Debt

The terminology of debt

A voluntary loan agreement may be presumed to confer benefits upon both borrower and lender, and to have no effect upon other parties. The terms of the agreement may be expected to take account of "social time preference", which is an observed tendency to attach greater value to current enjoyment than to deferred enjoyment. That behavioural characteristic confers a benefit on the borrower at the expense of the lender, in return for which the borrower may be expected to compensate the lender by the payment of "interest". The agreement may also be expected to take account of the possibility that the borrower may "default" upon its terms by failing fulfil its obligations concerning the payment of interest or the return of the original payment (termed the "principal"). The agreement may include the provision of "collateral", which gives the lender title to an asset belonging to the lender, if the borrower defaults (the term "mortgage" may be used if the asset is property). Alternatively, or in addition to the provision of collateral, the agreed interest rate may embody a "risk premium" in addition to the appropriate "risk-free interest rate".

Attitudes to debt

Since a loan agreement so defined confers benefits and does no harm, it is not obvious that it should be an object of disapproval; and there is no obvious reason for objecting to the charging of interest, unless the exercise of social time preference is deemed objectionable. It has nevertheless been widely condemned at several stages in the course of history. The divine instructions received by Moses, as recorded in the Bible, include:

And if thy brother be waxen poor, and fallen in decay with thee; then thou shalt relieve him: yea, though he be a stranger, or a sojourner; that he may live with thee. Take thou no usury of him, or increase: but fear thy God; that thy brother may live with thee. Thou shalt not give him thy money upon usury, nor lend him thy victuals for increase.

- which have, from time to time, been interpreted by western religious authorities as forbidding all charging of interest. There has been much debate concerning the interpretation of the term "usury", and as late as the 1920s, the then popular Catholic author, Hillaire Belloc, wrote that:

It means any interest, however low, demanded for an unproductive loan. It is not only immoral [on which account it has been condemned by every moral code - Pagan, Mohommedan, Catholic] but it is ultimately destructive of society.

Secular objections to debt have been expressed by Shakespeare in Polonius's advice to his son:

Neither a borrower nor a lender be, For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.

- and by Benjamin Franklin:

But, ah, think what you do when you run in debt; you give to another power over your liberty. If you cannot pay at the time, you will be ashamed to see your creditor; you will be in fear when you speak to him, you will make poor pitiful sneaking excuses, and by degrees come to lose you veracity, and sink into base downright lying; for, as Poor Richard says, the second vice is lying, the first is running in debt.

Those objections and misgivings appear to have little influence on 21st century behaviour to judge by the unprecedented levels of household debt that have been recorded, but the terms "mortgage", "finance" and "hire-purchase" tend to be used rather than "debt", and Islamic banks provide their customers with arrangements for deferring the payment for purchases that do not involve the payment of interest.

Categories of debt

Personal debt

Mortgages

A mortgage is a loan secured on property - usually real estate. A mortgage may be used to help finance the purchase of the property or to obtain money for other purposes. Mortgage interest payments may be fixed or may be varied by the provider of the loan - usually in response to changes in the general level of interest rates. The term "adjustable rate mortgage" is used in the United States to denote a mortgage for which the interest rate payable is related to a published index, and a "hybrid mortgage" is one in which the interest rate is fixed for a period, and then varied.

Corporate and public debt

Bonds

A bond is an instrument that is issued by a company or by local or central government, that represents a loan that is repayable after an interval of not less than a year. Bonds issued by the government are termed "Treasury bonds" (or "T-bonds") in the United States and "Gilt-edged securities" (or "gilts") in the United Kingdom. A "straight" (or "plain vanilla") bond, that makes a regular fixed interest payment and is repaid (or "redeemed") on a predetermined date. The sum of money for which the bond is to be redeemed, is called its "par value", the annual interest rate that is paid is called its "coupon", and its date of repayment is called its "maturity date". An "irredeemable bond" (or "perpetual bond" or "consol") is an undertaking to make continuing fixed interest payments. A "zero-coupon bond" pays no interest, is issued at a price that is below its par value, and is held in order to obtain a capital gain. A "callable bond" has a redemption date that is at the discretion of the issuer. "Convertible bonds" contain an option to exchange them for an equivalent amount of the issuer's equity. A "covered bond" is a bond that is secured by other assets so that the investor can lay claim to those assets should the issuer of the bond become insolvent. In the United Kingdom the term "debenture" refers to a company loan secured by a claim on the company's assets, but in the United States the term is applied to unsecured loans. In the UK a "fixed-charge debenture" specifies the assets against which it is secured, whereas a "floating-charge debenture" is secured on the issuer's assets as a whole. Repayment of a "guaranteed bond" is guaranteed by a body other than the issuer - such as its parent company or its government. Bonds that are rated below a minimum credit risk level by a Credit rating agency (Baa for Moody’s or BBB for Standard and Poor) are termed "junk bonds" (or "high-yielding bonds") and bonds rated above that level are termed "investment-grade bonds". The term "eurobond" (or "global bond") refers to a bond that is traded outside the country in whose currency it is denominated - so called because it is often applied to a bond issued by a non-European company for sale in Europe.

The money market

Money market securities are short term loan instruments issued by governments, banks and businesses. Those that can be bought and sold during the period between issue and repayment are termed "negotiable". Those that a marketed on a “yield basis” are repaid on the due date by the amount invested, together with a stipulated interest payment. Money market security that are marketed on a yield basis include "money market deposits" which are repayable after intervals ranging from one day to one year and are not negotiable, and “certificates of deposit” which are receipts from banks for deposits made with them, and are negotiable. Money market securities that are marketed on a “discount basis” are sold at a price "below par" (– ie below the amount to be repaid), but without any additional interest payment. That category includes Treasury bills, which are promises to repay loans to the government – usually after 90 days; "bills of exchange" (or "trade bills", or "commercial bills") which are similar to Treasury bills but are issued by companies; and "bankers acceptances" which are negotiable, and "commercial paper" which consists of unsecured promissory notes issued by companies.