Saturday, 12 April 2014

How bad is debt?

Debt 6 —  How bad is debt?

"Neither a borrower nor a lender be; for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry." Hamlet 1.3

These words have found resonnance in puritan heads from Shakespeare till the last part of the 20th century. Polonius could have said more against borrowing. A debtor who is unable to repay his debts finds himself at a considerable disadvantage; he may lose his liberty, or his house, or find himself tied to a tredmill, paying interest he can ill afford without hope of escape. Furthermore, Polonius mentioned none of the advantages of debt.

Is debt, in general, a good thing or a bad thing?

Well, it is a good thing for the lenders who can expect a return on their capital of 2 or more % above inflation, even if their loans are of the non productive sort.  And it is a good thing for the entrepreneur who is trying to expand a winning business model (productive borrowing). But it is a bad thing for the "over indebted". Citizens Advice Bureaux (CAB) estimate that keeping up with bills and other financial commitments is a burden (or worse) for nine per cent of the population [2].

But the 90% who can manage their affairs intelligently can freely choose to enjoy a house and a car while they are young and pay as they get older. Inflation will considerably mitigate the amount they lose in interest payments. If they come on hard times they could lose their house; but end where they started, little the worse.  Many young people nowadays will take thought, and borrow. The case will depend on: [a] rate of inflation, [b] stability of the jobs market; but can be skewed by governmental tamperings  such as [c] capital gains legislation, [d] income tax relief, etc. Another factor is [e] temperament; cautious individuals will overestimate the chance of losing their job while the reckless will underestimate that.

Since 1975 the household debt as a fraction of annual disposable income rose in most western countries; in the UK it almost trebled  from 0.64 in 1975 to a peak in 2008 of 1.80, from which it has sunk in 2012 to 1.55 [1] We are more deeply indebted than the US, but trail Denmark, Norway and Switzerland. Since 2000, Germany has almost halved its debt/income ratio, while most other countries have only reduced personal debt in the last 5 years. One suspects that these data reflect a spectrum of several underlying factors: caution, stability, cost of the housing stock, age distribution of the population.

 (Unscrupulous lending (offering money to someone unable to calculate the consequences) is a social evil, like drunkenness, and should be subject to social and even legal regulation. Predatory lending (where a secured loan is offered in the hope that it cannot be repaid so that the lender can acquire the security) would be criminal were it possible to prove.)

Though it goes against my gut feeling to let myself be beholden in that way, I conclude that there is little case against debt if it is entered into with due thought, but that it should not be encouraged by the state (to the benefit of the bankers and to the detriment of the economy and society generally. Furthermore, there should be closer scrutiny, and better means of regulation and redress.

Ref.1: http://www.zerohedge.com/news/2013-06-04/debt-nations

Ref.2: http://www.citizensadvice.org.uk/pdf_the_value_of_debt_advice.pdf

 

Ian West, 12 Longhirst Village, NE61 3LT





Payday Loans

Payday Loans

I believe that it would be socially beneficial if the rapacious activity of the payday loan industry could be reined in. Though it is possible to argue that these companies serve a useful, even a necessary, purpose, it is nevertheless clear that it is only the desperate (or the foolish) who use the loans. Meanwhile the general public wince at the extortionate rates of interest; it is painful to watch; it seem no less brutal than trussing a weak man and pulling out his toenails. But the evil goes further. The near indigent find themselves on a downward spiral of debt from which there is no (legal) escape.

My remedy is fair, logical, and (with a stroke of the legislative pen) could be made legal. It is not hyper-novel as it enshrines a principle accepted in most civilisations from Roman times till the modern barbarism of the capitalist era; the distinction between usury and capitalism.

As soon as the accumulated interest paid on a loan equals the amount borrowed, the loan should be regarded as discharged. A low interest rate (say,  inflation plus 1%) should then replace the original high rate, but calculated back to the beginning of the loan. 

It can be argued that a high rate of interest is justified if there is a high risk that the principal will not be repaid. That cannot be argued as soon as the borrowed sum has been repaid. Suppose I borrow £100 at 10% per month interest. If I pay the lender £10 a month and keep up the payments for 10 months, the loan company will say that I still owe £100, as I have only been paying the interest. But I will have paid £100, and to my way of looking at it I will have repaid the loan, but not yet the interest. It cannot be argued that I am a high risk, so the due interest should be a trivial £5 (if 5% p.a. Is appropriate).

Ian West, 12 Longhirst Village, NE61 3LT