Vincent Cable: The trillion-pound time bomb is ticking away

One central area of concern is the promotion of credit, including misleading advertising
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The Independent Online

The Bank of England's confirmation that British household debt has now reached the symbolically striking level of £1 trillion coincides with growing official nervousness about debt. Until very recently, the Government and the Bank of England were confident to the point of complacency. Debt service ratios, they argued, are historically low, thanks to low interest rates. Rising household debt is balanced by booming asset values: rising house prices against which over 80 per cent of debt is secured. Apart from a small minority of feckless or unfortunate debtors, the vast majority of the great British public can handle its obligations without difficulty. And, of course, debt financed consumption keeps the economy ticking over nicely and keeps unemployment at historic lows.

This confidence is evaporating fast. Record levels of household debt in relation to post-tax income of over 120 per cent, three times the level of 25 years ago, is only sustainable while interest rates remain low. But interest rates are rising, and are expected to rise further; and a narrow brush with an oil shock has painfully reminded us that the days of inflation and high interest rates could return. In addition, the main household asset, the value of housing, is coming to the end of a long bull market, with the Bank of England seeking to manage a "soft landing" for house prices rather than the more brutal market correction, which economic history would suggest is more likely.

In fact, the housing market is showing little response to the Bank of England's hints. Buy-to-let investors, with large mortgages on very high income multiples are showing all the lemming-like wisdom of dot com investors at the peak of the share price boom. Prices continue to rise, with Nationwide showing yesterday a 2.1 per cent monthly increase in house prices in July, yet even the most optimistic of housing analysts expect, at the very least, a strong slow down in house prices in the fourth quarter of this year.

The Government, which hitherto had tried to pretend household debt was none of its business, is realising the dangerous potential of mounting personal debt. As a result, it has just smuggled out, through the improbable channel of the Deputy Prime Minister's office (why not the Treasury?) a series of proposals to deal with unsustainable debt. This could well be far too little to late.

How we tackle the building debt burden comes down to two fundamental issues of economic management. The first is whether there is a satisfactory system of macroeconomic management for dealing with asset bubbles - as has occurred in the housing market - and debt. We know from recent Japanese experience that major policy failures in this area can result in prolonged stagnation. But the UK has no policy framework other than the current improvisation of the Bank of England, using interest rates to deflate, gently, the housing market.

I have been endeavouring for some time to encourage serious public debate on the dangers of current levels and growth of debt, and published a 10-point plan of practical measures to address them. One central area of concern is the promotion of credit, involving misleading and aggressive advertising, such as unsolicited mail, or poorly explained or deliberately misleading offers.

In terms of the overall availability of credit, I believe there is no alternative but to focus also on the reserve requirements of the banks. At present, the only concern of the authorities is whether these meet prudential requirements as part of international agreements to safeguard against systemic risk. But reserves could be more actively managed to reflect - in the case of the housing market - the scale and growth of mortgage lending. In open, competitive, financial markets, old-fashioned credit controls are neither feasible nor desirable; but the use of reserves as a tool of monetary management has not been fully explored.

The other major policy issue concerns the balance of regulatory pressure in respect of saving and investment as opposed to borrowing. There are increasingly stringent and complicated regulatory requirements in respect of personal investment. But there are minimal restraints in respect of lending. Thus, it is ridiculously easy to borrow large sums. And large parts of the banking sector incentivise their branch level staff to sell more loans and credit cards.

The Government, the Bank of England and the Financial Services Authority need to review with the banks, building societies and other credit providers, the system of internal incentives used to promote personal indebtedness. Debt is being commission driven as were sales of pensions and endowments a decade ago. The authorities should be demanding of the credit providers much greater transparency in the marketing of debt-creating financial products.

The Government deserves credit for the policy innovations of independence for the Bank of England and the creation of a statutory independent financial regulator. They have been generally successful in tackling yesterday's problems. But the Government is ignoring today's challenges of asset bubbles and debt. The old problems of "boom and bust" are reappearing in a new form, benign neglect will not suffice.

The author is the Liberal Democrat Treasury spokesman