Flat whites, hipsters and the post-mortgage British economy

(Note to American readers — a “flat white” is a kind of coffee; like a cappucino with less milk. It was invented in New Zealand and is popular with British hipsters, hence its metonymic use to describe the creative and technology cluster in Shoreditch, East London. Don’t worry, you’ll catch up in a couple of years.)

The launch of Doug McWilliams’ book “The Flat White Economy” has been rather overshadowed by the personal problems of its author. And the underlying idea of the book (hipsters are the future, or something) seems a little bit too glib a version of the Richard Florida “creative class” thesis to be really relevant to the British economy. But reading reviews of the book, one very interesting thing struck me about its description of bearded, tattooed young people hanging round Shoreditch starting businesses of one kind or another.

And that’s that — in general, these guys don’t have mortgages. That actually makes them quite unusual when considered as small businesspeople in the UK. Because, historically, a very high proportion of business lending in the British market has been mortgage-lending-in-disguise. The business loan is usually secured, and usually additionally secured by a charge over the owner’s house.

This has a lot of consequences. First, it means that non-homeowners have found it surprisingly difficult to get access to business lending — that, among other reasons, is why the “flat white economy” is so piled up in sectors that don’t require large fixed or working capital loans. And second, it means that the banks have tended to be somewhat dilatory in the care and attention they pay to small business lending — the credit risk is very much mitigated by the fact that the lending is eventually secured by the, usually substantial, equity in the proprietor’s house.

One can compare this with, say, the SME lending industry in a country with a very low rate of home ownership, like Germany. German banks look on SME lending not as a slightly higher return, slightly higher risk version of retail. They take it as a high risk, high return unsecured segment which carries considerable risk of large loss, and which therefore needs to give something close to equity-like returns when it all goes right.

The way that the German banks achieve this is to take equity warrants when they lend — or even more commonly, to take equity warrants when they extend loan facilities as part of a restructuring when a business gets into trouble. That gives them the upside which offsets the downside risk from not taking security. Historically, British small businesses have been very reluctant to give away equity (this isn’t just the banks’ fault), and so we’ve been stuck in an equilibrium in which everyone knows that there’s something wrong with the small business finance market but nobody really knows what to do about it.

Now, however, as the culmination of thirty years’ worth of “Property-Owning Democracy” policies culminating in the “Help to Buy” scheme, we’ve got a generation of young adults coming through who neither own houses, nor have any realistic aspirations to do so. Residential housing as an asset has been more or less completely financialised, and now needs to be seen as part of the pension savings industry (I suppose there should be some full disclosure here — although I’m happy and grateful to all the various consultancy and journalism companies which make up my portfolio career, my lifestyle is very much supported by the rental income on two UK residential properties).

And if you have a generation of businesspeople who don’t own houses, and who therefore can’t be fit into the historic template of British small business lending, then you’ve got the impetus for a total reinvention of small business finance in the UK. The banks which realise this first will do best, and if the incumbents don’t then entrants will. Arguments of the form “this problem has to be made worse to heighten the contradictions so that real change will come” always sound a bit Leninist, and have a pretty bad track record as either predictions or policy advice. But in this case, all of the contradictions have already been heightened, as the result of other policy choices made which had very little to do with industrial policy at all. Nobody has really given much serious priority to the need to re-engineer business finance in the UK, but we’ve now reached a point at which the old way of doing things is no longer possible.

So, although the “Flat White Economy” seems like a bit of a gimmick to me, it is very much worth keeping an eye on those trendy young things working in a district of East London where they don’t have a hope in heck of affording a house. They might be the start of something very new.