Sunday, April 07, 2013
Household debt no longer as big a burden
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

What's changing in the economy? The promised rebalancing towards exports and investment has not occurred.

Nor, according to the Office for Budget Responsibility (OBR), should we hold our breath. Thnough it is optimistic on business investment from next year onwards, it does not see net trade contributing significantly to growth for the next five years.

Some things are changing, however. Last week I noted the financial sector’s shift from boosting growth to dragging on it. George Osborne wanted less reliance on financial services and has got it, though the effect on the measured recovery and the public finances suggests chancellors should be careful what they wish for.

There is another big change I want to focus on, and it concerns household debt. The rise and rise of debt has been one of the stories of our age. A nation of homeowners - nine-tenths of the debt is in mortgages - combined with easy credit availability to produce a striking increase in the amount owed by households.

From £239 billion at the beginning of 1987, household debt saw a more than fivefold rise to a peak of £1,550 billion at the end of 2008. Roughly £1 trillion occurred from the end of 1996. Though inflation played a part, debt rose from under 100% of annual household income to a high of 167.5%.

Times have changed. Household debt does not normally fall. In cash terms it carried on rising through the recession of the early 1990s, before regaining momentum as the recovery gathered strength.

This time, it has fallen. Not much, but it has fallen. At the end of 2011, household debt was £21bn lower than three years earlier. Though it has edged up a little since, it remains below its pre-crisis peak.

A more striking demonstration of this is when debt is measured against income. From that 2008 peak of 167.5%, it dropped to 141.4% in the final quarter of last year, according to the Office for National Statistics in its latest monthly economic review.

Nothing like this has happened before. Debt edged lower as a percentage of income in and after the recession of the early 1990s but not to any significant extent. This time the adjustment has been dramatic, and it many not yet have finished.

Why has it happened? If debt is to rise it needs to be available. Six years ago two-thirds of new mortgages came from so-called wholesale funding sources, rather than conventional bank and building society deposits. When the financial crisis hit, wholesale funding slowed to a dribble, turning mortgage feast into famine.

Even if mortgages had been available, households would still have been reluctant to take on debt. Debt appetite was replaced by an almost Pavlovian debt aversion.

If not, you might have expected individuals to compensate for the squeeze on their incomes by borrowing more. They did not do so, which is why consumer spending, despite a gentle rise since late 2011, is still 4% below pre-crisis levels.

People borrow when real incomes are rising and confidence high. It is not surprising falling real incomes and weak confidence results in a reluctance to borrow.

What happens now? The housing market is the key. Rising household debt is the natural consequence of a normally functioning housing market. Those who enter it, first-time buyers, do so with with debt, having taken on a mortgage to do so. Those who leave it, mainly older people, do so having paid off their mortgages years before. The net effect is a rise in debt.

Will the housing market ever function again in a normal way? The Funding for Lending scheme (FLS) has done a better job at boosting mortgage availability than it has in boosting small business lending, notwithstanding a small dip in mortgage approvals in the latest figures.

The Help to Buy scheme unveiled by George Osborne in the budget takes it further and has produced a curious reaction. The centrepiece of the scheme - £12bn of government guarantees to support £130bn of new mortgages over three years - seeks to address the mortgage famine that has so depressed housing activity.

Some of the criticism, suggesting it will create a sub-prime crisis in Britain, is preposterous. If we see mortgage lenders doling out loans to borrowers with no income, no jobs and no assets, America’s infamous Ninja borrowers, you might believe it. But that is not going to happen.

As for taking action at all, governments have always intervened in the housing market. In the 1970s local authorities were an important source of mortgage lending. For more than three decades homeowners received tax relief on their mortgage interest payments. A three-year time-limited scheme is modest in comparison.

Will the scheme pump up pver-inflated house prices? Prices have adjusted significantly, falling by by 26% in real terms since autumn 2007, according to the Nationwide building society. As Oxford Economics pointed out in the Institute for Fiscal Studies green budget, prices are now undervalued relative to their long-run trend.

The house price-earnings ratio is not a very useful measure of anything, but it has fallen by a quarter since before the crisis and, as Oxford Economics also pointed out, is in line with its average since the period of low interest rates began in the 1990s.

Will not government mortgage guarantees lead to the household debt burden rising? No. Even if Help to Buy results in £130bn of new mortgages over three years, which may be optimistic, the household debt ratio would not rise, based on what has happened to incomes in recent years. Nor is it likely to produce a new house-price boom: the scale is not there. Net mortgage lending was rising by well over £100bn annually before the crisis. £130bn over three years is small by comparison.

Should not people be encouraged to run down their debt further? There has already been unprecedented deleveraging and household balance sheets are healthy. Household assets are large in relation to income - 8.5 times according to the OBR - meaning that household net worth is 700% of household annual income.

That is not a bad position to be in. Some people took on too much debt in the run-up to the crisis and the overall level rose too quickly. But household debt, typically 25-year debt, of under 150% of annual income is sustainable. Encouraging it down much further will simply deprive the economy of the demand it needs.