Debt is hanging around the necks of households

By | January 11, 2010

headache

Debt is hanging around the necks of households, like Christmas cake on the hips.

Spanish researchers* have recently confirmed the existence of a long-run relationship between house prices and home loans, a so-called co-integrating relationship. Nothing particularly startling in that result. But dig a little more into the results and a more troublesome finding can be unearthed.

Like in the UK, Spanish home loans did not just grow alarmingly quickly in recent years, they are now markedly above their long-run trend and so too are house prices. As access to loans grew, house prices grew; and as house prices grew, the value of loans grew and so on. A co-integrating relationship; and one which was compounding terrible errors.

With house prices above long-run equilibrium levels there was an overvaluation of house prices, which fed through into a false sense of no over-indebtedness. A correction is now in process and the results of the study indicate that adjustment to trend will be lengthy.

The splurge on household debt will hang around the necks of households, like Christmas cake on the hips. A serious bout of debt dieting and restrained consumption is now on the cards. House price inflation will also be modest, because as banks reduce lending back to trend, house prices must fall back also. Any restraint in house prices will act as a substantial drag on household wealth and the ability to borrow and spend. Put simply, this all adds up to low economic growth into 2010 and beyond.

* Ricardo Gimeno, Carmen Martínez-Carrascal, The relationship between house prices and house purchase loans: The Spanish case, Journal of Banking and Finance, forthcoming, DOI@ 10.1016/j.jbankfin.2009.12.011

About Damian Ward

Damian studied at the Manchester School of Management before beginning his academic career at Bradford, where he now teaches business economics to postgraduate MBA students. His research interests focus on the financial services sector and he has acted as an advisor to the UK Financial Services Authority. Damian is also the author of the leading textbook, Economics for Business.

Specialties: Business economics, Financial services, Efficiency of the UK mortgage market, Economic predictions

2 thoughts on “Debt is hanging around the necks of households

  1. Damian Ward

    I’m just ploughing through this week’s edition of The Economist and came across a related article. http://www.economist.com/businessfinance/economicsfocus/displaystory.cfm?story_id=15269334

    This article looks at the debt burden in various economies. The study highlights that the debt explosion was both markedly different in scale across economies and at the same time is concentrated in different sectors, such as government, households, companies etc. Debt reduction will therefore have different spending impacts in different economies.

    However, from an examination of previous debt reduction periods the study arrrives at a most worrying conclusion. On average debt reduction begins in earnest 2 years after the start of the crisis. So sometime soon in our case! And carries on for between 5 and 7 years.

    Remember this sobering thought if the GDP figures, out at the end of the month, say the UK is finally out of recession.

  2. Brian Bennis

    A much bigger problem is being stored up by the debt explosion. The inability for people to properly fund their pensions. In time, the burden will fall upon the state. A bleak position by any standards.

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