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

Household debt

• The term "consumer credit" refers to short-term unsecured loans, usually related to specific purchases. It includes deferred payment arrangements made by sellers and by credit card companies, as well as "hire-purchase" agreements and short-term bank overdrafts.
• A mortgage is a loan secured on property - usually real estate - that is used to finance the purchase of the property, or to obtain money for other purposes. An "adjustable rate mortgage" is a mortgage whose interest rate is related to a published index, and a "hybrid mortgage" is one in which the interest rate is fixed for a stated period,after which it may be varied.

Corporate and public debt

The bond market

A bond is a fixed-interest loan that is repayable after an interval of not less than a year. 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".

• A "treasury bond" (or "T-bond") is a bond issued by the United States Government.
• A "gilt-edged security" (or "gilt") is a bond issued by the British Government.
• A "straight" (or "plain vanilla") bond, makes a regular fixed-interest payment and is repaid (or "redeemed") on a predetermined date.
• An "irredeemable bond" (or "perpetual bond" or "consol") makes indefinitely 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.
• A "convertible bond" contains a conditional option to exchange it for an equivalent amount of the issuer's equity.
• A "covered bond" is secured by fixed assets to which the investor can lay claim if its issuer becomes insolvent.
• A "debenture" in the United States is an unsecured loan; in the United Kingdom it is a loan that is secured by a claim on the company's assets.
• A "guaranteed bond" is guaranteed by the issuer's parent company or the government.
• An "investment-grade bond" is one that is rated above a minimum credit risk level by a credit rating agency (Baa for Moody’s or BBB for Standard and Poor)
• A "junk bond" is one that is rated below that level.
• A "eurobond" (or "global bond") is a bond that is traded outside the country in whose currency it is denominated.

The money market

Money market securities are short term loan instruments issued by governments, banks and businesses. Those issued by companies are known as commercial paper.

• A "negotiable" security can be bought and sold during the period between issue and repayment.
• A "money market deposit" is repayable after a stated interval between one day and one year and is not negotiable.
• A "certificate of deposit" and a "banker's acceptance" are negotiable receipts for bank deposits.
• A "treasury bill" is a promise to repay a loan to the government – usually after 90 days.
• A "bill of exchange" (also known as "trade" or "commercial" bill) is a promise to replay a loan to a company.