November 28, 2016    4 minute read

Credit Bubbles: Self-Employment And Income Misrepresentation

Benign Borrowing?    November 28, 2016    4 minute read

Credit Bubbles: Self-Employment And Income Misrepresentation

In an environment where lenders receive relatively low-interest rates, one way by which lenders can preserve or enhance their profits is to increase the volume of credit that they lend. Indeed, the low-interest rates (or the price of credit, in this situation) means that although it is cheaper for borrowers, lenders will face a relative shortfall in profits. Thus, expanding the volume of loans they issue (or borrowers they have on their books) is a means by which to offset this.

The Self-Employed Trend

However, one particular group that can be analysed is the self-employed – especially since one is experiencing an increasingly prominent ‘gig economy’ with up to 30% of people working in this way, according to the McKinsey Global Institute. Furthermore, the Office for National Statistics published a research article earlier in 2016, ‘Trends in employment in the UK: 2001 to 2015’, where they found that the “level of self-employment in the UK increased from 3.8 million in 2008 to 4.6 million in 2015.”

More worryingly, figures released by Citizens Advice in 2014 highlighted “how 33% of self-employed people who came to Citizens Advice for help in the last three months got advice on debt problems, the same proportion as those who are unemployed.”

4.6m people were self-employed in the UK in 2015

Although it has typically been difficult for the self-employed to access credit (since lenders are understandably wary of lending to those who have a history of fluctuating incomes, uncertain future incomes, etc.), the incentives to maximise short-term profits are well-documented.

These perverse incentives were cited as a significant causal factor of the 2008 financial crisis (associated most strongly with sub-prime mortgages), and one continues to see them institutionally enforced through the culture of quarterly reporting, sink-or-swim sales targets, etc. Self-employed people also face a host of regulatory uncertainties in addition to income risk; most recently and notably, Uber, the ride-hailing app, lost the right to classify UK drivers as self-employed in a “landmark employment tribunal.”

The Ripple Effect

Whether those incentives come from the borrower or the lender, the effects will be amplified throughout society, and one may be witnessing an unsustainable expansion of credit particularly in this sector. For example, salespeople, in their fear of not meeting sales targets and thereby potentially facing the axe may not mind exaggerating their client’s income or expected future income if their credit history looks fine otherwise.

Indeed, real estate researcher Zillow found in 2014 that self-employed people were 40% less likely to get mortgage quotes despite having higher incomes, putting down larger deposits and buying bigger houses than those who work for someone else.

Furthermore, encouraged by a willing salesperson, the borrowers themselves may be quite happy to misrepresent their income particularly when it is so uncertain, and it fluctuates. Alongside this, executives may not mind or even be aware of the systemic, perverse incentives so long as their balance sheets look ‘healthy’.

Indeed, this is a fundamental problem caused by the ‘division of labour’ and ‘specialisation’ in modern economies as it can often result in a somewhat myopic view of the world.


Although it is unlikely that people can get away with such discrepancies in mortgage applications (where the sums of money and property involved are generally far more substantial), both salespeople (or ‘agents’ as can often be the case) and borrowers may be more likely to engage in this for smaller-scale personal loans, educational loans or vocational training (since the latter two are expected to increase future earnings), to give a few examples.

Indeed, where all parties involved have incentives to issue or borrow credit through misrepresentation of the facts, the locus of ‘blame’ becomes blurred and difficult to apportion accordingly. This, on its own, may seem rather benign when it involves only small sums but, when it is spread out with increasing frequency across the economy and when one faces a host of political risks, regulatory uncertainties and expected interest rate anxieties, one cannot be sure of just how many (self-employed) people may default en-masse as a result of being ‘sub-prime’ especially since the stats are often just so fuzzy.

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