In previous posts
I have talked about why I am suspicious of (but not completely
opposed
to) the idea that the UK (or US) has a serious problem because there
is too much personal debt. Too much popular discussion goes as
follows: booms and busts are often caused by excess lending and
borrowing, household debt to income ratios are currently high
compared to a few decades ago, and so we must be on the verge of a
new personal debt crisis. The first two points are true, but the
third does not follow because of one thing: house prices.
I thought I would
illustrate the key point with a graph, based on data from the OECD’s
Economic Outlook.
The yellow line is house prices relative to income: the absolute
level is arbitrary. The red line is mortgage debt as a ratio to
personal income, and the blue line is the total debt to income ratio.
The green line is the difference between the blue and red i.e.
non-mortgage debt relative to income.
The key point is that most of total household debt is mortgage debt,
and this follows house prices. That the two should track each other
over the long term is not surprising, but the fact that mortgage debt
seemed to fall exactly with house prices is. (If house prices fall,
this changes the value of new mortgages, but not the value of
existing mortgages.) The reason may be that in the short term the
interaction is two way. A fall in the demand for house purchase (and
hence mortgages) will impact on price. Non-mortgage debt is now a
little lower relative to income than before the crisis.
The basic story is therefore very simple. The main reason people go
into debt is to buy a house. The more expensive houses get, the more
they have to borrow. If there is a problem, it is not that we have
all gone on unaffordable spending sprees. It is that house prices
have been rising. Rising house prices increase not only household
debt but household wealth, which is a key reason why wealth was also
rising
rapidly before the financial crisis.
The picture for the
US is similar, except that non-mortgage debt has returned to
pre-crisis levels.
This suggests no
near term risk of any private debt crisis. Indeed for the UK, as
Chris Giles reminds
us, 2008 itself was not a crisis about personal debt, but a crisis
about UK banks overseas lending. As a result, talk about private debt
nearing ‘2008 crisis levels’ in the future is highly misleading.
There are two
reasons why house prices have been rising in the UK: not enough
houses are being built and
real interest rates have gradually declined (secular stagnation). As
governments have relatively
little control over long term real interest rates, you will only
reduce mortgage debt by reducing house prices by building more
houses. To put it very simply, the aggregate private debt problem in
the UK is a reflection of our longstanding inability to build houses.
That is a serious problem, and not just because it prevents a lot of
potential first time buyers from being able to afford to buy. It
means that, if interest rates were to rise significantly, households
with mortgages would be spending much more of their income paying off
the mortgage, and they would be more vulnerable to shocks to income
as a result. One of the problems with the recent relatively slow
growth in nominal wages is that the real burden of a fixed nominal
mortgage has not been falling much as the mortgage grows older.
Worse still, if real
interest rates did start to recover (secular stagnation proved to be
less permanent than many people currently think) this would in itself
tend to reduce house prices. That could leave many relatively new
home owners with a mortgage larger than their house was worth. In the
UK people cannot walk away from this negative equity. Equally lenders
could have loans that were no longer covered by the value of an
asset. Deflation coupled with rising real interest rates is a toxic
mix. But all of these problems reflect the fact that house prices are
currently too high. [1]
I think the simple takeaway is this. Anyone who talks
about the growing problem of total private household debt without
also talking about what has and what will happen to house prices is
missing the elephant in the room.
[1] It is tempting
to write that high levels of private debt are a symptom rather than a
cause of these problems. That is too strong: people choose to take
out a mortgage to buy a house rather than rent. However as most
people only own one house, it has an element of truth. It seems odd
to argue that an irresponsible debt fuelled increase in the desire to
own houses is pushing up house prices.
