Clear Bad Debt In Times Of Calamity

Newcastle Herald

Monday September 17, 2001

Paul Clitheroe Making Money

I WAS still feeling shaken by the death of my Our House friend Shirley Strachan, when along comes the awful, inconceivable, premeditated assassination of untold thousands in America.

Then to cap off a week that you couldn't think could get any worse, Ansett collapsed, leaving some 16,000 employees without a job and income, a further 45,000 suppliers and contractors also in fear of their livelihoods, and many parts of regional Australia now without an air service.

It 's a lot to take in.

There's no doubt that over the coming weeks and months we're going to be primarily focused on the world's response to the US calamities, and on a local level what the Ansett collapse means for us all, and at such times human considerations rightly come to the fore, with financial issues taking a back seat.

That said though, it's worth remembering that before the World Trade Centre and Pentagon horror, the US economy was moving steadily towards recession, that European economic growth was flat, and that the Japanese economy continues to slide downhill.

Is there a bright spot in all of this? Well fortunately, to some extent there is.

Despite everything, even despite Ansett, the Australian economy has been chugging along pretty well, certainly better than our OECD trading partners.

Ironically, the day Ansett was shut down, it was announced that employment rose by 77,300 new jobs during August, the biggest rise in the number of new jobs in six years.

So where does this all put us?

Even though, again despite Ansett, we seem to be doing pretty well in this neck of the woods at the moment, until the bigger economies of the world start to show some growth then sooner or later our economy will start to struggle.

One thing we shouldn't do is panic. You need to hang on to your investments and wait for market stability to return, as it will, as it always has in the past.

But another thing you ought to do is try to eliminate as much `bad' debt as you can.

What do I mean by bad debt? It's the sort of high interest debt that funds consumption, rather than funding investment.

The worst kind is the mega high interest finance company debt you can get into by buying furniture and appliances and the like. And it also includes credit card debt, which attracts very high interest too.

Look, there's not much doubt we're well on our way to becoming a cashless society.

Over the past seven years, the number of credit cards issued by banks alone has jumped by almost 50% to 9.5million. And their usage has doubled during that period.

That in itself is not necessarily a problem, so long as they are used sensibly ? the trouble is that's not always the case.

Indeed more and more people are turning to them for cash advances, and it's a habit that's costing them plenty.

Credit cards are not a cheap form of finance. If you take a cash advance with the major banks for example, you can expect to pay a fee as high as 1.5% of the cash advance.

But, it isn't just the fees.

Double-figure interest rates are charged on outstanding card balances, and the banks have always justified these by pointing to the high risks they run in credit card lending.

It's called `risk based pricing' and the banks get away with it because they claim those who take out a cash advance on their credit card are three times more likely to default on their credit card payments. However, a recent survey by consultants KPMG for the VISA credit card company showed that fewer than 1% of credit card users actually default on their repayments.

And the total amount of defaults has decreased by 50% over the past seven years.

The banks claim the cost of maintaining the credit card infrastructure, anti-fraud systems and reward programs justifies their credit card interest rates.

But, if you look at the relatively low levels of interest charged on other forms of lending such as mortgages and personal loans, you have to wonder about such claims.

When credit cards were deregulated a few years ago, one of the arguments in favour of deregulation was that interest rates would fall on cards. But clearly this is still some way down the track. Paul Clitheroe is the chief commentator of the Money magazine, and a founding director of ipac, a leading financial planning firm. ipac has an office in Newcastle.