Where is all this household debt going to come from?


10:45 am - April 1st 2011

by Richard Exell    


      Share on Tumblr

This week there have been plenty of indications that business, and especially consumer, confidence are at very low levels. This provokes the question: just how likely is it that households are going to borrow on the scale the Office for Budget Responsibility expects?

Last week I pointed to OBR’s forecast for household borrowing and debt, which show this rising from 160% of income last year to 173% by 2015.

On Wednesday Paul Krugman blogged on this (referencing False Economy):

…the only way the economy can avoid taking a hit from government cuts is if private spending rises to fill the gap — and although you rarely hear the austerians admitting this, the only way that can happen is if people take on more debt. So we have the spectacle of a government that inveighs against the evils of debt pinning all its hopes on an assumption that over-indebted households will dig their hole even deeper.

I want to expand on this a bit, because this week there has been lots of evidence that this is unlikely to happen any time soon:

  • Reports from Incomes Data Services, the Labour Research Department and the Engineering Employers Federation show that pay deals are lagging the Retail Price Index by more than 2 per cent.
  • This is a well-established trend, so it isn’t surprising that the GDP figures showed that real household disposable income fell by 0.5 per cent in the last quarter of 2010, “the first annual fall in real household disposable income levels since 1981.”
  • The GfK NOP Consumer Confidence Index stayed put this month – but it was already at a low level, and Nick Moon, the Managing Director of GfK NOP Social Research talked about it having “stagnated at depths seldom seen outside of actual recession. The last time it was this consistently low was two years ago, and before then in autumn 1990.”
  • The Bank of England reports that mortgage defaults are up, despite low interest rates and falling house prices. There is a “marked decline in households’ demand for secured credit to finance a new house purchase.”
  • What do you know, debt advice agencies report that consumers must be lying awake at night worrying about debt because they’re seeing a big increase in the numbers ringing them after midnight.
  • This is feeding through to business confidence – the CBI’s latest Distributive Trades Survey reported that “sales growth remains subdued” – partly because incomes are depressed.
  • Dixons blames the VAT increase and cuts for poor sales; the Chief Executive of the Co-operative Group says that “consumers [are] feeling the squeeze on their spending,” which won’t recover until 2012; Signet, the US company that owns Ernest Jones and H Samuel, reported that confidence is much more fragile in the UK than the US and Moss Bros Chief Executive Brian Brick said that “the consumer is being very careful where and when they spend their money.”
  • Lloyds Banking Group reports that business confidence is down, with the proportion of business reporting lower confidence this month than last rising from 36 to 44 per cent.

The falling demand for mortgages seems particularly important to me.

If you think you’ve got a steady income stream ahead, this is a good time to buy a house or move up the ladder: interest rates are low and prices are stagnant, so the fact that people aren’t doing so is very significant.

And where’s all that debt going to come from?

    Share on Tumblr   submit to reddit  


About the author
Richard is an regular contributor. He is the TUC’s Senior Policy Officer covering social security, tax credits and labour market issues.
· Other posts by


Story Filed Under: Blog ,Economy

Sorry, the comment form is closed at this time.


Reader comments


In effect Krugman is saying you can’t have GDP growth without credit and/or debt growth.

Which is of course classic Keynesianism, and at the same time total and utter rubbish.

I presume, given this “EasyBuy” or whatever it’s called, they’re banking on the staple of all UK Governments – a bailout by a rising housing market. Even throughout the ‘credit crunch’, I think there were only two individual months in which the total level of mortgage debt in the UK fell. It’s now growing at a net rate of between about £1bn and £2bn a month again, on a low level of approvals.

Essentially, mortgages being paid down are mostly from a time when houses were cheaper, so are smaller than the ones being taken out. People downsize, and money is redistributed from the young to the old.

Let’s assume that mortgage approvals go back up from the current 47,000 a month to an average of 70,000 a month between now and 2015. I don’t think that’s unreasonable as a compromise between current lows, and the bubble-era highs of well over 100,000 mortgages a month. Demand for mortgages may be falling, but it won’t fall forever, and mortgages actually agreed have been creeping back up.

Suppose the average house price to be about 200k, and the average mortgage be for 70% loan to value. That’s an extra £3.2bn a month of gross lending, with relatively little short-term impact on repayments. Let’s call it £2.7bn a month of extra net lending. Over four years then, adding that to the current level (say £1.3bn to be on the safe side) we see mortgage debt growing by £4bn a month.

In the 57 months to the end of 2015, then, that’s growth in net household debt secured on dwellings of about £230bn, based on new purchases. All they need then is the same again from the broader mass of people ramping up their credit cards, their equity release, their personal loans, their car and furniture hire purchase agreements, etc etc.

It’s at the boundaries of the probable, but given a high inflation environment, low wage rises, and a following economic wind (from somewhere, god knows where), I don’t think it’s impossible – though it is, of course, hypocritical and irresponsible.

You do know that the burden of government debt ultimately falls on households, don’t you?

4. Luis Enrique

yes, I’d like to know that too: who are they expecting to borrow more (compared to previous forecasts) and for what reason. Particularly whether it’s poor/middle/rich households.

it’s not obvious, as I’ve said on previous threads, that falling real incomes and government cuts caused higher borrowing / less saving.

Which is of course classic Keynesianism, and at the same time total and utter rubbish.

No, all the jobs are going to come from export led growth aren’t they? Oh no, wait, its the EZs! they’ll do the job like last time!

If you think you’ve got a steady income stream ahead, this is a good time to buy a house or move up the ladder: interest rates are low and prices are stagnant, so the fact that people aren’t doing so is very significant.

It’s not a good time to buy a house, if (a) you think prices are likely to fall further, (b) you’re worried that interest rates are likely to rise in the future, or (c) you simply can’t afford the deposit. With banks unwilling to lend at more than 75% LTV and average house prices anywhere between 3 and 6 times average annual income (depending on which part of the country you’re looking at) people can only get mortgages if they’ve already got a full year’s wages in the bank (or equivalent equity). How many people do you know in that situation?

7. DisgustedOfTunbridgeWells

the only way that can happen is if people take on more debt.

God forbid real wages should rise in line with productivity.

8. Duncan Weldon

What interests me is that the OBR is forecasting very weak houseprice growth alongside balloning household debt.

Would be nice to see some detail about the breakdown between mortgage and other debt in their forecast.

The OBR do provide sectoral financial balance forecasts which are worth a look:

tab 1.7 here – http://cdn.budgetresponsibility.independent.gov.uk/obr_economy_supplementary_tables.xls

9. Luis Enrique

It’s not clear to me whether Krugman is simply saying that (in a closed economy) falling public borrowing necessitates falling private net saving, or whether he is saying something about how credit expansion (i.e. not net borrowing, but gross) will be required to finance investment and private sector spending, if it is to fill the gap left behind by government cuts.

either way, I don’t think he should be interpreted as saying household borrowing has to rise – he just says “people” have to borrow more – because of course corporate sector borrowing could rise.

10. AnotherTom

It is quite extraordinary all this commentary about one technical piece of data in the OBR report, which people don’t seem sure how to interpret, whereas there is no commentary about the much more substantial analysis in the non-data part of the report.

In that very long report, there was no explicit reference to rising household debt. Indeed, the downgrade in growth forecast is clearly linked to higher than expected inflation, and it is not a very stretch of analysis to link this to changes in household debt assumptions (and debt assumptions in general).

Cherry-picking evidence to suit a political agenda just seems a total waste of time (and is what got us into this mess to start with).

11. AnotherTom

“With banks unwilling to lend at more than 75% LTV ”

Untrue. I’ve just got an 85% LTV mortgage.

12. Luis Enrique

umm, stupid question (I confess, I don’t really know my way around the UK national accounts like I ought to) – that OBR table just refers to “total household liabilities”, which sounds more like gross debt rather than net debt to me. Which is it?

If it’s gross debt, then it’s not right to say “households are borrowing more” because they could also be saving more. If households are both borrowing and saving more, then the distribution really matters – which households are the savers and which the borrowers?

So far there has been a tendency to interpret this increased forecasts household debt as if it’s poor struggling households borrowing to keep their heads above water. But it could be that poor households are continuing to deleverage and richer households are starting to expand credit again, maybe even at the same time as rich households are saving more! (maybe some rich households have spotted some investment opportunities and are borrowing from other rich households).

13. Luis Enrique

Another Tom

I don’t understand you: what are the links between inflation, growth and household debt?

Before the election, when he was a shadow Chancellor, George Osborne used to worry us about the scale of “consumer debt”:

“Gordon Brown has saddled Britain’s economy with the twin burdens of rising government debts and a heavy consumer debt,” said shadow chancellor George Osborne. [February 2006]
http://www.telegraph.co.uk/finance/2932143/Consumer-debt-level-beats-UK-output.html

Put simply, our prospective trouble is that consumer spending, business investment and net exports have to rise to fill the gap left in total demand from the government’s cuts in public spending.

If there is a hole, there is an increasing problem with growth, the buoyancy of tax revenues and with unemployment. If consumers – and businesses – don’t have the income to sustain higher levels of spending, they will need to borrow, which is where the banks, and bank lending come in. The banks usually like lending to consumers because the average returns are better than with lending to businesses while the default risk is lower.

15. AnotherTom

“Higher-than-expected inflation is likely to squeeze household disposable income
in the coming months and thereby weaken consumer spending growth. Recent
data also show that the economy had less momentum than we expected entering
2011, even after adjusting for the temporary impact of December’s heavy
snowfall. Largely reflecting these two factors, we have revised down our central
forecast for economic growth in 2011 from 2.1 per cent to 1.7 per cent.”

So the OBR links slower growth primarily with inflation rising. By also revising the inflation assumptions this has a knock-on effect onto debt assumptions (because one directly effects the other; for example, higher inflation helps debtors). However, and as you’ve noted elsewhere Luis, it’s hard to know precisely why they’ve increased the household debt assumption because no-one has yet found the bit where they’ve explained it.

Luis you would be the perfect person to call up the OBR and ask.

I’m sure they will be responsive.

As for bank lending to individuals, see this latest release from the BoE on 29 March:

Total lending to individuals rose £2.0 billion in February compared to the previous six-month average increase of £1.1 billion. The twelve-month growth rate remained unchanged at 0.7% (Table A).

Within total lending, lending secured on dwellings rose £1.2 billion, compared to the previous six-month average increase of £1.0 billion. The twelve-month growth rate remained unchanged at 0.7% and the three-month annualised growth rate increased 0.1 percentage points to 0.9%.
http://www.bankofengland.co.uk/statistics/li/2011/feb/lending%20to%20individuals.pdf

@ 5 Sunny

Well done for completely missing the point. Where did jobs come into it? Last time I checked we were talking about GDP growth and debt.

Classic Krugman/Keynes is that you can’t have one without the other, or to put it another way, spending drives growth.

Which is in part at least true.

However, another big driver of GDP growth can be increasing productivity, which need not include increasing spending/debt, and can in fact reduce it.

As Luis @ 9 hints at, Krugman really only has one setting – spending more solves all problems. Debt clearly isn’t the solution to a debt fuelled crisis.

Luis @ 12 also makes several very good points – gross debt can increase whilst net debts decrease and assets increase.

@ 14 Bob

See above, but no they don’t. The problem is, that credit extension/borrowing is the quickest and easiest way to stimulate GDP, and governments are hooked on it. Many economists also seem to have forgotten anything but as well.

19. AnotherTom

I think it’s worth pointing out that forecasts four years hence are largely speculative. No economist can forecast in detail beyond around 12-18 months.

Given that, arguing about an 8% rise in one indicator over four years seems peculiar.

@18: “Many economists also seem to have forgotten anything but as well.”

Try Hyman Minsky:

Hyman Minsky’s theories about debt accumulation received revived attention in the media during the subprime mortgage crisis of the late 2000s.

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector.

He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.
http://en.wikipedia.org/wiki/Hyman_Minsky

Northern Rock, which became infamous for lending people up to 125% of the value of their home before the credit crunch, has launched a range of 90% mortgages.
http://news.sky.com/skynews/Article/201102115942379

Northern Rock is now wholly state owned.

21. gastro george

@Another Tom

“No economist can forecast in detail beyond around 12-18 months.”

It would appear from recent years that no orthodox economist can forecast accurately beyond today, if that.

“Krugman really only has one setting – spending more solves all problems. Debt clearly isn’t the solution to a debt fuelled crisis.”

No, Tyler, you don’t know a thing about Krugman the economist because you only seem to care about krugman the political commentator.

We (the west) are still in a slump, and more demand can get us more output without many bad side effects.

In normal times he is mr neoliberal consensus (with maybe a little more redistribution than others [see talks given at the LSE on trade and inequality]) and once we’re recovered I think the left will be in for a shock.

More demand, lets get the central bank doing more.

23. Duncan Weldon

OBR (March forecast) say:

“We have revised down our forecast for consumption growth in 2011 from 1.3 per
cent to 0.6 per cent, with further small downward revisions in 2012 and 2013.
This subdued consumption outlook requires households to dip into their savings
again in 2011, so the saving ratio continues to fall back from its post recession
peak. Thereafter, the saving ratio stabilises at around 3½ per cent in our forecast
(much the same as forecast in November), which is around half its average over
the last 50 years.”

24. Duncan Weldon

@19.

“Given that, arguing about an 8% rise in one indicator over four years seems peculiar.”

8%? They forecast a 36% increase in household debt.

Luis ’12,

Yes, it’s gross not net. Agree more detail would be good!

@21: “It would appear from recent years that no orthodox economist can forecast accurately beyond today, if that.”

Sadly, Keynes and Minisky are dead now but try instead this review of Roubini: Crisis Economics (Allen Lane, 2010):

Professor Roubini’s “crash course in the future of finance”, in collaboration with freelance writer Stephen Mihm, has been particularly keenly awaited. His was one of the few voices in the economics profession to have correctly predicted the contours of the crisis. Having identified the US housing market as but one of numerous asset bubbles across the West, he warned that all finance was in danger, that investment banks would be wiped out, and that the world faced a recession on a par with the Great Depression.

Many years ago, Roubini had earned the nickname Dr Doom; in 2007 his doomy forecasts came true in almost every particular. The predictions in Crisis Economics about the dangers to the eurozone – written months ago – appear to be coming true, just as the book appears.
http://www.independent.co.uk/arts-entertainment/books/reviews/crisis-economics-by-nouriel-roubini-with-stephen-mihmbr-aftershock-by-philippe-legrain-1978235.html

The 2007/8 financial crisis was a hugely magnified re-run on a wider and greater scale of the Saving & Loan Association crisis in America in the 1980s and 1990s:

“The savings and loan crisis of the 1980s and 1990s (commonly referred to as the S&L crisis) was the failure of 747 savings and loan associations (S&Ls aka thrifts) in the United States. A savings and loan is a financial institution that accepts savings deposits and makes mortgage, car and other personal loans to individual members—a cooperative venture known in the United Kingdom as a Building Society. “As of December 31, 1995, RTC estimated that the total cost for resolving the 747 failed institutions was $87.9 billion.” The remainder of the bailout was paid for by charges on savings and loan accounts —which contributed to the large budget deficits of the early 1990s.”
http://en.wikipedia.org/wiki/Savings_and_Loan_crisis

American regulatory authorities evidently learned absolutely nothing from that debacle – even though I first learned about it from a well-reviewed, regular economics text: Donald Campbell: Incentives (Cambridge UP, 1st ed. 1995).

26. gastro george

@25

Thanks for the links.

I should, of course, have said “consensus economist” rather than “orthodox economist” to be more precise.

27. AnotherTom

Oh, the Roubini myth.

As a forecaster, it is easy to say “everything’s going to grow” (Web 1.0, Dow Jones 36,000), or “everything’s going to collapse” (Roubini). Like a stopped clock, at some point you’ll be correct, and if you’re lucky people will think you have some kind of awesome power. However, they quickly become out-dated and somewhat ludicrous.

A brief glance at Roubini’s 12 stages shows he predicted the easy stuff – that massively over-leveraged banks, the credit sector and things related to it would collapse – but he didn’t predict much else. People in the market (myself included) knew by 2005 (yes, 2005) that credit conditions were too lax. By end-2007, the only people who didn’t believe a credit-related crash would come were governments and the equity markets (generally the most stupid of all decision-makers). Roubini is good with media (and the ladies) but he’s no god.

28. AnotherTom

@24 my bad, the difference in 2015 household debt forecast as of August and February is c. 16%, which I think illustrates the volatility in forecasting even over a period of weeks and months. That was the number I was trying to point to, though realise it probably didn’t sound like that.

@ 20 Bob B

THanks for that. Agree Minsky seems to be much more on the ball….i did say *many economists*, not all.

@ 22 LO

Isn’t Krugman the economist and Krugman the political commentator the one and the same? It’s pretty hard to draw them apart.

Let me just remind you of his famous 2002 NYT op-ed…the one where he promoted “blowing up a housing bubble” (his words) to deal with the fallout of the Nasdaq crash. Worked out well for us all, didn’t it.

And that’s the problem in a nutshell really – the west is indeed in a slump, and more demand would indeed help, but you ignore the severity of the “side-effect” of ever increasing levels of debt. Politicians also willfully ignore it for the most part as it kicks the proverbial can many years down the road.

Remember also that increased debt levels serve to destroy demand – it forces a displacement of spending.

As for printing money….oh please….in real terms it is little different to debt (it is in fact forward starting debt). At some point it either needs to be removed from the system, or funded….by debt.

30. Planeshift

“he one where he promoted “blowing up a housing bubble” (his words) to deal with the fallout of the Nasdaq crash. Worked out well for us all, didn’t it. ”

Did for 7 years or so I guess. Reminds me of the Onion’s headline: recession plagued nation demands new bubble to invest in. At the very least such a policy would buy time.

@27: “Oh, the Roubini myth. ”

American regulatory authorities evidently learned absolutely nothing from the Savings & Loan Association debacle of the 1980s and early 1990s – even though I first learned about it from a well-reviewed, regular economics text: Donald Campbell: Incentives (Cambridge UP, 1st ed. 1995).

In the mid 1990s, well before the crisis, Campbell used the S&L Crisis as a graphic illustration of how ill-considered incentive systems could create unintended consequences – in this particular case, the unintended consequences of an explicit – or implicit – state guarantees to bail out failing banks to protect depositors and prevent systemic collapses of financial systems.

This is the “moral hazard” that Mervyn King goes on about – the effect of the explicit or implicit guarantee is to motivate high risk lending by banks and other financial institutions as their directors, traders and staff pursue bonuses regardless of the risks to the shareholders of the banks or financial institutions for which they work – and which conflicts with the regular assumption made about capitalist enterprises that their staff diligently work to maximise shareholder values. In games theory, this is known as the principal-agent problem.

In those circumstances, it ain’t too surpising that many economists didn’t foresee the crisis coming – the assumptions they regularly made about the working practices of financial institutions rendered such crises either logically impossible or Black Swan events.

Mervyn King has repeatedly urged the need for banking reforms to compensate for the moral hazard from deposit protection schemes, such as this recently:

King helps the case for banking reform
http://www.ft.com/cms/s/0/2e6ba9a6-49bd-11e0-acf0-00144feab49a.html#axzz1IHGZzQdO

Now we learn from yesterday’s news of HM Treasury trying to stifle the supposedly “independent” Banking Commission, chaired by Sir John Vickers, to the extent of reports in the financial press that the government appointed commissioners are prepared to resign.

We are still in the world as presented in this FT interview of Carmen Reinhart about recurring patterns in 800 years of financial crises:
http://video.ft.com/v/82349517001/May-3-800-years-of-financial-crises

She is co-author of a book with Kenneth Rogoff: This Time Is Different – 8oo years of financial crises (Princeton UP, 2009)
http://www.economics.harvard.edu/files/faculty/51_This_Time_Is_Different.pdf

Rogoff, now at Harvard, was previously chief economist at the IMF. He is also a Grand Master at chess.

@cjcjc

You do know that the burden of government debt ultimately falls on households, don’t you?

How does it do that then?

@ 30 Planeshift

Seriously? It also (and might still) almost tipped the world into another depression.

There is nothing so dangerous as compound interest….

34. Richard W

I really don’t know why people are struggling to understand this issue.

The economy consists of the government sector, private sector including households and corporates and the external sector which is our trade with the rest of the world. For GDP to grow over a period of time requires income to grow to generate an increase in aggregate demand. For real aggregate demand to be increasing requires that current spending plans, summed over all sectors, be greater than current received income. Productivity growth makes the economy more productive but also results in a loss of income for some. Therefore, for aggregate economic growth to take place requires one sector to increase their debts or sell assets.

Now ideally we would like the increase in debts to finance our GDP growth to be on the ROW and we would achieve that through net exports. If we sell more to them than we buy from the ROW our claims on the ROW increase and that is an increase in debts by the ROW. The OBR are forecasting little improvement on the current account and as a consequence net trade is not contributing to GDP growth. The coalition wanted an export-led recovery but inflation is a drag here because it deteriorates our ‘ terms of trade ‘. Rising input costs for British industry are not matched by the the price exporters can achieve exporting into markets with lower inflation and that means their terms of trade are worse than they would be without the higher inflation. The VAT rise contributed to that so they are partially responsible for the deterioration in terms of trade. Government inconsistency writ large.

So if trade is not going to contribute to GDP growth there must be an increase in debts, dissaving or sale of assets by the household or corporate sector for the government to increase their savings by reducing their fiscal deficit. When the government runs a deficit they are dissaving and when they run down the deficit the dissaving transfers to others. As the government reduces their spending the financial surplus of the private sector automatically falls. There would in aggregate be less income in the economy if someone was not accumulating debts and GDP growth could not be occurring. That is what the OBR and Krugman means by private sector debts increasing. Last summers talk about confidence leading to a business investment boom appears to have disappeared. Therefore, without an improvement in our trade with the ROW, an increase in business investment the dissaving will fall on the household sector as the government reduces their deficit.

.


Reactions: Twitter, blogs
  1. Liberal Conspiracy

    Where is all this household debt going to come from? http://bit.ly/gd2DIo

  2. Liz K

    RT @libcon: Where is all this household debt going to come from? http://bit.ly/gd2DIo

  3. Owen Millard

    RT @libcon: Where is all this household debt going to come from? http://bit.ly/gd2DIo

  4. False Economy

    RT @libcon Where is all this household debt going to come from? http://bit.ly/gd2DIo

  5. John Ruddy

    RT @FalseEcon: RT @libcon Where is all this household debt going to come from? http://bit.ly/gd2DIo

  6. UNISON MillionVoices

    RT @FalseEcon: RT @libcon Where is all this household debt going to come from? http://bit.ly/gd2DIo

  7. UNISON - the union

    RT @FalseEcon: RT @libcon Where is all this household debt going to come from? http://bit.ly/gd2DIo

  8. Boris Watch

    RT @libcon: Where is all this household debt going to come from? http://bit.ly/gd2DIo

  9. Josie S

    Why Osborne's secret Plan A (load debt onto people) can't work. http://is.gd/4piQyO Stop them before it is too late. #m26 #ukuncut #demo2011

  10. Josie S

    Be interested in your views on this. http://is.gd/4piQyO and this http://is.gd/4piQyO @DrEvanHarris

  11. Lucia Fry

    RT @FalseEcon: RT @libcon Where is all this household debt going to come from? http://bit.ly/gd2DIo

  12. paurina

    RT @libcon: Where is all this household debt going to come from? http://bit.ly/gd2DIo

  13. Duncan Weldon

    RT @libcon: Where is all this household debt going to come from? http://bit.ly/gd2DIo

  14. Hopi Sen

    RT @libcon: Where is all this household debt going to come from? http://bit.ly/gd2DIo > this worries me.

  15. Liberal Conspiracy

    RT @hopisen: RT @libcon: Where is all this household debt going to come from? http://bit.ly/gd2DIo > this worries me.

  16. Molly

    RT @FalseEcon: RT @libcon Where is all this household debt going to come from? http://bit.ly/gd2DIo

  17. Why I’ll be joining the right-wing Rally Against Debt | Liberal Conspiracy

    […] confidence is taking a huge knock, businesses aren’t investing, mortgage defaults have jumped “unexpectedly”, […]

  18. The next credit crisis will hit consumers, not banks | Left Foot Forward

    […] seen how worrying household debt figures are, with forecasts showing a rise from 160 per cent of income last year to 173 per cent by 2015. The silver-lining, […]





Sorry, the comment form is closed at this time.