Debt (by alaric)
At the time of writing, there is talk that the Cypriot banking system will "collapse under a mountain of debt" unless Something Is Done. In general, many financial institutions, governments, and people seem to be struggling to meet their debt repayments.
So I thought I'd talk a bit about what debt really means.
I assume we all know what debt is, but just to be sure, if you obtain something (such as money) in exchange for a promise that you'll give something back in future, then you're "in debt". Usually, you will agree to give more back than you gave, to make it worth while for the lender to do this; this is called interest.
This can be good news for the lender - if they had money lying around and didn't really want to spend it on anything, then rather than leaving it in a pile, they can lend it to somebody and get more back, by charging interest.
This can be bad news for the lender - you might disappear and not pay them back. Part of the interest they charge is to cover that risk. If you are a lender who makes millions of loans (such as a bank), some fraction of them won't pay you back; so you make sure you make enough on interest from those that do, to cover those losses, and still earn you a profit.
This can be bad news for you, too, as many people seem to be finding. You may find that you can't afford to repay your debt. Failing to repay usually has some negative consequences; you may be blacklisted from borrowing for some time, or your local legal system may offer a way for the lender to send people into your house to take your possessions to try and recoup their losses, or maybe even kick you out of your house so they can sell it. Or, in order to avoid those woes, you might repay the debt even though this leaves you too short of money to feed your family.
But let's not forget that it can be good news for you, too. Much has been said about how we've all ended up with too much debt, and it's probably true. But debt isn't just about greedy people wanting things now and not properly considering the consequences of those future repayments.
Debt is a form of time travel. If I have ten pounds spare a month, but want to buy something that costs a hundred pounds, I can wait ten months to save up the hundred pounds and then buy it.
But if I borrow a hundred pounds, in exchange for paying back ten pounds a month for ELEVEN months (the extra month being to pay interest on the loan), I can have that thing now. The difference is an extra month of not having my ten pounds to spend on anything else (which isn't a huge deal), but having my new thing now rather than in ten months (which is a big deal). By using debt, I'm teleporting the hundred pounds backwards in time by ten months. That's not just convenient and immediately gratifying - it can save me a tremendous amount of money.
What if the thing I want to spend a hundred pounds on is a tool, required for me to do my work and earn the money that covers my ten pounds a month spare in the first place?
If I don't have the tool, then I can't save up ten pounds a month to buy it.
What if it's to be spent on a domestic appliance such as a washing machine? If I don't have a washing machine, I'll have to go to a laundrette to clean my clothes, which will cost me more each month than the running costs of a washing machine. Buying the washing machine with borrowed money will cost me a bit of interest, but I will save more than that by not having to use a laundrette for the lifetime of the washing machine.
What if it's to be spent buying a house? If I have to rent while saving up to buy a house outright, then lots of my money will go on rent, and I won't have much to save up, so it'll take me longer to save up than I'm likely to live for. If I buy a house with a loan (that's what a mortgage is), then I'm spending money repaying that loan plus interest, and not having to pay rent. In twenty-five years I will have repaid that debt; I'd still be saving up by then if I was paying rent as well.
Now, I have a personal love/hate relationship with debt.
Once upon a time I had savings sufficient to pay the bills for several months, even if I wasn't working. This was great. But then we got married, funded partly from savings and partly from taking out a loan (as I wanted to keep some ready savings on hand). Then we had to move house in a hurry at the same time as we were expecting our first child, and then my wife was sick for the last third of the pregnancy and nearly died in labour, and I had to look after her and the new baby while setting up the new home; and as we were getting on top of recovering from all that, our house was catastrophically flooded and we had to find other places to live and work for nearly a year before it was habitable again.
This meant lots of extra expenses, and lots of time when I couldn't work for one reason or another. So the savings disappeared pretty quickly, and in order to keep my family fed, warm and dry, I had to borrow money in the form of buying things with credit cards. That's a terrible form of debt that charges lots of interest, but it was easy during a very hectic period of life. I never realised just how much I'd be needing to borrow; I somehow managed to delude myself that things would be back to normal soon, and it was only in hindsight that I realised I really should have just taken out a bank loan for ten thousand pounds or so up front. I converted the credit card debt to a straight loan once I'd taken stock, but by then I'd rattled up much more debt due to the interest payments.
I'll have finished paying that debt off at the end of this year, about eight years since it all started Going Pear Shaped. The amount I've been repaying has varied across that period, but it's currently five hundred pounds a month, and has been nearly a thousand pounds a month at times, during a horrid period when I was only just covering the minimum credit card payments, along with the payments on the loans we already had, but no banks wanted to lend any more to somebody in as risky a financial position as we were so I couldn't convert the credit card debt.
So I have suffered under the burden of debt, and cursed it, for nearly a decade. And yet, without it, I'd have had to go bankrupt (or something similar). To be honest, I'm still not sure if that might have been for the better in the long run - at the time, having my home ransacked by bailiffs and being largely blacklisted for credit would have been harrowing, but it would all have been water under the bridge by now. At each of the myriad financial crisis points during those years, taking on a little more debt to tide us over rather than facing that was always a rational-seeming choice; it's only when I can consider trading all of those for a single shot of financial distress that it looks irrational. But it's only with hindsight that I know how many things were going to go wrong in that period! At the time, we always seemed to be just about coping with what had gone wrong so far, and could only hope that things would be a bit less bizarrely unlucky going forward. The run of bad luck finally ended a few years ago, and we've been steadily paying everything off while living frugally.
So I can't really say for sure whether taking the debt route rather than the bankruptcy route was good or bad for us - but it might have been the right thing, and it certainly would have been the right thing if the run of bad luck hadn't been so long and deep. So it's certainly the right option for many people.
Therefore, I assert that debt is a powerful tool; useful in many situations, downright lifesaving in some, but it has to be used wisely and with consideration - because it can be terrible if abused.
Sat 23rd Mar 2013 8:23 pm 
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