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 Downing Street adviser to Gordon Brown and Tony Blair. He tweets @GavinJKelly1.

Photo: Getty
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How a small tax rise exposed the SNP's anti-austerity talk for just that

The SNP refuse to use their extra powers to lessen austerity, says Kezia Dugdale.

"We will demand an alternative to slash and burn austerity."

With those few words, Nicola Sturgeon sought to reassure the people of England, Wales and Northern Ireland last year that the SNP were a party opposed to public spending cuts. We all remember the general election TV debates, where the First Minister built her celebrity as the leader of the anti-austerity cause.

Last week, though, she was found out. When faced with the choice between using the powers of the Scottish Parliament to invest in the future or imposing cuts to our schools, Nicola Sturgeon chose cuts. Incredible as it sounds the SNP stood shoulder to shoulder with the Tories to vote for hundreds of millions of pounds worth of cuts to schools and other vital public services, rather than asking people to pay a little bit more to invest. That's not the choice of an anti-austerity pin-up. It's a sell-out.

People living outside of Scotland may not be fully aware of the significant shift that has taken place in politics north of the border in the last week. The days of grievance and blaming someone else for decisions made in Scotland appear to be coming to an end.

The SNP's budget is currently making its way through the Scottish Parliament. It will impose hundreds of millions of pounds of cuts to local public services - including our schools. We don't know what cuts the SNP are planning for future years because they are only presenting a one year budget to get them through the election, but we know from the experts that the biggest cuts are likely to come in 2017/18 and 2018/19. For unprotected budgets like education that could mean cuts of 16 per cent.

It doesn't have to be this way, though. The Scottish Parliament has the power to stop these cuts, if only we have the political will to act. Last week I did just that.

I set out a plan, using the new powers we have today, to set a Scottish rate of income tax 1p higher than that set by George Osborne. This would raise an extra half a billion pounds, giving us the chance to stop the cuts to education and other services. Labour would protect education funding in real terms over the next five years in Scotland. Faced with the choice of asking people to pay a little bit more to invest or carrying on with the SNP's cuts, the choice was pretty simple for me - I won't support cuts to our nation’s future prosperity.

Being told by commentators across the political spectrum that my plan is bold should normally set alarm bells ringing. Bold is usually code for saying something unpopular. In reality, it's pretty simple - how can I say I am against cuts but refuse to use the powers we have to stop them?

Experts - including Professors David Bell and David Eiser of the University of Stirling; the Resolution Foundation; and IPPR Scotland - have said our plan is fair because the wealthiest few would pay the most. Trade unions have backed our proposal, because they recognise the damage hundreds of millions of pounds of cuts will do to our schools and the jobs it will cost.

Council leaders have said our plan to pay £100 cashback to low income taxpayers - including pensioners - to ensure they benefit from this plan is workable.

The silliest of all the SNP's objections is that they won't back our plan because the poorest shouldn't have to pay the price of Tory austerity. The idea that imposing hundreds of millions of pounds of spending cuts on our schools and public services won't make the poorest pay is risible. It's not just the poorest who will lose out from cuts to education. Every single family and business in Scotland would benefit from having a world class education system that gives our young the skills they need to make their way in the world.

The next time we hear Nicola Sturgeon talk up her anti-austerity credentials, people should remember how she did nothing when she had the chance to end austerity. Until now it may have been acceptable to say you are opposed to spending cuts but doing nothing to stop them. Those days are rapidly coming to a close. It makes for the most important, and most interesting, election we’ve had in Scotland.

Kezia Dugdale is leader of Scottish Labour.