Thursday’s Autumn Statement is likely to generate headlines about energy bills, improving public finances and the promise of a return to real wage growth in the new year. At least that is what George Osborne, the chancellor, will be hoping for. He should also prepare himself for another rash of stories about debt-soaked Britain. When people sift the detail, they will see a projection for household debt that is likely to rise above £2tn – a large and round number.
We can confidently expect two reactions. First, there will be a string of stories about how maxed-out we are, spiced up with references to our economy being stalked by debt-zombies. Britain, after all, sits near the top of the international league table for household indebtedness. The Bank of England has recently issued new long-term projections for household debt compared with income: it is going up, the only question is by how much. For many people this invites incredulity. Surely, they say, we have learnt that ever more debt must be bad debt?
Then, in reply, wise heads will counsel that anyone spooked by the extent of household debt is being naive. Debt tends to rise in line with house prices, which, over time, generally increase. Looking at household debt in isolation, they will say, is meaningless. It is only one side of the ledger. What matters is the overall net wealth of households – taking assets into account as well as liabilities. And this is likely to rise. Since the crash, households have been gently running down their debts at the same time as the housing market has stabilised and now partially recovered. Problem, what problem?
But neither the panicky nor complacent view of household debt deals with the real problem – a distributional one. The sceptics are right to say that looking at total debt figures in isolation is not sensible. But what does matter is the distribution of the debt burden relative to household incomes: how many households will struggle to service their obligations when interest rates rise?
A swath of low- to middle-income households are exposed. Nearly a third of mortgage debt is held by households that have borrowed more than four times their income; and a sixth of it is held by those who have less than £200 a month left after spending on essentials.
That these families are already close to the edge has been brought home by the Money Advice Service’s finding that 9m of us are “over-indebted”, half living in families on incomes under £20,000. This fragile position has arisen despite 57 consecutive months of the lowest interest rates in 300 years. It is clear that some people are going to be in trouble when rates rise. Quite how many people, and how much trouble, will depend crucially on the sequencing of events.
If a frothy housing market means rates start to climb before wages have recovered their mojo, things could get nasty. Should, say, rates climb towards 4 per cent by the middle of the next parliament – roughly 1 per cent higher than the markets expect but still lower than the long-term norm – about 1.2m households would be spending more than half of their income on repayments – a perilous amount. Nearly 6m would be paying more than 25 per cent.
A gentler path would have rates staying low for some years, allowing wages to recover and households to adjust. So, while it is encouraging that the BoE looks willing to use its wider regulatory powers to avoid having to raise rates prematurely, on its own this may not suffice. As a final act in the crisis, we may still need aggressive debt restructuring to secure the position of today’s vulnerable but viable borrowers. Regardless of whether unemployment has fallen below the BoE’s key threshold of 7 per cent, it should be made clear that interest rates are unlikely to rise until real wages and incomes are buoyant.
Emerging from preternaturally low interest rates was never going to be easy. Our skewed distribution of incomes and debt makes it harder. We must avoid panicking at the sight of scary looking debt numbers just as we should steer clear of complacency. Our real debt problem is too important for that.
The writer is chief executive of the Resolution Foundation
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