Tag: payday loans

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The burden of debt

Household debt in the UK has reached a record level. Individuals now owe £1430 billion. This compares with the UK’s general government debt of £1443 billion – also at a record level. These figures are illustrated in the chart (click here for a PowerPoint).

But these figures are nominal. If you look at the real figures (i.e. corrected for inflation), household debt has been falling. In today’s prices, household debt peaked at £1668 billion in March 2008. Also, if you look at household debt as a proportion of GDP, it fell from a peak of 100.96% in May 2009 to 87.43% in July 2013 (see chart). However, since then it has begun rising again, standing at 87.65% in October 2013.

So has household debt become less of a problem? In aggregate terms, the answer is probably yes. However, it is too early to know whether a continuing recovery in the economy will be fuelled by real debt rising again and whether the recovery will encourage people to take on higher levels of debt?

For many people, however, debt has become more and more of a problem. In other words, the aggregate figures conceal what has happened in terms of the distribution of debt. According to a Centre for Social Justice (CSJ) study:

Indebted households in the poorest 10 per cent of the country have average debts more than four times their annual income. Average debt repayments within this group amounted to nearly half their gross monthly income.

And the poorest families, often with very poor credit ratings, are frequently forced to turn to payday lenders, charging sky-high interest rates (see Capping interest rates on payday loans: a government U-turn?).

As mainstream banks reduced access to credit following the financial crash, the market for short-term high-cost credit (payday lenders, pawnbrokers, rent-to-buy and doorstop lenders) increased dramatically and is now worth £4.8 billion a year.

Payday lenders have increased business from £900 million in 2008/09 to just over £2 billion (or around 8 million loans) in 2011/12. Around half of payday loan customers reported taking out the money because it was the only form of credit they could get. The number of people going to loan sharks is also said to have increased – the most recent estimate puts it at 310,000 people.

With rising energy and food bills hitting the poorest hardest, this section of the population could find debt levels continuing to rise, especially if interest rates rise. As Chris Pond, who chaired the CJS study, stated:

The costs to those affected, in stress and mental disorders, relationship breakdown and hardship is immense. But so too is the cost to the nation, measured in lost employment and productivity and in an increased burden on public services.

Articles

£1,430,000,000,000 (that’s £1.43 trillion): Britain’s personal debt timebomb Independent, Andrew Grice (20/11/13)
Average household debt ‘doubled in last decade’ The Telegraph, Edward Malnick (20/11/13)
UK household debt hits record high BBC News (29/11/13)
UK debt crisis: poorest face ‘perfect storm’ Channel 4 News (20/11/13)
One in five struggle with serious debt The Telegraph, Nicole Blackmore (27/11/13)
It doesn’t matter what we do with Wonga: personal debt is about to rocket The Telegraph, Tim Wigmore (26/11/13)
Poorest families ‘need more help over debt’ BBC News (20/11/13)

Report

More than 5,000 people a year ‘homeless’ as household debt crisis deepens, CSJ warns Centre for Social Justice Press Release (20/11/13)

Data

Monthly amounts outstanding of total (excluding the Student Loans Company) sterling net lending to individuals and housing associations (in sterling millions) seasonally adjusted Bank of England
Public Sector Finances First Release – Public Sector Consolidated Gross Debt ONS
Household debt (Economics Indicators update) House of Commons Library (29/11/13)

Questions

  1. What are the macroeconomic implications of rising levels of household debt?
  2. Why may an economy which has high levels of household debt be more subject to cyclical fluctuations in real GDP?
  3. What are the problems of having a recovery driven largely by increased consumer expenditure?
  4. Why have many people in the poorest sectors of society found their debt levels rising the fastest?
  5. Why may rising levels of debt of the most vulnerable people make it harder for the Bank of England to use conventional monetary policy if recovery becomes established?
  6. What policies could be pursued to try to reduce the debts of the poorest people?
  7. Discuss the effectiveness of these various policies.
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Kostas Economides and the Archbishop of Canterbury

A few weeks ago, Elizabeth wrote a blog on the payday loan industry and its referral by the OFT to the Competition Commission (see A payday inquiry). Now the Archbishop of Canterbury, Justin Welby, has joined the debate. He suggests that the problem of sky-high interest rates charged by payday loan companies would be tackled better by increased competition from elsewhere in the industry than by regulation.

In particular, he proposes an expansion of credit unions. These could provide a much cheaper alternative for people in financial difficulties who are seeking short-term loans. He would like church members with relevant skills to volunteer at credit unions and proposes setting up local credit unions operated from church buildings.

*            *            *            *            *            *            *            *            *            *

In this news item we hand over to ‘Kostas Economides’, an imaginary lecturer in Economics at the imaginary ‘University of the South of England’. Kostas’s blog is written by Guy Judge. Guy recently retired from the University of Portsmouth, where he was Deputy Head of Department, and is now a Visiting Fellow.

In his blog, Kostas frequently reflects on various economic issues, as well as on life at USE. Here he recounts a conversation with his colleagues about Justin Welby’s proposals. They consider various implications of the proposals from an economist’s point of view.

Kostas’s blog
Pay day loans Guy’s Other Stuff, Guy Judge (30/7/13)

To provide some background to Kostas’s blog, you’ll see below the normal set of links to newspaper articles.

We may well return to Kostas in the near future, as he is planning to look at a number of topical economic issues.

Articles

Why I support Justin Welby’s battle with Wonga The Telegraph, Jacob Rees-Mogg (30/7/13)
Church plans to compete with payday lender Wonga BBC News, Robert Piggott (25/7/13)
Archbishop of Canterbury wants to ‘compete’ Wonga out of existence The Guardian, Miles Brignall (25/7/13)
Let the payday lenders prosper, but not extort Financial Times (30/7/13)
Coalition will support Archbishop of Canterbury Justin Welby’s plan for credit unions, says Vince Cable Independent, Andrew Grice (28/7/13)
Former Archbishop Rowan Williams backs action against payday loan firms Cambridge News, Jennie Baker (30/7/13)
Why Justin Welby’s vision of kumbayah capitalism is wrong The Telegraph, James Quinn (25/7/13)
Wonga V The Church: Comparing Interest Rates Of Payday Loans And Credit Unions The Huffington Post, Tom Moseley (25/7/13)
Wonga Warned Church Of England Could ‘Compete’ It Out Of Existence The Huffington Post, Tom Moseley (25/7/13)
Credit unions thriving even before Archbishop Welby’s attack on Wonga The Guardian, Rupert Jones (29/7/13)

Questions

  1. Find out the monthly interest rates being charged by various payday loan companies. Take one loan company as an example and calculate what would happen to your debt over the course of a year if you borrowed £100 and paid nothing back each month. What would be the annualised rate of interest?
  2. What are the arguments for and against banning payday loan companies?
  3. What are the arguments for and against imposing an interest rate cap on such companies?
  4. What are the differences between credit unions and banks?
  5. Should the interest rates charged by credit unions be uncapped?
  6. Explain what is meant by ‘moral hazard’ and give some examples. What moral hazard would there be in placing a limit on the number of months over which a debt could go on accumulating?
  7. How would you decide what a ‘normal’ rate of interest should be? Should this vary with the risk of default and, if so, by how much?