He looks the whole world in the face for he owes not any man.

~ Henry Wadsworth Longfellow

I've been writing  a lot about sovereign debt and the dangers it poses to the global economy lately. Debt in general is a frequent topic in the personal finance blogosphere and it is often painted as the enemy – a nefarious villain, evil incarnate.

I happen to agree with the contingent that says that there is no such thing as good debt. That doesn't mean you can't ever have debt. It just means that you need to control it so that it can't control you.

Debt, by its very definition, is negative. It means below par, under water, less than zero. On your balance sheet, it's a liability. Liability is defined as “the state of being legally obliged and responsible” or “anything that is a hindrance or puts an individual or group at a disadvantage”. So it looks like debt is not good. But is it inherently evil?

Debt, like money, is not evil in and of itself. But it has truly become a four letter word – and for good reason. It's been used and abused. The rules of the debt game have changed and not everyone got the memo. In the U.S., banks have been allowed to hold less cash to back up loans and have given those loans to anyone who could fog a mirror.

When they inevitably went bad because the debtors could not pay, the debtors lost their homes and went bankrupt. The bankers got a taxpayer-funded bailout. Yeah. That means that you and I are footing the bill for the idiotic mistakes of both lenders and borrowers. (If you think my characterization is too harsh, read what Matt Taibbi had to say about Hank Paulson.)

The Lexicon of Debt

So is it the debt that's evil, or are people using it unethically? Well, let's ask the thesaurus. Here's a rundown of the various words associated with “debt”:

Nouns: obligation, liability, charge, default, bankruptcy, insolvency, usury, deficit, insufficiency, poverty, encumbrance, hypothecation, failure

Verbs: owe, borrow, run a tab, finance, repudiate, dishonour, write off, borrow from Peter to pay Paul, outrun the constable (I've never heard of that last one before.)

Adjectives: indebted, liable, chargeable, answerable for, in embarrassed circumstances, in difficulties, up against it, in the red, in the hole, in hock, broke, in arrears, delinquent

It seems to me that two main themes arise from this terminology:

  1. Debt Is Negative: Terms like insufficiency, bankruptcy, default, dishonour, in embarrassed circumstances, delinquent, and ultimately, failure, do not conjure up feelings of pride and accomplishment. The message is that debt is to be used wisely, if not avoided altogether.
  2. Debt Means Responsibility: If you take on debt, you are legally obligated to pay it back, or the consequences are severe. You can lose precious assets, or even your freedom – unless you are a “systemically important” financial institution. In that case, anything goes and the taxpayer's got your back. Can you say moral hazard?

The implications of debt provided by the thesaurus tell us that debt, while not a desirable condition, is not evil. I think the responsibility factor is the locus of our problem. Neither institutions nor individuals seem willing to accept the responsibilities inherent in a debt contract.

Under a properly functioning capitalist system, the borrower is supposed to incur no more debt than he or she can realistically pay back or he or she will lose the posted collateral. (That's right, you used to need to have some skin in the game.) The lender is not supposed to lend more than the borrower can realistically pay back, or he or she will lose the money lent. (Unless the government decides to replace that money with taxpayers' cash.)

So maybe debt is not a villain after all. It's more like the super power that a villain might possess. There's nothing wrong with the power. It's just being used by a villain. What if we gave it to a hero instead? Wanted: heroes.

What do you think? Is debt evil or just abused?

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