UK Floated by Borrowing Binge

POUND FOOLISH
Borrowing Binge Fuels
U.K. Economic Worries
Consumer Debt Soars
As Mortgages Rise;
Banks Draw the Line

By JOELLEN PERRY
May 10, 2007; Page A1

LONDON -- To understand why economists are increasingly worried about Britain, it helps to look to Adam Smith.

Not the 18th-century Scottish philosopher, but rather a 28-year-old Cheltenham mortgage-debt collector who shares the famous name. Last June, Mr. Smith was in debt to the tune of $50,000. Like many British consumers -- who are even more leveraged than Americans -- he had been borrowing largely to cover his rising living expenses.

Struggling to keep up with credit-card and loan payments on his $1,900 monthly salary, he sought protection from creditors. "I was just trying to live an independent life away from my parents' purse strings, really," says Mr. Smith, a chipper man with a scruffy beard and a pierced tongue. He recently moved in with his mom.

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With inflation at a 10-year high and interest rates set to rise as soon as today from their current 5.25%, concerns about Britain's borrowing binge are gathering momentum. Personal insolvencies in England and Wales last year hit a record 107,288, up almost 60% from 2005. In the first quarter, insolvencies totaled a seasonally adjusted 30,075, up 24% from a year ago. Treasury officials announced in January that they're considering a nationwide financial-education program. The consumer squeeze is particularly worrying for the British economy, reliant as it is on consumption for nearly two-thirds of its output.

"We see the potential for a significant slowdown, primarily via the housing market and the consumer," says Danny Gabay, a director at London-based Fathom Financial Consulting.

Such a slide in one of the developed world's most robust economies would be bad news politically for Prime Minister-in-waiting Gordon Brown, the man who, as chancellor of the exchequer, has overseen much of Britain's economic expansion.

To be sure, many in the past have predicted that rising debt would tamp down the British economy -- now the world's fifth-largest -- and yet it is in its 15th year of uninterrupted growth. And the U.K. has, in recent years, weaned itself from some of its dependence on the consumer, as business-investment growth has far outpaced consumption growth, says Ross Walker, an economist with the Royal Bank of Scotland in London. The International Monetary Fund earlier this year forecast that the economy will grow by 2.9% this year -- not sizzling, but still the fastest pace in the Group of Seven.

And yet, at the same time, a number of the economy's mainstays may be buckling: Immigration, which has helped propel growth is set to slow; the government's six-year spending spree is about to end; and cracks are showing in the property market.

Debt has helped power the British economy's ongoing success, and consumers have spent even as growth in their disposable income has stagnated. Debt, however, is at the heart of the present uncertainty, and debt levels in Britain are certainly eye-catching.

FAULTY CREDIT

The Issue: Towering consumer debt threatens to slow Britain's economy, now in its 15th year of uninterrupted growth.
The Counterpoint: Strong business investment is helping to pick up some of the consumption slack. But for how long?
What It Means: A stalling of growth could pose political problems for Prime Minister-in-waiting Gordon Brown, an architect of the British boom.
Personal debt has reached a record $2.6 trillion. According to the Organization for Economic Cooperation and Development, U.K. household debt as a percentage of annual disposable income hit 159% in 2005 -- the last year for which data is available -- compared with 135% in the U.S.

British banks lost a record $13.6 billion to bad consumer debt last year and are tightening their lending standards. Market leader Barclays PLC says it now declines half of all credit-card applicants. Such forced belt-tightening may be working: For the first time since the early 1990s, credit-card spending last year fell, by 2.2%, from the previous year's level.

Skyrocketing home prices have, in effect, force-fed the debt. Home prices have more than tripled over the past 15 years. In the first quarter of this year, Britain's ratio of average house price to mean income reached 6.1, the highest since records began in 1980, according to lender Nationwide Building Society.

Major mortgage lenders have been doling out mortgages at up to six times a credit-worthy customer's annual income. That's comparable to U.S. standards for high-quality borrowers. Still, with homeowners stretched, home repossessions in 2006 jumped 65% to hit a six-year high of 17,000. That's still low by historical standards, but experts expect the number to rise.


"More and more of people's money is tied up in servicing mortgages," says Chris Tapp, associate director of Credit Action, a debt-education nonprofit in Lincoln. "That means people are having to borrow more and more for just ordinary day-to-day living expenses."

There are other dangers. A big public-sector spending spree that's been greasing the economy's wheels is ending. From 2000 to 2006, boosts in public-sector employment and wages brought average public-spending growth to an inflation-adjusted 4.5%, more than double its long-run average. The government plans to halve that rate in coming years.

But even as public-spending growth slows, taxes will remain high, further squeezing consumers. To finance its largess, in recent years the government has "been looking to raise any tax they could think of," says Michael Saunders, an economist with Citigroup in London, ticking off rises in sales, property and energy taxes among those pinching consumers' pocketbooks.

A slowdown in immigration may also weigh on future growth. When the European Union expanded eastward in 2004, France, Germany and others made it difficult for citizens of the new EU member states to enter their labor markets. Britain, by contrast -- along with Ireland and Sweden -- opened its doors. A sudden influx of some 600,000 immigrant workers from Eastern Europe, particularly Poland, propped up growth. It also helped the housing market.


The British government, however, has said it won't welcome immigrants from the newest EU members, Romania and Bulgaria, as easily. In recent quarters, national statistics showed work-force growth slowing, a potential sign that the net inflow of immigrants is leveling off.

Alongside this, the British housing market may already be starting to sputter. Some surveys have shown a small downturn in the pace of home-price appreciation, though rates remain in double digits. February's new buyer inquiries, a leading indicator for many analysts, dropped to their lowest level since October 2004, according to the Royal Institution of Chartered Surveyors.

Kelvin Davidson, a property analyst with Capital Economics in London, says he expects rising interest rates to take property-price increases down to around 4% by year end. But unless interest rates spike above 6% or the economy slides suddenly, he says, "it'll be an appreciable slowdown, not a crash."

People like drama teacher Andrew Hodson may help spark that slide. The 39-year-old father of two owes about $421,000 on two apartments he had hoped to rent out to subsidize a paltry state pension. But rising interest rates on his variable-rate mortgage and a glut of supply mean rent for his flat in the northern city of Leeds falls some $200 short of his monthly mortgage payments. Future interest-rate increases will push those payments higher still.

"I'm just doing my best to keep my head above water now," says Mr. Hodson, who is married to a theater director. Last week, he applied to change to a fixed-rate mortgage. If that fails, he says, he may have to sell one of the flats.

Mr. Hodson is part of the U.K.'s so-called buy-to-let revolution. The phenomenon took off in 1996 with a law that made it easier to buy property to rent out. Since then, red-hot housing price gains, shaky government pension plans and the promise of a steady supply of tenants in the form of immigrants or young professionals priced out of the property market have made buy-to-let landlords a fundamental feature of the housing market.

Today, buy-to-let owners make up 9% of mortgages outstanding by value. Last year, they accounted for more than 11% of total mortgage lending. The vast majority of this army are amateur landlords like Mr. Hodson. If they start selling, it could trigger the long-feared house-price tumble in the broader British housing market.

Some are already jumping ship. London, where house prices have more than tripled over the past decade, has been the fulcrum of the property boom in recent years. Now, in parts of the city's gritty, immigrant-heavy east, "To Let" signs are as common as kebab shops, testament to an apartment glut.

Outlook Property real-estate agent Daniel Barbanel says many of his clients in the area, worried prices have peaked, are selling: "They're just thinking, I'd better cash in on this now." Home prices are already slowing in many of the 13 countries that share the euro currency.

But signs of a global slowdown aren't swaying other British borrowers.

Early last year, Stephen Holdway, a 51-year-old production worker at a Gillette factory in the southeastern town of Reading, took a $5,000 weekend course run by property-investment company Inside Track Seminars.

Last spring, he and his wife, Ann, refinanced their own home and signed on for three buy-to-let properties -- one in Birmingham, one on a Spanish golf course, and another in Orlando, Fla. The couple, who together earn some $110,000 a year, owe a total of about $1.25 million in mortgage debt and hope the three flats will help fund their retirement. Mr. Holdway, who's never been to the U.S. or Spain, believes any property-price slowdown will be short-lived. "Occasionally you have a blip," he concedes, "but you just have to weather that storm."

Other borrowers are already in trouble. The volume of calls to Britain's largest debt-advice charity, the Consumer Credit Counseling Service, increased by nearly 50% from 2004 to almost 300,000 last year.

Some of the recent spike in British personal insolvencies may come from an April 2004 law change that shortened the amount of time people spend in bankruptcy from three years to one. But increasing numbers of struggling Britons still recoil from bankruptcy's stigma. They are opting instead for an Individual Voluntary Arrangement.

Introduced in the 1980s, IVAs were originally designed for small-business owners. The practice lets borrowers write off as much as 75% of their debt and pay back the rest over five years. They are attractive also because they stay behind the lace curtain, and aren't public: Local newspapers routinely write up news of bankruptcy filings.


As debt levels have risen, so too has the popularity of IVAs. Last year, they totaled more than 40% of individual insolvencies. Despite British banks' increasing reluctance to sign off so much bad debt, analysts say they expect the IVA numbers to continue rising. In the first quarter of this year, IVA totals in England and Wales rose by almost 50% compared with the same period last year; bankruptcies rose 10%.

In the scruffy east-coast hamlet of Barton-upon-Humber, truck driver Steve Bagshaw is a poster-child for the IVA. He entered into one last June when a bank turned him down for a personal loan to cover his debts.

For years, Mr. Bagshaw had kept retailers and banks happy by living it up on credit cards. On a truck driver's income, he made frequent jaunts to Jamaica and Spain, $800 impulse jewelry purchases for his girlfriend, and took scuba-diving lessons. By last year, he owed 13 creditors nearly $100,000.

An Internet search led him to Thomas Charles & Co., one of many firms that has sprung up to specialize in IVAs. The burly, tattooed 48-year-old wrote off three-quarters of his debt, but says he still has to pinch pennies. In the sparsely furnished, two-bedroom flat he now shares with his 20-year-old son -- decorated with Manchester United soccer memorabilia -- he sits and fingers a gold charm around his neck.

The charm depicts Indalo, the symbol of Almería, a Spanish town he used to frequent on borrowed money. "He's supposed to bring you luck," says Mr. Bagshaw. "But he sure hasn't brought me a whole lot of bloody luck."

Write to Joellen Perry at joellen.perry@wsj.com3

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