en-us http://backend.userland.com/rss Your Friends @ Myvesta.org.uk (stever@myvesta.org) myvestaukblog_archive.html stever@myvesta.org 114306186673306348 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.

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.


The Sunday Times March 12, 2006