Sunday, February 15, 2004
Happily wallowing in debt
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

Plenty of people are losing sleep over debt. With each month that goes by, household debt gets closer to the 1,000 billion mark (it is currently 934 billion and growing in double figures).

“Our green and pleasant land is in the red,” said Oliver Letwin, the shadow chancellor, in a recent speech. He is not predicting imminent disaster, but is mightily concerned about a culture in which borrowing is good but saving, it seems, is only for cissies.

Some individuals are already in the disaster zone. Official figures show that 10,271 people became personal bankrupts in the last three months of 2003, the highest quarterly figure for 11 years. You do not become bankrupt unless you are fairly heavily in debt.

We all know, or think we know, somebody who is irresponsible about debt — the flashy new car, the house that is bigger than they can surely afford, too many expensive holidays — they must be living on what used to be called “the never-never”.

The issue of debt also looms large on the Bank of England’s radar screen. Mervyn King has been presenting the Bank’s inflation report to journalists for 44 quarters, even before he was promoted to governor. Too often — and again last week — the discussion has revolved around debt.

The Bank, in fact, is in an unusual position as regards debt. As guardians of financial stability and prudence, central bankers are obliged to warn of the dangers of excessive debt, and this it does on a regular basis.

But the Bank also has to take an economic view on debt. Is debt about to drag the consumer into the abyss? Could high levels of debt prevent interest rates from going up for fear of tipping a fragile economy over the edge?

The Bank’s economic answer to the first question is “no”. On the second, higher debt makes households more sensitive to interest-rate hikes but will not stop them rising. By pointing us in the direction of money-market forecasts suggesting a base-rate rise to about 4.75% over the next year or so, King gave us an insight into the way he also expects things to be heading.

So should we be worried about debt or not? Were the 10,271 who succumbed in the final quarter of last year unlucky, feckless or the shape of things to come?

Let me come clean with my answer straightaway. Household debt is like a contented sow — large and obvious but not at all dangerous. The people of Britain are happy to wallow in debt, and can go on doing so.

The first point to make about debt is that, contrary to impressions, its rise has been controlled, even modest. The lion’s share of debt is accounted for by mortgages, 765 billion out of the 934 billion total. In the past 10 years mortgage debt has risen by 125%. House prices, however, have increased by 170% according to Nationwide building society. In a period when we have all been supposedly mortgaging ourselves up to the hilt, debt has actually fallen in relation to property values.

Over the period 1995 to 2002, according to Bank figures, mortgage debt rose by a muted 7.1% a year, even during a powerful house-price boom. It has risen by more over the past year, 14.2%, but a large part of that reflects the recent wave of remortgaging.

Are big mortgages getting people into difficulties? No, mortgage arrears are at record lows. Not only that but there is scant evidence that borrowers are overstretching themselves, despite headlines in some newspapers about loans being offered on multiples of 10 times income.

Fewer than 10% of current mortgage advances are for more than the value of the property, compared with 40% in the late 1980s. About a third of new mortgages are for 90% to 100% of the property, down sharply from two-thirds as recently as the mid-1990s. The Bank also produced evidence showing that, even though mortgages are growing in size, low interest rates mean that the monthly payment burden relative to income is lower than at any time in recent decades.

That’s fine, you say, but what happens when interest rates go up, as they will? Economists at Standard Chartered say rates would need to rise to 7.25% to produce the kind of housing strains (and the eventual crash) seen in the late 1980s. Rates are heading higher but nothing like as high as that.

What about other debt, such as the explosion in plastic cards? Even the wary can get caught out using their credit cards too much, as the bankruptcy figures testify. Again, we should not get too concerned. The households with the most unsecured debt are those that can best afford it. People with the highest incomes are borrowing the most.

While 10% of households with such debt think it is a heavy burden, this proportion has been roughly the same since the mid-1990s. Moreover, the rate of growth of unsecured debt has slowed over the past year. The saving ratio has also quietly crept higher.

The rise in unsecured debt is, like that of mortgages, largely a rational response to lower interest rates. Credit-card interest rates are still scandalously high, but they have fallen in the past few years from an average of nearly 25% to 15%.

This drop, big though it is, disguises another shift. The credit-card industry has opened up a new avenue for the rational borrower, free-riding on the zero-interest balance transfers offered by many card providers. This has made credit-card borrowing, once the preserve of the financially illiterate and famously not for Barclays’ Matt Barrett, quite sensible.

Of course, debt will always produce sad cases. In a financially liberalised economy, with no government controls on the amount people can borrow, some will always get in over their heads and end up in the bankruptcy court.

Caveat emptor is a rule that some individuals find it easy to ignore. Changes in personal circumstances can wreak havoc.

But the fact that a few find themselves in trouble should not change the way we run the economy. Nor, sympathetic though I am, will it make me lose sleep at night.

PS Gordon Brown was in full flight at the EEF’s annual dinner on Tuesday, telling the assembled engineers and manufacturers how much he had done for them. The chancellor, to judge from his presentation, had aggressively slashed industry’s taxes and red tape and, short of a bit of spot-welding in his spare time, could not have done more for manufacturing.

The audience, I sensed, had a Victor Meldrew/Lord Hutton “I don’t believe it” attitude to this, admiring Brown’s chutzpah but regarding his claims as barely credible. And this has now become an important battleground for the Treasury. Fed up with the charge that Labour inherited a flexible and deregulated economy and has done its best to tie it up with taxes and red tape, the chancellor and his team are fighting back.

A new book, Microeconomic Reform in Britain: Delivering Fairness and Enterprise, is about to be published by Palgrave. It is edited by Ed Balls, Gus O’Donnell and Joe Grice, the former Brown’s long-time adviser, the latter top Treasury officials. It will claim that Labour has done as much for the supply-side of the economy as it has for macroeconomic stability, most notably, by making the Bank of England independent.

The chancellor, meanwhile, maintains that business claims of higher taxes and excessive red tape melt away when put under the spotlight. So let’s have a great debate. If you are in business and being smothered by this government’s red tape, let me know about it at the e-mail address below. Names will only be used by agreement. If I don’t hear anything, I’ll have to assume that Brown is right.

From The Sunday Times, February 15 2004