Consumer debt getting out of control warns Financial Services Authority.

FSA fears consumers can't afford debts
By Robert Miller (Filed: 26/01/2006)
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/01/26/cnfsa26.xml&menuId $2&sSheet=/money/2006/01/26/ixcitytop.html
The City's top watchdog warned banks, building societies and finance houses yesterday they could suffer severe damage to their reputations if the current turn in the lending cycle reveals "they have given credit to large numbers of consumers who are unable to afford their debt repayments".
In its Financial Risk Outlook 2006 the Financial Services Authority said: "Even in the current benign economic environment we are seeing signs of growing distress among consumers, including more insolvencies, more late payments on credit cards and a rise in mortgage repossession orders."
The FSA said: "Our research shows that many consumers with significant borrowing commitments are currently struggling to keep up, with repayments."
The watchdog also expressed concern that rising household debt problems, coupled with the current economic slowdown, meant consumers were taking financial decisions "with inadequate understanding of the potential risks."
In the wake of misselling scandals, such as those involving personal pensions, endowment mortgages and split capital investment trusts, the FSA noted that many people "have become increasingly disengaged from the market".
It also said some regulated firms were failing to make their product literature and sales processes "sufficiently transparent. There remains concern this could lead to unsuitable products being sold to consumers who, in reality, have a low-risk appetite and low risk tolerance."
The FSA also warned large banks and trading houses that they need to do more "stress" tests on their portfolios of sophisticated and complex investment instruments, such as credit risk derivatives, to be able to cope with a sudden shock to the world's financial systems.
These, it said could take a variety of forms including "natural disasters (possibly driven by climate change), global pandemic, political instability, in a major economy, a large terrorist attack, or a major corporate bankruptcy, Market participants might find it difficult to manage their positions in certain instruments and could struggle to sell large quantities."
In one the strongest worded passages of the 100-page risk outlook the FSA said the illiquid nature of some of these complex investments "may increase the risks of conflicts of interest, or even fraud, to the detriment of the investor and of market confidence more generally.
"A significant proportion of revenue, of both traditional and alternative fund managers, comes from management and performance fees. Since these fees are a function of asset valuations there may be incentives to overvalue assets." Incidents of "false and fraudulent" valuations are increasing, the FSA said.
Debt helpline swamped by anxious callers
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The only problem with this information is that it's all a bit late. About the best any lending institution can do is do more checks for new customers before they lend to them.
--
Sam



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Sam Smith wrote:

rs

Checks? I have a friend who has no income but Income Support (lone parent) and she was yesterday offered (Barclays) up to £25,000 loan. Three years ago they let her borrow £5 she needed as a rental deposit, and it has crept up ever since. She has already borrowed 10K then upped it to 12k and now 15k. She has a drawer full of credit cards with increasing limits and could probably get herself 50k in debt overnight. With no income. I don't think they even care anymore how people will pay the money back, but I just can't work out why.
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Miop wrote:

It's called moral hazard: do you really think that the govermment would let Barclays go bust if they lost vast billions due to stupid lending? If the economy goes well and people keep paying interest they win, if the economy crashes and they're loaded up with bad debts, they'll get bailed out.... so why would they worry?
Mark
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snipped-for-privacy@my-deja.com wrote:

They let BCCI go. Likewise Barings!
Bad debts in relation to Argentina heralded the demise of the Midland and left it open to takeover by HSBC.
In none of these cases did the government intervene.
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Mel Rowing wrote:

Well, no, but imagine if all four big high street banks found themselves in serious trouble as a result of reckless lending, with the risk of them collapsing. It might be OK to let one go, maybe even two, but if loked like they were all going tits-up the government would have to intervene.
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snipped-for-privacy@virgin.net wrote:

Can't happen!
All money lent by the banking system ends up back in the banking system.
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[snip]

Ah, the fallacy of what I call the "magic money". Let's start with a bunch of empty banks, and a bunch of people with money in their mattresses. People take the money out of the mattresses, and give it to the banks. In return, the banks promise two things. First, they will pay "bonus" money to the people. This money is called "interest".
Second, the banks promise to give the money back to the people if the people want it back.
In order to pay the interest (remember that this is in a time where the only real money is made of gold or silver (depending on where you are)), the banks lend it to other people, who promise to pay it back, plus interest. But the banks hang on to a small part of the original money, in case someone wants their money back.
Now the people who borrowed the money put it in the banks, and so it goes around. (It all went back in to the banking system, as you say.) Let's say the banks hang on to 10 per cent. Before the first round of this particular form of lunacy, there is (let us say) 100 pounds per original depositor (let's say there are 100) in the system. That's all the *real* money there is in this system, 10,000 pounds. They put it in, the banks lend out 90% (9,000 pounds), and these people put it in the banks. There is now 10,000 pounds of real money in the system (look, you can count the coins in the vaults!), and 19,000 pounds of deposits!
This goes round and round, smaller at each turn, and finally stabilises when the banks have 100,000 pounds of total deposits against 10,000 pounds of real currency. If the banks fold, they will need to find that 100,000 pounds from somewhere, as all those punters will expect to have it back. In the US, this is guaranteed by the FDIC (Federal Deposit Insurance Corporation) for up to $100,000 per deposit, and a similar concept applies here in the UK, covering up to 10,000 pounds per deposit, but until this kind of thing comes into existence, and even afterwards, there's a problem.
The illusion of 100,000 pounds of deposits in a system which only has 10,000 pounds of real currency is what I call the "magic money". If the banks fold, this magic money goes back into the mysterious "ether" from which it came, and causes havoc in the economy. You get all sorts of unpleasantness, like "runs" on banks, where people panic and all pull their money out. The banks have only 10% of the real currency needed to pay back their depositors, and this causes panic, and more withdrawals, and so on.
So, yes, all the money lent by banks ends up back in the banks, but the government would be forced to help out - partly from a wish to make sure that all depositors are covered, partly to "keep the engines of capitalism going" (hah!), and <cynical> partly to help keep the folly of the magic money under wraps. </cynical>
--
SteveR
(throw away the dustbin, send to stever@... instead)
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"SteveR" wrote

OK, 10K in - fair enough.
"SteveR" wrote

So, those people have both 9K loans (in total) & 9K deposits - they are *neutral* overall.
"SteveR" wrote

... OK ...
"SteveR" wrote

... plus the 9K of loans, which nets to 10K deposits - which matches exactly what the vaults hold. Hurray!
What's the problem? Surely the only problem is if the borrowers default on the loans, but also run off with their deposits?
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M Holmes wrote:

But surely if "actual cash" becoming worth more is a problem (or if the government perceives it to be), can't they just wave a magic wand and make it worth less by printing more of it?
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"M Holmes" wrote

Not only those with debts - according to your comments earlier, *depositors* would be in trouble too - because they can't get their money out of the banks!
In fact, the depositors would arguably be **worse** off than the debtors.
At least the debtors can go bankrupt...
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Fair point.

In fact after most such incidents, legislation is enacted to preent mass bankruptcy and some sort of political settlement is reached whereby debtors must continue to try to pay off at least some of their debts.
Essentially it becomes politically and financially infeasible for a government to permit those in debt to simply renege on them because this would lead to total financial collapse.
FoFP
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SteveR wrote:

and what economists call M3, as opposed to M0 which is real notes and coins.
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SteveR wrote:

Banks 'hold back' only a tiny proportion of deposits. The cash present in the tills and vaults needed to service day to day cash over the counter transactions which in these electronic days are reducing in volume anyway.

Presumably people who borrow money do so in order to spend it. It is those with whom it is spent that return it to the system via their accounts.

No! Once the money is loaned out it has ipso facto left the system. It only returns when the acquirers of this borrowed money put it back into their accounts. It may well be in these days of plastic, cheques, electronic transfers etc. that the note and coin (or a substantial proportion of it) does not physically leave the vaults. However, this does not matter since the system is only the custodian and these are not available for lending until the original sums lent return.
In historic days, banks used to issue banknotes in lieu of heavy gold coins. Banknotes (in effect bearer bonds) being more convenient and hence popular than the heavy coins became negotiable in their own right. This gave banks the opportunity to issue notes to a value well in excess of the deposits they held ie.e. print money. This left depositers money vulnerable and a number of bank failures led inevitably to legislation which regulated the issue of banknotes.

But you ignore totally the role of reserves in all of this. The requirement for them to hold reserves means that only a proportion of deposits are available for any type of lending and a smaller proportion still is exposed to the the type of lending we are talking about - private lending to individuals. Capital reserves (shareholders' money) insulate deposits even further from bad debts that cannot be met out of profits.

The illusion is yours!
£10,000 of deposits can only create £10000 of debt. In fact the £10000 worth of deposits represent a liability to the bank so long as this money is not loaned (including loans to the issuers of bonds and other securities in order to build reserves) Once the money is loaned it becomes an asset and the debt is transferred to the new debtor. It is he who is the ultimate holder of the debt and not the bank.
The role of the banks in all this is two fold. The first is to connect those with money to lend (savers/depositors) with those who wish to lend (potential debtors). The second is to provide the depositor with maximum security for his funds.
Even stuffing money into a mattress is not totally devoid of risk. In fact it's far more risky than a bank deposit.

" from

There is a run on a bank when depositors for whatever reason, demand their deposits in cash. They refuse to accept any other form of payment. What would happen if there were a run on Barclays?
To begin with any such run could not be instantaneous. To pay every depositor is full due in cash would take weeks. There is no obligation on any bank to extend its opening hours. During this time, cash is still entering the bank. Depositors may have discretion over where they deposit, debtors have no discretion over to whom they should make their payments. Liquid reserves (short term bills) could be quickly realised. Longer term reserves become more liquid with time. It would indeed need a sustained run before available cash reached critical levels.
However, if that happened the very existance of the long term security component of the reserves would facilitate security for short term loans by other banks who, in the long term interests of the industry would be only too anxious to help (bear in mind the cash coming out of Barclays is going into these).
If all this fails then there is the business itself. The outstanding good debts, remaining securities,the buildings, the ancilliary services (brokering, insurance, foreign exchange, safe deposits, etc.) all of these are saleable but I doubt whether we would get this far. However, if we do, depositors would have first call (after staff wages, redundancy payments etc.) on any funds raised. It would be the shareholders who would take the hit.
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But the borrower does not have to sell the asset in order to continue the repayments. So why does the situation have to lead to deflation. Why can the scenario not be more - the borrow cannot afford to sell the asset for less than the outstanding loan and other borrowers are in the same situation. This leads to less of that particular asset being available for purchase, but buyers may still want to buy the now scarce asset which will tend to increase the price.
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The aforementioned mechanism of people reneging on or paying down debts and consequent effects on the money supply.

It usually runs like that after normal periods of overexcitement in asset markets. Credit bubbles though have had a very strong tendency to lead to deflations.
FoFP
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On Sat, 28 Jan 2006 23:15:20 +0000, SteveR wrote:

is 31.7K GBP per depositor.
Best Regards, Alex.
--
Alex Butcher Brainbench MVP for Internet Security: www.brainbench.com
Bristol, UK Need reliable and secure network systems?
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Mel Rowing wrote:

How many people do you know who had accounts at either of those banks? Barclays is a major high-street bank, and any government which let it collapse would be voted out at the next election by ex-Barclays customers.
Mark
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snipped-for-privacy@my-deja.com wrote:

You talk as though they are dorr to door tally men!
Leaving aside wholesale fraud, the likelihood of Barclays going bust is as close to impossible as it is possible to get.
Not only are todays banks diverse businesses but they are tightly regulated.
The overiding principle surrounds the notion that customers funds (deposits) are kept seperate from shareholders funds (capital) Deposits cannot be used as equity.
Banks make money by borrowing it from depositors and re-lending it at a higher rate of interest. In order to safeguard deposits banks are required to maintain a proportion of their deposits as reserves (i.e. in rock solid securities e.g. treasury bills) a proportion of these reserves must be kept in liquidable form (i.e. in securities that can be quickly realised) This ensures that when you take out your £5-50 savings, it is there for you to take.
The proportion of deposits that are not held in reserve is covered by capital reserves. These are shareholder funds and owe their origin to share issues and profits that have historically accrued.
In short shareholders underwrite potential bad debts so that deposits remain at minimal risk. Like any other business if its liabilities exceed its assets then it must cease trading. However, in this event deposits are safe. The business, its customer base, its assets etc. would be available for purchase from the appointed administrator.
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