Excesses and excuses - the household sector’s role in the GFC

It sounded and looked like a problem at the time and while the party lasted a little longer than one would normal expect given the imbalances in the economy, when it ended, there was the global financial crisis.

The problem in the aftermath of the crisis and when the economy starts to recover, there will be the strong probability that householders be less keen to borrow and less willing to spend and rack up debt at frenzied levels. As a result, the pace of economic growth will be constrained. It will be a jobless recovery without huge gains in wealth. While consumers will bounce back to some extent, the prior wealth destruction, job losses and evil of excessive debt will be too clear and too fresh in people’s memories for there to be a consumer led resumption of 3 per cent plus GDP growth, at least not in the G10 economies.

Making the matter all the more problematic will be the risk of over-regulation or over-cautious lending practices imposed by financial institutions many of whom, after all, owe their existence to government bailouts and tax payer cash.

In all, the outlook for the world economy points to an extended period where consumer demand is unlikely to repeat the rampant growth of the 1990s and early 2000s. Very unlikely. What is more likely when market and economic conditions finally stabilise, and even start to recover, is a very modest pick up in consumer spending and with it a slow process of reducing unemployment and rebuilding the wealth that has been destroyed during the crisis.

Households and consumers will be reluctant to borrow too much, banks will be more prudent in their lending and the regulators will make it harder for the excesses to be rekindled by imposing a range of measures to prevent silly and unsustainable economic behaviour.

This will not necessarily be a bad thing for the long run sustainability of the next upswing in the business cycle. If household debt levels are low, the vulnerability to a credit crunch is low. High debt levels leave open the possibility that lenders will, one day and for whatever reason, want their money back. When this happens, borrowers need to sell their assets, often into a falling market, compounding the downturn. Without excessive debt, there is no such problem.

So enjoy that glass of wine - have two. It’s actually good for you. Don’t be afraid of debt, just don’t borrow or lend any amount that is not based on a prudent set of guidelines. In this instance, the upturn will be less potent than what we saw in the 1990s, but it is likely to be much more enduring.