The debt trap: Hey, big spenders, time to tighten-up

As long as she had a roof over her head, Alice* never worried much about money. In her mid-50s, running a small business with her partner, she never imagined she would spiral into debt.

But when her partner left the business was wound up leaving Alice with debts to pay. She moved to Auckland to rebuild and borrowed - buying appliances and furniture on hire purchase and her credit card.

"I guess I was careless and a bit naughty," she says. "I just let it go on."

Six years on and approaching retirement, she's renting a one-bedroom cottage just outside Auckland, paying off creditors with the help of a budgeting service. She has $100 a week to live on.

John* should have no such worries with a combined household income of $250,000 but he, too, needs help to repay debts. "He just doesn't know where it goes," says Fiona Snijder of the West Auckland Budget Advice Service. "I ask him to try to think back - but it's gone."

From the glass citadels of the well-heeled to the glass coffins of boy racers, New Zealanders have shares in a debt timebomb. Rather than save and invest, we're spending $1.13 for every $1 we earn. Household debt has soared to 143 per cent of disposable income.

Debt is not only financing our homes, plasma TVs, cars and holidays, it's fuelling our economic growth.

On both a personal and national level we're being told that we can't go on borrowing to the max. But who's listening? Successive interest rate hikes have failed to rein-in house price inflation and we're continuing to buy consumer items on credit.

In September, more than $4 billion was owing on personal credit cards, up $217 million in a year.

Add hire purchase, store cards, and other forms of credit and $10.5 billion was owed on consumer items. Half was owed to non-bank lending institutions charging higher interest - despite a trend to load the borrowing on to the mortgage.

Economists say there's nothing wrong with debt if we retain the ability to service it.

"Used well it can work to our advantage," says ANZ chief economist John McDermott. "How else would we buy a house? But it is possible to overindulge. The pinch comes when circumstances change - and the signs are that they are about to. Reserve Bank governor Alan Bollard and Finance Minister Michael Cullen - are crying enough, not only playing pre-Christmas Scrooge but threatening screws on bank lending for mortgages.

Their immediate worry may be the contribution of rising house prices to overall inflation, but there are other indicators that our credit-driven lifestyle could burn us.

Without domestic savings, the consumption boom is financed largely by foreign investors and what we owe them (the current account deficit) has ballooned to 8 per cent of GDP. If they get cold feet, credit could become more expensive or dry up. A fall in the exchange rate could hasten investor flight.

The upward trend in house prices is unsustainable and a fall in values likely, Bollard says. If he's right, heavily-mortgaged homeowners and property investors paying higher interest will be going backwards.

Efforts to slow the economy have also shattered business confidence, which could impact on job security. Pay rises may not come along to cover those rising interest payments.

People over their heads in debt stand to lose more than just their assets. Debt can lead to depression, stressed families, wrecked marriages and child poverty.

And while we're paying off debts, we're not saving. That stifles business growth and increases our reliance on foreign investors.

It's understandable why we're spending like there's no tomorrow. We've had six years of favourable economic conditions leading to record employment levels. Although interest rates are rising, they're a long way from the double-digit numbers of the early 90s and our high exchange rate has made imported appliances cheaper. Retailers backed by finance companies have been offering deferred payments with no deposit.

And it's never been easier to get credit, with banks lending up to 100 per cent on mortgages and second-tier lending institutions waving cash at people who banks have turned down.

But those who work with people in debt say something prevents us from saying no. "We're acting like kids - we can't defer gratification, everything has to be instant," says financial planner Susanna Stuart.

"Is there something we're not getting fulfilment on - is that why we're spending on renovating our houses, buying flash cars and plasma TVs? Are we reacting to a previous generation who were frugal and savers? It's sad that shopping's become a form of entertainment."

Denise Conroy, a senior lecturer in Auckland University's marketing department says there used to be a social stigma attached to needing credit. "Now you're a rarity if you're not in debt."

There's an element of keeping up with the Joneses but research suggests the key factor is our attitudinal change towards borrowing, she says. "Most of us don't like to delay gratification anyway and now we don't have to."

Conroy traces this revolution not just to financial deregulation - making credit easier to obtain - but to deregulation in the 1980s. Before then, there wasn't that much available to buy in our shops - we were the most tightly regulated place in the world.

Lower interest rates, a buoyant economy and record employment have greased the wheels of temptation. "We are not born shoppers but are socialised into consumption by our parents, peers and the media."

The household sector may be being smart, says the ANZ's McDermott. "With the exchange rate where it is, people see it as a good time to buy those plasma screens. When the dollar drops to US60c, it will be harder and if they're using a credit card to pay it back then they're in trouble.

"It's not a good time to load up the credit card - interest rates will go higher. We all want to enjoy Christmas but some caution is needed to avoid a bad hangover in the New Year."

Although McDermott and other bank economists have reacted strongly to Cullen and Bollard's exhortations, almost no one disputes that the present rate of consumption is unsustainable.

Borrowing beyond our means has become a defining national characteristic.

Most Western countries have become debtor societies since financial deregulation, none to the extent of New Zealand. We're the worst savers in the OECD, "dis-saving" at 12 per cent of household disposable income. Forty per cent of adults owe money on credit cards, an estimated 20 per cent have hire purchase deals.

Booming house prices have given homeowners an artificial sense of affluence, says Paul Ballantine, a university colleague of Conroy.

"People are measuring their standard of living in terms of the number of appliances. The number of cars per household, the number and size of TV sets and average house sizes all keep rising. There's an element of self-control failure."

Ballantine says retailers are setting people's awareness of debt months or years in advance - "take it today and payments don't start until April 2007" - but there comes a time when you have to pay it back.

"The classic example is signing up 18 months ago to a plasma TV costing $10,000. Now it's worth $5000 and you're only just starting to pay and interest rates have risen. There's nothing underhand about it but consumers have a certain naivety, always thinking of the positive rather than the negative. "The positive is: 'I can get the car I want now'. The negative is when you have to start paying and it's worth half the price."

Many debtors fail to allow for a change in circumstances between signing up and when repayments start. "You make an assessment based on where you are now even though things could be wildly different in 18 months, such as a baby or redundancy," Ballantine says.

Budget services and financial planners see the results every day.

"The buoyant economy has created a false sense of security," says Denise Smith, of the Papakura Budget Advisory Service. "People are more likely to spend beyond their means."

Seventy per cent of Papakura clients are overcommitted with debts, including those for hire-purchase cars and expensive stereos and TVs. A typical early-1990s client had two creditors, but today he may have 12. The average client owes $4000.

Not all are low-income earners, Smith says. "Everyone tends to spend up to the limit."

Blind optimism has a lot to do with it, says Smith's West Auckland counterpart Fiona Snijder. Most clients have only a nodding acquaintance with their true outgoings and income. "They work out in their heads that they can afford it without putting pen to paper and discovering whether they really can afford it.

"After three months, they're two months in arrears - it's just happening constantly.

"I always ask: Did you look at your income and expenditure? And the answer is always, 'No, we thought we could afford it'. It's almost wishful thinking."

Banking ombudsman Liz Brown has ruled in several cases where she believes banks have extended credit when they should not have done.

There was the case of the beneficiary with a gambling addiction and bipolar disorder, initially given a credit card with a $3000 limit and later upgraded to a gold card with a $9500 limit.

Brown gets some complaints over banks extending credit through bulk mail-outs. "I would quite like to see a change in the code so that when banks are offering credit increases, the customer has to take some action to receive that extra credit."

Although banks generally still refuse to lend to people beyond certain income-to-debt levels, the rise of second-tier lending institutions - such as moneylenders - is worrying budget services.

Some second-tier lenders don't even do credit checks, says Snijder. "When they sign up, everything in the house is listed as a chattel and they have someone as guarantor.

"With Pacific clients, it often means the fonu covering the loan - and around you go."

Should the rest of us care if a few come unstuck? "Someone has to end up paying for it at some stage," says Susanna Stuart, who left PricewaterhouseCoopers to set up an independent advisory service.

"As a country, we're not saving enough to withstand the shocks that might occur.

"Now, take it back to the basic household and think: What happens if you get sick or lose your job? People have forgotten that when property prices come down and people have forced mortgagee sales, a lot of lives are ruined.

"We've had a good run. We've had lots and lots of good figures, but at the end of the day we still owe the rest of the world. I liken it to a household living in permanent overdraft and something has to give in the end."

Financial commentator and Herald columnist Mary Holm says, however, that we should be careful about turning debt into the anti-Christ. "Borrowing is not necessarily bad and I think it's got a bad rap lately."

While borrowing for consumption is not good, using credit to repay high-interest debts or for investment is not such a bad thing if it's done responsibly. For instance, Holm says, borrowing on your mortgage at 8 or 9 per cent to repay a credit card debt at 18 to 20 per cent is wise, assuming it's repaid quickly. Dragging repayment of a $5000 debt out over the length of your mortgage would negate any benefit.

Borrowing to fund investments, such as rental properties, is a legitimate way of increasing wealth, if you plan prudently and have the cashflow to cover hiccups such as interest rate rises. Using debt to buy shares is riskier, but has benefits too, Holm says.

Savings expert Michael Littlewood, a member of the Todd Taskforce on Superannuation, is not convinced there is a problem at all, and wants to see more information before a national emergency is declared.

"Our information at the micro-level is bloody awful," he says. Most promising, he believes, is the Statistics New Zealand Survey of Family, Income and Employment Dynamics (SoFIE), which came out this month.

The survey will be repeated over coming years, tracking how participants' financial situations change as they age.

The first survey shows that people aged 45 to 64 are best off with a median net worth of $155,800. Net worth is calculated by adding up all assets (including house values) and subtracting total debt (including mortgages).

Those in the age bracket below (25 to 44) were about $100,000 worse off.

Littlewood says this is not unexpected. He suspects that when those now in the 45 to 64 bracket were in the 25 to 44 age range they would have been better off than today's generation. But he does not believe this is anything to panic over yet.

Derugulation in the mid-1980s made borrowing easier, so what's wrong with consenting adults making informed lending decisions?

"We have politicians and people in the financial sector saying New Zealand is in a dire position and yet all the micro data doesn't support that," Littlewood says.

But the New Zealand Institute, a think-tank promoting household savings and investment to boost productivity and exports, says countries cannot spend their way to prosperity. "Private consumption can provide short-term impetus to economic growth but does little in terms of growing the productive base of the New Zealand economy," says its latest report, No Country Is an Island.

Institute chief executive David Skilling says that to sustain economic growth we need to boost labour productivity and expand our export businesses.

"We need to shift from a consumption-heavy economy focused on residential real estate to one more dependent on business investment and generating income from offshore."

The Government's Kiwisaver scheme was a "fairly modest" start.

"If we want to address the consumption imbalance in a meaningful way we've got to do something around savings policy.

"As with most things in life, if you want a better tomorrow you've got to put something aside today."

* Names changed to preserve anonymity.