Lee Friday – July 22, 2017
When bankers and financial gurus tell us that bad debt is actually good debt, it is no wonder so many of us end up drowning in debt.
Pattie Lovett-Reid, Chief Financial Commentator at CTV, wrote:
Good debt is an investment that will grow in value or generate long-term income.
I agree. A perfect example is an entrepreneur who borrows money saved by other people in order to start a business producing products which consumers desire. If consumers value these products sufficiently, the venture will be profitable, and benefits accrue to the entrepreneur, as well as consumers. This is good debt, as defined above – an investment that grows in value or generates long-term income, or both. Perhaps Lovett-Reid would agree with this example, but this is not the sort of debt she discusses in her article.
STUDENT LOANS AND CAR LOANS
Lovett-Reid offers this example of good debt:
Taking out student loans to pay for your education is the perfect example of good debt. . . . a post-secondary education increases your value as an employee and raises your potential future income.
I disagree. Student loans, with few exceptions, represent bad debt, very bad debt! Tuition is expensive because the government hands out student loans like candy. Thus, students are often saddled with an unmanageable debt load, while future income potential is vastly overstated. I have written about this here.
Lovett-Reid also suggests that borrowing money to buy a car also qualifies as good debt. Again, I must disagree. I have covered this previously:
According to this Financial Post article from March 8, 2016, in a 2014 report from debt-ratings agency Moody’s, the agency noted that auto lending by banks had grown at a compounded annual rate of 20 per cent since 2007, “significantly outpacing” the growth of even red-hot mortgages, credit cards, and lines of credit. In seven years, vehicle loans had jumped to $64 billion from $16.2 billion. . . . “Since our report, both consumer debt levels and auto loans at Canadian banks have increased,” Jason Mercer, one of the authors of the Moody’s report, said Tuesday. “Today, Canadian consumers face increased uncertainty due to persistent low oil prices and potential housing overvaluations, so these risks remain as relevant as ever.”
There has been a lot of talk about a housing bubble in Canada, but we also have a car loan bubble. Anyone who considers their car loan to be ‘good debt’ will likely change their opinion if they lose their car – as many of them will – in the next recession.
When you buy a house, you get a mortgage. Lovett-Reid considers this to be good debt, and she offers another definition of good debt: “money borrowed to advance your overall financial situation.” To support her case, she points to
the Fraser Institute’s report suggesting concerns about Canada’s $2 trillion in household debt is overblown because net worth has increased to $10.3 trillion. While our debt levels have increased since 1990, so have our household assets . . . This suggests Canadians have been increasing their good debt and the personal balance sheet is improving.
But is it true that the personal balance sheet of Canadians is improving? Is it true that a mortgage represents “money borrowed to advance your overall financial situation”? Let’s take a closer look. According to a recent poll:
“Three in ten home owners say that they will be faced with financial difficulties if the value of their home goes down,” the report read. “Even if home values don’t decline in the near future; more than a quarter of Canadians (27 per cent) who have a mortgage agree that they are ‘in over their head’ with their current mortgage payments.”
27% of Canadians who have a mortgage are in over their heads. Clearly, this is bad debt, not good debt! As interest rates rise, many more Canadians will find themselves in trouble. Perhaps many of these homeowners have been liberal users of home equity lines of credit, a very foolish decision. As Lovett-Reid rightfully says, bad debt is often consumption-oriented. But she does not make the “consumption-oriented bad debt” distinction when assessing the overall situation in the country – $2 trillion in household debt and $10.3 trillion in net worth – which does not concern her.
Yes, total household debt is only 20% of net worth, but the devil is in the detail. The Fraser report did not delve into much detail, but on page 29 it warns us:
One concern is that much of the net worth of Canadians is currently based on the value of real estate and this, in turn, is fueled by rising housing prices in larger urban centers—especially Toronto and Vancouver. Indeed, the Bank of Canada’s (2016) Financial System Review of late last year noted sharp increases in households with a debt-to-income ratio greater than 450% in Toronto and Vancouver. A housing correction in these two markets could therefore bring a significant decrease in net worth and, given the spillovers into the broader economy and financial sector, complicate the manageability of private debt.
This is a valid observation, which Lovett-Reid fails to acknowledge. Moreover, she is guilty of generalizing when she expresses little concern about the overall debt-to-net-worth ratio. This 1:5 ratio is the average ratio, which obviously does not apply equally to all households. The ratio is much more favourable to the rich, and much less favourable to the middle class, including the aforementioned 27% of Canadians who are already in over their heads. The middle class will be hit hard by a severe housing correction. Many will lose their homes. When this happens, will Lovett-Reid admit her error, and concede that home mortgages do not automatically qualify as good debt?
Debt per se is not the problem. The problem is the monopoly which the government grants to banks to create money by creating debt. Thus, debt plays a prominent role in our lives, with enormous benefits accruing to bankers, special interest groups, and government officials, but not the general citizenry. Most of us tend to live beyond our means, with our standard of living compromised every time we are forced to endure a recession, a direct result of banks’ monetary policies; and further compromised by the favours handed out to special interest groups, facilitated by vast government bureaucracies funded with debt and tax dollars. I have written about these issues elsewhere: Money; Capitalism; Recessions. In so doing, I have attempted to simplify this vital area of economics which banks and governments want us to ignore, because according to them, we must leave these matters to the experts, as this stuff is far too complex for us mere mortals to comprehend.
Student loans, car loans, home mortgages. There are some exceptions, but in all three cases, these are bad loans for many people. It is our own ignorance which causes us to take on this bad debt. Educate yourself, dear reader. Listen to bankers and financial gurus, but do not blindly believe. Use the links I have provided to read the material I have written, but do not blindly believe. You have a brain. Use it. Think for yourself.
Additional source: Edward N. Wolff Recent Trends in Household Wealth in the United States: Rising Debt and the Middle-Class Squeeze—an Update to 2007 (Levy Economics Institute, March, 2010) http://www.levyinstitute.org/pubs/wp_589.pdf