Monday, 9 May 2011

Illusions and delusions - the lure of credit and the price of debt

This blogpost is all about debt - national debt, personal debt, government debt - and its effect on the UK economy and the lives of the people of the UK.

We hear a lot about the "national debt" being too high and growing because we are running a deficit. There has been an astonishing degree of confusion between "debt" and "deficit" from some notable people - including the Chancellor of the Exchequer - so I thought I'd start this blogpost by explaining "debt" and "deficit" and how they relate to each other.

By "national debt" people usually mean Government debt, which is the money that the Government borrows from banks and other financial institutions to fund the difference between its spending and income.  In any one year, the difference between Government income and expenditure is either a surplus (if income exceeds expenditure) or a deficit (if expenditure exceeds income). If there is a deficit, additional money must be found to cover the excess expenditure, either by selling assets (for example by privatising state-run industries) or borrowing from banks and financial institutions. The Government has been running a deficit every year for nearly 20 years now, and has borrowed every year to cover that.  The accumulated debt over that time is known as "Government debt". Every year the Government runs a deficit and pays off no debt, the total amount of Government debt rises by the amount borrowed to cover the deficit. So debt is not the same as deficit, but deficits usually result in debt.

As with all debt, Government debt is only a problem if it is not affordable. The Government's ability to service its debt depends on its income and on the interest rate it is paying.  Government income, which is mainly from taxation, is positively related to "gross national product" (GDP), which is the monetary total of all outputs into the economy from all sources: if GDP rises, tax income rises. Increasing GDP in relation to debt also reduces the risk to the lending institutions: the lower the perceived risk, the lower the interest rate.  Conversely, as debt rises as a proportion of GDP, the perceived risk to the lending institutions rises.  Historically UK Government debt has always been regarded as a completely safe investment, so interest rates are very low - but if the proportion of debt to GDP rises too high, the lenders might change their minds about this and start to charge higher interest rates, which would have to be paid from tax income, which would increase the deficit further or require further spending cuts.  This is the primary reason for the austerity measures put in place by the present Chancellor in June 2010 and further extended in April 2011. The concern is that debt is growing at an unsustainable rate and lenders may start to raise their rates. Austerity measures are designed to reduce the rate of growth of debt in order to demonstrate to lenders and credit rating agencies that Government debt is as safe as it has always been. They have nothing whatsoever to do with reducing debt.

The best way of reducing the impact of Government debt is often to take measures to increase GDP - i.e. economic growth - because if GDP grows more than the amount of the debt the proportion of debt to GDP declines, tax incomes increase and the whole thing becomes more affordable. Stimulating economic growth is actually the current Government's strategy for reducing debt - but there is as usual disagreement over whether their measures to stimulate growth, such as cutting corporation tax and other measures to encourage business investment, are appropriate or effective. The debates are endless.

Government debt at present runs at getting on for 60% of GDP excluding financial sector intervention (source: Office of National Statistics), which for a peacetime economy is uncomfortably high and expensive to service - interest payments on this debt currently cost about £43bn per yearIt is true, as Richard Murphy and others have pointed out, that Government debt has actuallly been higher than that as a proportion of GDP for most of the last century.  It is also true that the high debt levels were mainly because of two world wars and a major depression, so shouldn't really be compared with the present situation.  To be honest the reason for the debt is irrelevant. The question is whether it is unmanageable.  Is it unmanageable at present? All the major political parties seem to think so, but many top economists disagree. The debates are endless.

As usual when there are endless debates about the best way of achieving something, something major is being ignored. In focusing on Government debt alone I believe we are missing the real issue. The true level of debt in the UK economy is MUCH higher and is completely out of control. It is ruining people's lives, destroying businesses and wrecking any prospects of a return to prosperity in the near future.  I am referring to the levels of personal debt - the amount of money that people in the UK individually owe to the banks.  

Personal debt levels are currently running at just under 100% of GDP (see Credit Action's useful if horrifying statisics on personal debt). Add this to the 60% of GDP figure represented by Government debt, and you arrive at a total debt figure for the UK economy (excluding corporate debt, which is complicated by cross-border issues) of about 160% GDP. I believe we should regard this as the true "national debt" - not Government debt alone. Now, we have paid off debts of this stature before, so it's reasonable to suppose that we could do so again. But so far we haven't even admitted it exists, so of course there are no policies for reducing it.  On the contrary, current Government policies for reducing the deficit are expected to raise personal debt levels by 20% over 5 years (source: Office for Budget Responsibility quoted in sturdyblog).  So what the Government is actually doing is cooking the books - shifting the responsibility for the deficit from the state to the individual.  Government debt will indeed grow more slowly, which will placate credit rating agencies and institutional lenders. But the total national debt level will rise nearly as fast as before.

This is madness. Government can borrow far more cheaply than individuals. The cost of servicing that debt will rise significantly as it shifts on to the shoulders of the ordinary people of this country, many of whom are already carrying debts that they can't afford. It seems that yet again, in order to keep banks and markets happy and Government borrowing costs low, we are prepared to accept vastly increased costs and higher levels of poverty for the people of the UK.

But why are people so heavily indebted? And does it really matter anyway?

The single biggest cause of the massive rise in personal debt since the second world war is the increase in home ownership. Virtually all homes in the UK are bought with a mortgage, and most people either have bought their own home or aspire to do so. Policies of successive governments have encouraged individual investment in property, including mortgage interest tax relief (now ended, but significant in the 1980s property bubble), extension of housing benefit to cover interest payments on mortgages, and most recently property finance schemes aimed at people on lower incomes, such as shared ownership and low-start mortgages.  Along with the mortgage debt usually goes other debts as well, such as home improvement loans, because people who own their own home are responsible for maintaining that property.

Obtaining a mortgage became much easier in the years leading up to the financial crisis. Mortgage lenders made loans at higher and higher income multiples - at the time of its failure Northern Rock was offering mortgages at 6 times income. They offered non-status loans, where people could obtain a mortgage without having any evidence of ability to pay. They offered mortgages of 100% or more of the property value - at least one lender offered up to 125% of purchase price, which amounts to an unhedged speculative investment in an overpriced market. Insane.

As a consequence of all this easy money and insufficient availability of property, house prices soared - a massive asset price bubble that still has not come down sufficiently.  Now we have had house price bubbles before, most notably in the 1980s when it was followed by a housing price crash in which lots of people lost their homes and lots more spent years unable to move due to negative equity (I was one of them). You'd think we would have learned from that.  But we were sold a myth that the Government had fixed "boom and bust". There wasn't going to be a crash. House prices would continue rising for ever. Cheap credit would be available for ever. You couldn't lose.

It wasn't just mortgages, either. Credit cards became so readily available that people with little or no income could obtain them without difficulty. Credit limits were unchecked and often raised without the holder's consent. Yes, you can argue that people shouldn't have spent on their credit cards. But when 0% credit cards were so easy to obtain, you could simply spend on them and move the balance from one card to another, never really paying them off. Again, you couldn't lose.

What this easy credit actually did was plug the gap between people's real wages and the prosperous property-owning lifestyle we were all encouraged to adopt.  Banks were happy - they were lending out huge amounts of money, were getting interest on it (admittedly at low rates, but they were lending so much it didn't matter) and were hugely expanding their balance sheets. People were happy - they had the money they wanted or needed, and the fact that it wasn't theirs didn't really matter because interest rates were low and if they managed things right they wouldn't need to pay it back.  Businesses were happy - they kept their labour costs under control while at the same time benefiting from hugely increased consumer spending. And the Government was happy, because GDP and tax income were growing due to inflated bank lending and high consumer spending.

The credit bubble burst in 2008 with the near-collapse of two major mortgage lenders (Northern Rock and Bradford & Bingley) and two retail banks (Lloyds TSB and RBS)  together with a raft of other financial institutions throughout the Western world, mainly due to mortgage defaults and rapid house price deflation. Since then, interest rates on unsecured debt, especially credit cards, have soared, and it has become very difficult to obtain mortgages and bank loans. Living costs have risen - notably food, fuel, gas and electricity. Taxes have also risen - VAT, National Insurance, and for higher paid people (who may also have serious debt problems so may effectively be living on very little) lowering of the threshold for higher rate tax and taxation of Child Benefit. So far mortgage rates have not risen, but the other rises are nonetheless making it difficult for many people to maintain their payments. Some benefits are being withdrawn earlier - notably child tax credit - and others are becoming harder to get.  And lenders are now much less patient and accommodating with people in difficulties. Repossession of houses is now occurring not to settle mortgage defaults, but increasingly to settle defaults on unsecured loans. And people who maintain their payments do so at increasing personal cost: many people work harder and harder, and go without more and more, just to ensure they keep up their debt payments. Christians Against Poverty (CAP), who specialise in helping people get out of debt, have stories to tell of people who will go without food rather than fail to make a debt payment.

Well, you might say, people shouldn't have been so stupid as to fall for the illusion of easy money. After all, you don't get something for nothing. But most people I know who have debts they struggle to service have acquired those debts not because they are profligate or spendthrift, but because circumstances made it the best (or even the only) option. They are single parents trying to hold it all together on a low income. They are people who have had periods of illness when their earnings have been very low. They are people doing casual or seasonal work, whose wages vary (but the bills don't). They are people who have lost their jobs and found it hard to get back into work at the same income level they had before. They are self-employed people whose businesses suffered downturns - or whose savings didn't stretch far enough to cover the time needed to build up the business to economic level. They are couples (especially in the South East) who relied on dual income to afford their house but discovered that childcare costs made it uneconomic for one of them to work.  They are people who claimed and were paid child tax credits only to discover they weren't entitled to them and had to pay them back. They are people ripped off by banks mis-selling insurance policies. They are people whose insurance policies wouldn't pay out for household disasters. In short, they are ordinary people who have had problems and solved them in what seemed the easiest and best way at the time. I am one of them.

It seems inevitable to me that a significant proportion of people currently struggling with high levels of debt will end up bankrupt or in IVAs. We are already seeing increases in personal bankruptcies (see statistics in Credit Action's report, op.cit.), particularly among women with children and in depressed areas of the country such as the North East.  Other people with high levels of debt may avoid bankruptcy by selling their homes and using the equity to settle debt. They will end up in the rented housing sector and if they are over 40 will probably never again own their own home. At the other end of the scale it is becoming harder for younger people to buy a house at all because of the difficulty getting a mortgage, the high deposits now required and the fact that many young people who would previously have bought their first home in their mid-20s will not now do so because of the debt they will already be in from their university days. And above all, people will rein in their spending - in fact they are already doing so.  They will go without holidays, new cars, new clothes, improvements to their houses, and concentrate on paying off debt.  Many will stop making provision for their old age in the form of savings and pensions, and use that money to pay down debt instead. After all, what is the point of saving when you owe so much money?

The result of this is that the overall level of debt in the economy will gradually fall.  Debts are written off fully for personal bankrupts, and partially for people in IVAs and others who negotiate settlements with their lenders. Mortgage and unsecured debt settlements will increase as people sell their houses and rent instead. Small businesses will also go bankrupt - many of them due to cash flow difficulties because of the unwillingness of banks to provide working capital at present, and others due to collapse of their market as people stop spending - and any debts they have will also be written off. And people will gradually pay off their debts and will not take on any more.

That sounds positive, doesn't it. But look at the cost. Think of the people who will lose their homes, their possessions, their self-esteem, maybe their jobs (personal bankrupts are barred from some lines of work), maybe their marriages and their friends, maybe even their physical and mental health. Think of the years and years of grinding poverty for many people. And there is an economic cost too. Collapse of consumer demand in an economy is catastrophic for business. All the Government's current economic stimulus measures are aimed only at encouraging business, not at enabling people to spend. If people are not spending, and there is no increase in exports, then businesses will fail whatever stimulus is given.

I have written at length because I really believe no-one is addressing this issue. None of the three main parties have anything to say about the human and economic cost of the high personal debt levels we carry.  All of them are focused so much on controlling Government debt that they don't notice the approaching disaster. Unless they take action on personal debt the UK economy will crash again at some point in the near future, and will not recover for a generation.  This is the appalling legacy from our years of illusory money and delusions of prosperity. Our children, and our grandchildren, will spend their lives paying for our folly.

5 comments:

  1. We now average 130,000 personal insolvencies a year...

    In doncaster 1,000 people every year go bankrupt,

    In Mansfield, Sedgefield etc it has grown 500% since 1997...

    It is adversely affecting Northern English areas where there is less employment

    The government should restructure the public sector to create more employment up north,, they should extend vocational educational to areas with a history of worklessness, they should work
    harder to introduce affordable housing.. and lastly they should introduce a living wage...

    These four actions in my view would help people avoid bankruptcy and increasing personal debt...

    Good post Frances

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  2. That was so clearly written! I wish I could get everyone to read it.

    Hubby and I have been living in poverty for some time. We did just as you said - we sold our house and paid off our debts, living on a little of the equity every month to make up the shortfall. Ironically, we now pay MORE in private rent, but have no choice.

    Soon that will be gone and our debts are creeping up again. This is why I fight so hard for sick and disabled people.

    The myth that they "never had it so good" is just laughable, and the idea that you can squeeze them any further is madness.

    We will almost certainly have to declare bankruptcy in around a year. (We've fought it for 17 years though, we're just run out of options)

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  3. I have thought this, if I got well enough to go back to self employment, because of the lack of money people will not buy enough of my talents for me to live on. It is not a good time for anyone who is not super rich at the moment to feel financially secure in any way...which adds the the stress of stress related illness so more burnouts....

    I agree great post.

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  4. I have seen articles quoting personal debt at 170% of GDP and projections of it rising to 220%. As always it depends on how you calculate the figures

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  5. Excellent post Frances.

    As I begin to understand more about such murky practices (from blogs such as yours) I begin to understand less about why we as citizens allow monies deducted from our salaries to be managed as such. By that I mean that I don't see how affordability even enters the equation as we know that this fluctuates with many of the factors outlined in your post which seem to be endemic and public and private lives to devastating effects - all so we can be bought and sold during election cycles.

    Nolly.

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