Sustainable Borrowing?

Many years ago I worked for a finance company, providing credit facilities to motorcycle dealers to enable their customers to buy bikes. At that time Honda advertised their Cub range to commuters as a cheap way to travel to work, and the iconic machine has sold over 100 million world-wide since 1958.

Most buyers however were teenagers chasing a dream, but whoever the customer was it was always drilled into us to prove their ability and willingness to repay the loan before granting the credit. 

This was in the days before computers. A credit check was done by the telex operators sending off the customer details, and the result coming back a couple of hours later. If that was inconclusive an enquiry agent could be hired to physically check out the details we'd been given. Time-consuming, expensive, and far less effective than todays data and algorithms.

Then we looked to see if the proposed purchase fitted the buyer. A 70 year old pensioner buying a Honda 750 was likely to be doing so on behalf of a grandson. If he couldn't get credit in his own right it was unlikely he'd repay with his grannie's name on the finance agreement.

It was a high-risk business, but ultimately turned a profit - possibly helped by the not inconsiderable interest rates being charged.

Those that didn't pay had it reflected on their credit file, meaning the next time they wanted to borrow money the mainstream banks wouldn't help and they'd pay higher rates to get the money elsewhere. This cycle would be repeated with further defaults, until ultimately they'd run out of lenders.

But even those willing to repay the loan could find their circumstances changing, and suddenly their ability to repay had gone, and they also defaulted, and a credit file made no distinction between them and the serial defaulters.

We've been told today that energy bills are to be capped at £2500 for a typical household until 2024. That's higher than last year, but still very welcome considering what we were potentially looking at. The cost is said to be in excess of £100 billion, and will be funded by government borrowing.

The government wants to cut taxes, not raise them, so in order to help people with energy bills the money will have to be borrowed. But when governments borrow the money has to be repaid eventually - with interest. That means taxpayers ultimately pay.

The total amount the government owes is called the national debt, which is currently around £2.4 trillion - almost as much as the total of all goods and services produced in the UK in a year. Interest on this over the next two years is expected to be around £100 billion, and interest rates are increasing.

Traditionally the government borrows by issuing bonds - basically interest-bearing IOUs - which are bought by investors, pension funds and private individuals. UK government bonds are known as gilts - short for gilt edged securities - seen as a solid investment as they have never yet defaulted on a repayment.

However like any borrower there must be a limit to borrowing, based on their perceived ability and willingness to repay the debt. They will always want to honour a debt, but the ability is dependent on the money they can raise - in other words taxes - which is finite. Particularly if you pledge to reduce personal taxes and don't want to levy windfall taxes or other increases on businesses.

There has to come a day of reckoning if it isn't managed along the way, which would affect us all. The cost of this current crisis hasn't been lessened, just deferred, like any buy-now-pay-later scheme which we're repeatedly advised to avoid.

The government could do worse than follow traditional credit advice and learn to budget more effectively now, rather than face a situation like the Greek debt crisis later.