The real credit crunch has only just begun

Northern Rock is hardly a distant memory - but with the immediate crisis past, most investors are no doubt hoping that we’ll get back to business as usual pretty sharply. But Northern Rock’s woes were just symptoms of a deeper problem in the markets. The days of easy money are gone.

This feature is part of our FREE daily Money Morning email. If you'd like to sign up, please click here: Sign up for Money Morning

Northern Rock is hardly a distant memory - but with the immediate crisis past, most investors are no doubt hoping that we'll get back to business as usual pretty sharply.

The trouble is - as we note in this week's MoneyWeek cover story - Northern Rock's woes were just symptoms of a deeper problem in the markets. The days of easy money are gone.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The bank which has caused Mervyn King and Gordon Brown so much heartache was one of the first to hurt when the credit crunch took hold, because it was among those most reliant on debt to fuel its profits growth - but its by no means the only one.

Profit growth across many sectors in recent years - from retailers to house builders to financial services - has been built on a house-price fuelled borrowing boom. A large chunk of the economy has been reliant on that borrowing binge continuing. But now it's coming to an end.

Northern Wreck was the first casualty - but it won't be the last

It's gradually getting tougher for consumers to borrow the money they need to make ends meet, whether that's through plastic cards, or securing a loan against the house.

Barclaycard is currently rejecting half of all applications for credit cards, and has cut the credit limits for half a million customers since 2006. The credit card unit saw profits fall by 17% in the first half of the year.

Barclays is also thinking of selling its FirstPlus loans unit (that's the one responsible for all those daytime TV loan adverts featuring Carol Vorderman) at a loss. The loans portfolio amounts to £4.5bn, but The Sunday Telegraph reports that Fritz Seegers, head of global retail at Barclays, is so worried about bad debts that he's considering selling it for less than its book value - meaning the business itself would effectively be given away.

It's no surprise that he's worried. FirstPlus generally does second mortgages - mortgages secured against a house, over and above the existing mortgage. That's not so bad when house prices are rising - at the end of the day, if the owner defaults then there's enough money to go round from the repossession to keep everyone happy.

But if house prices are falling, then often, after the first mortgage has been repaid, there won't be any money left over for the second mortgage. So this is an area of business where bad debts could stack up very very rapidly, given the right sort of unfavourable environment.

But it's not just people on the edges of society that will be hurt by the credit squeeze. Economist and stockbroker James Ferguson, who regularly writes for MoneyWeek, recently related to readers of his Model Investor email service about how some of the young City traders he knows could easily find themselves in trouble. Like everyone else, even with their high salaries and huge bonuses, these people stretch themselves to the limit to get on the housing ladder - and of course, bachelor pads in central London don't come cheap.

But because they rely so heavily on their bonuses which may well be much smaller this year and also are seeing their two-year fixed-rate mortgages coming to an end, they could be put in the position of having to find an extra £1,000 a month or so to pay the bills. That's a lot of disposable income suddenly being sucked out of the economy.

James also has some very clear views on why the buy-to-let sector is going to make the next housing slump in the UK worse than anyone expects.

There are companies that can do well in this sort of environment of course. The doorstep lenders, such as Provident Financial and Cattles, have been upbeat on trading recently. They are the traditional subprime lenders - collecting payments from door to door. In recent years, amid easy lending conditions, people who would have had to borrow money from them have been able to go to the high street. But with credit conditions rapidly tightening, they've been forced back to subprime lenders.

However, regardless of how well their specialist credit control systems work, the likes of Provident and Cattles remain exposed to increasing bad debts. A better bet is to opt for a pawnbroker. A pawnbroker's loans are always secured against an asset which can then be sold if the borrower doesn't pay the money back.

A good option is Albemarle & Bond (ABM). Yes, we've been tipping it for a while, but the tough times for consumers - and therefore, the good times for pawnbrokers - have only just begun, so we see no reason why its strong run cant continue. It trades on a forward p/e of around 16.8 which doesn't seem unreasonable given its growth prospects.

Turning to the wider markets

Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email

In London, the FTSE 100 ended the day up 27 points, at 6,456. Randgold Resources led the fallers with a 4.3% drop, whilst British Energy Group headed the gainers with a rise of 6.55%. For a full market report, see: London market close

On the Continent, the Paris CAC-40 was down 12 points, at 5,700. And the Frankfurt DAX-30 was up 51 points, to 7,786.On Wall Street, the Dow Jones rose 53 points, to 13,820. The tech-rich Nasdaq climbed 17 points, at 2,671. And the S&P 500 added 7 points, to 1,525.In Asia, the Japanese Nikkei fell 99 points to close at 16,312 today, whilst the Hong Kong Hang Seng was up 141 points at 25,843.Crude oil had slipped to $81.07 this morning, and Brent spot was at $78.38 in London.Spot gold was at $734.90 this morning. Silver, meanwhile, had risen to $13.54.In the currency markets, the pound was at 2.0254 against the dollar and 1.4358 against the euro. And the dollar was at 0.7089 against the euro and 114.94 against the Japanese yen.And our recommended articles for today...Where to invest in these volatile times- After a dramatic week in the equity markets, you may be wondering whether to snap up a cheap bank - or whether to avoid stocks altogether. However, there are attractive investments around - you just need to be very selective. For Jeremy Batstone Carr's suggestions on which stocks look safest - plus why he thinks UK rates should fall - Where to invest in these volatile timesSoaring milk prices - who will benefit?- Supermarket price-fixing aside, there are plenty of reasons why the price of a pint of milk has rocketed in recent months. In this MoneyWeek article from a few weeks ago - just available to non-subscribers - we look at why prices have been rising and what that means for farmers: Soaring milk prices - who will benefit?

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.