“Negative equity is only the tip of the iceberg on personal debt, writes Bill Hobbs”
Countless thousands of ordinary people, through no fault of their own, are caught in a spiral of indebtedness that may prevent them becoming productive members of society again for years to come. That unwelcome scenario faces many citizens unless an alternative debt resolution or modern personal insolvency system is put in place – and quickly.
In 1995 the ratio of household debt to disposable income was 46%. By 2009 this had risen to a world beating 176%. In the space of five short years, between 2003 and 2008, consumer mortgage debt rose by over €70bn and other personal debt rose by over €11bn (excluding lenders such as car leasing companies and credit unions). Much of the money was borrowed by people under 40, many of whom have personal debt they cannot ever hope to repay and are now or will shortly be living in a state of long term insolvency.
It seems that one in three mortgaged households will end up owing more than their homes are worth – in negative equity. This recent estimate is based on a 50% decline in house prices from their peak 2007 values. In drawing parallels with other countries experience of property busts, it’s said that 10% of borrowers could default. But as Ireland’s property bust is of unprecedented scale and impact, defaults will probably be far worse. By year end it appears upwards of 36,000 unemployed homeowners will be on mortgage interest relief income supplement. This does not include people earning an income who are struggling with mortgage and other debt repayments.
Negative equity is only the tip of a large ice-berg that threatens not only to freeze economic activity at recessionary levels for years to come but is also currently causing a social disaster. Consumer’s unaffordable indebtedness is not fully captured by headline negative equity statistics. Add the billions borrowed to finance cars along with lifestyle debt and the real landscape of personal indebtedness becomes clearer. Not only are those with mortgages caught in a debt spiral but tens of thousands of others are unable to make their loan repayments as they fall due.
Clearly it is manifestly unfair to commit people to unending indebtedness with little hope of becoming once again productive members of society. Modern advanced societies realise that honest people who can’t pay must be given a chance to get out from underneath unaffordable debt. In the US, debt resolution laws allow people to declare personal insolvency and exit with a clean slate in less than six months. European debt resolution systems which stress responsible borrowing, allow for full debt relief over a 3-5 year time frame.
What’s more advanced societies realise that unsophisticated consumers are hopeless at understanding risks when borrowing money. And realise that pursuing people who cannot pay through the courts to try to recover debt in full is an outdated system belonging to a time when borrowers knew more than bankers. At one time the power in the banker/borrower relationship rested with the borrower and banking was far riskier. Banks did not make loans to ordinary people because banks could not manage the risks involved.
Today, banks deploy sophisticated credit and behavioral scoring models in lending to ordinary people. They are better able to judge risks than borrowers. Explicit within this is the notion that the responsible lender and not just the responsible borrower must bear losses when consumer banking fails, as it has here in Ireland. The power in the banker/borrower relationship rests with banks that have the capacity to understand risk and act accordingly. Borrowers must pay what they can and banks must write off the balance.
The outcome of the banking crisis here has seen far too many people being marginalised, as banks are lending only to their better credit risk customers. And bankers will also undoubtedly escalate aggressive court based debt recovery, unless tempered by a fair and just alternative non-court debt resolution system.
So far talk has been about doing something for home mortgage holders. From earlier this year, banks have had to comply with a code of conduct in dealing with mortgage arrears – but this merely piles more sand on the land mine of unaffordable mortgage debt. It is abundantly clear solutions will have to be implemented to stave off what will otherwise become a home repossession nightmare no one wants.
Recently published, the Law Reform Commission’s consultation document on personal insolvency, proposes an alternative debt resolution scheme similar to ones used in advanced societies for decades. The Commission distinguishes between people who “can’t pay” their loans and those who “won’t pay”. Under its scheme those who “can’t pay” would earn a debt discharge over time. It would; have open access for honest and long-term insolvent people; be a legally binding debt settlement agreement between a borrower and their lenders; preserve a reasonable standard of living for people; and would result in a debt discharge after a reasonable length of time. As such schemes typically exclude mortgage debt; the Commission did not propose solutions for homeowner mortgages.
It seems that Government is to contemplate an alternative to the current Dickensian debt recovery system which jails people who cannot afford to repay their loans. But is it to be left to Law Reform Commission’s slow pace of inquiry and consultation to ensure a just equitable solution to personal indebtedness?
Creating an alternative debt resolution system is not the stuff of rocket science nor does it require a uniquely “Made in Ireland” solution. Proven systems and mechanisms exist elsewhere. All it takes is resolute government action to implement a system. Bringing all stakeholders together within a fast track process aimed at enacting the requisite legislation and executing on a new system is something that should be done immediately.
It should not be conveniently long fingered by political rhetoric and lame excuses that home repossessions are low.
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