London's housing bubble is beginning to burst. The first effects are already being felt in London and it is very likely that over the next few weeks the prices of residential and commercial property will experience a slump of nearly 20 percent, according to estimates of various analysts in Europe.
Is this a problem unique to the UK? Not exactly. The finances of the big British banks are deeply intertwined with the rest of the world. This catastrophe will likely spread to Europe and thus Italy, where the banks already face major problems satisfying the need for new credit and the urgency to rid themselves from the burden of bad loans. It seems the stage has therefore been set for an extremely hot summer in the Italian finance world, making it all the more important for Brussels and Rome to negotiate a meaningful intervention that aids Italy's banks.
But what exactly is happening in London and what are the first signs of a crisis? Recently, six important real estate funds which operate in England announced that they have frozen investors from withdrawing money. Among the six institutions, four are considered pillars of the real estate market: M&G, Henderson, Standard Life and Aviva. How do these fund work and what precisely do they do? Basically, they collect funds through complex financial means (using capital as well as debt) and buy up the big commercial centers and office buildings throughout the city.
By managing these properties, they are able to reimburse their investors and their stability rests on the value of the properties themselves. However, post-Brexit, many institutional as well as single investors are asking to withdraw their money, based on the understandable fear that many companies based in London could start abandoning their offices. The funds are not in a position to meet these requests, given that they do not have the liquid assets and will not have them for months, or even years, since gathering that amount of assets would require them to put property on the market. Naturally, placing an immense number of houses and offices on the market will cause prices to drop drastically, thus bursting a real estate bubble that was disproportionately inflated over the last few years thanks, in part, to wealthy Russian, Arab and Asian investors.
The greatest danger, however, does not lie in the bursting of the real estate bubble itself, but rather in the way it will affect the financial sector, as well as the mortgages and loans of both English and European families and businesses. Consider the fact that four of the real estate funds currently facing difficulties depend on some of the biggest insurance companies in the United Kingdom: Prudential, Aviva, Standard Life and Canada Life. The heads of these companies are already anxious about losing investors, so much so that they are preparing themselves to take preemptive action. Take for example Mark Wilson, the CEO of AVIVA, who promised the company's stock holders that he would pay out 50 percent of its profits in dividends.
Alas, it is not just the insurance sector that is under pressure.
The general opinion amongst analysts who work in the London market is that there is an inevitable correlation between the real estate funds and the banks. Institutes such as Barclays, Deutsche Bank and UniCredit have some involvement in property funds. An extreme devaluation of said funds could result in corresponding loss of value in banking assets. If the real estate market crashes, the value of the families' mortgage guarantees will also fall, setting off a vicious cycle for both the banks and their clients. It is a classic example of the domino effect, somewhat similar to what happened during the infamous subprime mortgage crisis of 2007 and 2008.
How dangerous the bursting of this real estate bubble will be for Europe and Italy specifically will be decided by the actions of the London banks. It will greatly depend on how far house prices fall. On the one hand, there is a certain optimism in the fact that the infamously toxic CDOs and ABS that greatly aggravated the American crisis nine years ago do not come much into play here. On the other hand, an eventual further loss in value of European bank assets would dangerously increase the difficulties that are already destabilizing financial institutions, such as the derivative problems currently plaguing Deutsche Bank or the bad loans before Banca Monte dei Paschi di Siena.
It seems inevitable that the hammer is poised to fall on the European and Italian banks, but whether the blow will be glancing or crushing remains to be seen.
This post first appeared on HuffPost Italy. It has been translated into English and edited for clarity.