Worrywarts are concerned about household debt. They're fretting about the wrong thing. Despite austerity, the welfare bill continues to soar, says James Ferguson of the Macrostrategy Partnership.
A year ago the Financial Conduct Authority (FCA) conducted its first Financial Lives survey, a large-scale (13,000 respondents) examination of Britain's personal finances. The regulator found that almost eight million (15%) people might be over-indebted and that a similar number (17%) would struggle if their monthly rent or mortgage payment rose by £50. Half of all adults displayed at least one characteristic of potential financial vulnerability, although almost all of these were young in the 25-34 age range, 13% said they were "in difficulty", compared with just 1% of the over-65s.
With interest rates at 5,000-year lows (as Andy Haldane, the Bank of England's chief economist, puts it) and unemployment at 4.3% (the lowest since 1975), this suggests that the economy could be very vulnerable to rising interest rates. Historically, quarterly consumer credit write-offs (bad debts) tend to come in at 2%-3%, but when unemployment rises these can grow to 4%-5%. During the financial crisis, when unemployment rose by 1-2 percentage points a year, write-offs reached 6%-7%.
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So perhaps it's no surprise that in July the Bank of England warned that the double-digit rise in personal loans looked "dangerous". It then, in September, warned the banks that in the event of another recession they risked losing up to £30bn on the £200bn of consumer debt they have lent out, due to default. The Bank demanded that they add a further £10bn to their precautionary capital buffers.
Meanwhile, a more recent survey of 2,000 people, carried out on behalf of CompareTheMarket.com, revealed that the average owed in the UK by those who have debt is £8,000 (excluding any mortgage). Of the respondents, 62% said they were worried about their personal debts, and 22% claimed to be struggling to make ends meet. Even so, a third plan to take on more debt over the next year. The average respondent didn't expect to be debt-free until the age of 57, while 12% think they will never be debt-free.
We are less indebted than we think
At first glance, this all looks very worrying. But are these survey results and dire official warnings really a fair reflection of the UK's debt burden? Let's start with the CompareTheMarket.com survey. Official statistics show that total UK household consumer credit comes to £206bn. We also know how many adults there are in the country 51 million. So, if we average across all adults (rather than only those with debt) to get a better idea of how systemic the problem is, then consumer credit per adult is less than £4,000. If we add in the £100bn of student debt, we still only get an average of around £5,900.
Student debt doesn't have to be repaid by the poorest graduates. The government's Student Loans Company assumes that 40% of outstanding debt will never be recovered and that two-thirds of students will not repay their entire debt (which makes you wonder what a university education is worth these days).
No repayments are required until earnings exceed £21,000 (set to rise to £25,000 next year) and all debts are written off after 30 years. So a student loan is not a loan per se, but rather a higher tax rate imposed only on those graduates productive enough to earn more than the threshold. (Incidentally, forgiving the debts of the least productive students is no way to help with the UK's appalling productivity growth.)
Our credit-card habit isn't that bad
Aside from the £100bn of student loans, a large chunk of the remaining £200bn of consumer credit is the £55bn of credit-card debt outstanding at any given time. Yet most credit-card debt (sometimes as much as 95%) is paid off each month so it's not really debt at all. An FCA report on problem credit-card debt estimated that borrowers in arrears (6.8%) and others who persistently carried over debt balances (11.8%) made up 18.6% of borrowers by number, but significantly less in terms of the value of the debt.
As a result, net credit-card debt probably amounts to less than £10bn. Banks earn a lot of interest on credit-card debt, and so make at least £2.5bn off this £10bn. Now, the current level of credit-card write-offs is 3.2%, which would deduct £1.7bn from the gross profit. At the height of the crisis, the write-off rate rose to 9.5%. This suggests a worst-case loss scenario for banks of around £3.5bn maybe double that across all consumer credit.
Credit cards were the worst-hit loan segment during the crisis, so the £30bn in consumer credit losses that the Bank of England claims banks should brace for seems overly pessimistic. The more prosaic truth is that the Bank needed a narrative to justify raising the banks' minimum capital buffers by £10bn. You see, the Bank's mandate is to raise such buffers counter-cyclically (in other words, when things are good, to prevent overly risky lending). But of course capital buffers constitute a "rainy day" fund for absorbing loan losses, which made the explanation sound quite negative.
Even the "dangerous" recent double-digit growth in non-credit-card consumer debt has yet to bring the total back up to early 2006 levels, after which such debt collapsed by a third over the five years from 2008 to 2013. Nominal GDP has risen by 40% since then, meaning consumer credit has fallen from 13% of GDP pre-crisis to just 9.4% now. Take out the over-counting of credit-card debt and total consumer debt is no more than 7.5% of GDP.
It's a similar story with outstanding mortgage debt, which differs from consumer credit because it is more than fully backed by housing assets. Mortgage debt reached 74% of GDP on the eve of the banking crisis, but has slipped to 63% since 2009. So while banks have doubled their capital, they have also substantially ratcheted back on lending, at least relative to the size of the economy.
Britain's real debt problem
In case I sound complacent about debt, I'm not. It's just that our attention is being misdirected towards household debt, where there's no discernible systemic problem. Instead, it should be focused on government debt, where there certainly is a problem.Before the crisis, UK government debt (the national debt) only amounted to a third of annual GDP. Then-chancellor Gordon Brown had run it up from 27% of GDP.
He had kept the annual deficit (the government overspend) running at around 3% of GDP in order to fund a raft of public-sector giveaways. This was mainly in the form of welfare benefits to the (mostly part-time) working poor. It's true that the £1.6trn bank bailout sent government debt surging to 144% of GDP in 2009. Yet most of those financial interventions resulted in profits for the taxpayer.
Today the remaining bailout debts (mainly guarantees to the Bank) amount to only around £235bn (11.8%) of GDP, if you exclude the government's 72% stake in RBS. That's an overall decline of 85%. But even excluding financial interventions, the deficit ballooned to 9% in 2009-2010. While it has made steady progress lower since then, it remained above 2% of GDP in the second quarter of 2017. At this rate, tax revenues won't cover government spending until well into the 2020s, according to current chancellor Philip Hammond's latest budget.
The trouble is this is as good as it gets
A great unasked question hangs over this state of affairs. If GDP is now almost 10% higher than at its pre-crisis peak; tax revenues are higher as a proportion of GDP (37% compared with 36% in 2007); unemployment is at a four-decade low; and students now pay £9,000 extra for tuition then why has austerity affected everything from the NHS to our schools, defence spending, and the police? How can we still be running deficits if taxes are up, yet spending is down across the board?
The answer is depressingly simple. One area of government spending has risen remorselessly since Brown's chancellorship: welfare benefits. Contrary to what most of the press would have you believe, benefits have little to do with the unemployed. Job Seeker's Allowance and the associated Housing Benefit account for just £3.5bn (1.6%) of the £218bn welfare budget. The largest items by far are the state pension at £100bn (45% of the welfare budget) and the £112bn in social security and tax credits, which, despite the name, are nothing more than welfare payments, most of which go to working claimants (effectively subsidising corporations' wage bills in the process).
With less than half of the population now paying income tax and few of these transfers to the working poor being discretionary, there appears no way to rein back this spending. Until now, departmental austerity and increased government borrowing have absorbed the slack, but with government debt now at 95% of GDP (81% if we exclude the remaining bailout debts) and growing by 2% a year, there's little scope to absorb a recession, let alone another crisis. In short, it's not household debt we need to be worried about it's government debt.
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