Drowning in debt

There is a good article in the TJ today about the high debt load the average Canadian family faces these days.  This piled on top of public debt and it would take decades and decades of determined effort to pay it down.  Of course, some economists don’t mind debt – as long as your ability to service the debt (i.e. pay the interest) doesn’t become too onerous.

There is a small but growing group of economists suggesting that all this debt has far more pernicious effects and use the example of mortgage default in the U.S. as an example.  Apparently, the average U.S. household has deleveraged a lot faster than the average household in Britain because it is a lot easier to default on your mortgage in the U.S. so hundreds of thousands of American families are just walking away from their mortgage debt -because they can.  To those of us outside the U.S., it seems strange that the people can deleverage by walking away from debt with virtually no negative impacts.   It raises the question of what would happen if everyone who had an underwater mortgage across the world just walked away scott free.

Nassim Taleb says there is no way to predict black swan events and therefore we should try to keep debt to an absolute minimum.  Imagine a world where there was 95 percent less debt.   90 percent of the finance industry would disappear.  Virtually all of the growth in the finance sector in the past two decades has been in areas meant to manage the risk associated with leverage/debt.

It is an interesting thought experiment.  Commerce would still continue.  People would still buy houses.  Consider the example of Brazil.  Because of hyper-inflation until the mid 1990s, banks did not offer any kind of longer term mortgages because they were impossible to price.   People had to save up to buy houses.  Families would chip in/loan the money – people would just wait.  They still bought houses but they had to wait a little longer.  The same was the case with other major purchases as well.  Now, that is changing because of the stable inflation and Brazil is starting to see worrisome levels of household debt, too.

But it is interesting that many of my relations in Brazil – in my age group – have a house and no mortgage debt.  I, on the other hand, am sitting on a fairly large mortgage with 19 years left on it.

While my views on this are evolving, I am starting to think we should look seriously at this issue longer term.  Maybe we should set as a goal across society to limit debt across the board.  From Millken and LBOs in the 1990s to investment banking in the 1990s, financiers have used massive leverage to make enormous profits until the bubble burst.  Maybe the morality of debt should matter.

7 thoughts on “Drowning in debt

  1. The Telegraph-Journal article is behind a paywall so there’s no point referencing it – it is invisible to the internet and therefore essentially does not exist.

    Having said that, it is in my view more worth mentioning that the major problem with debt is not the debt per se but the interest on the debt. The continuing high rates of interest, even in an era of record low interest rates, are a constant drain on the economy, diverting money from the productive sector into the speculative sector.

    Debt wouldn’t matter if it didn’t bleed money out of the economy. As it is now, a person, via debt, will spoend $250K to buy a $100K home – only $100K goes into the economy, while the rest of it is diverted to the bank, which instead of reinvesting it into the community uses the money for high stakes gambling on the international market.

    Reduce the cost of a $100K home to something like $110K and the fact that a person has gone into debt to pay for it constitutes no drain on the ewconomy.

    Yes, I agree, people should not take ouyt loans they cannot afford. But this should not be a problem for the government or for society – if banks are foolish enough to loan money people cannot afford to repay, the banks should pay the price. If investment agencies are foolish enough to buy fraudulent traunches, they should pay – and the people who solfd them should be put in jail.

    It is only because so much leverage has been allowed to accumulate in banks, and only because normal civil and criminal sanctions seem not to apply to the financial sector, that defaults become a national problem.

  2. CIA World Fact Book –
    Brazil GDP – per capita (PPP):
    $10,800 (2010 est.)

    GDP – per capita (PPP):
    $39,400 (2010 est.)

    Your contemporaries in Brazil, do they make near that $10K figure or do they make more? I can’t help but feel you are purposely misleading people to try to make your point.

  3. Whoa, Mike E., not need to get snippy. I am not commenting on comparative income levels between countries. I am saying that folks I know in Brazil buy their homes for cash – they save up – at least historically – because of very high inflation and the unwillingness of banks to lend out money beyond the very short term. I don’t know who that is misleading anyone on any level.

    It’s off topic but you shouldn’t fall into stereotypes. There are tens of millions of middle class Brazilians that buy homes, cars, travel, save for retirement, etc. I am told there are more computer science university graduates every year in Brazil than here.

  4. @David Campbell
    Sorry about that, upon reflection, I was way too harsh in what I wrote.

    I think my point is that things in Brazil are very cheap because of local conditions. There is a large growing upper middle class – middle class would make around that $10K(PPP) mark and not be able to pay for houses, so I’m guessing the people you know there fall into the middle-high and high income groups. Those people are buying homes that haven’t appreciated and that are out of the reach of the ordinary Brazilian. Once incomes in Brazil rise across the board, there will be more demand for houses and people like your friends won’t be able to afford to purchase expensive assets without borrowing against the asset. It will take fifteen years to save for those homes. Or they will go around the financial system and borrow from their families (which is still part of total household debt).

    So to me it seemed like you picked an unrealistic example in order to make your case that we can live without debt.

    Again sorry for the snippy comment, I really truly didn’t intend it to be.

  5. “Nassim Taleb says there is no way to predict black swan events and therefore we should try to keep debt to an absolute minimum. ”

    There are actually three different issues here:
    1. the use of debt as a financing vehicle (which has had many many benefits, both for individuals and businesses (you did not refer to the latter in your post)). Taleb should define what he means by ‘minimum’.
    2. debt load – how much debt is too much; that largely depends on:
    3. the interest rate.

    The current problem in much of North America seems to be individuals taking on a large amount of household debt. I think that is a response to two things: very low interest rates and a growing inability within the middle class to ‘keep pace’. The middle class is getting squeezed – that is the real issue that needs adressing, not debt per se.

    As for Taleb, he has gotten a lot of mileage out of Black Swan. Is he a genius, or (like many past analyst ‘flavor of the month’ types) just lucky?

  6. My concern with debt is the opportunity costs of the debt servicing costs.
    What could we do as a province with that ~$650 million per year that goes to debt service. That is an ongoing yearly expenditure that returns nothing to us today. Yes it has allowed previous expenditure (sometimes labelled “investments”) but if we aren’t paying down the principal, we will forever be paying for these past expenditures.

    The other downside of debt is the relinquishing of control to financial markets. As Greece has discovered, a jurisdiction becomes a slave to the whims of the financial system and market. If inflation kicks into high gear and interest rates skyrocket, how is NB going to be able to service the debt?

  7. We have 3 times as many civil servants as anybody else and 5 times as much spent on government created departments etc, for their friends. But, blame it on the old folks. Comical. So they cut the drug plan where more then half the Seniors pay for their drugs or pay for Blue Cross.
    No body has da balls to do the things that need to be done, so nothing will ever improve. Been downhill, ever since the pandering, for those that stayed here. But can I ever tell you stories of big money for the frequent fliers to Alberta.

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