The Bank of England and the growing credit bubble – a piecemeal response to a systemic problem

Recently, this author discussed the rapid increase in auto-finance delinquencies that need to be seen as just one component of a growing bubble. The argument, which focused on the role credit rating agencies are playing in the expansion of this consumer credit bubble, essentially called for a widening of our perspective when looking at the issue, on the basis that failing to do so, so close to the last Financial Crisis, could have dire effects.

In June, the Bank of England dictated to the banks in its jurisdiction that they must hold more capital - £11.4 billion more – in reserve in preparation for the anticipated bursting of the growing consumer credit bubble that is undoubtedly forming. In light of this, this post will answer a question posed in the British media recently – can the Bank get Britain to kick its cheap credit habit? – by discussing the societal issues that are affecting the expansion of the bubble; doing so demonstrates that a societal alteration is needed.

The Bank of England, predictably and understandably, is adamant that there is no impending threat of a financial crisis in the near future, but rather that risks to systemic stability are neither ‘elevated nor subdued’ and that, at most, there are ‘pockets of risk that warrant vigilance’. Whilst this may be true, it is more appropriate to remember that the Bank of England has a duty to reduce panic in the marketplace. So, whilst we must remember that qualifier, it is even more important to study the reality of the situation; the Bank of England, in contrast to their downplaying of the situation, also confirmed however that ‘consumer credit has increased rapidly. Lending conditions in the mortgage market are becoming easier’

This comes just a few short months after its proclamation that it was concerned about a growth in consumer borrowing in relation to cars, with an underlying fear being that lending standards are rapidly decreasing at the same time. This issue - of car finance becoming a central figure in a new bubble - was repeated last weekend with MPs calling for car leasing companies to reveal the delinquency rates on their loans, so that the true scale of ‘sub-prime’ loans can be understood properly.

So, whilst the aim is not to create a panic about the health of the financial system, all official statements point to a bubble that is rapidly becoming out of control. Yet what are the main reasons for this growing bubble, and can it be reduced at this point in time? To answer this question honestly, there is a need to look at a mixture of focused economic data and abstract societal understandings.

It was reported recently that the rate at which residents in the U.K. save has dropped to a record low – the Office for National Statistics recorded the ‘savings ratio’ at 1.7% in the first quarter of this year – whilst the amount of credit consumed within the U.K. rose by £1.7 billion in May 2017, making the outstanding total £198.4 billion. The result is that British society is rapidly becoming a borrowing society, rather than a saving society, which can be translated into a relatively simple deduction of short-termism.

However, why this is the case is of importance, firstly because it can reveal the processes behind that shift, but also because it can, potentially, suggest whether the current bubble can be reduced before it explodes. 

One reason being put forward is that the growth in wages and disposable income has been reducing steadily, meaning that workers have less to save.  Recent data suggests that, in contrast to their European neighbours, the British have seen their real wages decrease whilst the economy has grown, which is a trend that has been consistent since the Financial Crisis.

Furthermore, the shifting patterns in labour have, supposedly, contributed to this trend - while employment was expanding, it was in lower-paid jobs, and wages have not been keeping up with inflation. These factors are said to be the main issues affecting current living standards in the U.K., with data showing that regular pay has risen by 1.9% against a 2.3% increase in prices. This divergence, as discussed previously by this author, is just one aspect of the increase in the usage of short-term lending sources which, as discussed, exposes people to potentially unscrupulous practices that are of constant concern to regulators.

Yet there are some theoretical interpretations of the phenomenon that attempt to explain why, although becoming indebted creates ‘stress and strain’, consumers will borrow because of a so-called ‘life-cycle’ consumption model that describes people borrowing against future earnings early in their lives and then consuming saved-assets in their retirement. However, whilst the increase in consumer credit has been painted as an almost ‘entrepreneurial’ endeavour, or the result of a generalised increase in the ‘financialisation’ of society, the almost constant issue of austerity looms large over any explanation. 

It is hard to escape the correlation between the reduction in wages and the steady increase in consumer credit consumption, but is this a reason? There are mixed sets of data concerning this issue which make a conclusive understanding difficult to obtain; for example, while the reduction in wages and living standards ‘is obviously an incentive to borrow’, PwC suggest that consumer credit confidence is at an all-time high.  This paints two very different pictures - one of consumers being forced into indebtedness, and one where consumers are actively and willingly becoming indebted. The confusion, or lack of certainty in why the credit bubble is expanding is perhaps the main reason why it is expanding – if nobody knows why it is expanding, then how can one stop it?

The notion of culture is arguably the best source of an answer to question posed in the introduction to this post. The development of a culture that is built upon ‘instant gratification’ is one understanding; an American-inspired revolution of ‘buy now pay later’ that began in the early 20th Century that has spread globally is another. 

This viewpoint represents one endpoint, as against the ‘forced indebtedness’ endpoint at the other end of the scale; together they  represent two extremes that, when viewed in isolation, can be argued well by almost anybody. Yet, when taken together, a holistic picture emerges of a society that has been financialised, but whose members have then had the safety that existed with that culture withdrawn. 

What was required, in part, was for the public to refrain from purchases like brand new cars and reduce their propensity for a certain lifestyle in reaction to the health of the marketplace; whilst lenders have a great responsibility, individualism in terms of accessing credit irrespective of the economic environment must also be considered as being a major factor in the impending crisis.

Yet, we know that such a "reduced propensity" has not happened, with increased rates of credit consumption and, quite remarkably - if we follow PwC’s figures - an increased rate of confidence in the credit system. This confidence, however, is seemingly misplaced with cheap credit being the forerunner to lower lending standards and ethics, which form a cyclical pattern that has to result in a burst bubble. 

Ultimately, this understanding means that not only will the Bank of England’s recent manoeuvrings not stop the impending bursting of the consumer credit bubble, it fundamentally cannot. The cultural addiction that the financialisation of society caused is the maturation of a culture long in the making; what we are witnessing are the effects of that phenomenon.

The real danger, as this author has discussed on a number of occasions, is the proximity to the last financial crisis,  because the economy, and society too, have not had chance to recover enough from its effects; any narrative that suggests the piecemeal nature of this impending bubble makes it ‘different’ to the last crisis, and therefore less of a worry, is a particularly short-sighted one that usually presages a large scale crisis.

Dr Daniel Cash is currently a Lecturer in Law at Aston University. His research specialisms include Credit Rating Industry analysis and Financial Regulatory matters.  He regularly blogs at Financial Regulation Matters