I was speaking yesterday at the Irish Banking Federation's seminar on debt management. I was looking at just how big a problem consumer debt is right now; at new research into who in particular is affected by debt problems; and how the current debt situation is impacting the wider economy. You can see my presentation here. Warning: some of the trends are disturbing ...
Other speakers - from the banks, MABS, askaboutmoney.com and Mason, Hayes & Curran - shared their experiences of dealing with debt issues arising from the binge borrowing of the Celtic Tiger years. Sobering stuff, and the scary thing is that our debt problems as a nation are only beginning. What is unprecedented about our debt problems is not just the scale - horrendous as that is - but rather the location of the problem. This is a middle class recession: it is people in their forties and fifties - people who, in the normal scheme of things, would have built up considerable equity in property, shares and pension funds - who have been 'wiped out' financially. As I noted before, we are experiencing not just an income shock - due to rising unemployment - but also a wealth shock due to the collapse in Irish equities and house prices.
And that's what struck me about several of the presentations yesterday: it is 'people who never had debt problems before' who are now a rapidly growing source of demand for services such as MABS (who have seen inquiries double in just twelve months). And their problems are not your common-or-garden credit card/electricity bill sort of problems: rather you get a complex mix of someone like a part-time landlord who has lost his full-time job just as his tenants have upped stakes and left for Eastern Europe, oh, and whose pension fund has been wiped out within a few years of his retirement. I've talked to people like this in focus groups recently and, well, my heart goes out to them. All they can hope for (like the rest of us) is a recovery that reflates the labour market and house prices. You've got to hope.
But what if recovery is several more years away? That's the scary thought. It's all well and good giving someone in arrears with their mortgage a few months 'grace' on the repayments to get themselves sorted (as most banks will if the borrower is behaving reasonably). The problem is when a few months is not enough because the labour market is shut down and the economy is contracting (as it is at present). The danger is a vicious circle - a debt deflation spiral - whereby the 'hard facts' of debt meet the 'increasingly pessimistic opinion' of property prices. The result is the economic equivalent of cardiac arrest, or as Gregor Macdonald puts it - 'the future is cancelled':
The problem, generally, with collapses is that observers think they are simply more extreme versions of a recession. Standard recessions tend to be disinflationary because spare capacity grows and demand falls but each of these occur outside of a catastrophic framework. Production shuts down more slowly, and more reluctantly. Credit carries onward, and the anchors of the banking system remain intact. Much of the work done in a standard recession is preparation for recovery. Much of that work is intentional.
In a collapse of the kind we are experiencing now, however, the future is cancelled as the system both behaviorally and structurally can no longer make plans for it. Production is closed immediately. Labor is let go at a hyper rate. The collapse has started out in textbook fashion with a demand crash, and the result has been what I call a petite deflation. The petite deflation feels strong, because of the rate of change.
The risk now is that we move next into the heart of this bust, which will be an inflationary depression. In its nastiest form, it won’t matter one whit that entrepreneurs want to raise more cattle when beef prices skyrocket, pump more oil when black-goo goes back up in price, deliver more fruit when juice demand rises, or innovate. When the future’s been canceled there will be no credit for any of these business propositions and lenders will say, “I don’t care that X is rising in price and that your plan to more efficiently deliver X looks profitable now.”
Back to the banks again. The banks are at the centre of the debt hurricane now sweeping through our economy. We are experiencing what Edward Harrison and others have described as the Great Deleveraging, to wit:
In a normal recession, credit becomes tight, but it is not central to the downturn. In fact, 80% of the decline in GDP is due to a de-stocking of inventory. Basically, businesses get ahead of themselves and forecast future demand that turns out not to exist. They are forced to ratchet back production and sell off inventories. In this case, policy makers can step in with fiscal and monetary stimulus and re-kindle domestic demand with a bit of a lag. Bing, presto, we are off to the races again. That’s why recessions are over in 12-18 months tops.
That’s not what happens in a depression - and this is a depression. In a depression, what happens is macro disequilibria build up so much and become so unsustainable that when the break in demand happens, there is no bing, presto from traditional policy responses. The leverage and debt in the system is just too large. The debt cannot be worked off without de-leveraging.
The problem, as I see it, is that even if the government 'rescues' the banks (i.e.: gives them taxpayers' money), many middle-aged, middle-class householders will be stuck with property-related debts that they have no chance of paying off due to falling house prices and income losses. In that scenario, people are going to get (even more) angry with the banks: as Fred Goodwin has just discovered. They will not take to their new impoverishment peacefully, and they won't be long reminding politicians that householders have votes, not banks.