Bob Champion: Grappling with debt and mythology

Bob Champion looks at the impact of QE on government debt, asks if the whole concept needs a rethink and applies the logic to equity release in his latest column for RP

For many months now I have been grappling with a problem I could not get my head around. That is the impact of quantitative easing (QE) on government debt.

If the Bank of England, which is a subsidiary of the government, creates money to purchase government debt does that debt still exist? If the government pays it back, is it just paying off a debt to itself? Basically, that becomes the reverse of QE – you raise money just to cancel it

This raises further issues. We are faced with headlines about the government debt mountain. It is now standing at £2.1trn. However, roughly a third of that is owned by the Bank of England. It makes a big difference to the government finances if that debt does not have to be repaid.

Another issue is what is the effect of moving money into the economy? In theory, it should be inflation. We may have seen inflation in assets values, for example, stock markets and house prices, but not in wages, or essentials such as food clothing and energy. The impact of the Covid pandemic may be hiding this and as the economy recovers, inflation may come back sooner than we expect.

If the amount of QE is inflationary in the long term how does the government withdraw the excess money supply that the government, through the Bank of England, has created?

People far cleverer than myself have been grappling with these problems. I would recommend reading The Deficit Myth by Stephanie Kelton. A book which explains what Stephanie calls ‘Modern Monetary Theory’.

This could be a time in our history when the pillars of our own, and other countries’, economic policy and management could be radically reformed. However, many myths will have to be dispelled to sell the potential changes to those who influence the electorate.

There are many myths about debt in financial planning. The biggest debt most people take on is a mortgage to buy a house. Other debts include credit card interest, bank loans, car purchase and other large purchase arrangements. Often commentators talk generally about good debt and bad debt.

A mortgage is often promoted as a ‘good’ debt. However, if it not affordable, or leads the borrower into negative equity, is it that good? Credit card interest is often labelled as bad. However, if used to meet a pressing need such as replacing a washing machine and paid off in a couple of months, is it that bad?

While we work, we create income through the sale of our labour and other talents. From that income, we pay for necessities, for example, a roof over our head, food, heating and clothing. We then pay for desirables, and from what is left we put aside for the future. The bits we put aside are building our wealth.

When we reach retirement, we are probably at the pinnacle of our wealth. Many people are not aware their State pension could be worth close to £300,000 when they come to retire, probably more than they have in their pension. Maybe more than the value of their house. This wealth will be drawn down to finance retirement.

Maybe, we should begin to look at repayment mortgages differently. Each monthly payment is the cost of servicing the debt taken on, plus a regular contribution to savings. The repayment element is ‘buying’ a little more equity in the home, acquiring a little more wealth. When it comes to drawing down wealth in retirement the use of housing wealth will become more common. There are typically three alternatives: downsizing; a retirement interest-only mortgage; and equity release.

Those considering downsizing need to fully understand the transaction costs and hidden costs of moving home. Will they realise as much money from the sale as they anticipate? Also, how are they going to use those proceeds to provide income throughout their retirement?

From a technical point of view, the other two alternatives use mortgage products. When buying a house, you take on debt to make the purchase. You do not have the wealth to buy the house without taking on debt. This is how the man in the street views a mortgage.

In the retirement market you usually own the house outright. You are using a mortgage to release capital. In the USA, Canada, Australia and New Zealand retirement and lifetime mortgages are often referred to as ‘Reverse Mortgages’. Would it help consumers understanding if we in the UK did the same?

Is there really a difference between a retirement interest-only mortgage and an equity release lifetime mortgage? The latter with generous early repayment terms could in theory be used as a retirement interest-only mortgage. This can only confuse the consumer.

Confusion that can only be compounded when some advisers, due to regulatory authorisations, can only offer a limited range of the large number of products available. They may not be able to offer the most suitable product to meet the client’s objectives and needs.

2021 may see some challenges as to how we view and manage debt on a macro-economic level. It should also be the time for the same in personal financial planning.

Bob Champion is chairman of the Air Later Life Academy