You thought the housing crisis was bad in the US? Wait ‘til you see what happens in Britain.

We thought some new top in conceit had been reached when we saw last week’s cover of Country Life magazine.

“Why everyone loves England,” was the headline.

While, the gentry’s rag exalts Britain’s geographic particularities, the headline might be useful for any publication in the country. The travel press could use it in every issue; everywhere you look, vacationers find something to like about England. The tabloids pull it out to describe illegal aliens sneaking aboard ferries in order to make their way into Britain’s robust service industry. And in the financial press, too, that everyone loves England fuels so many heady delusions: such as why property prices always go up… and why Britain’s economy can never go down.

To put it plainly, we spend the next few minutes explaining why the headline may soon get a rest.

Today’s worldwide boom has been the greatest ever. Its leading industry is finance. And the financial capital of the world is right here in London.

Ben Bernanke explained the broad outlines of it in his speech in Berlin earlier this week. Over the last few years, he said, oil producers made more money than ever. So too, Asian exporters booked huge surpluses. They were making so much money they didn’t know what to do with it all, ending up with a “glut of savings.”

Ben Bernanke didn’t mention it, but this wash of foreign savings was further pumped up by an extremely liquid and extremely abundant reserve currency — the dollar. Since Paul Volcker left the Fed, dollars gushed into the world financial system, like sewage into a Chinese lake. And then, whenever the flow threatened to weaken, central bankers rushed to open the valves even wider.

What to do with all this money? The stars lined up… the heavens smiled. And nowhere was the smile wider and more sincere than over the City itself. Many rich people moved to London to spend their fortunes. Others turned to London to help hold onto them. What better way to invest it than through London’s sleek financial intermediaries? What better way to separate a man from his money than with a good accent and an aloof, slightly contemptuous air?

The money flowed; Britain flourished. But in Britain as in America, it was a strange, fantastical boom — fueled almost entirely by credit, the financial industry… and by foreign money. While the City slicker made his millions, the average Englishman got his own portion of ruinously good luck. His house went up 200% in the last 10 years…twice as fast as houses in America. And now the poor man is delusional; he thinks it will never end.

“The City generates so much wealth,” he says.

Alas, a long string of good luck is hard to recover from. But what the financial industry really generates is wealth for a few and debt for many. And now, according to Grant Thornton, British debt has surpassed total GDP — a milestone. Most of the debt is in the housing sector, which has pushed up prices in Britain far higher than those in America, and made the UK even more vulnerable to a downturn. The ratio of housing prices to disposable income — a fairly stable figure in the US — is a rollercoaster in Britain. Today, it is at its highest level ever…with the last major peak in ’89. And Fitch estimates that UK house prices are 20% overvalued, and that Britain is one of the three most vulnerable to a house price crash/correction, after NZ and Denmark.

In America, the National Association of Home Builders says market conditions are the worst in 27 years. Its index of prospective buyers — a leading indicator — is at its lowest level ever. Housing has held up consumer spending and consumer spending has held up the economy. Owners “took out” equity (Mortgage Equity Withdrawal or MEW) in order to continue spending. (Wages actually went down slightly since 2000). Figures are only available through the first quarter, but they show MEW dropping almost in half from a year previously. That represents an amount of money nearly equal to America’s entire GDP growth.

In America, the sub-prime borrower loses his house… and the whole economy sags along with housing prices.

In Britain, it is the Buy-to-Let speculator who threatens to bring down the price structure. He buys his houses — on credit of course — and counts on rental income to pay off the loans. But lenders are now wary… investors are timid… and rates are rising. The spread of three-month LIBOR (London Inter-Bank Offer Rate) over the UK base rate has leapt to a record high. Without fees for sticking bad credits on dim investors, the financiers’ bonuses are bound to fall and so will the availability of cheap finance. At the margin, the BTL investor is no better off than an American sub-prime borrower or leveraged hedge-fund hustler. He will have to sell into a declining market in order to stay solvent. Result: falling prices, less MEW, softening sales, rising defaults, failing economy.

Then, everyone won’t love England quite so much — not even the English.

Regards,

Bill Bonner
The Daily Reckoning

Bill Bonner [send him mail] is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter publishing companies, and the author of the free daily e-mail The Daily Reckoning. He is the author, with Addison Wiggin, of New York Times Business best sellers "Financial Reckoning Day: Surviving the Soft Depression of The 21st Century" and "Empire of Debt: The Rise Of An Epic Financial Crisis". Copyright © 2007 Bill Bonner