Should we be worried when our Ministers and our Central Bank Governor express strong concern about what they call a big increase in household debt and in debt defaults?
The Governor and Minister of Justice recently quoted the fact that some 400 000 Finns have defaulted on payments of their debts, and that household debt in relation to disposable income has doubled over the last 20 years from 60% to 120%. They also spoke about that many were addicted to gaming or were unable to understand the risks of borrowing too much debt.
They then concluded that we need the following new policies to improve financial know-how:
- A “positive” credit register will be introduced to flag both good and bad debtors
- The government is proposing to limit the time after which a debt can be claimed.
- More resources for debt and financial advisory activities by professionals.
- More regulations needed to restrict marketing of consumer debt and wage-day lending.
- Stricter regulations to curb debt collection malfeasance.
However, there is reason to be cautious in listening to bankers and ministers! They have been on the austerity march for far too long!
The actual ratio of housing loans and other household debt to after-tax household income has remained remarkably stable at around 80% this last two decades according to Statistics Finland. The Governor was using “Disposable Income” and “Total Household Loans” from Statistics Finland for calculating his ratio. But if you use “Household Income less Taxes” (a commonly accepted definition of Disposable Income) and “Household Mortgages and Other Household Loans” from Statistics Finland you end up with this figure which is much less dramatic:
Banks and regulators have said that the maximum amount of a housing loan should set by the monthly repayment rate of a 25 year housing loan with an interest rate of around 3% to 4%, well above today’s low interest rates. This amount should not exceed 40% of your net after tax monthly wage.
This is a good rough way to calculate the maximum amount you can borrow without taking on huge risks taking into account you and your partner’s after tax salaries added together. Banks use the following rough guide, but you should note that this adds together both of salaries for married partners. However, if one of you loses your job for a longer period then you may be forced to sell your home for a smaller one:
Again looking at the average debt per household for housing loans from Statistics Finland the figures tell a story of relatively low levels of household debt on average. It is clear that many people in each age group do not own but rent their home, while others have more wealth and need less debt. Naturally there is plenty of room for crisis situations in these figures but at least banks are more cautious now, and the figures on average do not point to anything particularly alarming.
…. But getting back to what is relevant – looking at the figures presented by our Minister and Governor, the numbers of defaulting debts, not just the numbers of people, reveal a very different story from “addiction” or “widespread ignorance” of the dangers of wage-day lending.
Just 30% of all defaulting debts are related to debt arrears from consumer loans. Since consumer loans from banks and wage-day lenders have not increased that much over the last 10 years one can assume that defaults from this source do not explain the increase of some 100 000 defaulting people over this period. According to official figures the remaining 70% of all default payments are from non-payment of amounts invoiced by the public sector for social housing rent, traffic fines, public healthcare care, etc. These have increased because past governments and municipalities have substantially increased these public services fees and fines over this period well ahead of consumer inflation.
This has then led defaults growing – many people cannot afford to pay because they are low-paid workers, pensioners or otherwise financially challenged. These same folk then turn to other sources of funding, like loan sharks, to try to cover their debts and fall even deeper into debt. It has become a vicious circle, that those sitting in ivory towers fail to notice.
… and these defaulting debtors are the same folk who also receive basic public subsides for food and housing and that represents a big cost to taxpayers. Educating them to achieve better management of their finances is tough if not impossible since they many have limited or no income and they are often confronted with life’s challenges of discrimination, poverty, alienation, abuse, etc.
The above proposed policy solutions do not match the needs. A better approach would be to cut public fees for those who clearly cannot afford to make these payments….
… and loan sharks need to be regulated out of the market, just like banks that may not grant loans to people who obviously cannot or are probably unable to not repay their housing debts.
Restrictions on aggressive advertising by loan sharks is a waste of time when anybody can create a company abroad and sell money at exorbitant rates on the internet to those in need. These lenders should be banned altogether and their contracts declared to be criminal by law. Why should taxpayers pay subsidies to allow these companies to receive extortionate loan repayments?
But today’s bigger financial problems today is to be found in another area – that created by banks, brokers and pension insurance companies are selling expensive and inappropriate financial products to the unwary with “great returns being offered”.
A good start would be to require that banks, brokers and pension insurance companies should be forced to allow all financial discussions and negotiations with private clients to be recorded on their customers’ smart phones. That would certainly reduce the amount of hard-selling that is currently going on today. The amount of cash being scalped off by banks and brokers is huge – just try to win a court case against these people when they bring in their lawyers about “what was said or promised.”
There can be no doubt that ordinary people need to understand much more about the cost and risks of borrowing and investing. Giving that job of educating ordinary people about borrowing and investing to banks, brokers, pension insurance and the media is just plain wrong. You cannot expect the salesmen to be objective. The same gos for the financial media that depends on bankers and brokers for their advertising. This work needs to be done for children at school where you can learn the basics, and adults need to learn more from totally independent and regulated advisors who do not sell or otherwise rely on bankers, brokers or others selling financial products.