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Letwin: The problems of household debt cannot be ignored

Last November I gave a speech entitled Towards a Saving Society.

At that time net lending to individuals stood at £916 billion, having broken through the £900 billion barrier the month before.

The figure now stands at £956 billion, and will, on current trends, break through the £1 trillion barrier within five months.

Of course, this is a purely psychological barrier.

There is no reason why this particular number should lead to economic meltdown, even in the context of relatively high - and probably rising - real interest rates.

But, as I said back in November, it is possible for problem debt to rise to a level that is socially unacceptable even if it is economically sustainable.

Today we are closer to that possibility than we were back in November.

It is becoming increasingly clear that the unprecedented rise in household debt cannot be explained as the consequence only of increased mortgage lending to a buoyant housing market.

There has also been a massive expansion of unsecured debt, which now stands at £172 billion and is still growing at over 10% per annum.

In addition, there has been a massive expansion in mortgage equity withdrawal, which from negative levels in the mid-1990s now stands at over £50 billion, rivalling credit cards as a means of borrowing.

Unlike credit cards, we don't know how much withdrawn equity is used to fund immediate consumption.

But we do know that the growth in consumer credit is associated with a growth in problem debt:

· While mortgage repossessions have fallen, individual insolvencies in England and Wales have hit their highest level since the early 1990s. Indeed, at 10,271, the figure for the final quarter of 2003, is exceeded only by that for the first quarter of 1993 - and then only just.

· According to Leeds University Business School, the amount of debt being chased by bailiffs has increased by 70% in the last two years, reaching a record level of £5 billion - an increase blamed on "an alarming rise in the number of people falling behind on credit card and personal loan payments."

· As a percentage of credit card outstandings, credit card write-offs have almost tripled since 1996 - to just under 0.7%. Though this figure is not quite as high as in the early nineties, it relates to much higher levels of credit card lending (which have more than quadrupled in a decade).

· Several debt advice agencies have reported an increasing demand for their services: For instance, the Citizens Advice Bureaux report a 47% increase in new cases over the past five years. Crucially, the increase has been driven by inquiries on consumer debt; inquiries on most other kinds of debt have actually fallen.

It is clear that debt problems are on the increase. But is problem debt at a socially unacceptable level?

The answer, of course, depends on one's definition of social unacceptability.

According to a DTI-commissioned report from Bristol University's Personal Finance Research Centre, one in twenty households use up more than a quarter of their income on consumer credit repayments, and one in fifty use more than half their income in this way.

This may seem like a relatively small proportion of the population, but it involves hundreds of thousands of households—who form part of what, in a recent speech, I called the third nation: the part of the population whose economic problems current social and fiscal policy fail to address.

Many more households report being in arrears in the past twelve months - nearly one in five. But for certain groups, the proportions are truly disturbing: 40% of 20 to 29 year olds are in arrears, 42% of families with a new baby are in arrears, 48% of lone parents and 52% of recently separated couples are in arrears.

Whatever the political judgements made on the social acceptability of the current situation, those judgements will have to be revised if the situation deteriorates.

And there is evidence to suggest that the debt problem has the potential to become significantly worse:

· Though debt-to-income ratios have increased significantly in the last few years, there has been no corresponding increase in individuals' subjective awareness of their growing indebtedness. Even among the most indebted households, one in six believe they can take on more debt, and less than a quarter believe they have borrowed too much.

· Ominously, Britain is not only willing, but also able to go deeper into debt. More than half the most indebted households have unused credit facilities. In the population as a whole there are 72 unused credit facilities for every 100 in use. And we read of mortgage lenders now moving to increase the multiples of income lent.

· This is all taking place against a background of rising interest rates. The rises may be small in absolute terms, but, proportionately, they are high. A rise in base rates from 4% to 5% over a period would imply something like a 20% increase in annual interest costs for families with typical floating rate mortgages. As the cost of servicing rises at that rate, the budgets of some households who have debts equal to four or five times their income, will come under increasing stress.

· Nor will inflation eat away the value of the liabilities. We are, (from other points of view, very fortunately) living in an age of stable and low inflation. That, together with relatively high real interest rates make this, paradoxically, a benign time for savers, of whom there are certainly too few, and an expensive time for borrowers, of whom there are probably too many.

But our greatest concerns should be for those households least likely to own their homes.

The idea that debt is mainly a middle-class problem is wrong.

Whilst absolute levels of debt are correlated with household income, the burden of debt is heaviest on the poor:

· The debt to income ratio is highest for the poorest households, where it has also risen faster than in any other group - doubling between 1995 and 2000.

· When measured on the basis of debt payments as a proportion of income, the debt burden on the poor is even heavier, and an indication that the poor pay more for debt.

· Unsurprisingly, the poor are more likely to get into debt payment difficulties, with households earning less than £15,000 twice as likely to be in arrears than richer households.

So, how concerned should we be?

A recent Bank of England report puts it this way:

"The higher levels, and in some cases more rapid growth, of debt-income ratios among the youngest and lowest-income households are important findings, given that [these] are the households most vulnerable to financial and other shocks likely to increase financial stress, such as spells of unemployment or unexpected increases in interest rates."

Of course, debt problems are to be found throughout society.

And the collapse of the savings ratio is a problem for us all, even for generations as yet unborn.

That is why I have, on previous occasions, set out far-reaching policies to revive this nation's savings culture.

But on this occasion, our focus should be on those least able to bear the burden of debt.

Those who owe the most, and pay the most for the privilege.

And as grateful as I am for your participation today, this event represents no more than a start to my Party's commitment to this issue.

That is why I am today announcing the formation of a Conservative commission on indebtedness - in particular the indebtedness of the poor.

It will be a serious undertaking, with a serious mission. It will, I hope, draw on the experience of all those gathered here today.

I have asked Brian Griffiths to serve as its Chairman.

Brian is a member of the House of Lords, a distinguished academic economist, a former Director of the Bank of England, the Deputy Chairman of Goldman Sachs and the former head of the Downing Street Policy Unit, where incidentally, he was my boss.

Though the Griffiths Commission has been formed at the request of the Conservative Party and will recommend policy to the Conservative Party, it will be free to act and speak independently of any Party.

Let me say here that I recognise the Government's efforts on the issue of indebtedness, and I welcome many of the proposals that have emerged from these efforts.

But I have asked the Griffiths Commission to dig deeper. I have asked the Commission to gather first-hand evidence about the way in which families get into debt-spirals. I have asked it also to identify means by which—without distorting markets, and without introducing burdensome new regulation—these families can best be helped to avoid debt-spirals.

I do not for a moment imagine that this is an easy problem to tackle. I recognize that it will require both wisdom and imagination if we are to formulate a sensible and effective approach. But I believe that the time has come for such width and depth.

This is too serious an issue for limited thinking.

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