International Comparison of Consumer Debts - Part 2


1.2 Dealing with government debts

“The debt ceiling is the legal limit on the level of debt the federal government can hold, and the debt is expected to reach that limit early in 2013. Congress has the authority to raise the debt ceiling as needed (National Priorities Project, 2013)”. As in the case of the budget not being inclusive of the fiscal cliff, debt ceiling was also not made part of the fiscal cliff. In essence, this particular deal of the fiscal cliff left quite a few crucial issues unsolved, comprising the debt ceiling, sequestration (automatic spending cuts), and a comprehensive final budget that would fund the government for the current year in its fiscal policies.

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Fiscal policy, usually, influences growth performance of an economy through its effects on resource allocation and how efficiently such resources are managed. Rational allocation and productive use of resources certainly help in waste reduction of scarce capital and raising the economic growth rate (Federal Reserve Bank of San Fransisco, 2009).

Among the various aspects of efficiency issues, the level of Incremental Capital Output Ratio (ICOR) is important for any economy for that matter. The economic development is dependent upon the above ratio and the same has been a matter of serious concern for many developing economies of the world where the above ratio was very high. A decline in the same would decrease the new resources required to achieve a targeted economic growth rate.

Needless to say, the government has the power to influence the purchasing power of consumers by affecting their disposable income. Stabilization policies are the policies undertaken by the governing authorities to maintain full employment and a reasonably stable price level. The government often seeks to stabilize the economy by using expenditure and taxing powers to influence the macroeconomic equilibrium (ICFAI Center for Management Research (ICMR), 2003). Whenever a particular economy is suffering from a recessionary GDP gap, as in the case of United States, consumption is obviously likely to suffer. The overall investment prospects of the economy also seem to be very gloomy, as investors forecast very pessimistic profit projections (The New York Times, 2008).

The research of Brown and Taylor (2008) “Household debt and financial assets: evidence from Germany, Great Britain and the USA” reveals which factors motivate to accumulate the debt (Taylor, 2008). The statistical data show that lower interest rate lead to more borrowing as it becomes cheaper to service the debt. In addition, the vulnerability towards the debt accumulation was measured in accordance with the age of the head of household. The results reflect that households with younger head of household are more disposed to take credits. In addition to this, the study display that savings-to-income ratio assumes the possibility of households to serve the debt, while debt-income ratio embodies the financial pressure the households experience as financial or other shocks which influence the income like unemployment, for instance. From empirical data 2000 the higher number of households can potentially fail in Germany and Great Britain with 8% and 11% respectively. Having a negative net worth is more widespread for households within the lowest income quartiles (Taylor, 2008).

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For decades, many global banks have focused on making massive volumes of money from corporate consumers. However, things have dramatically transformed today. Banks are awash with excess liquidity; interest rates are decreasing. Corporations thus have become less inclined towards borrowing from banks because of a variety of reasons like economic slowdown, infrastructural restrictions etc. ((ICMR), 2003). Given such a backdrop, banks are forced to consider the retail segment for their lending activities and thus the spotlight for bank lending has now shifted to the retail segment, and household consumers fall in this category. Banks across the globe are experiencing cut throat competition while trying to enter new segments – car loans, consumer loans, housing finance, educational loans, credit cards etc.

The big bonus for banks came in the form of the Securitization Bill (Melissa D. Beck, 2010), which gave banks and institutions muscle to recover bad debts. Competition, securitization, automation and regulation are the major forces that are driving and shaping consumer lending. This Securitization gives superior quality assets to all the investors of the organization due to the good worth of its structures which consequently shield investors from the risk of bankruptcy from the Originator (Standard & Poor, April1998). It is in this scenario, the role of Special Purpose Vehicle comes into picture. A Special Purpose Vehicle is small pool that is engaged to buy assets from the Originator and later issue securities against such assets. The benefit of doing so is that this kind of a structure offers a comfort to the investors of the company that their investment in this kind of an asset pool which is held on their behalf by the Special Purpose Vehicle and hence which may not undergo or experience any decline in credit rating of the Originator. “The SPV is usually a thinly capitalized vehicle whose ownership and management are independent of the Originator. The main objective of SPV is to distinguish the instrument from the Originator (Standard & Poor, April1998).”

The move to slightly higher interest rates is the first aspect to be considered. To state the obvious, higher interest rates will increase the cost and reduce the affordability of both the stock of consumer lending and new loans. Although the monetary authorities both in the US and abroad are managing the turn in the interest rate cycle with great care, regulators are required to acknowledge the risk that the shift to a more moderate rate of growth in consumer borrowing may not be universally smooth (Hale, 2004).

Secondly, the decline in lending margins. A long period of strong personal sector credit quality, coupled with strong competition for lending business, has helped squeeze margins to historically low levels. The effects of this on the bottom line have been disguised by strong volume growth. There are two downside risks for the banking sector in the US as felt by the FSA. The first is that, the period of strong volume growth may be coming to an end. The second is that a downturn could expose banks as having under- priced risk through the cycle.

For securitization of cash assets, the primary focus lies upon the non-recourse (non-recourse to the originator/seller) investment. Such structures are regarded to be bankruptcy remote thus the chances of liquidation by an originator do not harm the right to the cash flows of the vehicle’s assets to the investors. The originator is anxious about the numerous accounting issues, predominantly that the structure meets requirements for off-balance sheet treatment of the assets, and such assets will not be merged on the balance sheet of the originator/seller for various accounting purposes. “For bankruptcy and accounting purposes, the structure should be considered a sale. This is represented in the documentation as a true sale at law opinion. The sale is also known as a conveyance (Tavakoli, 2003).”

Consumer borrowing in the United States which was once held in check by pragmatic limits is today a national curse. Justifiably, when people of a nation find themselves unmitigated beyond their limits, they search for a way out. The bankruptcy court is the most sought after answer to such a situation as 1.56 million Americans filed cases in such courts in the year 2004, a figure that has doubled in a decade’s time. The method most commonly selected is that under Chapter 7 of the Bankruptcy Code by which the debtor may preserve selected assets, along with any other accompanying obligations, while relinquishing all other indebtedness. “As expected, credit card debt held by wage earners of modest means, often extending into the tens of thousands of dollars, is now systematically repudiated. The answer by the nation's creditors to this predicament is as you might expect: enactment of a law prohibiting the use of Chapter 7 (Jacobs).”

There was a period before the financial crises outbreak, which saw dramatic growth in the Croatian household consumer debt. This actually led to certain relaxation in the financial constraints of the households. This was primarily on the projections of rapidly growing income. There was also a parallel concern on over dependence on debt which led to the primary question of stability of the entire financial system, as the outlook began to bleak.

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Earlier, the household consumers were seen to be trustworthy which repaid in time. The degrees and quality of loans traditionally followed the historical recessions and were seen to be confined to corporate sector. Thus, the household consumer debts always had a clean record. However, such benign-ness came under intense scrutiny when the Croatian economy went into a nose dive.

The study concluded that most common credit takers are households with big size and young head of household with good education level. The major part of credits is issued to the households with medium and high level of income. Households with poor income are varying from 8 to 16 % out of all households, which used such opportunity as consumer credit. The explanation of small share of poor households is the assumption that this category is a risky borrower. The most popular kind of the consumer credit is car loans.

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