Why the UK's bad debt boom is just beginning

According to the OECD, most countries are well-placed to cope with a housing downturn. But, judging by the state of Britons' household balance sheets, the UK is unlikely to be one of them.

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"We're not worried about the housing slowdown. Really, we're not. In fact, our big concern is still inflation. No, seriously, it really is." Paraphrasing only slightly, that's what Federal Reserve chairman Ben Bernanke told the world yesterday.

"Yeah, right, bomber Ben" was the resounding reply from the markets, as the dollar continued to slide merrily against every other major currency. The pound breached the $1.95 mark, while the euro climbed above $1.32. Meanwhile, the Dow Jones rose 14 points to 12,136.

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Everyone knows that Bernanke is just like his predecessor, Alan Greenspan. His normal reaction would be to cut rates at the first sniff of trouble - if it wasn't for the vulnerability of the dollar he would probably have done so already.

But now the dollar is on the slide anyway, and his credibility is so tattered that even the stock market laughs off his threats of further interest rate hikes.

Still, not to worry. The Organisation for Economic Cooperation and Development (OECD) says everything's going to be all right

It's no surprise that everyone ignored Ben Bernanke's tough talk on inflation yesterday. US economic data was abysmal - durable goods orders plunged 8.3% in October, their biggest fall for six years; house prices fell at an annual 3.5% rate, according to the National Association of Realtors; while this month saw consumer confidence fall back - unsurprisingly, given the other data.

But it's all OK - everything's going to be fine for the global economy, says the OECD.

Don't worry about the US economy going into a tailspin - Europe and Asia will pick up the slack. And anyway, it's not that serious - the US is only going to see a mild lull that may last "only the first few months of next year," reports Reuters. "What we see is a slowdown, not a recession," said chief economist Jean-Philippe Matis.

And while the US housing downturn - or 'freefall', as some might describe it - marks "the end of a decade-long [property] boom that also occurred across much of the rest of the world," the OECD reckons the impact will be less pronounced in other countries.

'It is comforting to note that in many countries households seem well prepared to cope with the consequences of a downturn in housing markets ... household balance sheets are generally sound and debt-servicing burdens still moderate, although some low-income households may be overstretched.'

We're not sure which countries the OECD is talking about, but if consumers in the UK have sound balance sheets', it's news to Barclaycard. The Times reports that the UK's most popular credit card expects to see bad debts of £1.5bn this year. And the problem has been getting worse - the company wrote off £1.1bn last year.

In the second six months of this year, bad debts on credit cards and personal loans have been written off at a rate of £31m a week. That compares to £26.8m a week in the first half, £22.7m a week in the second half of 2005, and £19.5m a week in 2005's first half.

In fact, the total bad-debt loss is equal to £140 for every one of the company's 11.2m UK cardholders. When you consider that the average balance per customer is £857, you begin to get an idea of the scale of the problem.

The group said that "flows of new arrears and levels of delinquent balances have stabilised", suggesting that the rate of decline may have slowed - but that's not surprising. The bank now rejects 57% of all credit card applications.

We suspect that the 57% that Barclaycard now throws out comprises the target market for many of the sub-prime mortgage lenders currently engaged in a race to the bottom to see who can lend the most money to the least credit-worthy households. And we also suspect that the same people who borrowed too much on their credit cards in the past, are now being allowed to borrow too much against their homes.

The OECD may be right in its optimistic assessment that Europe and Asia can stay strong even if the US runs into trouble. But regardless of what happens to the rest of the global economy, the UK's debt burden almost certainly means tougher times ahead. All of which will no doubt be exacerbated by whatever Gordon Brown's got hiding in his little red bag for us in next Wednesdays Pre-Budget Report.

Turning to the wider markets...

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The FTSE 100 closed 24 points lower but off session lows to end yesterday at 6,025. The share price of insurer Old Mutual plunged nearly 6% on disappointing results, making it the day's biggest blue-chip faller. For a full market report, see: London market close (/file/22288/london-close-us-keeps-blue-chips-lower.html)

On the Continent, the Paris CAC-40 closed slightly lower, slipping 2 points to end the day at 5,306. In Frankfurt, profit-taking saw the DAX-30 close 16 points lower, at 6,281.

On Wall Street, a generally positive response to the latest economic data and remarks by Federal Reserve chairman Ben Bernanke saw the major indices recover somewhat from yesterday's heavy losses. The Dow Jones industrials ended the day 14 points higher, at 12,136. The Nasdaq was 6 points higher, at 2,412. And the S&P 500 closed 4 points higher, at 1,386.

In Asia, Japanese stocks were boosted by stronger-than-expected industrial production data. The Nikkei closed 220 points higher, at 16,076.

Crude oil futures were slightly higher this morning, last trading at $61.07. However, Brent spot was lower, last trading at $60.29 a barrel.

Spot gold was trading at $639.40 this morning. Silver reached its highest level since mid-May yesterday - $13.72 - but had fallen to $13.67 this morning.

And in London, steelmaker Corus announced a 63% rise in core third-quarter earnings this morning. The company, which agreed a takeover offer from India's Tata Steel but is also waiting on proposals for a higher bid from Brazil's CSN, said that higher steel prices had offset the increased cost of raw materials.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.