Sunday, March 12, 2006
Still climbing the debt mountain
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

It has become the great divide, though not quite on the scale of 1981, when 364 economists (including two current members of the Bank of England’s monetary policy committee) wrote in protest over the Thatcher government’s economic policies. That schism, 25 years ago this month, was over Tory “monetarist” policies, which the 364 said would prolong and deepen the recession.

Unfortunately for them, the economy began recovering before the ink was dry on their letter. That, however, is another story.

The current debate is all about debt. On one side are those who think Britain has been on a mad, debt-fuelled binge that is about to end in tears. On the other side are those who see nothing alarming in the rise in household debt.

The debt worriers include Liberal Democrat shadow chancellor Vince Cable, who warned last week that growing numbers were “drowning” in debt, and has devised a 10-point plan to tackle it. They include George Osborne, the Tory shadow chancellor, who has accused Gordon Brown of being the pusher who has created Britain’s “debt addiction”.

Some newspapers are developing a speciality in daily stories of impending debt doom. But in the bigger picture debt hardly seems to figure. The Bank of England, in its latest inflation report, published last month, was relaxed. “Aggregate data suggest that most households are not having difficulties servicing their debts,” it said.

Charlie Bean, the Bank’s chief economist and MPC member (not one of the 364), told me in an interview late last year that household debt was not a pressing macroeconomic issue. Nor, according to the Bank, was it threatening the financial system. “Overall, near-term risks to major UK banks from households, companies and foreign borrowers appear low,” the Bank said in its Financial Stability Review, published in December. “Write-off rates on banks’ mortgage books are very low and losses on unsecured household lending are modest in relation to banks’ profits.”

Rising bad debts, acknowledged by HSBC last week — it said that in 2005 there was “a significant rise in personal bankruptcies following an earlier relaxation in the law and a general expansion in credit availability” — did not stop the bank making a record £12 billion profit last year.

So who’s right? Is debt a problem or not? Let me start with a few facts. Household debt, according to the Bank of England, stands at £1,168 billion. A slightly wider definition, used by the Office for National Statistics for national accounts purposes, puts household financial liabilities at £1,276 billion.

Those are big numbers, but what do they mean? Household debt is similar in size to Britain’s gross domestic product, £1,211 billion last year. On the broader ONS definition it stands at 154% of annual personal disposable income. Debt, in other words, is equivalent to more than 18 months of household income.

The history of this ratio is quite interesting. From 1970 to 1982 debt fluctuated between 60% and 70% of household income. Then, with the abolition of controls on credit and the entry of the banks into the mortgage market, it began to increase quite sharply, reaching 100% by 1988 and more than 110% by 1990.

It then trod water during the 1990s, people having been scared off debt by the housing crash of the early 1990s, before starting to climb again some five years ago. The rise in debt from 110% to 154% of income dates only from around 2001.

There’s another way of looking at debt, which I bring to you courtesy of Michael Saunders, chief UK economist at Citigroup. This is the ratio of household debt to net household wealth, the latter made up of both financial assets and housing. It currently stands at £5,689 billion.

This ratio has been a lot more stable than the others, fluctuating between 13% and 16% from 1970 to 1990 and only creeping above that in recent years to its current 18.3%. Household debts, in other words, are more than five times covered by household assets, though evidence from the Bank and others suggests that the people who have the assets aren’t necessarily the same as those who have the debts. Whichever measure you use, the lion’s share of household debt, about 83%, is in the form of mortgages and only a minor part of it is on plastic cards.

The arguments in this debate are familiar ones. Cable and others point to a 70% increase in repossession orders last year, a rise in personal bankruptcies to a record 67,580 in 2005, a 7% rise in county-court bad-debt judgments, and the Financial Services Authority’s assessment that 2m families are “constantly struggling” with debt, though are not yet in arrears. Every five minutes, household debt rises by more than £1m.

The Bank, while accepting that debt distress is undoubtedly increasing, points out that it remains low by past standards. Last year, for example, about two in every 10,000 homes were repossessed. Without wanting to make light of it, those are about the same odds as dying by electrocution or drowning.

It is not the case, despite the headlines, that most or indeed many households are struggling with debt. It is not the case, either, that we are all stretching ourselves with mortgages of five or six times income. The median mortgage for first-time buyers is 3.1 times income, for home-movers, 2.9 times.

Nor is it the case that many would struggle even if interest rates went within the bounds of what is possible. I’m not of the school that believes a 5.5% base rate would inflict damage on the scale of the 15% interest rate of the late 1980s.

And that, perhaps, is the problem. It looked at the end of last year as though debt aversion was starting to kick in and, wonder of wonders, people were starting to repay debt.

It is early days, but that does not appear to have lasted. Borrowing, particularly mortgage borrowing, has picked up. So has house-price inflation, up to 5.5% last month from a low of 2.3% in July, according to Halifax.

The script was that this would be a year of debt and housing-market consolidation. So far, not for the first time, people aren’t sticking to that script. Debt is not a big problem yet. But in time, if we carry on like this, it could be.

PS: Penguin is said to have paid $8.5m (£4.9m) for Alan Greenspan’s memoirs, slightly more than it paid me for my classic, The Rise and Fall of Monetarism, now sadly out of print, but not quite as much as the £5m Harper Collins is said to be paying Wayne Rooney. Let us hope for Penguin’s sake that the great man (Greenspan) is less opaque in print than when running the Federal Reserve.

Memoirs of economic policymakers can be hard going. Notable exceptions include Nigel Lawson’s The View from No 11, a doorstop of a book that should be required reading for those interested in the Thatcher era. I still dip into the late Eric Roll’s Crowded Hours, an account of an adviser’s life over many decades.

Derek Scott’s Off Whitehall is mainly a book about Europe but it does have a couple of entertaining chapters about being Tony Blair’s economic adviser during a period when getting any information out of Gordon Brown and the Treasury was about as easy as trying to borrow a couple of gold bars from the Bank of England.

On the other side of the Atlantic, Robert Reich’s Locked in the Cabinet, an account of his four years as labor secretary in the first Clinton administration, stands out.

Greenspan starts with one advantage; a ready-made title. What else could it be but his most famous phrase, Irrational Exuberance?

From The Sunday Times, March 12 2006


I find the figure of 3.1 salary multiple for first time buyers very hard to believe.

It would be interesting to see figures for the average price paid by a FTB to cross reference. Or the average salary of a first time. Logic says it just cannot be so. The average salary in London is in the high £20ks. Let's say to be generous that the average FTB in London earns a little higher than that, lets say £30k. That gives you £93k. Add in a generous £20k deposit and you've got. £113k. Now I defy you to find anything for that price in London save the odd 1br flat above a kebab shop in Tottenham.

So what is happening here? Maybe some buyers are wrongly falling into the FTB category through some kind of classification anomaly - buy to let landlords for example.

Or maybe first time buyers are getting massive deposits from parents. Where is much of this likely to come from? Mortgage equity withdrawal. So the FTB is actually more highly-geared than the 3.1 figure would suggest.

Either way, the 3.1 figure is highly questionable and worthy of investigation, perhaps by yourself or your newspaper David! How about commissioning a small poll of first time buyers? Let's get to the bottom of this!

How did house prices rise so much faster than wages? Were people borrowing 1x salary at the end of the 90s? It really does't add up!

Posted by: El_Pirata at March 12, 2006 11:27 AM

The figures are on the Council for Mortgage Lenders' website: - and show a rise from around 2.4 back in 2000.

Posted by: David Smith at March 12, 2006 02:09 PM

I agree with the previous comment. The only properties in London under 120K are low-end 1-bed flats above shops and in council blocks in the absolute farthest suburbs. It cannot be that all FTBs in London are aiming for those properties. I believe that most FTBs in London aim around 175K - ironically the national average - and to do so, are either a) couples working at investment banks, or b) in receipt of very significant deposits.

As has been pointed out elsewhere, the income multiplier for FTBs is only applicable to those FTBs taking out mortgages. If the average house price in London was 100x average income, but Branson Jr, Gates Jr and Mittal Jr each bought with a giant parental deposit and 3.1x their income as streetsweepers, then we would also have a reasonable-looking multiplier. Economists would sit, staring at the numbers, as an angry mob gathered outside, asking why the market should have priced ordinary people out of home ownership.

Posted by: Alex at March 12, 2006 02:38 PM

Mr Smith's citations look to be based based on unsound data (on the data providers own admission)!

Lets have a look at the caveats on the CML website (the small print):

1. Totals shown are estimates grossed up from the sample of lenders reporting to reflect total market size.

"Grossed up"? As in "inflated"?

2. All figures from April 2005 onwards are based on Product Sales Data reported to CML. Figures pre-April 2005 are taken from the survey of Mortgage Lenders. There are material differences in both the reporting methodologies and the sample of contributing lenders for the different surveys. Figures after April 2005 are not strictly comparable with those up to that point.

"Not strictly comparable" is a byword for "meaningless" in statistical terms.

4. Average figures shown are medians, as this tends to better represent the poisition of the typical borrower.

Do they? If its a median of completed purchases, then it will only represent typical purchases for that period. NOT the position of the typical borrower. Again, the figures are hiding the fact that it's not what's happening, but what's NOT happening.

6. Affordability calculations are based on averages of calculations for individual transactions.

Again, see the comment for point 4. The typical borrower is not borrowing. It also ignores the statistical anomaly created by SELF-CERTIFIED mortgages where the borrower "declares" their income rather than proving it - remember those?

7. Prior to April 2005, estimates of the proportion of first time buyers and movers exclude cases where the previous tenure of buyers is not known.

This seems to be an arbitrary exclusion. The baby is being thrown out with the bathwater. An unwanted child perhaps?

Circumspection is always good when dealing with statistics and mortgage lenders and mortgage lenders' statistics! I know that it's very unfashionable to do so currently, but ...


Posted by: Paul Owen at March 16, 2006 01:55 PM

You're well behind the game on this one - see the discussion we've had on the forum. And "not strictly comparable" means just that. "Grossed up" applies to pretty well all economic statistics; unless you sample everybody it can't be avoided.

Posted by: David Smith at March 16, 2006 07:32 PM

"Not strictly comparable" might not detract significantly, and "grossed up" on it's own could still make the data relevant, but combined and factoring in all of the other caveats they point out, and the data you're left with isn't worth the electons expended.

What I'm getting at (and what has not been mentioned yet on the forum) is that if there were such a thing as a reliability index, this data would score very poorly.

That's not my opinion though as the CML do point it out under the data - if you take the time to read their unnaturally small writing!

Posted by: Paul Owen at March 17, 2006 01:58 PM
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