Good and bad debt

We have always had a love-hate relationship with bankers.

We have always had a love-hate relationship with bankers. Jesus famously threw them out of the Temple, an act which helped spread his gospel so rapidly among the debt-laden underclass of the Roman Empire, while later on the Medici bank established a special mobile branch to accompany the Pope on this travels.

Since then, nearly every human on the planet has become enmeshed in the banking system, or aspires to be. At the same time, few topics have been more popular than bank-bashing. Everyone from mediaeval anti-Semites to communist revolutionaries to fashionable political commentators have had a go at denouncing high finance as selfish and destructive. The current financial crisis is merely the latest round.

So it’s no surprise that Yukoners have reacted with alarm to our cabinet’s plans to dive into the debt market. While the central Yukon treasury remains in the black, for now, it is emptying rapidly and the government has directed Yukon Energy to issue $100 million in bonds and the hospital to borrow $67 million.

And since the Yukon rather conveniently recently had its borrowing limit raised by Ottawa, we can expect more of the same.

How worried should we be?

To begin with, let’s distinguish between two kinds of debt; simplistically, let’s call them “good” and “bad.”

Good debt is merely a way to take the savings of one group and transfer it to someone else who has a more productive use for it, and who is happy to pay the savers interest to compensate them from being separated from their cash. The money borrowed has to be invested in something useful, hopefully something so useful that it generates enough profit to pay back the loan and interest.

Borrowing $20 from your dad to buy a shovel so you can go into business shovelling driveways is “good” debt.

Bad debt, on the other hand, is spent on something unproductive; something which doesn’t leave a legacy to help repay the debt.

Borrowing $50,000 for Aerosmith to play your wedding is “bad” debt, even if they do put on a very fine show.

Lying in some dangerous territory in between is what economists call “consumption-smoothing” debt. Instead of eating Kraft Dinner in your 20s and caviar in your 50s, you might run up the line of credit while young and then pay it back in your prime earning years. The danger is, of course, that your prime earning years turn out to be less lucrative than you hoped.

Buying a house can fall into this category, or putting a trip to Mexico on the credit card in university. Lots of people do this and, while they end up paying some extra interest, think it was worth it. On the other hand, there are thousands of Californians right now who bought houses that were too big and whose adjustable-rate mortgages were unsustainable five years later; that big promotion just never happened.

Despite its large size by Yukon standards, the $100-million Yukon Energy bond issue feels like “good” debt, with the Mayo B hydro project position as a $161-million version of the shovel mentioned above. The money will be used to build power facilities that will then bring in electricity revenue for decades.

Disaster, of course, can be in the details. The Mayo B project is very costly per megawatt of capacity. And there might be cost overruns. But with $71 million donated by Ottawa, the project’s economics – from the Yukon electricity customer’s point of view – look reasonable so far.

Borrowing $67 million to build hospitals in Dawson City and Watson Lake risks being “bad” debt, however. There is no revenue stream associated with these investments, and in fact there will likely be additional annual operating costs to maintain the new buildings and equipment.

All this will have to be paid for by the Yukon Hospital Corporation, presumably out of its annual health-care budget from the Yukon government.

Perhaps the Yukon government will boost the hospital corporation’s budget for the next 15 years to cover the interest costs. But one suspects the hospital managers will be told to find the millions of dollars needed to pay the bank through internal efficiencies; that is, lower service at its Whitehorse hospital than they could have afforded had they not been saddled with expensive, remote facilities to pay for.

Perhaps our transfer payments will keep rising to cover all this expense. Or perhaps not. It begins to look like a nice Californian house with an adjustable-rate mortgage: you can make the payments at first, but you can’t afford it unless you get a big raise.

So this columnist’s bet is that the Mayo B project will end up being a nice addition to the Yukon’s infrastructure, but that the two hospitals will be a multi-decade burden on the public purse that we will all pay for through longer lines and reduced service at Whitehorse General.

And you don’t have to be an anti-banker revolutionary to be mad about that.

Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels.