Opinion: The seriousness of our household debt problem

By Neville Bennett Another OECD Report has come and gone. Predictable responses: Government says will do better, opposition fulminates. Life goes on. Uninterested in change, the nation watches rugby, shops more carefully, waits for the chimera of "green shoots" to spring into recovery. Of course, everyone makes a few mid-week economies, but Friday and Saturday are coming and the good times will revive. The OECD's message was about risk not recovery:  New Zealand is still very vulnerable because of its high current account deficits and overseas indebtedness. There will no real return to prosperity until productivity improves, the "unsustainable" current account deficit is halved, and household and foreign indebtedness curbed. These messages are unsurprising to readers of this column. My "Iceland" series revealed high overseas debt and the banks vulnerability to short-term funding. There is no point in an update on external debt except to say the OECD claims it was 93% of GDP in December; actually my check with StatisticsNZ estimates it at 137% of GDP.

Household debt reached 160% of disposable income in 2008 "“ a very serious problem, as the global crisis is enforcing deleveraging on households and business. House prices have fallen, damaging households' net worth. Servicing debt is more difficult as earnings are under pressure. Consumption is falling, business investment has been curtailed and wage and salaries are under pressure. Weakness in earnings can aggravate the housing correction, intensify a drop in consumption and increase the heat on business. In most previous recessions, our economy suffered more than many other countries because of a debt overhang and a shortage of capital. Government leeway was narrowed by debt servicing demands and credit rating concerns. The OECD is again warning that debt is an issue. The Organization says that any further stimulus, either fiscal or monetary, could trigger "a disorderly or severe exchange rate adjustment".  Moreover, rising sovereign debt projections present a risk to New Zealand's country credit rating. In the OECD's view, therefore, there is again very little leeway for more stimulus. The Government is advised, to work on an exit strategy; to withdraw stimulus when recovery increases. It advocates "fiscal consolidation", a code for increasing taxes or reducing government expenditure.  Fiscal consolidation will not assist household balance sheets. The Government recognises that gross official debt, projected to rise to 57% of GDP by 2023, would be imprudently high. The remedy includes consistent budget surpluses. However, a surplus may require caps on health and pension spending. It seems impossible to maintain health and pension spending as well as creating budget surpluses and debt reduction. It is the modern manifestation of an acute dilemma of debt. What I might call "the Vogel inheritance" haunts all Kiwi governments in recession. Household Debt This recession will impact differently to former ones. This Government is unusually compassionate, and determined to maintain a high minimum standard of living. But households have probably never been as indebted as they are now, and paying it down in a deteriorating economy imposes great burdens, especially as some assets are declining in value. The general picture of struggling households needs further definition. Obviously some household will be very secure, and even if indebted, be enjoying rather low interest rates. So where is the debt concentrated? How vulnerable are some people to shocks arising from falling housing values, rising interest rates of deteriorating employment? New Zealand's household debt-to-disposable-income ratio is very similar to that of the USA, Australia and the UK. These counties moved from an average of around a 100% ratio in 2001 to an average of about 160% in 2007. New Zealand began with the lowest house prices, but its house prices increased the most, by about 70% (2001 to 2007) about double the USA's increase. Australia lagged, but by 2005 New Zealand overtook the UK. A RBNZ Report by Mizuho Kida surprises: a bigger bubble does not mean extra stress for New Zealand. Most households (63%) are mortgage free.  Most debt is held by high income households. Debt-service ratios have actually fallen among lower-income households. Debt is concentrated in the top 40% of income earners (quintiles 4 and 5). The lowest income quintile (a quintile is 20%) hold only 1% of mortgage debt, partly no doubt as they do not qualify for a mortgage. For much of the last few years, increased house prices caused loan-to-value-ratios (LVRs) to decrease. But the owners (usually high income) with high LVR are much more exposed to falling values. The people with a high debt-service ratio (DSR's) tend to be lower income: their debt often takes 50% of disposable income. As high income households have low DSR's, there are few people with high LVRs and DSRs. The evidence came from Household Economic Surveys, the ending with the benign conditions of 2007. The Bank models recent data. It looked at LVRs over 80% and DSRs above 55% and assumed shocks to house prices, unemployment, and interest rates. Most people seem quite well insulated. But a combination of shocks could hurt more households and affect banks. But even severe conditions, including a fall in house prices of 30%, a 3% rise in interest rates and 9% unemployment would make only 3.6% of households vulnerable. The Bank's modeling is welcome but the results taken with a pinch of common sense. They could be tested against known facts such as foreclosures. More might have been said about other claims on household income - the credit card, the boat, the bach, the rates, the holiday, the school fees, the dentist and other outgoings. As it stands the Bank indicates little household stress, while the OECD emphasizes that household's debts average 160% of disposable income. In the overall context, including comparisons with difficulties in the US and UK, I share the OECD's concern that many households are over-leveraged. "”"”"”"”"” * Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared. neville@bennetteconomics.com www.bennetteconomics.com http://www.rbnz.govt.nz/research/bulletin/2007_2011/2009mar72_1kida.pdf http://www.oecd.org/document/30/0,3343,en_2649_33733_42547230_1_1_1_1,00.html