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How Much Debt Makes Sense?
04/22/2011 10:26 am EST
Debt can be good, but much of America’s growth in the last few decades has been based on debt. Getting away from that dangerous model will set the stage for real growth in the long term, says Randall Eley, president and CIO of the Edgar Lomax Company, in this exclusive interview with MoneyShow.com.
Randall, I know a lot of people are upset about debt not only on the national level, but personal level. A lot of people are trying to pull out of that debt hole. Is there any time that debt could be good?
Debt can be good. In fact, debt should be used in some cases, but always sparingly.
The big problem we've seen in America is that people have been willing to use increasing amounts of debt, ever-justifying growing percentages of debt to net worth, or debt to income, or whatever the case.
I have no problems with the fact that in the early 1900s, this nation decided that housing—whether purchasing housing, or to some extent even long-term leasing—that debt was a good form of financing.
If only we had stuck to the long-ago prudent rules, that the debt level should not be over some portion of the appraised value of the property—and that debt repayments should not be over some portion of monthly income, like 20% or 25%.
The problem is that each decade we've tended to loosen the rules. So first maybe 20% of income was an acceptable figure that debt repayments could be, and then eventually it was 25 and then it was 30.
There were people arguing very strongly by the time the housing bubble burst—it was late 2005, 2006 or 2007—people who were arguing that it should be 40%, maybe as even as high as 50% of income. Those levels never made sense.
So today, while I think that debt can be good for certain purposes—including certain business purposes— I think America ought to focus more now on reducing debt for the time being.
This will give us a chance to get back to discussing with our children and others prudent uses of it. Once we first make sure we haven't committed the greatest sin of all, which is just having so much of it that the good users don't help us at all.
Well, isn't that a recipe for very slow growth? Because this economy is based on the consumer. 70% of economic growth is the consumer. The last decade there was no wage growth.
So they adopted and embraced debt, whether it was in their house or credit cards, or whatever. Now they're trying to pay it off, so we're not going to move anywhere.
Yes, and they're trying to pay it off of growth.
One of the things that Americans as a people have to accept is that human development has always been a process of either growth or decline. We hate to decline, so we try to grow. But good, healthy growth in the long term has never been in a straight line.
You've had periods where it appears you're stalling, when you actually go through instances that you show no growth statistics, but when you look at companies or countries that have succeeded over time, during those periods some problem was being fixed.
Of the American economic growth since World War II, much of it in my opinion has not been real growth, to the extent it was all debt-based.
Smoke and mirrors.
Yes, smoke and mirrors—and much of the smoke needs to be cleaned up. So I wouldn't have a problem if we were to go through a three- to five-year period that, looking back, we saw no GDP growth—because debt was being paid down.
I think that can establish the foundation for real growth in the next five to ten years, and that's based on investment. Where we'll be building things we can sell outside of the country. And where the American economy is going to be no more than perhaps 60% consumer-driven, as opposed to 70%.
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