The Morality of Debt
David put his hand in the bag, pulled out a stone, slung it and hit the Philistine in the head. I Samuel 17:48
I’m no biblical scholar but as an investor David’s take-down of Goliath strikes me as a tale of bronze-age leverage. Think of it; confronted by a pagan mutant three times his size, the plucky shepherd forsakes Saul’s clunky armour and instead margins up with a slingshot and six rocks. The next thing we know he’s the new king of the Israelites and the builder of Jerusalem as well as the spiritual godfather of debt finance. Now that’s what I call a gearing ratio.
From there debt in all its forms – peonage, barter, chattel, consumer credit, the home mortgage, junk bonds – evolved into the staff of human industry. We measure the sophistication of an economy by the depth of its debt markets. While cash economies struggle with low rates of growth and mobility, bankers in the industrialized world design instruments of great complexity which, duly leveraged by global capital markets, can either enrich societies or enslave them.
If that sounds like hyperbole you haven’t been paying attention. Over the last several months a drip-feed of data has revealed the magnitude of US indebtedness at the public, corporate and household level at a time when interest rates have only one way to go. Moreover, consumer bankruptcies and delinquencies associated with household debt are hovering at pre-2008 levels. And if you trust the Congressional Budget Office – one of the last enclaves for independent, non-partisan analysis left in Washington – things are going to get worse.
The origin of our debt dependency is obvious enough: a near-decade of record-low interest rates was bound to stimulate borrowing, not just in the US but globally – an estimated $57 trillion in incremental credit worldwide since 2007. But what of the consequences? Let’s start with the Feds: according to Bloomberg, the CBO estimates that debt held by the public to cover the nation’s budget shortfall will increase to 86 percent of GDP by 2026, twice the historic average and the highest since 1947. Borrowing costs will rise precipitously; to the three-year Treasury’s estimated 2.8 percent by 2026 and the 10-year’s 3.6 percent during the same period. This represents a crushing repayment burden for a government with a record-high national debt of $20 trillion.
The weight of corporate debt is no less daunting. By 2020, estimates S&P Global Ratings, it is expected to rise to $75 trillion from its current $51 trillion level. Much of those funds were raised to finance share buybacks and mergers and acquisitions. Now, assuming the economy grows as forecast and wages rise along with employment, companies will need to invest in their businesses. That means raising more debt at significantly higher cost as it competes with the public sector for available credit.
And what of household borrowing, the third leg of the debt triad? According to the New York Fed, consumer credit rose by $460 billion in 2016, the largest increase in a decade, for a total of $12.6 trillion. That’s only 0.8% shy of its all-time peak of $12.7 trillion set in 2008. The increase was led by new mortgages though debt increased across the spectrum of household obligations. The value of student loans, the fastest growing component, rose by $31 billion last year for a total of $1.3 trillion. The delinquency rate on those loans, at 11.2 percent, “continues to deteriorate with every passing quarter,” according to the Fed. (The Wall Street Journal recently reported that the Department of Education had inflated loan repayment rates for all but a tiny fraction of colleges and trade schools in the US.)
Car loans also figured heavily at $142 billion for the year, the highest level in the 18-year history of auto loan data. The delinquency rate on those commitments continued to rise, at 3.8 percent. Possibly as a result, car sales among the leading six auto makers in the US market (including foreign brands) fell in January on a year-on-year basis.
Bankruptcies are also on the rise. Business failures last year totaled 37,823, up 26 percent from the 2015 figure, while household defaults rose by 5.4 percent in January on a year-on-year basis after climbing by 4.5 percent in December. Not surprisingly, according to The Financial Times, banks have begun tightening lending standards.
Clearly the staff of human industry has become an overburdened crutch, though we are not panicking. After all, US credit is denominated in US currency – the world’s reserve currency, as it happens – which guarantees it a compelling level of support. This alone militates against pell-mell budget cutting in the name of fiscal responsibility or regulating Wall Street to pre-empt another toxic-debt led collapse.
However, I am concerned that borrowings of such breadth and depth may be symptomatic of a greater failure of democratic capitalism. No doubt a majority of consumers understand the perils of borrowing beyond their means but risk them anyway as wages have failed to keep up with growth in an economy that weaves through boom-and-bust cycles at ever-faster rates. That places the burden on us in the financial sector to respect the laws of gravity and the prudential power of restraint, even if deregulation may tempt some of us to stray.
We might also remind our political elites that, as the authors of fiscal policy, the responsibility for reviving the nation’s economy resides with them. We might suggest that the best way to do that is to pass legislation that will create jobs that pay respectable wages. And while we’re on the subject of leverage, they might consider how a subway system employs people to build them and, once completed, extends the radius job-seekers might comfortably travel to find work. And then they can start attacking waste where it really lives: in energy and farm subsidies, the cartelization of such industries as civil aviation, telecommunications and pharmaceuticals, and the lost trillions of dollars accrued over the years by the Pentagon’s inability to audit itself.