the years before the crisis. Until these debts have been recognized and dealt with, the UK will continue to bump along the bottom, with growth of around 1% per year.

According to the Financial Services Authority (FSA), between 5% and 8% of UK mortgages are subject to forbearance. It is likely that a good many of these will have been taken out in 2007, when tracker spreads were at record lows, and house prices at record highs. The individuals holding these mortgages are likely to be among those paying near-zero rates of interest. Only able to survive in a near-zero interest rate environment, these are the true economic ‘Zombies’. Fear that these Zombies will begin to default is discouraging banks from lending and restraining growth.

The US introduced its Troubled Asset Relief Program, or TARP, more than four years ago. Shortly afterwards, we advocated that the Bank of England offer something similar, using QE to purchase bonds secured on these troubled assets at something close to fair value. Where the losses incurred meant that recapitalisation was necessary, QE could be used to purchase newly-issued bank equity.

Had the UK introduced its own TARP programme at the same time as the US then, the UK economy might have produced, cumulatively, more than £120 billion of additional goods and services by the end of last year. According to Fathom’s own calculations, this sum far exceeds the cost of recapitalising the banks to make good on their bad mortgage debts.

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