The truth about UK debt
- 16 March 2012
- From the section Business
Why did we have a financial crisis? And why has the recovery been so slow?
Ask any normal person these questions, they would probably blame the banks. But then world-weary "experts" - policy makers and commentators - would usually step forward, to put them straight.
"The banks made mistakes", these wise heads will say, "but really it's all our fault, for running up so much debt. We all had a binge, and now we have to pay."
It's an excellent morality tale, which chimes well with the British tendency towards self-flagellation.
There's just one problem. It's not really true.
In a nutshell, that's the argument that Ben Broadbent, a member of the Monetary Policy Committee has made, convincingly, in a new speech.
He says that debt is indeed a large part of what caused the crisis, and a large part of the explanation for Britain's historically feeble recovery.
But the debt that's caused the problems hasn't been the debt of households. It really has been down to silly bets by Britain's banks (and other parts of the financial system), which were NOT bets on UK residential property. Most of them weren't even in the UK.
You might find this argument a bit confusing. After all, don't we hear - ad nauseam - about the massive increase in UK household debt in the years before the bust, as shown in this scary chart? (See right).
Don't we also hear that it is the slow process of unwinding Britain's massive debts - public and private - that is slowing down our recovery?
Broadbent has heard all of this as well. He even has a spiffy new chart (below, right), showing just how much slower this recovery has been, in Britain and other parts of Europe than the long-term average, which includes other times when the government has tightened fiscal policy early on.
As he points out, the chart showing the rise of household debt is usually accompanied by another one, adding all the debts of the UK private sector together, showing how Britain is the "most indebted country in the world", with private debts of more than four times our GDP.
All this is true. And scary-sounding. But, says Broadbent, it is also rather stupid.
First, it leaves out the other side of the balance sheet entirely. The suggestion is that British households and firms are massively in hock to the rest of the world. They're not.
All told, foreign investments in the UK are worth more than UK investments overseas. But our net overseas debt, as a nation, is not enormously greater than other countries'. In any event, it is no larger now than it was in the mid-1990s.
As chart 5 shows, before the crisis, Britain's private sector was borrowing from the rest of the world, but it was building up foreign investments to match. That's in stark contrast with countries such as Portugal and Greece, who were indeed borrowing a lot more than they invested.
You can tell a similar story domestically. Households, as a group, have a lot of debt. But they also have a lot of assets - in fact, a lot more. (see chart 6).
Households' total wealth, including housing, was worth eight-times annual disposable income at the end of 2010. That's above the 25-year average, despite everything that happened in 2008-10.
The second problem with the usual story is that it seems to imply that all increases in debt are equally problematic - and equally likely to cause a crisis. He says they're not.
It's true that losses in the UK financial system played a big part in the UK's crisis.
But Broadbent (a former economist for Goldman Sachs, we might remember) reckons only around a quarter of those losses were on UK investments.
Here's the most striking statistic: UK-owned banks have lost 15 times more on foreign mortgages, since the crisis started, than on mortgages in the UK.
Third, and related, the morality tale suggests that all debt is equally likely to retard the recovery.
There is some, fairly weak, evidence that countries with credit booms are more likely to have crises. But, allowing for all the other factors that typically affect growth, a study by the Bank of International Settlements finds no evidence that the level of household debt has any growth effect whatsoever.
The same study finds that government and corporate sector debt, above a certain threshold, may hurt growth. But having a lot of indebted households doesn't seem to make any difference at all.
But surely that rise in household debt in the noughties is a symptom of terrible excess? Broadbent thinks not.
It's true that house prices and debt levels went up, but his research suggests the causation runs from prices to debt, not the other way round.
Here's the argument: first you had a structural fall in the real interest rate, long before quantitative easing. This, alongside very limited new supply of housing, pushed up UK house prices, because it made it easier to make money renting property, and made it easier to service a higher level of debt.
Those higher prices (and lower interest rates), in turn, led households to need - and obtain - higher mortgages, to go with the higher price of a house. But, as I said before, the rising value of houses meant that overall, the household sector was getting better off.
Here's another interesting fact: the median loan-to-value ratio on a new mortgage didn't go up during the "boom" years - in fact, for most of the 1990s and noughties it was falling.
That's consistent with the idea that rising house prices caused bigger mortgages - not the other way around. According to Broadbent, there isn't even much evidence that "mortgage withdrawal" - loans taken out on the basis of rising property values, were used to fund extra consumption.
Not everyone will buy these arguments.
Some will say he's too cavalier about the distributional aspect of household debt (though he does raise this as a concern). To state the obvious, the households with the increased debt are not, in many cases, the households with the more valuable assets.
Thus, we might well worry about the social and economic consequences of rising interest rates, in an economy with high levels of household debt, even if we don't have to worry about Britain being 'bust'.
Likewise, had it not been for the Bank of England's record low interest rate policy, bank losses on UK housing over the past few years would have been considerably greater.
You could also read the speech and still worry about the high level of government borrowing. Certainly, George Osborne will read nothing here to make him change his mind. (For what it's worth, Broadbent supported Mr Osborne's broad strategy on the deficit before joining the MPC.)
Still, the next time you hear a politician - or a columnist - talk about the price "we all have to pay" for running up too much debt, you might ask them who, exactly is included in that "we".