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The Tragedy of Hamlet

Posted on April 23, 2016 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

 ‘Neither a borrower or a lender be’ so said Polonius in The Tragedy of Hamlet Prince of Denmark by William Shakespeare. However, economies in modern times don’t work this way and neither did medieval societies notwithstanding the moral strictures placed on usury.  The fact is that income does not match spending on a day-to-day or year-to-year basis.  Lending and borrowing are based on timing and with it some level of trust and legal protection.

A young couple or family will need to space out spending by means of borrowing. The word ‘mortgage’ comes from two French words joined together: mort (death) and gage (pledge). It was said that French peasants worked until death for the privilege of owning a house! 

So, borrowing is a normal part of the lifecycle and is associated especially with the purchase of a home but also with other big ‘lumpy’ and upfront spending such as that for a car, postgraduate education or health treatment if one is fortunate enough to be able to access these. Whether borrowing is too high or unsustainable all depends on:

  • The probability of a continuing and adequate income stream in the future to repay the loan;
  • The value of the property of the good or collateral on which the loan is taken out; and
  • The risk taken by the lender and the rate of interest charged

The Republic of Ireland stands out as having the third highest level of personal or household debt among the European Union countries (Chart 1). The level of personal or household debt as a percentage of disposable household income was in excess of 200% in 2014 according to OECD figures  (for a different measure see Central Bank of Ireland Quarterly Financial Accounts here ).  This contrasts with a ratio of government debt to GDP of under 100% last year.  According to the Central Bank total private debt (households and corporations combined) came to 258% of GDP in the third quarter of last year – dangerously high considering that economic activity is bound to slow down some time in the not too distant future.

 

The trend in household debt since 2001 (data are not readily available for before 2001) shows a pre-recession peak of 236% of net personal disposable income in 2007 up from 111% in 2001 (which was probably well above the average in the previous decade). Clearly, something was seriously wrong by 2007 and these indicators are evidence. In simple terms a representative Peadar and Elizabeth Murphy-Smith with a combined debt of €33,000 in 2001 with a combined income of €30,000 between them.  Six years later their combined debt had jumped to say €120,000 while their income had risen to say €50,000. Put another way, although wages and others costs were chasing to follow the property bubble the total of personal debt was racing ahead at breakneck speed to reach some of the highest levels in the OECD world. During the period from 2000 to 2007 vast amounts of capital flowed into the Irish banking system from the UK, US, Germany and France.  

From being 12 th out of 24 countries in a ranking of OECD countries on household debt in 2001 the Republic of Ireland had moved to third place behind Denmark and the Netherlands and ahead of Norway.  Although Denmark (think of Hamlet!) and the Netherlands had high and unsustainable levels of personal debt various factors prevented a severe crash as happened in the Republic of Ireland presumably due to somewhat better macro-economic management and regulation of banking in those countries prior to 2008. The toxic link between the banks and property developers and investors for buy-to-let as well as commercial and office property was the killer arrow in the celtic tiger balloon. Wages did rise rapidly in the years prior to the crash but these were driven by a property-led boom and a dramatic escalation in house prices and an ever escalating level of personal debt.

 

When people lose their job or become suddenly ill and unable to work or experiences a pay cut they are typically faced with a huge challenge in meeting loan or mortgage repayments. This is particularly true of Ireland and the UK in recent times where much of the boom in property prices was driven by easy lending and low interest rates. When the property market collapsed in 2008-2010 along with a sudden stop in inter-bank lending many households were straddled with huge amounts of personal debt in the form of mortgages which they were not able to service. The scale of mortgage distress rose sharply as many were forced into restructuring or non-payment. At the same time many corporate and institutional borrowers experienced severe financial difficulties leading to various agreements and commercial wind ups. Of course, the real tragedy of the period 2008-2011 was that capitalism was not allowed to function in particular ways involving write-downs for major investors that had unwisely over lent to financial institutions. Instead, senior bondholders walked away courtesy of European and epecially Irish taxpayers while millions suffered through foreclosures, business liquidations or evictions from homes. We witnessed the sudden rise of socialism for bankers with the nationalisation of banks and their bad debts while we now wait for others to buy up public banks possibly with the same money extracted from the taxpayers in some cases.

A further twist to the story of private household debt is that it is very heavily concentrated among the poorest households. Analysis by the TASC thinktank of data from the CSO/Central Bank Household Finance and Consumption Survey (The Distribution of Wealth in Ireland - refer to Chart 10 on page 17 of the latter) shows that, in 2013, 37% of the total value of debt was concentrated in the poorest net wealth decile (the bottom 10% of all households ranked by net wealth. These households are hugely vulnerable to interest rate increases in the long-term. Many are caught in the shadow world of payday loans and loan sharks charging exhorbitant rates of interest to struggling families.

Polonius greatly overstated the case against borrowing in Hamlet but he had a point especially in that which followed:

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine ownself be true.

The celtic tiger period was an extreme example of how markets fail to properly value assets including that most precious of assets – your own home. It is not evident that all the necessary lessons have been learned. There is still something rotten in the state of denmark as the palace guard declared in Hamlet. O if we were only a little more like Denmark!

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