HOW did we get into debt. How do we get out of it.

rizla01

This makes VERY interesting reading.

How did we get into this debt black hole and how do we get out?

By John Stepek



The British people now owe more money than our entire country generates in a year. Accountants Grant Thornton report that, at the end of June, consumers owed a total of £1.444 trillion through mortgages, loans and credit cards. That's up 7.3% on last year. Over the same period, Britain's gross domestic product (GDP) was just £1.41 trillion.

You might be feeling a sense of d!jà vu as you read this. That would be because this is actually the second year running that personal debt has outstripped GDP. The GDP comparison doesn't really mean anything in itself - it's simply a nice way to show just what an astounding amount of debt we've all taken on.

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How did it come to this?
The obvious reaction is to blame the people who borrowed the money in the first place. After all, no one forced them to take out all that debt. No one can know your own financial circumstances better than you do.

I have a lot of sympathy with this view - I'm a great believer in personal responsibility. I don't mean this from a moralising, finger-wagging point of view. The simple reason you have look out for yourself is because no one else will.

Companies (banks in particular) and governments like to give you the impression that they're on your side, that they want nothing but the best for you. But all they care about is your money and your votes, in that order.

So yes, all those people who took out stupidly large mortgages and saw a rising credit card limit as the equivalent of a pay rise, should have been more careful.

But it's too easy to just say: "We've only got ourselves to blame." After all, back in 1997, personal debt was almost a third of what it is now, standing at just £503 billion.

Either the British population turned grossly profligate overnight, or some other factor happened to create an environment where borrowing insane sums of money seemed like a good idea.

You can start to get a clue about what this factor is when you consider the breakdown of our debt. Roughly 80% of the money we owe is mortgage debt. Nothing has been more responsible for the credit boom in this country than the property bubble.

British people are very attached to the idea of home ownership. Renting is looked down upon as an inferior option, something that only people who can't afford to buy a home would do. Buying a home is seen as a key milestone in the journey towards respectable adult society. That means there's a strong social pressure to buy.

As banks and building societies made lending ever easier (partly down to low interest rates and partly down to their ability to sell the loans on), house prices inevitably rose as buyers borrowed more to beat each other to the punch.

The fact that buy-to-let investors get tax relief on their mortgage interest made things worse. If you can buy using an interest-only mortgage, you can afford to borrow more, because the monthly payment is lower. That pushed prices up even further.

Tax and debt
This is where the personal responsibility argument becomes a little fuzzier around the edges.

Whacking a £10,000 dream holiday on a credit card when you earn £15,000 a year is pure greed and stupidity. But panicking about rising house prices and taking out an insanely large mortgage because you're listening to an adviser who keeps telling you that there's no chance of interest rates or your monthly payments going up or house prices going down, is something of a different order. This has a lot more to do with economic ignorance than greed.

I'm not making excuses here. Buying a home is a complicated financial decision, the biggest that most people ever make. So potential homebuyers should take the time to educate themselves.

But when every mainstream expert the papers interview says there won't be a recession and there won't be a housing crash (as was the case until about a year ago); when the TV channels are full of property !!!!!!; and when the government talks of low inflation, low unemployment and how we've never had it so good, who are people meant to believe?

The rantings of a vocal doom-mongering minority (in which I proudly include myself)? It's just not going to happen.

Saving ourselves
On top of that, we live in a society which disapproves of saving - positively punishes it in fact. The Bank of England's target inflation measure, the Consumer Price Index (CPI), is rising at an annual rate of 4.4%.

But if you take the cost of living measure, the Retail Prices Index (RPI), then it's growing at 5%. That's the same as the base rate. That means in real terms, UK interest rates are sitting at 0%.

Now banks are paying a little bit more than that for money, because they're desperate to get it. But after you take tax into account, a lower-rate payer has to be getting at least 6.25%, which is possible, or 8.33% for a higher-rate taxpayer, which isn't.

Again, the government hasn't helped. The tax-free ISA allowance has risen from £7,000 when introduced in 1999 to - wait for it - £7,200 now.

So the amount you can save tax-free has also fallen in real terms. If it had kept up with inflation, it'd be well over £8,000 now.

The trouble is, if people are saving, then they're not spending. And if they're not spending, then the UK economy isn't growing. That's because our economy is almost entirely propped up by consumption - it accounts for around two-thirds of GDP.

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So where to now?
Stephen Gifford of Grant Thornton said there's no need to panic "as personal debt is well covered by the UK housing stock".

However, with prices plunging, how long will that last? As if in answer, he adds: "If the property market and economy continue to weaken, the current levels of personal debt will become unsustainable and there will be a marked increase in insolvencies." He reckons that "it will be the next six to 12 months which reveal how seriously the credit crunch has affected individuals".

Well, house prices will keep falling and although we may not know it until well after the fact, we are likely to fall into recession this year - we've just learned that the economy didn't grow at all during the second quarter.

And with banks unwilling to lend where they can avoid it, it seems very likely that our debt black hole will shrink a little over the next year, as more money is paid back than is withdrawn.

That's a good thing. Consumers have to rebuild their balance sheets, just like the banks, and the government for that matter. The concept of thrift is no longer something to be sneered at - in fact, as anyone who reads women's glossy magazines (I can't get enough of them myself) will realise, it's practically trendy. And I haven't heard the phrase, "renting is dead money" spoken with any conviction in recent months.


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Fallout
The bad news is that this will mean a lot of collateral damage. A collapse in credit will have a devastating effect on the British economy. Company profits will be hammered and that means job losses. People who simply borrowed too much will end up bankrupt or losing their home, or both.

And sadly, those people who saved and who were careful with their money will have to pay for it. On the one hand, tax payers will be squeezed by our over-indebted government, as it seeks to bail out both troubled homeowners and collapsing banks with our money. And on the other, the Bank of England will try to keep interest rates as low as possible, regardless of what happens to inflation in the next two years or so.

In terms of practical advice to these people, my suggestion would be that any savings you have (above and beyond the emergency stash of three to six months' salary) would be best employed paying down your mortgage. You get a guaranteed return on this at least, in terms of the interest you will save, and you don't have to worry about inflation eating away at your savings.

For those who are concerned about their debts, there's little for it but to knuckle down, set a budget and start making sure your income surpasses your outgoings every month. Then pay down the debt, and once that's done, start building up an emergency cushion.

The good news for people who do have savings and manage to see the recession out is that there will be solid investment opportunities arising out of this, which only those with cash at hand will be able to take advantage of. But for now it's time to take cover.

loofer

yup, it was a good read indeed.

I was only thinking yesterday about how the effects of inflation are erroding away the real worth of my savings. Worrying. I would be devastated if we had anything on even a millionth (I think) of the scale of what happened in Zimbabawe. The only thing to do would be to invest in some stable commodity...???

If BoE keeps interest rates low then it's not going to help in the slowing (or backtrack) of the housing market.

As the author said, borrowing seems to be celebrated whilst saving is frowned upon. The minute rates go up... everyone is up in arms. It's the borrowers who immediately benefit from the pressure to keep rates low.

Caveat: Yes I appreciate that a significant majority of the adult population has a lot of debt of which a mortgage would be considered neccessary debt. I also understand that low rates encourages investement from business. Economic growth, employment, R&D and innovation.

I guess you can already tell which side of the fence I sit on when it comes to HPC and all that:rolleyes: