BOXED IN BY THE CREDIT CRUNCH?

The credit crunch started in the US, but first hit the UK over a year ago with the Northern Rock crisis and has grown in seriousness ever since. The sea change in the world's financial structure is affecting more and more people's lives.

Bank deposits The collapse of three Icelandic banks may be viewed as this generation's reminder that even in the world of bank deposits, the rules of risk and reward still apply. Many people invested in the Icelandic banks because they were regular 'chart toppers' in the interest league tables, but it now appears that the marginal extra rate was there for a good reason, just as it was for BCC117 years ago.

On this occasion, individual depositors were lucky in that the government was willing to fill the gaps left by the Financial Services Compensation Scheme (FSCS), notably for deposits above £50,000. If there had not been such a crisis atmosphere, the government might have decided the FSCS was enough (see page 6).

Mortgages US sub-prime mortgages - property loans to risky borrowers - have been blamed by
many commentators as one of the main causes of the crisis. Once those mortgages started to default, the effect was felt throughout the world because of the way in which the loans had been repackaged and sold to a wide range of institutions.

The backwash in the UK has seen banks and building societies adopt much more cautious lending policies. In some areas of the mortgage market - notably buy-to-let - there has been an over 70% contraction in the number of mortgage offerings.1

If your solution to a cash shortage in the past has been to remortgage, you may now need to rethink your options.

House prices By October 2008, house prices were falling at an annual rate of 15% according to the Halifax. That drop exceeds the entire fall of the early 1990s and looks likely to continue at least well into 2009. The Halifax notes that the current ratio of house price to earnings is 4.92, which is still almost a quarter above the long-term average of 4.0. This view is echoed in data from the Nationwide.

The decline in house prices is a reminder that relying on residential property - be it your home or buy-to-let - as your only retirement/savings fund can be a dangerous strategy.

Pensions The drop in share prices has inevitably reduced the size of many pension funds. For private sector final salary schemes, deficits will generally have widened as a consequence. That could mean higher employer (and employee) contributions in the future, unless there is a major market recovery. It will also increase the likelihood that these schemes will close to existing members - many have already shut their doors to new employees.

For other types of private pensions, including personal pension plans, smaller funds will normally mean lower pensions, although annuity rates have been rising (see page 3). Once again, higher contributions may be required to restore benefits to the original target levels.

If you need help in managing any of the issues raised, let us know.

1. Source: Yourmortgage.co.uk, 30/09/08