Debt to more debt, but for how long?

“If you suffer from small loans, you have a problem; but when you borrow alarmingly large sums, then it is the lender who will suffer a greater problem!” Simply put, this is the dangerous financial position of the US presently, undermining its continued ability to raise borrowings or to service them. If its debt bubble bursts, it is feared that the global economy will bear the brunt, reminiscent of the 1929 Great Depression.

Debt Addiction

The national official debt of the US Treasury capped at $14 trillion made S&P (Standard and Poor’s) – the World’s leading rating agency downgrade US credit rating. Add to this, the “unofficial” part, which includes social security promises and the defense expenditures, after deducting all the expected tax collections of the Federal Government — and the fiscal gap could go to unimaginable levels.

In the last three decades the US economy saw tremendous rise in the debt levels, from $5 trillion in 1980 to about $54 trillion today which is more than tenfold of the increase. The gap between official debt and overall debt is not known but the concern is even if the official debt of $14 trillion is reported, it is by no means, a comforting figure to either the borrowers or lenders.

Also Read about India Housing Finance.

Scenario of The US Economy

i) The interest rates on savings were drastically cut to discourage savings, driving households to move their savings to the stock market. People not only spent at levels that exhausted their savings, but also went beyond and borrowed heavily, the repayment of which was contingent on a stagnated market.

ii) Post 9/11, the stock market suffered as a sequel to the “dotcom bubble” and the economy took a beating.

iii) The Federal Reserve reduced interest rates to attractive lower levels, making it easier for financial institutions to borrow money and continue issuing debt liberally, and at very low interest rates.

iv) Such loans were made to ‘sub-prime’ customers who were unable to make mortgage payments when the economic situation took a turn for the worse.

v) The interest rate on these mortgage loans started increasing in 2007, creating a housing crisis in 2008 which spun out of control. The economy took a further beating, the stock market plummeted, and there was further unemployment.

One of the common factors in this escalating crisis is the constantly rising level of debt, both at the household and the Government levels. Despite the continued recessionary trend which is prevailing in the economy, the debt level rising trend, has been increasing year after year. Debt has been tackled not by encouraging savings. Heightened consumerism has resulted in unsustainable levels of debt, and created an unabated appetite for US borrowings. The perceived strength of the US currency is under challenge. The US, in the last few decades, has been the beneficiary of large FDI flows into its economy, along with talent. Its continued ability to attract capital and talent is under threat. This is contracting the economy and increasing joblessness. The capacity to spend will also fall, further contracting the economy.

Learning from Asia

The West will have to borrow the idea of savings from its Asian counterparts, in the place of its debt-driven consumerism, to reverse its declining trend. Asian countries are no exceptions to this global problem of household debt, but they are expected to have relatively greater resilience. Their savings and the family acting as an informal institution of insurance, will enable them to “de-couple” from external uncertainties for a longer period of time. This would also be an eye-opener that inter-dependence within family as an institution is a more sustainable approach than heightened individualism, with strong dependence on the state. This holds true, no matter how good the delivery systems of the state may be.