A recent poster on the influential Irish Economy blog site wondered if they’re might be a debtor’s revolt. The notion of ordinary people revolting en-masse and refusing to repay their bank debts in full is not at all far fetched.
Household unaffordable indebtedness is known to cause immense social damage and incur immeasurable economic costs. Government’s budget this week will almost certainly worsen household financial fragility. Published last month, the 2009 Genworth Index, measuring financial vulnerability and security, reported Irish households as the most financially vulnerable of the countries studied. It seems four out of every ten households have difficulty in meeting their financial commitments and expect to have problems in the future. And only 2% feel financially secure.
During favourable economic circumstances and the low interest rate environment of the recent past, Irish household use of debt underwent a dramatic and fundamental transformation. Two powerful forces were at work. The first was “keeping up with the Jones’” as people emulated their neighbours lifestyles and role models promoted by mass media advertising. The second saw bankers relax prudent lending policies and broaden credit availability through financial innovation. Responding to these forces, households changed their behaviour, significantly increasing spending relative to income and consumer debt skyrocketed. People believed it was safe to borrow more and banks believed it was safe to lend more to them. Government, whose policies encouraged the debt fuelled consumption party, was blind to the twin dangers of exploding household debt and bank reckless lending to consumer and property sectors. Central bankers and regulators were lulled into a false sense of financial stability. By 2008 Government’s economic mismanagement created the conditions for a perfect storm for over-indebted households and triggered a dramatic collapse in consumption and tax revenues.
In the early 90’s a double income couple had to put 20% down and could borrow a maximum of 2.5 times one income and once the second income, to buy a home. By 2007 they could have borrowed 100% at multiples of four to fives times their income, and have two car loans, two credit cards and one or two unsecured loans. Experts argued the debt burden was affordable as incomes were rising and interest rates were quite low. They worried only about interest rates rising. Few considered a boom to bust cycle.
By 2006 household debt was running at dangerous levels – all it would take was an income shock and vulnerable households would be plunged into financial distress. This is precisely what has happened. Should interest rates rise, as they will, household financial fragility will worsen.
Experiencing increasing demand, largely from people on social welfare and low incomes, MABS offices took on 15,000 new troubled debt cases in 2009. MABS says its 30,000 active cases have average debts of about €16,500 which represents about €500m in collective debts. But with consumer loans of €140bn comprising some €110bn in mortgage debt and €30bn in other loans, the number of households experiencing financial stress requiring debt management and counselling services is likely to be considerably higher than the numbers currently going to MABS for help. Its figures are but the tip of a very large iceberg of household over-indebtedness.
Estimates put the number of overly indebted households at close to 300,000 with about 750,000 individuals experiencing problems with personal debt. By far the most vulnerable cohort is couples under age 40, with children, who have experienced a long term reduction in take home pay. Heavy users of debt many will or have become hopelessly insolvent.
So far Government has done little to understand or address the massive burden of unaffordable household debt built up during the boom years. Getting banks to forbear on home repossessions is like pouring sand on a land mine and claiming it’s been decommissioned. People’s capacity to participate in modern society depends on income security, access to affordable credit and ability to meet their financial commitments. Well documented, the social consequences of unaffordable indebtedness are dire, causing reduced workplace productivity, family breakdown, depressive illness and in some cases suicide. Stigmatised many people withdraw from being active members of society. Hopelessness and loss of self-esteem add to the misery of being unable to repay loans.
Exacerbating the problem, Ireland’s draconian debt collection law emphasises borrower’s obligations to pay debts in full and overly protects creditor’s rights. Lenders and their debt collectors are engaged in an unsecured loan collection arms race, with each one trying to get into court first to stake a claim on a debtors household income. What’s more when banks start lending again, they will tighten lending conditions, charge more for loans and refuse credit to over-indebted households. Consequently many people, once considered good borrowers, will be marginalised and financially excluded.
Other societies have long recognised the adverse social consequences and economic costs of household unaffordable indebtedness. The Danes led the way in 1984 when they introduced a landmark personal insolvency system designed to provide a full debt discharge over a reasonable period of time during which people pay what they can afford and the balance owing is written off.
NAMA whilst designed to rescue banking from failure, will write off billions in unaffordable loans over time. Most of its customers are hopelessly insolvent or unable to repay their borrowings in full. They will pay what they can and NAMA will write off billions in debt – some say it may cost well over €30bn.
But what of ordinary people who cannot afford to pay what they owe in full? People who borrowed believing it was safe to do so and who made rational decisions based on their expectation of continuing income security? Their expectations were fostered by a government that first promoted a consumption boom and then a soft landing. It could well be that ordinary people will organise into a collective group and demand a “NAMA for the little guy”. In the absence of affirmative action that promises a way out of unaffordable debt, Government runs the real risk of a citizen’s debt revolt.
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