The financial system will be strained by our economic collapse

Anyone on a low income will be in real trouble, while anyone on a middle income will have to drastically cut their budget to make ends meet. But it is the impact on financial stability that should really concern us. Here’s why.

First, a lot of small businesses are going to be struggling this winter. Everyone talks about bailing out households, but hardly anyone mentioned helping independent shops and restaurants that won’t be able to pay huge electricity and heating bills very soon (and let’s not even think of all the tanning salons you see on every High Street – those things use a lot of energy).

Many of them didn’t make much money to begin with. They will soon start closing en masse, and the banks will take a huge hit on the money they have lent to them.

Then the private equity industry racked up mountains of debt and dumped it on the companies they now control. These overstretched businesses are vulnerable not only to rising interest rates — though those will hurt — but also to soaring costs for electricity and supplies.

They were once pressed for every spare penny when times were good. In the event of a downturn, all will struggle, and a few will default.

Third, when around 80% of mortgages are fixed rate – phew! – that still leaves 20% of borrowers with variable rates. They will have already seen their monthly repayments double in recent months, and they could well double again before Christmas. Here is also a guess.

People who didn’t fix their mortgage rates were probably not very good at managing their finances. Some of them will be able to cope with this, as well as huge heating bills, but many will not. Mortgage foreclosures have already increased by 39% in the last quarter (admittedly from low levels) and will climb much higher.

Finally, even the big banks could be in trouble. They have all been stress tested by their regulators. Here’s the catch, though. These tests did not include double-digit inflation for the simple reason that no one thought it was possible. If there’s a cascade of losses on small business loans, followed by commercial landlords running out of tenants, followed by repossessions from people who can’t afford a variable rate mortgage, then a ton of private equity debt turns sour too, so there will be huge writedowns to take. And it won’t be pretty.

In fact, we’ve been here before. The inflation of the 1970s led to the secondary banking crisis and a wave of bailouts, with the collapse of Slater Walker, a high-flying conglomerate-turned-bank. It may be largely forgotten today, but the more subdued inflationary surge of the 1990s was almost as bad.

“The early 1990s witnessed the failure of a large number of smaller banks in the UK,” argued a 2016 Bank article reviewing the lessons of the time. “Although these banks were not in themselves systemically important, the episode was serious enough that the Bank of England provided emergency liquidity assistance to a few of them in order to prevent contagion to larger systemically important banks.”

It would be crazy to think that this cannot happen again. Nor can we be confident that an increasingly unhappy governor, Andrew Bailey, will know about the situation. The Bank didn’t see inflation come down the track and probably won’t have seen it either. Of course, inflation can be transitory and come down again during the following year.

But if it gets out of control, financial markets will be in big trouble – and possibly sooner than anyone imagines.

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Don F. Davis