I want it all, I want it now

Borrow, borrow, borrow…or should we?

That dream cottage overlooking the crashing sea, that turbo-charged beast in impossibly luminous red .....you can have it!

On the house, one eager bank or another will lend to you at prime less two percentage points for 25 years.

As for the car, an equally indulgent HP bank, in collaboration with the car company, will lend you the money at prime less 6% over 60 months. You can afford it. It's only Rx per month - albeit for many months.

So you buy it, insure it and (gulp) start paying for it as - in the case of the car - it loses 20% of its value.

That's the way life is in SA these days. As the Reserve Bank put it recently "the ratio of household debt to disposable income scaled new heights".

The great attraction of debt is that you can have the thing of your dreams now and pay later. So long as we are employed and our personal cash keeps flowing as anticipated in the household budget, all is well.

Debt, we are saying, is good:

  • You have the object of your lust now rather than in five or 20 years.
  • The house builder/car dealer gets a dollop of cash and trades happily on.
  • The bank lends to you at five to ten percentage points more the cost of money to it.
  • The pensioner with savings gets a return on money that he doesn't need right now but will need on a future rainy day.
  • Business benefits, invests in new capacity and hires more people.

I know a young man whose dad stood surety for him on a R100 000 loan to buy a machine. Today his sweet factory produces 80 tons of sweets a month and sustains 120 employees.

Some people who made personal micro loans at interest rates of up to 100% pa have no regrets. If that small sum enabled someone to matriculate or graduate, if it enabled a man to fix a bakkie and keep on trading, the loan might have been a great investment.

But before we all rush out and buy the things of which we dream, we should consider what happens when conditions suddenly change - when the job is lost or even when income falls unexpectedly, when interest rates rise and suddenly it's hard to maintain the payments.

Bank bad debts have literally doubled since interest rates were raised in six steps by three percentage points from last June - and it's expected to get worse. Wesbank and its rivals have reported diabolical delinquencies. Their problem is compounded by falling used car prices.

Imagine the heartache in thousands of families as the cars of their dreams are driven away to the repossession lot. If they could, they would be advised to buy their cars back at a fraction of the amount owing but of course, by definition, they don't have the funds or the credit rating.

In the past, people would keep the roof over their family's heads at all costs. That made mortgage lending the safest type of credit to extend.

We all know that has changed in the US, where, The Economist reports, delinquencies in the sub-prime sector are now 14,8% and in the mortgage market 5,1%. The Financial Times reports that in the UK people are keeping up their car payments and handing in their house keys. They can sleep in their cars and continue enjoying mobility and status by keeping the car.

The sub-prime meltdown in the US highlights the danger of assuming very low interest rates could continue indefinitely. People who borrowed stupendous sums at 2% found 5,5% a hill too steep to climb. Their mountainous debt had been packaged and onsold and a default amounting to perhaps a trillion dollars continues to shake credit markets.

Americans like to consume, while Orientals prefer to save and invest. This imbalance explains present global imbalances.

South Africans are also eager consumers and reluctant savers. Our ten-year bond rate at about 8,5% is not quite double the 5,2% of the US and 6,6% in the UK. That is probably justified and healthy as our huge capital account surplus shows.

The National Credit Act puts the onus on traders and bankers to be nannies. They have to make sure the person to whom they are lending is credit worthy. If they don't, the debtor can default with impunity.

So we will see credit tighten. We'll also see a slow down in all sorts of bigger ticket items, from houses to cars, through to surround-sound TV systems. Such a dampener might be desirable since many consumers are over extended. But it is going to hurt motor and furniture retailers. Fortunately, the infrastructure binge should sustain growth.

Never mind the squeeze on borrowers, the banks and the micro financiers, will continue to prosper as they drop their deposit rates more slowly than their lending rates, keeping their profits intact even as bad debts rise.

Neither a borrower, nor a lender be? At this stage I'd rather be the latter.

Article by: David Carte - www.moneyweb.co.za