Chill out about the debt bubble?

Not yet.

What role did high levels of household debt play in generating the crash and what do they mean for our economy over the next few years? 

Well-worn questions, you might think. And no shortage of people have asserted answers.  Following 2008, a whole new crunch-lit genre of books emerged to explore this. There is – or perhaps, was – something of a post-crash orthodoxy that the rise of easy credit, fuelled by run-away rewards for the super rich, and a squeeze elsewhere, encouraged ever greater borrowing. 

A favoured narrative, often echoed by the coalition, is that debt ballooned as consumers (and home buyers) went on an irresponsible binge – it was all demand-led.  Others argue, particularly in the US, that exploding debt reflects an act of policy – whether explicit or implicit – to increase the supply of easy credit for low and middle income groups who were seeing their wages stagnate.  From this perspective, it was less a story of families living beyond their means and more about coping when their means stopped growing. 

More recently, however, there has been a counterblast to these prevailing views.  The FT’s economics editor Chris Giles, a leading authority on our current economic predicament, maintains that fast-rising household debt should be greeted with little more than a shrug of the shoulders. Ben Broadbent of the Bank of England’s MPC makes a similar case. Higher debt is essentially about mortgages and it reflects rising house prices (let’s leave to one side for now the fact that rising debt and assets signifies a big transfer between the generations, benefiting the old at the expense of the young). And once we do take assets into account we find that the net financial position of households is roughly similar to the position twenty years ago. Relax.

Nor should we get het up about the banks having undertaken an orgy of easy and ill-judged lending. Few of the loans made to UK households have turned nasty. Banks made stupid mistakes, to be sure, but they mainly came in the form of bad loans made overseas, not in the UK (as highlighted in this good blog by Ben Chu discussing the speech by Broadbent). 

So, rather than fret about the enormous size of our debt overhang and what it means for our future growth prospects, we should move along and worry instead about something more meaningful.

This account is right, of course, to point out that not all the growth in household debt is problematic.  Plenty of households will have borrowed  more for an asset (a house) that is worth a bit more, and achieved this by taking on a debt they are capable of servicing. Nothing much wrong with that. But in scoring this point, advocates risk downplaying a bigger one: debt still matters.

First, the distribution of debt burdens across different income groups is important.  Aggregate data often conceals far more than it reveal. As the chart below shows, at the bottom of the income distribution the growth in consumption appears to have massively outstripped increases in income – unsustainably so.  (A health warning is necessary here: survey data on the lowest - and highest -  incomes can be highly imperfect, so a degree of caution is warranted on the precise numbers, but the overall pattern is likely to be correct). 

Source: NIESR analysis for the Resolution Foundation

What was driving this growth in consumption is less clear cut. Part of it is likely to be underlying shifts in the cost of living that bore down hard on low income families. Another element will have been increased mortgages (though the proportion of the poorest holding a mortgage barely rose from 1997-2007, so this isn’t likely to be the only thing going on here). And if the UK consumer is anything like their US counterpart, high levels of inequality may have played a role in generating ‘trickle-up consumption’ – whereby lower income groups strain to keep up with the spending of the affluent.  

Second, we shouldn’t be complacent about the number of bad loans or repossessions. Depending on the definition applied, between 5 per cent and 8 per cent of mortgages are  currently in forbearance – an agreement between mortgagors and their bank which usefully allows repayments to be rescheduled – but this stay of execution cannot be expected to last indefinitely or resolve the underlying affordability issues that hang over many households.

Third, the revisionist argument is in danger of downplaying the risks – potentially scary ones – of what might happen if, eventually, interest rates rise before we have strong household income growth (a point highlighted on this blog before).  True, at the moment, with the economy crawling along the floor and the euro-zone teetering on the brink, talk of higher interest rates feels very far-fetched.  But with inflation still stubbornly above target, and the Bank yet again claiming it will be another year before it falls into line (meaning inflation will have been above target for most of eight years) the medium term outlook for interest rates remains uncertain. At some point the interest rate hawks will regroup – and eventually a more normal level will return.  

All this matters greatly because a high debt burden means many households are already highly exposed; we just tend not to talk about it much because the headline Bank rate is so low. Consider the current burden of servicing mortgage payments for low to middle income households.  It is broadly similar, incredibly you might think, to the burden faced in the late 1990s when interest rates were 5 to 7 per cent. That’s partly due to the rapid growth in interest rate spreads, and partly due to the greater stock of household debt. 

An increased burden: proportion of gross income accounted for by mortgage payments among low to middle income owners

Source: Resolution Foundation 

Which takes us on to the final point: the extent to which the burden of debt will continue to bear down on UK consumers – or at least a sub-set of them. The truth is no-one really knows whether or how far household debt needs to fall. If we listen to McKinsey, we’d believe that the UK is only just beginning the painful adjustment – behind countries like the US – and it could take a decade before the ratio of UK household debt to disposable income returns to its pre-bubble path.  Other analysis  argues that to be "sustainable", household debt needs to fall from the current level of just below 150 per cent relative to income to nearer 115 per cent - a process that is likely to take until 2019 (after fiscal balance has been achieved). If so, deleveraging as well as public austerity will be a drag on consumers.  

Four years on and we’re still to have a full reckoning with the crisis. UK household debt didn’t cause it all. And high levels of debt aren’t always bad in themselves.  But we’d be silly to be sanguine.  The debt mountain makes us highly vulnerable, and will be living with it for some while yet.

In the shadow of a debt mountain. Photo: Getty Images

Gavin Kelly is a former adviser to Downing Street and the Treasury. He tweets @GavinJKelly1.

Photo: Getty
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Labour's trajectory points to landslide defeat, but don't bet on a change at the top any time soon

The settled will among Jeremy Corbyn's critics that they need to keep quiet is unlikely to be disrupted by the result. 

Labour were able to tread water against Ukip in Stoke but sank beneath the waves in Copeland, where the Conservatives’ Trudy Harrison won the seat.

In Stoke, a two-point swing away from Labour to the Tories and to Ukip, which if replicated across the country at a general election would mean 15 Conservative gains and would give Theresa May a parliamentary majority of 40.

And in Copeland, a 6.7 per cent swing for Labour to Tory that would see the Conservatives pick up 52 seats from Labour if replicated across the country, giving them a majority of 114.
As the usual trend is for the opposition to decline from its midterm position at a general election, these are not results that indicate Labour will be back in power after the next election.. That holds for Stoke as much as for Copeland.

The last time a governing party won a by-election was 1982 – the overture to a landslide victory. It’s the biggest by-election increase in the vote share of a governing party since 1966 – the prelude to an election in which Harold Wilson increased his majority from 4 to 96.

To put the length of Labour’s dominance in Copeland into perspective: the new Conservative MP was born in 1976. The last Conservative to sit for Copeland, William Nunn, was born in 1879.

It’s a chastening set of results for Ukip, too. The question for them: if they can’t win when Labour is in such difficulties, when will they?

It’s worth noting, too, that whereas in the last parliament, Labour consistently underperformed its poll rating in local elections and by-elections, indicating that the polls were wrong, so far, the results have been in keeping with what the polls suggest. They are understating the Liberal Democrats a little, which is what you’d expect at this stage in the parliament. So anyone looking for comfort in the idea that the polls will be wrong again is going to look a long time. 

Instead, every election and every poll – including the two council elections last night – point in the same direction: the Conservatives have fixed their Ukip problem but acquired a Liberal Democrat one. Labour haven’t fixed their Ukip problem but they’ve acquired a Liberal Democrat one to match.

But that’s just the electoral reality. What about the struggle for political control inside the Labour party?

As I note in my column this week, the settled view of the bulk of Corbyn’s internal critics is that they need to keep quiet and carry on, to let Corbyn fail on its his own terms. That Labour won Stoke but lost Copeland means that consensus is likely to hold.

The group to watch are Labour MPs in what you might call “the 5000 club” – that is, MPs with majorities around the 5000 mark. An outbreak of panic in that group would mean that we were once again on course for a possible leadership bid.

But they will reassure themselves that this result suggests that their interests are better served by keeping quiet at Westminster and pointing at potholes in their constituencies.  After all, Corbyn doesn’t have a long history of opposition to the major employer in their seats.

The other thing to watch from last night: the well-advertised difficulties of the local hospital in West Cumberland were an inadequate defence for Labour in Copeland. Distrust with Labour in the nuclear industry may mean a bigger turnout than we expect from workers in the nuclear industries in the battle to lead Unite, with all the consequences that has for Labour’s future direction.

If you are marking a date in your diary for another eruption of public in-fighting, don’t forget the suggestion from John McDonnell and Diane Abbott that the polls will have turned by the end of the year – because you can be certain that Corbyn’s critics haven’t. But if you are betting on any party leader to lose his job anytime soon, put it on Nuttall, not Corbyn.

 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.