The City gets the jitters

FOUR weeks ago, the housing market was in the doldrums, personal bankruptcies were at an all-time high, inflation was edging up, the Government's finances seemed to be unravelling and no one seemed to care.

Labour sailed into the General Election on a sea of confidence, believing - rightly as it turned out - that Chancellor Gordon Brown would win it for them.

And that he did. Voters looked at the economy, looked at their wallets and purses and saw no real need to change.

But that was then, and now is now. Elections are supposed to clear the air, deliver certainty and let everyone get on with their lives. Not this one, though. Barely had the votes been counted than the mood began to change.

Business and consumer confidence has dissipated with astonishing speed, going (in the words of some old political slogans) from 'you've never had it so good' to 'you've had it' in the blink of an eye. This is not just an a illusion. The public mood normally changes slowly, but this has some hard financial numbers backing it up.

The most sensitive economic indicator of all is the volume of money spent on advertising, because it plays into people's willingness to spend, which they do when they are feeling comfortable. But here, too, the news is bleak.

The volume of advertising on television, commercial radio and newspapers tailed off before the election, as it usually does, and was expected to bounce back later - again, as it usually does - once the uncertainty was out of the way. But this time there has been no bounce. Quite the opposite. In many markets the spend is 20% lower than it was last year.

What is worrying is that no economy can go on like this for long without it affecting other things. If people don't spend, retail sales fall, stock builds up in factories, shops are forced to close and people get laid off.

True, much of what is sold in shops these days does not get manufactured in this country, but the truth still holds. There are enough jobs in distribution, retail and associated services for it to hurt. Then, if people lose their jobs, that mortgage which was always going to be a bit of a struggle becomes an impossible burden.

Multiply that across the country and you get a rash of houses coming on to the market from people who have to sell because they can't afford the payments any more, coupled with no buyers because they think that once prices start falling, they will fall further.

It is not high interest rates that cause housing markets to fall, because people do everything they can to meet the payments rather than lose their home. The crunch comes when - through illness, divorce or unemployment - that simply becomes impossible.

Things are nowhere near that bad, but the change in recent weeks is that people probably now sense they could be, whereas earlier in the spring it simply never entered their heads. All the talk of tax rises in the election, whether or not it turns out to be true, has made people think that they are not going to have as much money in their pockets next year as this.

So without doing anything dramatic they have decided to rein in their spending, to pay a bit more off the credit card and to try to build up a protective buffer against tougher times.

It is all very sensible and prudent behaviour, but unfortunately it is one of the paradoxes of economics that individual common sense can become collective madness. If everyone stops spending at once, the resultant slump in sales creates the very adversity that, as individuals, they were worried about. Again, though, we are nowhere near that point yet.

But while it is easy to retain a sense of perspective when you are dealing with what is familiar, it is different when it comes to the closed book of high finance, where almost nobody has a clue what is going on.

That is why rumours of mounting problems in the City, built around the losses and financial difficulties faced by hedge funds - which are hi-tech, high-skill, and often high-risk investment vehicles mainly for the wealthy - have sent a frisson of fear through communities that have no idea even what a hedge fund is.

This ignorance, though entirely understandable, is part of the problem. People on the outside do not understand what the trouble is, so they fear that it will spill over into the mainstream markets, sending interest rates soaring and the stock market crashing.

That could happen, just as there could be a housing market crash, but it is highly unlikely. The current problems affect only a small minority of the 8,000 or so hedge funds and, in spite of the fuss made about them, the total amount of money they have at their disposal is small - minute, in fact - when set against the huge sums inside our big insurance companies like Legal & General, Prudential or Norwich Union. And for every fund in difficulty-there are two more in rude health waiting to take advantage of the other's misfortune.

Ironically, while outsiders are biting their nails, the industry itself is quite relaxed. It is Darwinian down there. They believe in survival of the fittest and many welcome a shake-out that should clear away some of the weaker funds.

Now it is also true that the City has a saying: in any crisis, the person who doesn't panic is the person who doesn't really understand what's going on. One could certainly apply this to some of the hedge fund community, who combine an arrogant belief in their own infallibility with an alarming ignorance of what really happens when markets dislocate. But there is no reason to believe that is where we are heading.

All in all, this feels much more like a summer squall than the onset of economic winter. Our economy is still growing at 2.5%, a figure for which we would have been supremely grateful not so long ago. World trade still grows and the Chinese boom also continues.

So perhaps the best analogy is with a long-distance flight where at some point the plane hits an unexpected patch of turbulence for no apparent reason. All those bumps can be extremely unnerving and indeed panic-inducing at the time, but when we come out the other side and back into clear skies, everyone feels a bit silly for getting so alarmed.