A flat market

The depth of the malaise facing the UK housing market was amplified by a research note by Dresdner Kleinwort. This follows the revelation that mortgage approvals from August this year were 98 per cent lower than at the same time the previous year. Dresdner has been researching the situation in the midlands and north of England, stating:

"We believe quoted housebuilders could be forced to issue early profit warnings and are in danger of widespread breaches of banking covenants. The turmoil in the banking sector looks almost certain to take lending to a new low and deter would-be buyers indefinitely, in our view." They reported a fall of between 45%-50% in the average prices of urban apartments, with virtually no volume at all, saying "many developers have gone bust and land in many cases appears to be worthless".

This is the real overproduction for available (paying) demand that lies behind the financial turmoil in the US, UK and elsewhere. The panic on the financial markets is but a reflection of this deeper underlying cause. While the media tend to focus on stock market movements the real issue lies elsewhere - the effect of toxic mortgage-based financial instruments on the money markets. Banks have all but stopped lending to one another - so wary are they of one another's hidden toxic debt - and the three-month London Inter-Bank Offered Rate (Libor) was yesterday at 6.26 per cent, a full 126 basis points above base rates of 5 percent, when the two are usually closely matched. there was a similar mismatch with Euro-Libor and Dollar-Libor.

Yesterday's stock market declines (over 8.5 per cent on the S & P 500 in the US, which is the most reliable index there) were serious too, though the impact of this isn't likely to be nearly as catastrophic for industry as the near-collapse of the credit markets.

In capitalism, asset classes compete for capital investment, driven by the law of value. Over the last 10 years or so since the peak of the dot-com bubble money has poured into property and real estate instead of stocks, leading to a bubble in the former and underperformance in the latter.

Currently, most stock markets are hugely undervalued when seen this way; the best way to see this is to invert the p/e ratio - the (share) price to earnings (profits) ratio for the market as a whole - to give an earnings yield. It is currently over 9 per cent in the UK and rising, while property yields and bond yields are barely half as much, and falling. This sort of gap happens very rarely in history.

This is almost certainly the reason why despite all the mammoth shocks to the system in recent weeks and months (some of which are unprecedented in the entire history of capitalism) the stock markets go down so far but keep bobbing back up again as if an invisible string is tugging them back higher. If it wasn't for this effect, it is likely the plunges on the markets would be more akin to the secondary banking crisis in 1973-4 (which also followed a property bubble) when the UK stock market lost over 70 per cent of its value (as opposed to just under 30 per cent at the time of writing today).

Quite what stage of the bear market recent events prove to be, it is hard to tell, even if some contend that they have all the hallmarks of the sort of 'final capitulation' that marks the bottom (or at least close to it). What is certain though is that the real lifeblood of capitalism's financial apparatus is the money markets. And these are infected with a serious virus for which there is no effective outside antidote, only an internal purging mechanism instead, as banks go bust or swallow one another up.

DAP