US ahead of UK on road to reducing debts


The consultants McKinsey has returned to one of the business and economic issues of our age, the massive debts of the rich developed countries that borrowed excessively to fuel growth in the boom years.

In a new paper, with the racy title Debt and Deleveraging: uneven progress on the path to growth, McKinsey asserts that the task of reducing the indebtedness of consumer-led economies such as the UK and Spain is barely underway (and see my earlier post, UK's debts biggest in the world, for more on this).

McKinsey makes the striking claim that "the ratio of UK household debt to disposable income would not return to its pre-bubble trend for up to a decade" - which implies that as we in the UK look for a return to more normal levels of economic growth, momentum is not going to be provided by consumer spending for perhaps up to 10 years.

And looking at the 10 largest developed economies, its analysis is that only three of them have seen a fall in indebtedness or "leverage" since the crash and recession of 2008.

McKinsey adds together the debts of companies, households, government and financial businesses to arrive at a figure for the overall indebtedness of an economy, which it then relates to the output of the said economy or GDP.

On this measure, the aggregate indebtedness of the UK has risen from an already large and arguably unsustainable 487% of GDP in the second quarter of 2008 to an even bigger 507% of GDP in the middle of 2011.

Only Japan, hobbled by its debts for 20 years, is more indebted - with a debt to GDP ratio of 512%. I guess there is small comfort in this, because as I noted in the autumn, in the first quarter of 2011 the UK was a little more indebted than Japan.

What is striking is that there has been modest reductions in the indebtedness of British households and non-financial companies over the past three years, to 98% and 109% of GDP respectively - which are still high levels of leverage or high debt ratios by historic standards.

But all that slowish progress in cutting debts to more bearable levels has been more than offset - McKinsey says - by a 28 percentage point rise in government indebtedness to 81% of GDP and an 11 percentage point rise in the indebtedness of financial institutions (the City) to 219% of GDP.

Now there is a bit of an argument about the significance of the financial institution debt, about how much of it is genuinely a risk or potentially deadening weight for the British economy. But even putting that to one side, the rising indebtedness of the state more than offsets any progress by the private sector in reducing debts.

Which is why McKinsey argues that the UK is still at a very early stage in reducing debts sufficiently to allow a significant rebound in economic growth (as you will have read here many times, growth tends to remain insipid or worse, while businesses and households repay what they owe - either by choice or by order - because they invest and spend less).

Now to give more of a clue to how and when our economy will recover, McKinsey has looked at the experience of two Scandinavian countries, Sweden and Finland, which experienced credit and housing booms (rather like us) in the 1980s that turned into an economic and financial bust in 1990 (sound familiar).

Both Sweden and Finland returned to fairly robust growth in a matter of a few years, on the back of six phases of recovery. So McKinsey has looked at what it calls these six "markers" of recovery to assess how early or late in the rehabilitation process the UK, Spain and the US are.

So what are the six stepping stones to a resumption of economic health? Here they are:

1) A stabilisation of the financial sector, with lending volumes rising. On that measure, the US is ahead of the UK, which is ahead of Spain.

2) Structural reforms have been implemented to make the economy more competitive. There has been a good deal of talk about such reforms in the UK and Spain (for example planning reforms in Britain), though not a great deal of action yet.

3) Credible medium-term public deficit reduction plans are in place. Well many would argue that's truer of the UK than it is for the US, where the political rows continue about reducing the deficit. As for Spain, its austerity measures are work in progress.

4) Exports are growing. Well exports have been rising in the UK, but not enough to offset weakness in other parts of the economy.

5) Private investment has resumed. This is the big concern in the UK, that big companies are hoarding record amounts of cash rather than investing, and smaller companies lack the finance from banks to invest.

6) The housing market is stabilised and residential construction revives. Well there's no sign of that in Spain. In the UK, house prices seem to have stabilised, but McKinsey would argue there is grossly inadequate housebuilding. And in the US, the housing market still seems fairly weak.

McKinsey argues that the US is furthest ahead in the deleveraging or debt-reduction process, with its ratio of aggregate debt to GDP having fallen 16 percentage points to 279% since 2008. What's most striking in the US is that a fall in private sector indebtedness has significantly exceeded an increase in government borrowing - with household debt actually falling in absolute terms (in large part because of write-offs of housing debt).

What may seem odd is that the US advantage appears to reside, to an extent, in the way that householders peremptorily walked away from their unaffordable mortgages and handed back the keys to their respective properties or were evicted from their homes by banks - forcing the banks and other lenders to incur big upfront losses. Banks and citizens took a big early hit and then moved fast to restore their finances.

From the outside, it may all have seemed a bit brutal. But arguably these mortgage writeoffs have facilitated an earlier restoration of the confidence of banks and consumers.

In the UK, by contrast, banks behaved in what would be seen as a socially responsible way, by allowing homeowners with mortgages they can't afford to cease interest payments for a period (banks exercised what's known as "forbearance").

The problem with easing the pain for those with big housing debts in this way is that neither bank nor borrower recovers properly: banks don't properly recognise the losses they are likely to one day incur on the mortgage; homeowners are still burdened by an excessive debt.

So McKinsey contrasts the 14% of British mortgages either in forbearance or explicitly delinquent with a very similar proportion in the US that have been written off or are in the process of being written off. And the implication of that is that there is much more pain to come for banks and those with excessive mortgages in Britain.

Which is another of the manifold reasons why economic growth in the UK is likely to remain lacklustre for years.

As for Spain, its problems reside in a corporate sector with bigger debts, equivalent to 134% of GDP, an extraordinary housing boom that over 10 years created five million new homes in a country of just 14 million households, and a banking sector that is yet to recognise all the losses it will incur on property and business loans.

And you don't need telling that its problems are currently massively compounded by its membership of the eurozone - which shackles it with an uncompetitive exchange rate, punitive interest rates on government debt, and no lender of last resort to fill the breach if investors decide to boycott lending to the state.

Which is why, broadly, and on McKinsey's analysis, it would seem that in the vital process of getting debts down and putting the economy on a sustainable financial footing, the US is ahead of the UK, which has an important advantage over Spain.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 30.

    These outcomes are unsuprising. Less to do with "crowding out" of enterprise by the public sector, and more to do with crowding out by real estate and finance capital. Can't say that we lefty economists didn't warn you!!

  • rate this

    Comment number 29.

    House market price correction with a Land Value Tax should solve all the issues and provide the Goverment with a nice earning.

    WIth increased unemployment, decreased wages these house prices cannot be sustained.

    Time to increase the IR and start the LVT.

  • rate this

    Comment number 28.

    Gordon Brown has so much to answer for.

    By the way, has anyone seen or head of Gordon recently? No thought not.

  • rate this

    Comment number 27.

    I love the green and pleasant land as much as anyone, but we need to sort out planning to ensure that we can build houses to keep up with increasing demand, the alternative will be more housing bubbles in the future as people scrabble to get on the ladder, pushing up prices. Its supply and demand stupid! Of course this wont happen until comps de-leverage costs and start to look to the future.

  • rate this

    Comment number 26.

    McK report is interesting but also deeply flawed They take no account of assets covering that debt The UK has very large foreign investments, the debt taken on to fund those is in the debt figures but not the value of the assets (neither will income generated unless repatriated to UK)

    Starting point is that delveraging happens first in private sector and that is what the UK consumer is doing.

  • rate this

    Comment number 25.

    Now do you guys see why I have been banging on about this for years!

    UK debt deflation is critical to our recovery but we are in a dire position and it is still getting worse!

    The Guardian has a 'nice' graph (in the print version) showing we are the worst Nation on the planet. ( worse even than Japan and still going!

  • rate this

    Comment number 24.

    The US have a far more brutal mortgage system, whereby the mortgagee (the bank) enforces through foreclosure whereas in the UK foreclosure is extremely rare, and the bank uses its power of repossession and power of sale. The difference is that where a property is repossessed and sold, the sale proceeds are held on trust and any surplus paid to the mortgagee (borrower).

  • rate this

    Comment number 23.


    You want a bank to take risk ? are you mad !!!

    If you want them to take a risk then the tax payer will have to do it , they will of course take a whooping fee for arranging this transaction.

    Banks taking a risk tchhh that is so 20th century,

  • rate this

    Comment number 22.

    In the US banks take 100% of the risk - here people take 100% of the risk of a mortgage.

    A fairer solution would be for the risk to be split according to the proportion of the loan to the cost of the property; e.g. if a bank provides a loan that is 80% of the house price, they are then liable for 80% of any losses incurred in a default, with the householder liable for 20%.

  • rate this

    Comment number 21.

    So the crisis which began with greedy bankers lending mortgages to stupid people who can't them, continues because of greedy bankers lending mortgages to stupid people who can't afford them.

  • rate this

    Comment number 20.

    Re " ...reduce indebtedness... increase lending", debt on more debt, what nonsense!

    and re #15, pretty much correct. As I have stated myself before, the long term "cost" of money has been approx 2.5% to 3%. We probably need to get back to this level fairly soon.

  • rate this

    Comment number 19.

    So the financial sector needs to start lending again or we're all doomed. But there's nobody to lend to because we all need to reduce our debt?

    If contradictory nonsense like this is the best these experts can come up with we're in big trouble.

  • rate this

    Comment number 18.


    "...In the US, if you can't pay the mortgage the bank gets the house and that's it..."


    That's the general position. However, if your house is worth $200,000 and you only owe $10,000, they still get the house, equity and all. It's a gamble many lenders have been willing to take. That's Foreclosure, baby.

  • rate this

    Comment number 17.

    That's not one of the BBC's better articles.

    We have a debt based monetary system. It is impossible for overall levels of debt to fall in such a system unless there are substantial defaults.
    Great Uncle Mervyn fires up his press.

    Just look at point 1 for instance; to reduce our indebtedness we need lending volumes to increase!

    Come on R.P. a bit of common sense please.

  • rate this

    Comment number 16.

    bassanus points to a key difference between UK and US mortgages.

    In the UK, if you can't pay the mortgage the bank can repossess the house and sell it but if the sale doesn't cover it all you still owe the rest.

    In the US, if you can't pay the mortgage the bank gets the house and that's it.

    That makes US banks more careful about what they lend you. They take the risk on future house prices.

  • rate this

    Comment number 15.


    Raise in interest rates will do that quickly. See countless JFH posts

  • rate this

    Comment number 14.

    In the UK the stabilisation of the financial sector has been deferred. Structural reforms are starting from a low base. Deficit reduction is still not credible. Exports are weak. Private investment is cherry picking. The housing market has yet to adjust.

    There are too many people in the UK still thinking that radical change to the economy is not needed. It is going to get very uncomfortable.

  • rate this

    Comment number 13.

    In America the tax payer was left holding the liability for all the failed mortgages, do you envisage the UK Government taking on the 14% of all mortgages ?
    It would be bad for banks to have to take the loss , we need the trickle down from there bonus's....

  • rate this

    Comment number 12.

    I'm unconvinced US "jingle mail" defaults, leaving people without homes and banks with a big loss, are better than UK forbearance, where the bank still gets some interest and the mortgage payer stays in their home. If anything, the possibility of escape via "jingle mail" just encourages people to over-borrow in the first place. BUT banks must be forced to recognise the expected losses up front.

  • rate this

    Comment number 11.

    If debt is the problem, deal with it in a radical way: Declare a Jubilee. All debts are considered paid in full, then start over sustainably. Most of us - states, businesses, individuals - can live within our means if we didn't owe anybody anything.


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