Tag: household debt

Houses of Parliament: photo JSThe last two weeks have been quite busy for macroeconomists, HM Treasury staff and statisticians in the UK. The Chancellor of the Exchequer, Mr Phillip Hammond, delivered his (fairly upbeat) Spring Budget Statement on 13 March, highlighting among other things the ‘stellar performance’ of UK labour markets. According to a Treasury Press Release:

Employment has increased by 3 million since 2010, which is the equivalent of 1,000 people finding work every day. The unemployment rate is close to a 40-year low. There is also a joint record number of women in work – 15.1 million. The OBR predict there will be over 500,000 more people in work by 2022.

To put these figures in perspective, according to recent ONS estimates, in January 2018 the rate of UK unemployment was 4.3 per cent – down from 4.4 per cent in December 2017. This is the lowest it has been since 1975. This is of course good news: a thriving labour market is a prerequisite for a healthy economy and a good sign that the UK is on track to full recovery from its 2008 woes.

The Bank of England welcomed the news with a mixture of optimism and relief, and signalled that the time for the next interest rate hike is nigh: most likely at the next MPC meeting in May.

But what is the practical implication of all this for UK consumers and workers?

Money: photo JS

For workers it means it’s a ‘sellers’ market’: as more people get into employment, it becomes increasingly difficult for certain sectors to fill new vacancies. This is pushing nominal wages up. Indeed, UK wages increased on average by 2.6 per cent year-to-year.

In real terms, however, wage growth has not been high enough to outpace inflation: real wages have fallen by 0.2 per cent compared to last year. Britain has received a pay rise, but not high enough to compensate for rising prices. To quote Matt Hughes, a senior ONS statistician:

Employment and unemployment levels were both up on the quarter, with the employment rate returning to its joint highest ever. ‘Economically inactive’ people — those who are neither working nor looking for a job — fell by their largest amount in almost five and a half years, however. Total earnings growth continues to nudge upwards in cash terms. However, earnings are still failing to outpace inflation.

An increase in interest rates is likely to put further pressure on indebted households. Even more so as it coincides with the end of the five-year grace period since the launch of the 2013 Help-to-Buy scheme, which means that many new homeowners who come to the end of their five year fixed rate deals, will soon find themselves paying more for their mortgage, while also starting to pay interest on their Help-to-buy government loan.

Will wages grow fast enough in 2018 to outpace inflation (and despite Brexit, which is now only 12 months away)? We shall see.

Articles

Data, Reports and Analysis

Questions

  1. What is monetary policy, and how is it used to fine tune the economy?
  2. What is the effect of an increase in interest rates on aggregate demand?
  3. How optimistic (or pessimistic) are you about the UK’s economic outlook in 2018? Explain your reasoning.

Ten years ago (on 9 August 2007), the French bank BNP Paribas sparked international concern when it admitted that it didn’t know what many of its investments in the US sub-prime property market were worth and froze three of its hedge funds. This kicked off the financial crisis and the beginning of the credit crunch.

In September 2007 there was a run on the Northern Rock bank in the UK, forcing the Bank of England to provide emergency funding. Northern Rock was eventually nationalised in February 2008. In July 2008, the US financial authorities had to provide emergency assistance to America’s two largest mortgage lenders, Fannie Mae and Freddie Mac.

Then in September 2008, the financial crisis really took hold. The US bank, Lehman Brothers, filed for bankruptcy, sending shock waves around the global economy. In the UK, Lloyds TSB announced that it was taking over the UK’s largest mortgage lender, Halifax Bank Of Scotland (HBOS), after a run on HBOS shares.

Later in the month, Fortis, the huge Belgian banking, finance and insurance company, was partly nationalised to prevent its bankruptcy. Also the UK government was forced to take control of mortgage-lender, Bradford & Bingley’s, mortgages and loans, with the rest of the business sold to Santander.

Early in October 2008, trading was suspended in the main Icelandic banks. Later in the month, the UK government announced a £37 billion rescue package for Royal Bank of Scotland (RBS), Lloyds TSB and HBOS. Then in November it partially nationalised RBS by taking a 58% share in the bank. Meanwhile various other rescue packages and emergency loans to the banking sector were taking place in other parts of the world. See here for a timeline of the financial crisis.

So, ten years on from the start of the crisis, have the lessons of the crisis been learnt. Could a similar crisis occur again?

The following articles look at this question and the answers are mixed.

On the positive side, banks are much more highly capitalised than they were ten years ago. Moves by the Basel Committee on Banking Supervision in its Basel III regulatory framework have ensured that banks are much more highly capitalised and operate with higher levels of liquidity. What is more, banks are generally more cautious about investing in highly complex and risky collateralised assets.

On the negative side, increased flexibility in labour markets, although helping to keep unemployment down, has allowed a huge squeeze on real wages as austerity measures have dampened the economy. What is more, household debt is rising to possibly unsustainable levels. Over the past year, unsecured debt (e.g. personal loans and credit card debt) have risen by 10% and yet (nominal) household incomes have risen by only 1.5%. While record low interest rates make such loans relatively affordable, when interest rates do eventually start to rise, this could put a huge strain on household finances. But if households start to rein in their borrowing, this would put downward pressure on aggregate demand and jeopardise economic growth.

Articles

The crisis: 10 years in three chart BBC News, Simon Jack (9/8/17)
Darling: ‘Alarm bells ringing’ for UK economy BBC News (9/8/17)
Alistair Darling warns against ‘complacency’ 10 years on from financial crisis The Telegraph (9/8/17)
A decade after the financial crisis consumers are still worried Independent, Kate Hughes (9/8/17)
Bankers still do not understand complex reasons behind financial crash, senior politician warns Independent, Ashley Cowburn (9/8/17)
We let the 2007 financial crisis go to waste The Guardian, Torsten Bell (9/8/17)
Bank of England warns of complacency over big rise in personal debt The Guardian, Larry Elliott (24/7/17)
On the 10th anniversary of the global financial meltdown, here’s what’s changed USA Today, Kim Hjelmgaard (8/8/17)
Financial crisis: Ten years ago today the tremors started Irish Times (9/8/17)
If We Are Racing to the Pre-Crisis Bubble, Here Are 12 Charts To Watch Bloomberg, Sid Verma (9/8/17)

Videos

The financial crisis ten years ago to the day Euronews (9/8/17)
Ten years later: What really sparked the financial crisis Sky News, Adam Parsons (9/8/17)
Bank of England warns on household debt Channel 4 News, Siobhan Kennedy (25/7/17)

Questions

  1. Explain what are meant by ‘collateralised debt obligations (CDOs)’.
  2. What part did CDOs play in the financial crisis of 2007–8?
  3. In what ways is the current financial situation similar to that in 2007–8?
  4. In what ways is it different?
  5. Explain the Basel III banking regulations.
  6. To what extent has the Bank of England exceeded the minimum Basel III requirements?
  7. Explain what is meant by ‘stress testing’ the banks? Does this ensure that there can never be a repeat of the financial crisis?
  8. Why is it desirable for central banks eventually to raise interest rates to a level of around 2–3%? Why might it be difficult for central banks to do that?

Household borrowing on credit cards and through overdrafts and loans has been growing rapidly. This ‘unsecured’ borrowing is now rising at rates not seen since well before the credit crunch of 2008 (click here for a PowerPoint of the chart below). Should this be a cause for concern?

Household confidence is generally high and, as a result, people continue to take out more loans and so household debt continues to increase. Saving rates are falling and, at 5.1% of household disposable income, are the lowest rate since 2008, mirroring the high levels of spending and borrowing.

But as long as the economy keeps growing and as long as interest rates stay at record low levels, people should be able to continue servicing this rising debt. Indeed, with generous balance transfer offers between credit cards and many people paying off their full balance each month, only 56.6% are paying any interest at all on credit card debt, the lowest level on record.

But there could be trouble ahead! Secured borrowing (i.e. on mortgages) is at record highs as house prices have soared, limiting the amount people have to left to spend, even with ultra low interest rates. Student debt is growing, putting a brake on graduate spending.

With economic growth set to slow and inflation set to rise as the effects of the lower pound filter through into retail prices, this could initially boost borrowing further as people seek to maintain levels of consumption. But then, if unemployment starts to rise and consumer confidence starts to fall, real spending could decline, putting further downward pressure on the economy.

Confidence could then fall further and we could witness a repeat of 2008–9, when people became worried about their levels of borrowing and cut back on consumption in an attempt to claw down their debt. The economy was pushed into recession.

The Bank of England is well aware of this scenario and wants banks to ensure that their customers can afford loans before offering them.

Articles

Bank governor Mark Carney warns on household debt BBC News, Brian Milligan (30/11/16)
Credit crunch: Household debt is rising just as the economy’s future is uncertain The Telegraph, Tim Wallace (10/12/16)

Bank of England publication
Financial Stability Report, November 2016 Bank of England (30/11/16)

Data

Money and lending Bank of England Interactive Database
United Kingdom Households Debt To GDP Trading Economics
Household debt OECD Data

Questions

  1. What determines the amount people borrow?
  2. What would cause people to cut back on the amount of debt they have?
  3. Distinguish between secured and unsecured borrowing and debt.
  4. Why has secured borrowing risen? Does this matter?
  5. What is meant by the term ‘re-leveraging’? What is its significance in terms of household borrowing?
  6. Find out what the affordability tests are for anyone wanting to take out a mortgage.
  7. What are the greatest risks to UK financial stability?

We have frequently looked at patterns in lending by financial institutions in our blogs given that many economies, like the UK, display cycles in credit. Central banks now pay considerable attention to the possibility of such cycles destabilising economies and causing financial distress to people and businesses. There is also increased interest here in the UK in bank lending data in light of Brexit. Patterns in credit flows may indicate whether it is affecting the lending choices of financial institutions and borrowing choices of people and businesses.

Data from the Bank of England’s Money and Credit – September 2016 statistical release shows net lending (lending net of repayments) by monetary financial institutions (MFIs) to individuals in September 2016 was £4.65 billion. This compares with £8.89 billion back in March 2016 which then was the highest monthly total since August 2007. However, the March figure was something of a spike in lending and this September’s figure is actually very slightly above the monthly average over the last 12 months, excluding March, of £4.5 billion. In other words, as yet, there is no discernible change in the pattern of credit flows post-Brexit.

Leaving aside the question of the economic impact of Brexit, we still need to consider what the credit data mean for financial stability and for our financial well-being. Chart 1 shows the annual flows of lending by banks and building societies since the mid 1990s. The chart evidences the cycles in secured lending and in consumer credit (unsecured lending) with its consequent implications for economic and financial-welling being.(Click here to download a PowerPoint of Chart 1.)

After the financial crisis, as Chart 1 shows, net lending to individuals collapsed. More recently, net lending has been on the rise both through secured lending and in consumer credit. The latest data show that annual flows have begun to plateau. Nonetheless, the total flow of credit in the 12 months to September of £58 billion compares with £33 billion and £41 billion in the 12 months to September 2014 and 2015 respectively. Having said this, in the 12 months to September 2007 the figure was £112 billion! £58 billion is currently equivalent to around about 3 per cent of GDP.

To more readily see the effect of the credit flows on debts stocks, Chart 2 shows the annual growth rate of net lending by MFIs. In essence, this mirrors the growth rate in the stocks of debt which is an important metric of financial well-being. The chart nicely captures the pick up in the growth of lending from around the start of 2013. What is particularly noticeable is the very strong rates of growth in net unsecured lending from MFIs. The growth of unsecured lending remains above 10 per cent, comparable with rates in the mid 2000s. (Click here to download a PowerPoint of Chart 2.)

The growth in debt stocks arising from lending continues to demonstrate the need for individuals to be mindful of their financial well-being. This caution is perhaps more important given the current economics uncertainties. The role of the Financial Policy Committee in the UK is to monitor the financial well-being of economic agents in the context of ensuring the resilience of the financial system. It therefore analyses the data on credit flows and debt stocks referred to in this blog along with other relevant metrics. At this moment its stance is not to apply any additional buffer – known as the Countercyclical Capital Buffer – on a financial institution’s exposures in the UK over and above internationally agreed standards. Regardless, the fact that it explicitly monitors financial well-being and risk shows just how significant the relationship between the financial system and economic outcomes is now regarded.

Articles

Higher inflation and rising debt threaten millions in UK The Guardian, Angela Monaghan (5/11/16)
Consumer spending has saved the economy in the past – but we cannot bet on it forever Sunday Express, Geff Ho (13/11/16)
Warning as household debts rise to top £1.5 trillion BBC News, Hannah Richardson (7/11/16)
Household debt hits record high – How to get back on track if you’re in the red Mirror, Graham Hiscott (7/12/16)

Data

Money and Credit – September 2016 Bank of England
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. Explain the difference between secured debt and unsecured debt.
  2. What does it mean if individuals are financially distressed?
  3. How would we measure the financial well-being of individuals and households?
  4. What actions might individuals take it they are financially distressed? What might the economic consequences be?
  5. How might uncertainty, such as that following the UK vote to leave the European Union, affect spending and savings’ decisions by households?
  6. What measures can institutions, like the UK’s Financial Policy Committee, take to reduce the likelihood that flows of credit become too excessive?

In April we asked how sustainable is the UK’s appetite for credit? Data in the latest Bank of England’s Money and Credit publication suggest that such concerns are likely grow. It shows net lending (lending net of repayments) by monetary financial institutions (MFIs) to individuals in March 2016 was £9.3 billion, the highest monthly total since August 2007. This took net borrowing over the previous 12 months to £58.6 billion, the highest 12-month figure since September 2008.

The latest credit data raise fears about the impact on the financial well-being of individuals. The financial well-being of people, companies, banks and governments can have dramatic effects on economic activity. These were demonstrated vividly in the late 2000s when a downturn resulted from attempts by economic agents to improve their financial well-being. Retrenchment led to recession. Given the understandable concerns about financial distress we revisit our April blog.

Chart 1 shows the annual flow of lending extended to individuals, net of repayments. (Click here to download a PowerPoint of Chart 1.) The chart provides evidence of cycles both in secured lending and in consumer credit (unsecured lending).

The growth in net lending during the 2000s was stark as was the subsequent squeeze on lending that followed. During 2004, for example, annual net flows of lending from MFIs to individuals exceeded £130 billion, the equivalent of close on 10.5 per cent of annual GDP. Secured lending was buoyed by strong house price growth with UK house price inflation rising above 14 per cent. Nonetheless, consumer credit was very strong too equivalent to 1.8 per cent of GDP.

Net lending collapsed following the financial crisis. In the 12 months to March 2011 the flow of net lending amounted to just £3.56 billion, a mere 0.2 per cent of annual GDP. Furthermore, net consumer credit was now negative. In other words, repayments were exceeding new sums being extended by MFIs.

Clearly, as Chart 1 shows, net lending to individuals is again on the rise. This partly reflects a rebound in sections of the UK housing market. Net secured lending in March was £7.435 billion, the highest monthly figure since November 2007. Over the past 12 months net secured lending has amounted to £42.1 billion, the highest 12-month figure since October 2008.

Yet the growth of unsecured credit has been even more spectacular. In March net consumer credit was £1.88 billion (excluding debt extended by the Student Loans Company). This is the highest month figure since March 2005. It has taken the amount of net consumer credit extended to individuals over the past 12 months to £16.435 billion, the highest figure since December 2005.

Chart 2 shows the annual growth rate of both forms of net lending by MFIs. In essence, this mirrors the growth rate in the stocks of debt – though changes in debt stocks can also be affected by the writing off of debts. The chart captures the very strong rates of growth in net unsecured lending from MFIs. We are now witnessing the strongest annual rate of growth in consumer credit since November 2005. (Click here to download a PowerPoint of the chart.)

The growth in household borrowing, especially that in consumer credit, evidences the need for individuals to be mindful of their financial well-being. Given that these patterns are now becoming well-established you can expect to see considerable comment in the months ahead about our appetite for credit. Can such an appetite for borrowing be sustained without triggering a further balance sheet recession as experienced at the end of the 2000s?

Articles

Consumer credit rises at fastest pace for 11 years The Guardian, Hilary Osborne (29/4/16)
Debt bubble fears increase as consumer credit soars to 11-year high The Telegraph, Szu Ping Chan (29/4/16)
Fears of households over-stretching on borrowing as consumer credit grows The Scotsman, (29/4/16)
History repeating? Fears of another financial crisis as borrowing reaches 11-year high Sunday Express, Lana Clements (29/4/16)
The chart that shows we put more on our credit cards in March than in any month in 11 years Independent, Ben Chu (1/4/16)
Britain’s free market economy isn’t working The Guardian (13/1/16)

Data

Money and Credit – March 2016 Bank of England
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. What does it mean if individuals are financially distressed?
  2. How would we measure the financial well-being of individuals and households?
  3. What actions might individuals take it they are financially distressed? What might the economic consequences be?
  4. How might uncertainty affect spending and saving by households?
  5. What measures can policymakers take to reduce the likelihood that flows of credit become too excessive?
  6. What is meant by a balance sheet recession?
  7. Explain the difference between secured debt and unsecured debt.
  8. Should we be more concerned about the growth of consumer credit than secured debt?