The way we think about debt is stopping us from solving the problem
As many as 3.2 million households, and more than 7 million people may be struggling with problem levels of debt, according to a new Centre for Responsible Credit study we commissioned with Unison.
A large number of those households face debt levels that they may never clear. This debt leaves them vulnerable to serious financial difficulties should they suffer a sudden drop in income or unexpected cost. This debt is also a drag on the economy as money spent servicing it cannot support consumption and growth.
Given the scale of the problem, radical suggestions for consumer debt have been notable by their absence from the debate. Why is that?
Well, since the crash of 2008 economic debate has focused on a household accounting model. The economy is portrayed like a family home, a fixed amount of money comes in and that amount (or ideally slightly less than that amount) gets spent before the next round of income. If, for any reason, consumption outstrips income then that incurs a debt and that debt will need to be paid for, normally via the mechanism of reduced the consumption in the future.
This is a satisfyingly frugal model; it implicitly links the morality of the saver to their financial probity, which may be why it has been granted such credence. Money exists in a fixed amount, which people earn by work, bring into the household and spend. Any excess must be borrowed from somewhere and then given back. That’s not to say debt is always a bad thing, a debt can be like a tool you use to fix a specific problem round the home. If a job requires a drill and you don’t have one you can borrow one from your neighbour. If you fail to give it back, the neighbour has clearly lost something real and tangible: their drill. But this is only one way of thinking about money, and it is not a particularly useful way, when it comes to trends on a national scale.
Simplifying considerably: loans create deposits. They effectively create hypothetical money which they lend to people. This money becomes actualised once it is put into the wider economy, it facilitates the purchase of a house via a mortgage, or a car via a car loan, or it gets loaned out again – via a payday lender for instance – to cover a gas bill or emergency repairs.
The, now actualised, money then arrives on the bank’s books via debt repayment along with the interest paid on the debt. The bank will likely have factored that money into future plans, it may find that its failure to recoup the debt impacts upon their cash flow, it may mean that other banks are reluctant to lend to it and so the cost of its own borrowing increases (e.g. through LIBOR), it may find it harder to pay back a previously incurred debt of its own. Non-repayment of debt is serious and the effects are bad for both lender and borrower. The consequences of wide-spread non-repayment would be hugely damaging. However, those consequences wouldn’t include the loss of a household drill (to drastically over-extend an analogy).
Once we start thinking of money this way then we can begin to think much more creatively about solutions to debt. We can rearrange the terms of payment to make them more manageable for the indebted household.
The most promising way of doing this might be to build on processes that are already in place. There are a number of agencies that assist individuals who are struggling with their debts: Debt advice agencies, including Citizens Advice and StepChange. All of these can help over-indebted individuals to restructure debts and reduce interest payments. Banks willingly engage in these processes for it is preferable to have the possibility of reduced payments than outright default. However, such processes are limited in scope and rely on individuals taking it upon themselves to seek out such assistance.
In addition, the Financial Conduct Authority has identified that 2.1 million people, predominantly from more deprived demographic groups, have maintained a balance of over 90% of their credit card limit for over 12 months. It also found that 5.1 million accounts will, on current balances and repayment patterns, take over 10 years to pay off. These are good candidates for assistance, as many have probably already have paid excessive levels of interest and fees. Credit reference agencies should be able to pro-actively identify people who are in financial difficulties.
So far these processes have operated without significant government involvement. The government (and/or other financial authorities) should consider whether other public intervention may greatly increase the efficiency of debt reduction, improving prospects for both borrower and lender. This might involve costs but this has not precluded other financial interventions on a vast scale. Moreover intervening more directly is likely to deliver significant advantages not only to well-being but also to the economy as a whole.
Debts that have little chance of being paid off, only serve to continually reduce the disposable income of indebted households, who have to spend money on servicing debts that they cannot spend on more productive consumption and inhibits growth, so everyone pays.