How Much More Can We Borrow?
News over the last couple of days that stock markets are having a little tantrum will be viewed differently by different people. Some will say that it’s a minor correction and that it will soon be reversed. Others will say it’s just a little ‘wobble’ that will soon be reversed and yet another group will say this is a sign that the rivets on the financial bolier starting to pop.
It’s impossible to forsee how things will develop over the coming weeks and months, let alone years. It is clear, however, that the reason most countries have been continuing to show growth has been due to borrowing vast amounts of money.
Individual borrowing has sky-rocketed and fueled booms in housing prices and retailing across the western world. Consumer debt has risen to new levels that were previously unimaginable but we are all having a great time and buying lots of goodies. On the stock markets borrowed money has been fueling takeovers and driving up values to reach record breaking levels. Everybody is doing really well and everything in the garden is rosy.
Unfortunately the road ahead has a big fat rock in the middle of it that we cannot avoid. I hate to be the one to spoil the party but this borrowing frenzy cannot go on. Unless we can somehow make the assumption that the debt we build up will never have to be repaid, we have to find the money to repay these debts.
You can borrow money and as long as you are able to repay that first debt you will be able to borrow more money but there comes a point where you just can’t borrow any more. If you are able to borrow more then it comes with huge penalty rates of interest that will destroy your financial security but inevitably, at some point you have to stop borrowing and start paying down your debt.
It may be reassuring to have financial security invested in your home but that security is only as secure as the housing market and strange as it may seem to those who have only seen upward movement in house prices, the value of houses can go down as well as up.
House prices could go down just as quickly as they went up. It isn’t hard to visualise a scenario where rising interest rates put the brakes on consumer spending leading to a downturn in company profits and halting any rise in house prices. Companies trying to reduce costs might have to lay off workers and those ex-workers can no longer afford the high levels of debt they previously thought they could cope with.
Forced sales of property will lead to falling house prices and as house prices fall further the banks will start getting nervous about the security the property provides on the loans they hold. With interest rates relatively high and house prices falling buy-to let on borrowed money becomes a financial nightmare and the market gets flooded with these properties being offered at sell-it-fast prices and prices fall further.
Banks are cold blooded creatures. They don’t care about you as an individual. They care about their money, nothing else. If you fall on hard times the bank are unlikely to be helpful to you unless they see a profit in it and if you cannot afford to borrow more money from them they will have little sympathy for your circumstances.
The hiccup on the stock markets may be no more that a blip but it could also be a sign of things to come. When so much of the money that drives our consumer society is borrowed people are going to suddenly wake up to the fact that they are not as rich as they like to imagine and they will have to stop spending. The financial industry keeps putting off the day this will happen by juggling numbers and finding new ways to enable people to borrow but it has to stop sometime. It cannot go on forever.
When that day comes the train might just come completely off the rails. Make sure you are not standing in its path.
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[...] Money Well asks “How Much Can We Borrow?" This post is a look at the borrower’s situation in the post market hiccup [...]