Sunday, January 07, 2007
Debt's a burden, but not for most
Posted by David Smith at 11:00 AM
Category: David Smith's other articles


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 unsustainable 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?

PS: There was a bumper response to the Economic Outlook Christmas quiz, including several e-mailed on Christmas Day. The challenge was to identify economics-related songs from fragments of lyrics, and you rose to it magnificently.

The answers, in case you want to download them onto your Ipod, were: 1. Money, Money, Money — Abba (1976); 2. Money — Pink Floyd (1973); 3. Money — Michael Jackson (1995); 4. Money, Money — Cabaret, film version (1972); 5. Can’t Buy Me Love — Beatles (1964); 6. Money for Nothing — Dire Straits (1985); 7. Bills, Bills, Bills — Destiny’s Child (1999); 8. We’re In The Money — Gold Diggers of 1933 (1933); 9. Money (That’s What I Want) — Barrett Strong (1959) — other versions were allowed; 10. Goldfinger — Shirley Bassey (1964).

There were also many suggestions for other economics-related songs, including Taxman (Beatles); Money’s Too Tight to Mention (Simply Red); Boom, Boom (John Lee Hooker); Wall Street Shuffle (10cc); and lots more. I’ll keep them back as material for a re-run sometime, or maybe just for an economics-themed karaoke evening.

Choosing a winner was difficult, so I had no choice but to put the names of the correct entrants into my bowler hat and ask my fragrant young assistant to choose one at random. The prize, a signed copy of Free Lunch; The Chancellors’ Tales, edited by Howard Davies; and Making Globalization Work, by Joseph Stiglitz; goes to Vivienne Upton of Cheshire. Congratulations to her, and the many other immaculate entries.

From The Sunday Times, January 7 2007


thanks for a great article

Posted by: the_austrian at January 8, 2007 12:20 AM

Thanks for confirming the uneven spread of debt.

It does call into question the effectiveness of monetary policy in controlling the UK housing market.

There is another non-linear effect in the control loop. I observe that very few of my peer group are moving house at present because they can't afford the next rung (high stamp duty is a lesser deterrent).

The effect is that as houses get more expensive, they become more scarce. As they become more scare, they get more expensive. This is a positive feedback loop. The limiting factor is supplying the cash for the people trading up. If this cash comes largely from property equity anyway, then there is no limit.

The end game will be very high house prices, where only a very small minority can afford to purchase, and the majority have to stay put wherever they landed before this situation arose.

To illustrate that, imagine a town of 100,000 dwellings. Eventually only 1 comes up for sale per year, because nobody can afford to move, and even if someone dies, the relatives hold on to the property as an investment. So long as the price of the 1 property remains attainable for one person in that town, the town's house prices will continue to rise. Especially if that one person is using equity from other properties.

I can't see a way to create supply in this scenario.

To control prices, one would have to control supply as well as demand. How can monetary policy force people to sell ?

Answer 1 : By making mortgage payments unaffordable. But as we have seen, this will only work on a small percentage of highly indebted households, not the majority of debt free households.

Answer 2: The only other mechanism is via unemployment, but it seems silly to cause a recession purely to limit house prices.

You said monetary policy "isn't easy". Maybe the current housing market situation shows that it is fundamentally flawed.

Time for a rethink!?

Is it time to look at lack of supply from the point of view of reasons why people aren't selling, rather than "shortage of stock" ?

Posted by: Nick Thorne at January 9, 2007 08:51 AM

I think your analysis is spot on. My anecdotal observation is that many properties that come on to the market are taken off by the vendors when they don't get enough interest - comparatively few are cut in price in order to generate that interest. So no transaction occurs and, as you say, people stay put. The risk is that we get the worst of both worlds - high prices but relatively low levels of activity. I'm not sure what the answer is to stimulating supply in this context.

Posted by: David Smith at January 9, 2007 10:11 AM

On returning to leafy Hertfordshire this Xmas, I noted that pretty much every house my friends grew up in, is still being occupied by their ageing parents. These are, on the whole not small properties, probably averaging around 4 bedrooms, three of which go largely unused.

My parents have acknowledged the peversity of two people living in a four bedroom house, but there are very few nice 2-3 bedroom properties that would appeal to them.

Getting the baby boomers to downsize would do alot to alleviate the current problem. How you make this happen in reality is beyond me, however.

Posted by: Tom at January 9, 2007 11:59 AM

Hi David
Intersting article - particularly the debt comparisons with other countries.

A quick question re the point you make about over half of 'home owning' households having zero debt - does it include rental households? If so, is it possible to see what proportion of home owning households have zero debt and what their age profile is?


Posted by: Richard at January 9, 2007 10:38 PM

There is some material on the age profile of debtors in the OECD report:$FILE/JT03220092.PDF

Sorry about the lenghth of the link

Posted by: David Smith at January 10, 2007 10:43 AM


Regarding Tom's comment and the question of increasing housing supply.

I started to think about how my elderly relatives got into their large (now rather roomy) home counties houses in the first place when they were my age with families.

What caused the previous owners to sell up ?

I think one answer is the very high local rates that were charged in the late 70s. I remember them always saying "we'll have to move when we retire because we can't afford the rates". Maybe today's council tax is kinder to large property owner than the old rates system.

Let's see how the new property value based "rates" work in Northern Ireland.

A lesser cause of lack of supply is the rise of the buy to let mortgage. This could be combated by reducing the amount of BTL expenses that can be offset against income. In other words, tweak tax benefits to give the owner occupier an advantage over the BTL owner.

But as we know, any changes would have to be implemented very slowly & carefully, because if the market is currently in any way speculative, it could cause a rush and then a fall (e.g. as happened with the ending of multiple mortgage interest relief in Autumn 1989 - for those of us old enough to remember).

But I guess non-monetary methods of supply modification are rather obvious and common. The question is whether policy will alter. And that is harder to predict.

Posted by: Nick Thorne at January 11, 2007 11:31 AM

Nick, David,

Your analyses provide what I believe is an unrealistically optimistic conclusion to the current debt and housing situation. I assume therefore that you are both homeowners who have seen considerable gains over the years. Let me offer a more realistic outcome.

The estate agency business has seen unprecedented growth with soaring house price inflation brought on by cheap and available credit. As transaction volumes fall, the survival instinct will kick in (after all the commission from selling 5 houses at 250K isn't as much as selling 30 houses at 150K). As this happens, and sellers come to them with houses at 250K, they look at their bottom line and say "well John, at that price you won't sell". So John goes away in a huff, and comes back a month later to ask "Well, at what price can I sell?"

Thus starts an inevitable process where instead of a rose-tinted virtuous circle of ever-rising house prices, we have a rather nasty unwinding of the market. As we know, no-one catches a falling knife, so prices tumble for some time yet.

I've been in the estate agency business long enough to have seen similar cycles. Of course (before you jump in), yes this time is different. But so is every time.

Keep watching transaction volumes. Then start watching prices. I'm sorry to bring unwelcome news on such a bullish website, but you know, either you go around living in a bubble or you go around bursting them.

Posted by: Dan Hudson at January 11, 2007 08:53 PM

Dan, nicely put, but we've been through this debate very many times. Nick was trying to take it on. This site is not excessively bullish, in fact house prices have been stronger than I expected. My central point has always been that you don't get a crash unless there are extentuating economic circumstances - a loss of control of monetary policy (very sharp rises in interest rates), a big increase in unemployment and a wave of business failures.

This, of course, is what happened in the early 1990s. You say you've seen similar cycles before. Unless you're very old, I suspect that was the only one - you have to go back to the 1930s for a sustained national fall in nominal (cash) house prices.

We've had a bit of recent history of weak transactions - from the middle of 2004 until the autumn of 2005 - a situation which reduced house price inflation, but did not give us falling prices.

You should also be a little bit careful about the use of the term bubble. Charles Kindleberger, probably the most famous analyst of bubbles, manias and crashes, defined it as “a sharp rise in price of an asset or a range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers – generally speculators, interested in profits from trading in the asset rather than its use or earning capacity”. I don't think this describes the UK housing market but I don't blame you for this, it is widely misused.

Posted by: David Smith at January 11, 2007 11:03 PM


"a sharp rise in price of an asset or a range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers – generally speculators"

Do speculators wear special hats to identify themselves? I don't think so. Buy-to-let ... ahem ... "investors" meanwhile appear to be speculators to me and the rest of the media.

How about runaway inflation? The word is that even the "Contrived Price Index" has overshot and Mr King will have to write that letter. The pips are squeaking already with recent rate rises, with some estate agents crying "foul" already, and I suspect (for the reasons I've given already) that there isn't much ceiling space left in the housing market.

Only a bullish optimist living in a bubble would see it otherwise.

Posted by: Dan Hudson at January 11, 2007 11:55 PM

I agree with Dan. Kindleberger's definition of a bubble sounds like a perfect match for the UK housing market to me.

Regarding Nick's analysis - yes, I agree with this up to a point. However, there is always a mechanism for the market to correct itself in extremis. In this case, it is UK Plc becoming so woefully uncompetitive due to the ridiculous proportion of income that individuals (and businesses) need to spend on rent / mortgages, leaving little or nothing left to sustain the rest of the economy. I believe this is Fred Harrison's theory in essence, and he has quite a good track record.

I think we are fast approaching the debt limit - much further along this road and a recession is inevitable. Unemployment then resets the market and off we go again.

I am unconvinced that the bubble can be deflated in a controlled manner (ie. long term stagnation in nominal terms). Markets so rarely stand still - if we stop going up, we WILL start going down, IMHO.

Posted by: Yogi at January 12, 2007 12:57 PM

I don't have time to go over all these arguments again, which have been rehearsed and responded to many times on this site. But if you want to believe it is a bubble, by all means do so; it is a common misconception. Speculators trade assets. Even buy to let investors hang on to houses. As for the proportion of income spent on mortgages - that was 13-14% for all households with mortgages before the recent rate rises (FSA/CML/Bank of England data) and is probably in the upper teens now. Still plenty left for the personal sector to spend on other things.

Posted by: David Smith at January 12, 2007 05:46 PM

David, with all due respect, to state that a belief that "the UK housing market is a bubble" is a misconception comes across as rather arrogant. It is surely a matter of opinion? You can't prove you're correct and neither can we. Time will tell - when the market falters, we will see how many of the thousands of recent new amateur landlords rush to offload their low-yielding / negative-cashflow investments. Until then, we will not know whether it is correct to label them as speculators. I'm happy to agree to disagree with you on this... for now!

Regarding those debt servicing stats. I contend that the use of those averages is inappropriate. It only takes a drop of a few percent in consumer spending to tip the economy into recession. This can easily come from the 30% or so most indebted portion of society, to whom the banks will surely soon be saying "Enough! No more easy credit for you!" The other 70% could continue merrily spending away and still not stop the slide into recession. Do you have the equivalent average figure for 1989? A comparison would be much more meaningful. (Apologies if you have covered this specifically in the past).

By the way, I appreciate the time you put into this site, even if I don't always agree with your views. It would be nice if more journalists were prepared to engage in similar public debate.

Posted by: Yogi at January 12, 2007 08:19 PM

Thanks for the comments. On "bubble", it is just my somewhat pedantic approach to terminology. Bubbles general involve prices rising to many times fair value. I don't think even the biggest housing market bear could claim this of house prices, which is why I prefer to use the phrase house price boom. But this may be splitting hairs, and it is a free country.

The distribution of debt is all-important, and it is the point I was trying to make in the piece. I'll have a look for the comparable figures for 1989 but one point that is worth making comparing then and now (apart from the huge differences in the economic backdrop) is that there was a late rush into the market by first-time buyers then, many of whom were fully extended even before mortgage rates began to rise dramatically. That has not been the case this time and nor, except for one or two isolated examples, have lenders left themselves wiithout a cushion. Typical loans to value are 80% or less.

Posted by: David Smith at January 13, 2007 10:24 AM

David, you stated there was a rush of FTBers rushing into buying in 89 that caused a lot of pain. Surely th e BTL brigade, which was reported to be much higher in 2006 compared to previous years, is the same thing. These people have geared up from MEWing from their current equity. If prices dropped, they would be hit twice (or more in some cases)

Posted by: Rev at January 16, 2007 02:58 PM