Managing People’s Debt

Admin’s note: This is a repost from Commentary, Philippine Daily Inquirer, 9 November 2013

Among the lessons that students of politics and economics may want to learn from the recent 16-day shutdown in the United States (Sept. 30-Oct. 16) is how a bicameral congress, or how the separation of the branches of government, works. That may as well include a study on why a system like that sometimes does not work.

For the Philippines, what America went through is worth a long and hard look, not only because the former’s system of government is practically lifted from that of the latter, but also because of its costly ramifications which even the world’s largest economy could hardly afford. Reports say that the shutdown temporarily laid off at least 800,000 federal employees, and that its estimated total cost to the US economy amounted to $24 billion. There is also a cost to how people perceive credit-worthiness, and this one is obviously unquantifiable.

What happened was that the US Congress was unable to pass legislation in time for the government to continue supporting its operations. Democrats and Republicans could not agree on the final shape of an appropriations bill, two of the most contentious issues being the amount of support needed to implement the 2010 Patient Protection and Affordable Care Act (also called Obamacare) and the lifting of the debt ceiling.

One may recall that last May, the US Treasury Department alerted the US Congress that starting Oct. 17, the government would not be in a position to fully service its debts unless a law raising the debt limit was passed before that date.

Unthinkable as it may have seemed, the US government was on the brink of defaulting on its maturing debts up to the minute that it took its political leaders to resolve the impasse.

These debts come in the form of government-issued securities such as treasury notes, bills or bonds. Latest counts show that America’s total debt amounts to $17 trillion. Creditors consist of both local and foreign investors, including the Philippine government. US residents can even buy these securities online.

People with extra money and are not operating their own businesses usually invest in stocks or bonds. (Bank deposits are okay, except that inflation rates, which usually outpace interest rates, can erode the value of depositors’ money.)

Bonds don’t usually earn as much income as stocks. But with worries that scandals or civil unrest may erupt one day and sink the prices of stocks to unknown depths, investors in bonds normally sleep more soundly than those who play the bourse.

For decades people believed that buying US treasury bills or bonds meant money in the bag, so to speak. (Government-issued notes, bills or bonds are also called securities, with the apparent connotation that they are risk-free.) That belief would change to something close to disbelief as the world watched the US government struggle from within.

Bills or bonds—notes often have short maturity periods, say 90 days—whether issued by any government or a private corporation, are investments for those who buy them (to be recouped, with profits, at a later date); the proceeds are used to pay for expenditures (including payment for maturing debts) to be incurred by the one selling (or issuing) them. One lives with the money of the other. In other words, buyers become creditors and sellers become borrowers.

Using other people’s money has cost (also called interest); it is by its rate that borrowers endure the pain of being poor, and it is also by the same rate that creditors, being rich, become richer. And yet, if one borrows with the plan of lifting himself or herself out of poverty—say, invest in education that would pay for itself handsomely in the future—borrowing can serve the interests of both the poor and the rich.

The real world may not be lived in such simple terms, however. For one, creditors (who are investors, as we mentioned) want to make sure that they will get paid when payments become due. The poor (who are borrowers) are credit risks; indeed, it is when one needs money the most that people find him or her unbankable, as it were. For another, there are borrowers who pretend to be poor, such as corporations or individuals whose properties can be used as collateral, or governments whose power to tax their constituencies is more than enough guarantee for payments for their borrowings.

Over the years, the art of managing debt (if there is such a thing) has evolved to get the world to continue turning and to provide conditions for the rich, the poor and the pseudo-poor to exist, with the interests of all amply protected.

We may take the case of Juan, a poor but bright student, who wants to apply for a P1,000-loan (inclusive of P200 as interest) for his college expenses. Bank A hesitates, but finds that it has a rich client, Sam, a borrowing monster with properties valued at 10 times his loans. Bank A asks Sam if he wants to buy Juan’s credit for P900. Sam likes what he hears and walks away with the discounted purchase. After two years Juan returns to Bank A and asks for refinancing, to which Bank A agrees at an additional interest of P100. After five years and one year since graduation, Juan operates his own computer shop. Six months earlier he found that everyone wanted to loan him money. In fact he got one (amounting to P2,000) from Bank B, P1,100 of which he used to pay Bank A. The story ends with Juan better off, Bank A richer by P200, Sam happy with a few pesos more in his vault, and Bank B looking forward to profitable years ahead with Juan.

Of course, as we said, the real world is far more complicated than any story we can make up. The enormity of the task of managing debt is multiplied when Juan becomes a country like the Philippines. While innovations in financial instruments (e.g., derivatives-futures, swaps, discounts, etc.), refinancing, consolidation and hedging, among other things, are handy and continue to evolve in their utility to ease the burden of borrowers, risks that something may go wrong are facts of life. High in the to-do list of debt managers would therefore be understanding what these risks are and preparing for their mitigation in the event they happen.

Poor and rich countries alike need to borrow at some point. The challenge is how one can incur debt at least cost (interest) possible, with the minimum of risks (forex swings for external debt, fraud, default, political backlash, etc.). One thing going for the Philippines in the last few years is its improving credit-worthiness (as indicated, for example, by the growing economy and credit-rating upgrades). From being hesitant, banks and investors have turned bullish on the potentials of Juan. This means the government, by selling bonds, can have the cash whenever it needs it. And simply because demand is high, competition can keep interest rates at low levels, thereby easing the taxpayers’ burden on debt repayments.

Government debt (or people’s debt) is necessary to ensure that government operations, and delivery of public services, are not disrupted. It can also serve the ends of development by freeing up funds needed to promote, in the case of the Philippines, the basic goals of health and education, among other priority sectors.

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