The Independent Market Observer

Debt Isn’t a Bad Thing, as Long as It’s Affordable

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Aug 8, 2014 12:16:00 PM

and tagged Economics Lessons

Leave a comment

DebtYesterday, I wrote that banks starting to lend again is a plus for the economy. Today, I want to take a closer look at a key assumption underlying that statement.

Much of modern society revolves around consumption, and there's nothing wrong with thatif it’s affordable. If not, we find ourselves in 2009 again.

The real question here is what affordable means. In fact, this is the question at the core of saving, investing, retiring, and pretty much everything else I write about here. 

What does "affordable" mean?

An economist named Hyman Minsky defined affordability in the context of asset prices and debt. In brief:

  • Affordable debt can be paid off by the asset itself over time—say, buying a condo where the rent can cover the mortgage payments and all the costs.
  • Somewhat affordable debt is where the asset can pay the interest charges, but the principal has to be rolled over. Think about that condo with an interest-only mortgage that you have to refinance every five years.
  • Ponzi debt is where the asset can’t even cover the interest, but relies on selling at a higher price to someone else to repay. Imagine that condo bought to flip in 2006, by a buyer with no job who couldn’t possibly pay the mortgage.

You can also think about debt in another way: whether it's used for something with future benefits (e.g., a house you live in, which provides shelter as well as potential appreciation into the indefinite future) or immediate consumption (e.g., a luxury vacation, which will pass and vanish). Investment debt provides future benefits and can be economically beneficial over time; consumption provides an immediate boost to the economy at the cost of a long-term drag.

A return to healthy debt

Looking at recent consumer debt trends, much of the spending has been long term and investment oriented—think housing, cars, education. Today, no-doc mortgages are much less common, and borrowers should be able to pay off their loans. This is good debt, and it makes me believe the resumption of lending will benefit the economy. Meanwhile, consumption and unaffordable lending, which would be bad in the long term, remain at relatively low levels.

Beyond the current trends, the broader picture also looks healthy. Household net worth has hit new highs, driven by the stock market and real estate recovery, even as debt has declined. At the same time, low interest rates have made more debt affordable, and debt service obligations remain at low levels.

The proper use of debt is to smooth consumption over time, like the mortgage for the house you live in, or to invest in an asset that will pay for itself over time, such as a college education.

We’ve made substantial strides back toward that proper use. As long as we stay on that path, more debt will be a good thing.

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

New Call-to-action



see all



The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.


Please review our Terms of Use

Commonwealth Financial Network®