BEYOND REASONABLE DEBT
A background report on the indebtedness of New Zealand families

Part 4: Problem debt

Problem debt is a way of describing having too much debt or having unmanageable debt. Problem debt is also referred to in the literature as over-indebtedness.

Problem debt can be difficult to define in a measurable way. Firm evidence about the impact of debt is scarce (Valins, 2004; Williams & O’Brien, 2003). This is in part because it is difficult to determine whether debt causes a particular outcome, or vice versa, and in part because it is difficult to disentangle debt from other factors that may contribute to a particular outcome.

Being able to measure an outcome is important, however, if we are to identify New Zealand families who are encountering or vulnerable to problem debt, and distinguish them from other families who are not, but who are otherwise in the same financial position.

While we have not attempted to do this in this report, this section outlines what we may need to think about.

In terms of outcomes, problem debt is most likely to manifest itself in poor standards of living, stress and poor health. Longer-term consequences of debt could be measured in terms of quality adjusted life years (QALYs) and wealth disparities, which are not explored in this report.

In terms of explanatory variables, we need to consider both circumstances and behaviours, and how they interact.

Standard of living

Repossession, eviction, mortgagee sales, bankruptcy and utility disconnections are some direct ways in which debt can adversely affect families’ standards of living.

Problem debt can become a barrier to sustainable employment, or moving into work or between jobs, and can reduce the financial returns from work. As Valins (2004) notes:

• Debt repayments tend to increase when people move into work, or the fear of this can become a barrier to work. However, United Kingdom analysis found that those with arrears were no less likely to move into employment than those without.
• Creditors, who tend to be patient when a person is not working, increase the required repayment rates once they know someone is working.
• People who move into employment will receive reduced social welfare benefits and will face increased income tax, which reduces the financial gains from working. If such people are also under pressure to repay debts once they are working, the effective marginal tax rates can become such that in the short term it can be financially better to remain on the benefit (p 55).

Debt repayments, however, may simply be prioritised over essential items, including food, heating, shelter, clothing and medical visits (Valins, 2004). This behaviour could have long-term implications for families’ health and wellbeing. There is some anecdotal evidence that this is happening in New Zealand, with a reported increase in the number of applications for food assistance and budgeting advice from those with and without means (St John & Wynd, 2008, Williams & O’Brien, 2003). Of course, as Valins (2004) points out, debt avoidance strategies (such as going without essentials) may be equally problematic. Williams and O’Brien (2003) also note that what people forgo matters as much as the lower quality of what they buy.

Debt may put pressure on family time. It is entirely possible that some families choose to work longer hours to meet onerous debt obligations. Debt may also strain extended family relationships, particularly if the extended family is being asked to provide in-kind assistance, such as childcare.

In the United Kingdom, studies have used arrears and civil proceedings data to approximate problem debt, because of concern about capturing the poorest families (Balmer et al, 2005; Kempson et al, 2004). In New Zealand, some work examining the reasons for problem debt has been undertaken with evidence from the New Zealand consumer-debtor repayment programme, the Summary Instalment Order (Redhead & Rose, 1999).

Other New Zealand data sources might include:

• the Ministry of Social Development’s Living Standards Survey
• utility companies
• Baycorp, Veda Advantage & bankruptcy data
• store repossessions
• truancy
• problem gambling.

Stress and poor health

Managing debt can be stressful, particularly if high servicing costs are putting pressure on disposable income. Unsecured debt can increase families’ dependency on employment in order to protect future earnings:

• …simply making ends meet becomes a full-time job which pre-occupies the mind of many people most of the time – this seems to be especially so for women (Nettleton 1998s) (Williams & O’Brien, 2003, p 31).

According to Valins (2004), there are not many empirically robust studies studying the impact of debt on physical and mental health, family stress, stigma and social exclusions. In the UK, associations have been found between debt and various aspects of ill-health (Balmer et al, 2005).

There are a number of options for sources of New Zealand data that could be explored:

• the Ministry of Social Development’s Living Standards Survey
• Statistics New Zealand’s New Zealand Health Survey
• future waves of Statistics New Zealand’s Survey of Family, Income and Employment
• Massey University’s Health, Work and Wellbeing study.

Who is vulnerable?

In this section we explore how the circumstances and behaviours outlined in Parts 2 and 3 might interact to enable us to accurately classify who uses debt well and who does not.

From the information we have gathered, it appears that some circumstances (notably being young, having children and separation) and some personality traits (basing aspirations on comparisons with others or being impulsive) are important in determining who gets into debt, as illustrated in Figure 17.

Figure 17: Factors that may influence who gets into debt


Other circumstances (notably having a low income) and personality traits (having an external locus of control) are important in determining how well people manage debt (or whether people get into problem debt), as illustrated in Figure 18.

Figure 18: Factors that may influence how well people manage debt


Of course, these findings are generally at an aggregate level, or across a large population group. For different population groups, it is not entirely clear whether these conclusions hold. Do behavioural factors cease to explain variation if circumstances are held constant, for instance?

In our view, this question has not been properly explored. Circumstances and behaviours tend to be viewed in isolation. Livingstone and Lunt (1992) are a notable exception, but they do not appear to thoroughly examine some of the multi-colinearities (correlations between independent or explanatory variables), as discussed in Part 3, because their population group is too wide.

Overseas evidence

According to Valins (2004), the common correlates with ‘over-indebtedness’ include having four or more credit commitments; spending more than 25 percent of income on credit; and spending more than 50 percent of gross income on mortgage and credit cards.

According to international studies, a young single parent, living in rental accommodation, is the archetypical ‘problem debtor’ (Balmer et al, 2005).

According to Livingstone and Lunt (1992):

• …what determines how deeply people get into debt differs from that of who gets into debt in the first place, particularly with regard to the variables of age and number of children… (p 129).


• Disposable income seems to be irrelevant to whether one gets into debt (presumably once a certain minimum income is obtained), but it is a moderate predictor of how far one gets into debt, and an important predictor of how much one repays… (p 132).


• …psychological factors are more important in determining how much of a debt is repaid by those who have the resources to do so (p 133).

In a recent United Kingdom study (Balmer et al, 2005), the issue of causality was explored:

• In most cases, debt was as likely to come before as it was after other issues. Domestic violence and relationship breakdown problems, though, were notable exceptions. These problems more often occurred prior to debt problems; indicating the severe change in circumstances that can follow family breakdown (p 48).

Webley and Nyhus (2001, in Balmer et al, 2005) find that chronic debtors are a small group and are distinguished by having more limited economic and social resources, being more present-oriented and finding it more difficult to control their expenditure than temporary debtors. Dynamic analyses suggest that many of the psychological variables between debtors and non-debtors may be a consequence of being in debt rather than a cause of it.

Lea, Webley, and Walker (1995) studied groups of customers who were non-debtors, debtors and serious debtors to a utility company. They found that:

• non-debtors had more money-management facilities, such as bank accounts, than debtors, and rated their abilities at money management more highly
• debtors had shorter time-horizons than non-debtors
• there were no group differences in attitudes to debt or locus of control
• a complex mixture of psychological and behavioural variables affects debt and is affected by it. It is argued that these variables are linked to the psychology of poverty.

New Zealand evidence

New Zealand research (Redhead & Rose, 1999) on the reasons 234 people filed for bankruptcy found the following:

• three key factors – current consumption preference, inadequate income and unanticipated events – interacted to cause financial difficulty
• inadequate income was associated with financial difficulty for 68 percent of the sample; 14 percent of the sample had experienced two of the three factors, while two percent had experienced all three factors
• the sample was disproportionately young, with 46 percent being aged 25 to 34
• 27 percent were employed, 72 percent were beneficiaries and one percent were students
• the mean indebtedness was $10,600
• about half the debt was secured and one of the major components of unsecured debt was credit card debt
• the average value of assets was $15,700, more than two-thirds of which was investment in housing.

Summary

Whether debt is a problem depends on how we measure it. Ideally, we should establish an independent measure of financial strain that is not simply an arbitrary debt ratio (such as spending more than 30 percent of gross income servicing debt).

How people behave or their personality traits appear to be variables which can explain differences between savers and borrowers, and those with and without problem debt. It is difficult to disentangle these factors from circumstances, however. Age seems to be an important factor in development of self-worth, and thus people’s desire for less materialistic things and their propensity to save. Income, on the other hand, changes the social group people operate in and compare themselves with.

There also remains a question of whether psychological differences emerge before or after people become indebted – can we reliably use these factors ex ante to identify problem debt risk factors?

We have noted several areas for research in this report:

1. Define and identify families who are in or close to a problem debt situation. The Livings Standard Survey (LSS) dataset offers the most potential for determining both outcomes and explanatory variables. (Note that multivariate analysis of the LSS dataset for this purpose will be undertaken by the Families and Retirement Commissions in 2008/09.)


2. Mortgage debt of older people has noticeably increased in the past decade. It would be worth exploring whether this is because they are borrowing more, or because more older people are entering (or re-entering) the mortgage market. Data from the Household Economic Survey (HES) or the Survey of Family, Income and Employment (SoFIE) should shed some light on this question.


3. There is evidence in the United Kingdom of a positive, causal relationship between relationship breakdown and over-indebtedness. It would be interesting to explore whether this is the case in New Zealand. LSS and SoFIE data may be useful for exploring this research question.


4. Determine whether income is also a strong indicator of problem debt in New Zealand. LSS and SoFIE data should be suitable for this analysis.


5. There is little evidence linking ethnicity with indebtedness or over-indebtedness. In New Zealand, however, Māori and Pacific families have high debt-asset ratios compared to European families. This relationship would be worth exploring further if the effects of significant confounding factors such as age and income could be held constant.


6. Evidence suggests that savings and debt decisions are influenced by various personality and environmental variables, which may result in the development of habits, heuristics and coping mechanisms. Identifying these variables and understanding what influences them may help us predict and influence financial behaviour. Environmental variables are particularly appealing because they may be more amenable to change. The role that family, parenting and communication styles plays in consumer socialisation, and in family decision-making more generally, has emerged as a significant research gap.


7. Having an external locus of control, basing aspirations on comparison with others or having poor self-control (a tendency to be impulsive) tend to make a person more likely to have a spending than a saving habit. These traits may be significant factors influencing whether a family becomes financially better or worse off over time. Further research is required, however, to determine whether these relationships hold ex ante – that is, before people become indebted. Further research on gender and age differences in these variables is also required, as is an understanding of the interplay between these variables in a group or family decision-making setting. For example, where in a two-parent family one partner has an internal locus of control and the other an external one, it may be in the family’s long-term interests for each to be aware of their tendencies, strengths and weaknesses and to empower the partner with the internal locus of control to make decisions about the family’s finances.