18 March 2016
By Stephen Koukoulas
If debt is such a threat to global economic stability, why don’t we all pay it off? Get rid of it. Eliminate the source of financial sector instability.
Think about a scenario where every cent of your mortgage, credit card and university debt must be paid off. Then apply that debt elimination plan to the government sector … and then the corporate world.
If debt is so evil, pernicious, and threatening something akin to a 1930s Great Depression, surely the answer is to pay off debt and have none.
The debt debate has stooped to fresh lows in recent weeks, with a number of money managers and commentators joining the usual suspects to highlight the peril for the Australian economy of housing debt. A couple of years ago it was government debt that was the problem, but that scare faded as common sense prevailed, even though government debt has continued to grow at a steady pace.
Let’ stop there and think about debt.
It goes without saying, or at least it should, that debt is a good thing for the household sector, governments and corporations. It is essential. It allows each segment of the economy to invest and bring forward spending that would otherwise not occur. I can’t be sure of this but I would hazard a guess that every major infrastructure project in the world has been financed by debt and every business has had debt at some stage of its being.
With no debt, think of a government taxing people for years to accumulate the funds to build a power station, hospital or to build roads. Absurd, isn’t it?
What about consumers buying a car, let alone a house? Not many people, particularly the young, have saved the cash needed to buy a house. So too for corporations who are dependent on debt to invest, expand, innovate and grow.
And saving, don’t forget, can’t exist without debt because someone’s savings are another person’s debt. If I deposit $100 in a bank, the bank has debt of $100 to me. Which simply means that deposits cannot exist if there is no debt – they are opposites of the same balance sheet.
Debt is not the problem. The problem, to the extent there may be one, is the regulations that apply to debt.
If debt is sought and provided on the basis of robust due diligence – that there is no fraud and deception and that only creditworthy borrowers are forwarded the funds by creditworthy lenders – then it matters little whether debt is 10% of household income or 200% of income. Some people borrow six, seven or even eight times their income to buy a house, and it turns out to be a prudent decision. Others default on a $50-a-month debt linked to a mobile phone contract.
It is only when too much money is carelessly lent to high-risk borrowers that problems unfold. This was the case in the lead into the banking crisis in 2008 when in the US, UK and other countries (not Australia) anyone on any income could get a mortgage. It wasn’t debt that was the problem, but inept and foolhardy banking practices, financially ignorant borrowers who signed up for loans, and the regulators who let all this happen.
Australia’s banks, having seen the disasters of the US, Irish and UK banks in the crisis, have tightened their lending standards. In addition, regulators have tightened the rules for investor mortgage lending, albeit belatedly, but with an express objective of reducing the risk that the wrong people get access to debt.
Provisions of bad debts and non-performing loans from the banks and other financial institutions remain at near-historic lows, meaning the health of the debt market, at least for householders, is sound.
Which goes back to the starting point. Debt is an essential aspect of the economy, delivering growth, employment and rising living standards. The anti-debt campaigners seem to overlook this when they argue the perils of debt, not just in Australia but around the world.
