Of Heroes and Villains...

So England's pouting multi-millionaire football stars - the ones who didn't want to let something as trivial as the European Championships interfere with their Summer holiday plans - lined up at Wembley and swept the mighty football powerhouse, the USA, off the pitch by a stunning margin of 2:0. Oh, to live in the shadows of such heroes...

Sadly, if one looks at the state of the country, this seems to fit into the general landscape. There appears to be certain quotations which keep rising to the surface and one of them is from Warren Buffett, the Sage of Omaha, and the world's richest man who coined that wonderful phrase that it's only when the tide goes out that one learns who has been swimming naked. It is not the first time that we have used this but as the economic boom of the past years draws to a close, there are evermore situations emerging to which it is the most apt analogy. Prime Minister Brown is probably at this moment charging around the upper floors of Number 10 looking for his Speedos.

Up and down the country in all the media, in the pubs and on the terraces - though not in Austria and Switzerland - all the talk is of falling house prices. The fact is that this in itself is not a bad thing. As all investors know, the desirability of a rising market is merely a question of whether one has money invested or money to invest. Likewise, the opportunities in falling house prices are enormous, especially for the young and the less well off who have watched the dream of their own home vanish further and further into the distance over the past few years. The problem is not in the price of houses; it is in the amount of debt that has been raised against the asset. Negative equity is rearing its ugly head again - the spectre of the mortgage loan being higher than the value of the property used to secure it. Traditional repayment mortgages saw to it that every month a small part of the capital debt was repaid - and after twenty five years, all things being equal, the house owner actually owned the house having, as it used to be said, paid for another row of bricks every month.

House prices would never have risen so far if buyers had not been prepared to perform ever more sophisticated mortgage exercises in order to pay for that 'des res'. - and the banks had not assisted by willingly making such loans available. The poisonous misconception was that equity in a house is created by a rising value, not by repaying the loan. Thus, when the property market turns south that very assumption finds itself wearing the Emperor's new set of swimming shorts.

Over the past decades there has been a sea change in the attitude of of the average household to debt. Think of Charles Dickens' world with work houses and debtors' gaols. Debt was the one thing you didn't want to get into and the one objective in every two-point-four-child-one-car-one-dog household was to repay the mortgage. One borrowed to bridge. The concept of holding debt as a fixed portion of balance sheet, so to speak, was for companies, not for families. Sure, the poorest members of society always found themselves in financial trouble but the Welfare State was established precisely to be there as a safety net for these, the weakest and most vulnerable. The others were supposedly smart enough and capable enough of looking after themselves. Much of that key assumption with respect to joined up thinking now looks to be in trouble as our society appears to be prepared to treat persistent debt as an acceptable feature of everyday life, in many cases without the discipline to manage domestic leverage sensibly.

One of the catchphrases of the 1960's was "the permissive society". At the time it referred to sexual liberation. We still appear to have a permissive environment but it is now one which no longer stigmatises indebtedness or, perhaps more accurately, divesting capital for consumption by people who are still earning income - the notion that you accumulate assets until retirement and then slowly sell them down in order to fund the cost of living has faded away. The very thought of taking equity out of one's house at an early age was anathema but the concept of what has become known as "using one's house as a cash point" was born.

Britain was in an upward spiral of rising house prices, rising consumption and a buoyant wealth effect. Into this came Chancellor Brown who gently but consistently tightened the tax screw and like the rest of the nation spent it on consumption and not investment. Where is the transport infrastructure? Where are the centres of excellence? Where are the engineers? Although public services add to GDP, they do not create value added. It's a bit like trying to convince one's self that buying a new car is a capital investment. When the main contributor to fiscal revenues is consumption tax, be that in the form of VAT, Stamp Duty or Excise duties one becomes a soldier of fortune. When the spending stops, so do fiscal revenues.

In the past months the house price carousel has not only ground to a halt but gone into reverse and the feel-good factor has evaporated faster than a politician can submit an expense claim. The Nationwide House Price Index fell 2.5% in May alone taking it to
-4.4% for the year. The GfK Consumer Confidence Survey came in at -29, its lowest reading since November 1990. Free drinks for anyone who can spot Mr Brown's balloon inscribed "I have abolished the boom and bust cycles" flying past attached to a pig.

All the while, as the banks suffer, corporation tax contributions from the City are falling off a cliff. Just when the former Chancellor needs money to spend in order to help bridge the downturn in the economy, he also discovers that the credit cards are fully loaded and that the small mortgage becomes a big mortgage when the value of the house goes down.

Looking back, the Brown years at the Treasury do look as though their trumpeted success is a bit like celebrating that crushing defeat imposes by the Wembley heroes on our transatlantic cousins. To be sure, the global economic environment has deteriorated significantly in the past year or so - in the USA, the precipitous fall of the housing market began in January 2006 - but the government rode the wave of global growth while behaving as though the boom was all of its own making. Now it is trying to palm the blame for the downturn off on external forces. In doing so it has embarrassed itself and its level of credibility was demonstrated in the Crewe and Nantwich by-election.

Abraham Lincoln said that you can fool all of the people for some of the time and some of the people for all of the time but that you can't fool all of the people for all of the time. Democracy has given us the means to remove governments which get ahead of themselves on that front. However, sadly it looks as though some of the people are being found to be guilty of having fooled themselves.

Looking Ahead

Central Bank Watch:
Monet markets have been pricing in further rate cuts, going forward. However, in the past few weeks this has been reversed and higher or unchanged rates are now being discounted. This is reflected in renewed stress in equity and bond markets. Central Bank watchers are on full alert and markets will swing with any change in sentiment.

Commodities:
Reports are that speculators and hedge funds are exiting rather than entering commodity markets. Meanwhile there is, nevertheless, increasing pressure on regulators around the world to limit the activity of speculators on the commodity exchanges and first proposals should be made public before long.

Real Estate:
Both in the UK and the USA there is little sign of the recovery being "just around the corner" in the residential property market - on the contrary - it looks as though the UK is just beginning its correction. However, the proportion of non-conforming mortgage loans is lower than its sub prime counterpart in the USA. Watch for ongoing reports.

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This article represents a personal and light-hearted view from Director, Justin Urquhart Stewart of Seven Investment Management Limited, and is based on current financial news and events around the world. Its content should not be used for investment purposes and you should contact an independent financial adviser before making any investment or financial decision. Seven Investment Management Limited is authorised and regulated by the Financial Services Authority. Member of the London Stock Exchange. Head office: 23 Austin Friars, London EC2N 2QP. Telephone 020 7760 8777. Registered in England and Wales number 4092911. Registered office: 3 More London Riverside, London SE1 2AQ.