A Debt and Housing Bubble

Written by Dr. Vincent Cable MP, Liberal Democrat Shadow Chancellor of the Exchequer and published in Liberal Democrats In Business on Sun 1st Feb 2004

When employment is high and growth is strong and stable, concerns over the medium term stability of the economy may seem strange. Indeed, in pursuing worries over an asset bubble in the housing market and a debt bubble which is very much linked to it, invites criticisms of needlessly talking down the economy.

Recently though, I have noticed that, the group of worriers appears to be growing. It includes the IMF, the deputy governor of the Bank of England and growing numbers of analysts. It is undeniable that the UK has had a long period since the mid 1990's of unprecedented stable growth, with low inflation and falling unemployment. This is something that Gordon Brown is in part responsible for and should be commended on. We have even ridden out heavy drops in the stock market and global economic uncertainty relatively unscathed.

This though may be part of the problem because confidence has remained high and interest rates low, encouraging huge borrowing. Those who are too young to remember the crashes of the mid 1970's and early 1990's or have no sense of economic history are relaxed about unprecedented levels of borrowing. They do not envisage circumstances in which interest rates can rise substantially or the economy tips into recession. And, each month, the Bank of England releases new figures showing borrowing to private consumers alone, increasing by in excess of £10 billion. We are soon to hit the £1 trillion borrowing mark. The ratio of debt to post tax income is 135% and rising, a historic high.

The creditors view as articulated by the British Bankers Association is that this level or borrowing is nothing to be concerned about and, within a stable economy is perfectly sustainable. They rightly point out debt servicing ratios of households are at historically low levels (10% of post tax income as compared with 15% in 1990) and that the ratio of secured to unsecured borrowing is close to historical averages.

What is confusing the debate though is that there are two distinct debt problems. First, there is a minority of borrowers, mainly in low income households, who are in severe difficulty with debt. Analysis shows that the most serious problems relate to unsecured debt and families in social housing: a quite different problem from the home buyer borrowing over the odds to get a foothold on the property ladder. This latter is less of an issue outside of the South East of England but it is spreading throughout the UK.

Both of these groups though can and will be affected by a widely predicted increase in interest rates to over 5% in the next year. Although interest rates are rising it is at the same time becoming increasingly clear that there is a wider debt issue. Some banks are now lending on extreme income multiples, way over the traditional three and every post brings a deluge of unsolicited mail offering more and more credit with few strings attached.

80% of this stock of debt is secured against one asset, housing, which has been a historically unstable market and is now being fed by demand from 'buy to let' companies and individuals, investing in property because they have lost confidence in their pension.

The question then is what if, anything can be done the only major policy instrument to hand is interest rates. But the independent Bank of England is conscious that it has no mandate to deal with asset bubbles and household debt except as it impacts on inflation. Moreover it has to balance the impact of interest rates assets and debt with the impact on the rest of the economy. Its authority would be strengthened if it monitored and commented on systematically the main indicators of household debt and monitored the housing market. But the bank could also if prompted by the government, intervene directly to influence the level of bank lending through their reserves.

There are also serious deficiencies in the system of financial regulation which currently favours personal indebtedness over savings and investment, which are more highly regulated. A system of bonuses and incentives for bank employees who sell loans and credit cards leads to aggressive marketing and a lack of financial prudence. Not only does are current system of financial regulation fail to address this but it also fails to deal with the near monopoly profits of some banks and excess charging such as in payment protection insurance.

But someone; in practice the Chancellor needs to take ownership of the debt issue, which is of crucial importance but is in danger of falling through the crack of government responsibility. Unless this problem is grasped now there could be serious consequences for economy.