Private Individual Debt, an Endless Story

Current loan offers for individuals and families are very diverse and meet the needs of borrowers for money to be able to cope with both large expenses and small daily purchases. A primary form of loans had already developed in ancient Mesopotamia in 3000 BC, where the purchase of seeds needed for agricultural activities was “financed” and paid for with the fruits of the harvest from the seeds themselves. These forms of “agricultural credit” were regulated by the Code of Hammurabi, which not only set a maximum ceiling of interest taxable to the lender of 33% per year, but also established guarantees that the borrower was obligated to provide, as well as provisions for deferment or exemption from repayment in the event of crop failure due to unfavorable weather conditions. In ancient Greece, although the concept of interest, understood as payment for the risk borne by the lender on a loan, was generally accepted, with applicable interest ceilings set depending on the type and amount of loan requested – 12% for mortgages and 16% to 18% for very large sums – the ethics of lending activity was a widely debated issue among philosophers. In Plato’s view, for example, lending activities may have caused social instability given the lack of attention to less wealthy borrowers. But what is the result of lending activities that do not account for borrowers’ ability to pay?

Throughout most of history, there has always been a reluctance to go to a bank or lending institution for a loan, as credit was considered the last viable solution to cover large expenses, and individuals and families were more likely to utilize primarily available funds, accumulated savings. However, when mass production made the supply of goods safe and stable, companies, to avoid inventory accumulation, explored incentives to increase sales of their products. In the USA, General Motors and Ford, in order to be able to sell their cars to as many customers as possible, including those who did not have the necessary financial capacity, created two systems of financing the purchases. Thus was born Ford’s weekly payment plan and the credit plan of General Motor Acceptance Corporation, now Ally Finance, which is still one of America’s largest finance companies specializing in car loans. These financing plans provided for a downpayment of a fraction of the entire vehicle’s cost and the balance paid in deferred installments at predetermined times for the life of the contract.

Subsequently, appliance companies also began to stimulate the purchase of their products through these forms of consumer credit, which were also “copied” in Europe and, especially after the end of World War II, spurred a global economic recovery. In the post-war period, when family savings were virtually wiped out by the continuation of the war, credit was a tool to encourage and support consumption. For example, in 1951, the Federation of Entertainment and the General Industrial Bank of La Hénin in France founded Sofinco, which is still in operation today and is part of the French banking group Credit Agricole, for consumer loans for furniture and interior furnishings. In 1953, again in France, Jacques de Fouchier founded Cetelem, now a company controlled by the BNP Paribas group, to offer consumer credit products to the French home appliance industry.

In the early 1960s, the advent of payment companies further expanded and spread the use of consumer credit by systematizing the collection of credit data that one family requested from various merchants and/or companies. In 1958, Bank of America (BofA) launched BankAmericard, which effectively marked the birth of credit cards. This credit program, over which BofA relinquished control in 1970 and which was named VISA in 1976, began to bring profit to the US bank only after 1961, and in 1966 the bank group launched a competing interbank program, renamed into Master Charge in 1969, which in 1979 got the name Mastercard.

This very rapid transformation of shopping habits, dictated by the development of consumer credit and the introduction of credit card “technology,” led to the popular Latin motto, “Cras credo, hodie nihil,” which can be translated as “tomorrow there will be credit, today there is none,” attributed to the Latin scholar Marcus Terentius Varro. In 2023, the Institute of International Finance in its report “Global Debt Monitor In Search of Sustainability,” highlighted very alarming data regarding the mass of global debt, private and public, accumulated over the years: in mid-2023, the figure was $307 trillion, of which approximately 18% was debt accumulated by individuals and families. Of that $57.7 trillion, about $40 trillion belonged to the most economically developed countries, and the remaining approximately $18 trillion belonged to developing countries. According to Standard & Poors Global forecasts, by 2030 the debt stock will reach 336 trillion dollars or even 373 trillion dollars, if another 36 trillion dollars is allocated for the energy transition.

To date, according to the International Monetary Fund (IMF), the ratio of public and private debt to global GDP is 337%, and the countries with the highest ratio of household debt to national GDP are Switzerland with 128.3%, Australia with 111.75%, and the Republic of South Korea with 105.09%. All G7 countries have private debt-to-GDP ratios above 55%, except Italy with 41.72%. However, in all BRICS countries, the ratio does not exceed China’s 61%.

That being said, the ratio of public debt to GDP does not give an accurate picture of the mass of debt accumulated by individuals and families in each country. According to statistics compiled between September and December 2023, the US private debt was approximately $17 trillion, followed by China with $11 trillion. Households in other G7 countries have accumulated respective debts of $2.7 trillion in Great Britain, $2.6 trillion in Japan, $2.2 trillion in Germany, $2.1 trillion in Canada and France, and $1 trillion in Italy. However, the total debt of families in the EU member countries amounted to about $7.3 trillion. Among the BRICS group, with the exception of China, no country exceeded one trillion dollars, with Brazil having the largest debt at nearly $700 billion, followed by India with $440 billion, Russia with $397 billion, and finally South Africa with $147 billion.

The composition and structure of debt accumulated by individuals and families varies from country to country, given different spending habits and attitudes towards loans in general. In Europe, according to a report presented by Deloitte in 2019, the attitudes of residents of the old continent, especially in Germany, towards personal debt were still quite negative. The consulting firm’s study particularly analyzed credit card transactions. While credit card transactions accounted for 35% of personal debt in the Britain, transactions in Spain and France accounted for 16% and 11% respectively. Italy and Germany had the lowest interest rates: 6% and 2%, respectively. The European Central Bank (ECB) does not provide detailed data on the composition of debts accumulated by individuals and families in Europe. In its latest report dated October 2023, the ECB emphasized the decline in the ratio between household debt and European GDP, which fell to 89.5% from 95% over the same period in 2022, which perhaps was mostly justified by the reduction in loan repayments that fell to $6 billion in the third quarter of 2023 compared to $65 billion paid in the same period of 2022. The ECB gives only one distinction in the private debt structure of European citizens, separating long-term debt, roughly $7 trillion, from short-term debt, which is $300 billion. We can only formulate the hypothesis that, as in many other countries, mortgages on real estate purchases account for the majority of accumulated debt.

As for the Anglo-Saxon hemisphere, the available information is more detailed. According to statistics collected in November 2023, household debt in Britain increased by about $23.5 billion compared to November 2022. Although British households have had to pay about $90 billion in interest payments, total household debt will reach $3 trillion by 2025, according to a report by the government agency Office for Budget Responsibility dated November 2023. Statistics from the Bank of England (BoE) showed how debt accumulation from consumer credit increased by $2.5 billion at the end of November to a total of $277 billion. Debt accumulated through the use of credit cards has reached $87 billion with an average interest rate of 21%.

Across the Atlantic, the situation regarding individual and family debt is also much more complex, given the greater and more consolidated ability to utilize credit. Suffice to say that the number of credit cards in use in the US is about one billion units, and projections indicate a steady increase. The Federal Reserve Bank of New York warned in 2023 that consolidated debt resulting from credit card purchases in the United States exceeded $1.08 trillion at the end of the first half of the year, an increase of $48 billion from 2022. On average, one family accumulated about $10,000 in debt and, even more alarming, the interest rate on the payments due averaged about 21%. In January 2024, the Federal Reserve Bank of New York released consolidated data for 2023, and at year-end, credit card-formed debt reached $1.13 trillion, increasing by another $50 billion in the fourth quarter of the year alone.

However, credit card debt is only a small portion of household debt. Again, according to a report from the Federal Reserve Bank of New York, for January 2024, US households will have accumulated a total debt of $17.5 trillion by the end of 2023, a $600 billion increase from 2022. In the fourth quarter alone, debts from mortgages increased by $112 billion to a total of $12.14 trillion. Also, in the last quarter of 2023, auto loans recorded an increase of $12 billion and totaled $1.61 trillion, while student loans increased by “only” $2 billion and were stuck at $1.6 trillion. It also recorded growth in other consumer loans totaling $25 billion.

The increase in the mass of individual and family debt does not seem to be slowing down, even when credit card spending limits are reached or current account balances are insufficient to cover expenses. In fact, in the last five years, given the high interest rates, it has become very popular to use a new payment instrument, the so-called “buy now, pay later” (BNPL, “split” – translator’s note). Even for online purchases, it has become possible to “finance,” often at zero percent interest, your spendings by simply dividing the amount due into equal parts and “spreading it out” over a certain period of time. Companies that manage transactions under BNPL plans are not credit institutions or payment companies, so they are not required to disclose information about the transactions made, and the difficulty of tracking and accounting for these payments resulted in the appearance of the names “phantom” or “shadow debt.” American Wells Fargo bank estimated in a December 2023 report that BNPL usage in the USA alone grew 1000% between 2019 and 2021, reaching volumes of $24.4 billion, which represents 2.5% of the credit card market. Another demonstration that this tool, especially as the value of money has increased, is becoming more widely used is provided by data collected by Adobe: again in the US, between November and December 2023, there were $16.6 billion worth of BNPL transactions. Fraud and missed payments resulting from the use of this payment instrument are problems that should not be underestimated for the financial system, as BNPL is the form of payment most utilized by this group of certain consumers, according to an analysis by the Federal Reserve Bank of New York: the “financially fragile” or those with low credit scores who have been denied credit in the last calendar year or who were more than thirty days delinquent in the last calendar year. The US Consumer Financial Protection Bureau also found that BNPL is more attractive to people who already have a lot of debt or have negative balances or bankruptcies on their credit card accounts. In the United Kingdom, for example, 25% of those who use BNPL cannot meet payment deadlines, and in the United States, according to Morning Consult, a company that processes online surveys, another 25% of people who used BNPL, could not meet payment deadlines and incurred payment penalties due to late or missed payments.

The reason for the increase in private debt of individuals and families should be sought in the overly stimulation of consumption. The economic theory developed in 1954 by Franco Modigliani and Richard Brumberg in their book “Utility Analysis and the Consumption Function” assumed that families’ spending decisions are driven by estimates of spending and income needs for the rest of their lives, taking into account predictable events such as declining income after retirement. Thus, in this context, family debt was only an instrument of temporary “balancing” of consumption: in fact, debt could be used to maintain the level of consumption preferred by the family unit, thus compensating for changes in family income levels. However, this theory did not take into account, among other factors, the credit limits that individuals or families can utilize. With the advent of consumer credit, consumer habits are being rewritten and are no longer about the needs of individuals, but the need for companies to make a profit. Individuals and families in the role of consumers of goods and services are used as the engine of economic growth. Global household spending on goods and services rose from $1.7 trillion in 1970 to $35 trillion in 2009. The expansion of the monetary base following the 2009 financial crisis and the 2020 pandemic has further increased consumption to $53 trillion in 2021, according to the spending forecast, and will gradually increase to $77 trillion in 2030. In terms of GDP, the global average consumption of individuals and families is about half to two-thirds of national GDP. In 2023, private consumption accounted for 53% of GDP in the European Union, 63% in Great Britain, and 68% in the USA.

The lessons of the 2009 financial crisis were also quickly forgotten by individuals and families who, accustomed to an exorbitant amount of cheap money in circulation, failed to take into account that sooner or later the accumulated debt would reach maturity. Moreover, the sudden rise in inflation has not only accelerated the erosion of savings already accumulated by individuals and families, but has also “shrunk” their current purchasing power, stimulating a vicious cycle of accumulating new debts, and with increasing difficulty in repaying existing debts. The subsequent increase in central bank interest rates has added to the financial pressure on households as debt-related costs have increased. In January 2024, the Trades Union Congress (TUC), UK’s trade union confederation, raised the alarm that individual and family debt was becoming a “time bomb” due to explode in the near future. According to the TUC, uninsured debt in the UK – that is, without principal guaranteed by real estate – will actually increase by 11% in 2024 compared to 2023, and it will increase by 32% in 2026 compared to 2023. The cost of living, taxes, and welfare cuts are the factors that will increase household debt in the UK the most. According to a survey conducted by the Bank of England, among the largest English banks, financial pressures on individuals and families will increase, with defaults on unsecured debts rising by 32% and guaranteed debts by 40% in the first quarter of 2024 alone.

In November 2023, Fitch rating agency presented its projections for the future trend of household debt in the US: although consumption and hence the associated debt was expected to decline in 2024, the cost of repaying the already accumulated debt for American families would reduce another 11% of disposable income by 2025. While most of the accumulated debt stock is represented by mortgages, the increase in interest rates associated with credit card loans will lead to new records of debt financing costs in 2024. For all debt, except mortgages, the cost of managing it will increase by 7.3% by 2025. In addition, in February 2024, the Federal Reserve Bank of New York reported an increase in fraud related to missed loan or interest payments. Although these percentages were lower than the pre-Covid pandemic highs, the number of missed payments has been steadily increasing since 2022. The affected segments with the highest number of cases were credit cards and auto loans, highlighting the decline in borrowers’ credit standards.

Conditions seem more favorable in Europe, given the more serious debt problems. Actually, according to Fitch analysis of January 2024, individuals and families in the eurozone were expected to be better able to withstand the financial pressures of continued high rates. Indeed, according to ECB data, while the cost of new loans requested by households has risen by 270 basis points since the end of 2021, effective rates on all bank loans have risen by only 90 basis points. A key factor in the greater financial strength of the eurozone is the structure of the mortgage market itself, which in most eurozone countries involves fixed rates, therefore not linked to ECB rate fluctuations. For this reason, the effect of an increase in the value of money is delayed and spread over a longer time horizon. In Spain and Italy, the number of fixed-rate mortgages is lower than the European average, while in contrast, the number of fixed-rate mortgages is much higher in France and Germany. In addition, in September 2023, the European Parliament approved new consumer credit regulations that include an obligation for greater contractual transparency on the part of the lender with the ultimate goal of enabling lenders to borrow money on the best possible contractual terms.

The continuous growth of global debt, both public and private, is a huge challenge. Government deficits cannot be seen neither as a financial reserve for individuals and families, nor as a tool for growth in the industrial sector. Bloated debt puts pressure on the economy, causing lower productivity, higher taxes, and steadily rising inflation. The chances of inefficient credit extension to firms, individuals, and families alike increase in proportion to the expansion of the monetary base, while deteriorating the very standards of credit allocation and ultimately leading to the destruction of financial resources. In late February 2024, the Bureau of Economic Analysis, the US federal financial and economic statistics agency, provided an update to US GDP data, noting that in the last quarter of 2023, the US economy grew by 3.2%, which in absolute monetary terms amounts to $334.5 billion. However, US government debt over the same period increased by approximately by $834 billion, rising from about $33 trillion to $34 trillion, meaning that $2.5 was spent to produce every dollar of GDP.