EARLY January, and it isn’t just the usual excesses that have to be worked off. Many people’s thoughts turn to debt — and it will take more than lycra and a gym membership to tackle that.
Debt will lead 30,000 people into insolvency between now and the end of March, says Grant Thornton, the accountancy firm. Liberal Democrat shadow chancellor Vince Cable claims that a combination of ready access to borrowing and legal changes that have made personal bankruptcy easier mean debt levels are unsus- tainable and a “debt mountain” hangs over the economy.
The Organisation for Economic Co-operation and Development (OECD) notes that household debt levels in Britain are more than 100% of gross domestic product, and thus the highest in the G7; above America, Canada, Japan, Germany, France and Italy.
Rising household debt has been a central feature under Gordon Brown, the chancellor whose guiding stars were said to be prudence and parsimony. Rising government debt is another story, which I will return to soon.
When Brown entered the doors of the Treasury in May 1997, household debt was just under £500 billion; now it is nearly £1,300 billion. That, in a period of low inflation, is a big increase.
The question of debt is the classic one of: “Is the glass half full or half empty?” Depending on which way you look at it, people’s willingness to take on debt either reflects their confidence in the future, and hence their ability to repay it; or it is an impatient desire to have it all now, whatever the long-term consequences. Inevitably, there is a bit of both.
But how worried should we be? Is it the case, as Cable argues, that debt now hangs over the economy in a way that will significantly affect it? Or is it, as Bank of England governor Mervyn King has insisted repeatedly, that debt represents a potentially serious social problem but is not a big macroeconomic concern? Let me start with a few basic facts. Figures from the Bank last week showed that the level of outstanding individual debt is £1,278 billion, of which £1,066 billion, 83%, is secured on dwellings, and £212 billion is unsecured. In the past 12 months secured debt has risen by 10.4%; unsecured debt by 6.2%.
Britain, as noted, ranks near the top of the OECD’s debt league table, measured against GDP, although it is in the same ballpark as other “Anglo Saxon” economies; America, Canada, Australia and New Zealand. An alternative measure — the proportion of annual disposable income — put UK debt in 2005 at 159%, above America (135%) and Canada (126%) but below Australia (173%) and New Zealand (181%).
The outliers are Denmark, with debts of 260% of disposable income, and the Netherlands, 246%. At the bottom are France, 89%, and Italy, 59%.
These international differences tell us something about the willingness of people in various countries to borrow to consume. Contrary to what you might expect, there is no direct link between debt and levels of home ownership. Denmark and the Netherlands have lower levels of owner-occupation than Britain but more debt. Italy has roughly 80% owner-occupation but low debt.
The other side of the balance sheet to debt is net wealth; what households own in financial and non-financial (mainly housing) assets. In every advanced country, households are in pretty good shape, with net wealth ranging from 319% (Finland) to 936% (Italy again, surprisingly) of annual disposable income. Britain comes out pretty well, with net wealth of 790% of household income. This means that in theory we could live for eight years on the proceeds of selling our houses and financial assets, but in practice it could never happen, certainly not for all.
What is the debt problem? The fact that household balance sheets in aggregate are in good shape should not divert us from the reality that a minority have balance sheets that would make even Enron accountants wince.
More than half of households in Britain have no debt at all, says the OECD. That includes most pensioner households but also quite a number of working-age homes. So the £1,278 billion of debt is divided among the minority.
The Bank’s latest annual survey found that three-quarters of households with debt spent less than a quarter of their income servicing it (paying interest and principal). But for one in six, debt-servicing accounted for more than 35% of income even before recent rate rises, and a tiny minority, 2%, apparently commit more than their entire income to it. These are the ones who will be turning up at the bankruptcy courts in the coming weeks.
The distribution of wealth — assets — is even more uneven. A fifth of households have none at all; a quarter just a few thousand pounds. At the very top is a huge concentration of wealth. Our society ranges from the heavily indebted asset-poor to the asset-rich, who never need to borrow.
Looked at this way, some of the economy’s conundrums can be explained. Both housing and consumer spending have been stronger than expected, because only a small minority are really struggling with debt.
The fact that debt and wealth are distributed unequally also helps to answer the housing puzzle. Those sitting on big wealth gains can afford to trade up, or help their children onto the ladder. Unassisted first-time buyers, or others with modest savings hoping to jump from renting to owning, are at an enormous disadvantage.
Labour has even put obstacles on the route to owner-occupation that was so important in the Thatcher era. Tenants are now limited in the discounts they can get to buy their council house.
The consequence of the Brown debt boom and the related rise in house prices is a corrosive increase in inequality of wealth, debt and opportunity. This is a problem for the government and for the Bank. Most members of the “shadow” monetary policy committee want an immediate rise in interest rates, as we report today. I doubt the actual MPC will respond this week — I certainly wouldn’t — although February could be a close call.
Raising rates would hit the heavily indebted hard, and further increase those insolvency numbers. It could be the proverbial sledgehammer to crack a nut. But for the vast bulk of households — those with no debts or debt-servicing costs of less than a quarter of income — the impact would be modest. Financial pain, like wealth and debt, would be unevenly distributed. Who said monetary policy was easy?
Source: David Smith, The Sunday Times
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