Understanding causes of consumer debt crisis is key to solving it

Group set up to fix the credit crisis excludes many experts, writes Bill Hobbs

Almost two years on the Government has finally officially recognised the consumer credit crisis exists. But its announcement of the setting up of an expert group to look at solutions for consumer indebtedness was given a jaundiced welcome not only for what the group would be doing but for the absence of balanced expert participation and representation of the ordinary person. People experiencing the stress of unaffordable indebtedness can take little comfort from the announcement.

The expert group chaired by a corporate insolvency expert, comprises representation from the IBF, Financial Regulator, Free Legal Aid Centres, the Law Reform Commission, two accountants, a retired bank CEO and ssenior officials of the Departments of Finance, Taoiseach, Justice, Equality and Law Reform, Social & Family Affairs and Environment, Heritage & Local Government.

The expert group is remarkable for who hasn’t been included. MABS with almost two decades of experience in debt management during which it recently piloted a scheme with the IBF has been excluded. So too has the National Consumer Agency which is being merged with the Competition Authority, and is taking responsibility for part of the financial services consumer protection mandate. Informed observers hope FLAC and the LRC participants will balance indebted consumer’s expectations against what appears to be a bias towards the creditors or bankers interest.

On record in recommending first time buyers to use interest only mortgages and risk over borrowing in buying as big a home as possible, one of expert groups non-government members, commenting recently on mortgage unaffordable indebtedness wrote “Calling it the family home in some way confers a sacredness on it. We should not be doing this. If people lived a very high lifestyle and are now over borrowed, then they have to pay the price”.

Are similar views widely shared? Some commentators have recently suggested that people will deliberately use a personal insolvency system as a financial planning tool to protect their family home. Last week an eminent economist warned of the moral hazard risks in debt forgiveness. Such thinking appears to reflect an outdated Dickensian concern that people will abuse a personal insolvency financial safety net and the tax payer will have to carry the can.

Mature democracies have long since created schemes that effectively deal with such moral hazard argument. They have provided just and fair systems that limit the economic and social costs to society. More importantly these systems provide a future to people to live a productive life free from the stress of debt.

Crafting a financial safety net for people who are hopelessly insolvent and allowing for debt forgiveness is an issue that gives rise to emotive, ill-informed, naïve and scare mongering commentary. It seems some commentators may not fully appreciate the Law Reform Commissions recent proposals in which it carefully considers international precedents and recommends a non-court based personal insolvency regime for people who are unable to pay their debts in full. Its report deals with amongst other things moral hazard, an unwillingness to pay, earned debt forgiveness and discusses the social and economic principles that underpin fair and equitable debt resolution and forgiveness systems.

But many believe that banking stabilisation and banking profitability will override any consumer indebtedness initiatives. All the more so as the Government will want to ensure solutions are subordinate to its NAMA project and principal objective of ensuring a working banking system. The reality is that the consumer debt crisis will have to be dealt with, within the context of rebuilding a working banking system. And as the banks will probably be unable to raise capital from investors, the state will have to provide additional capital to fund their consumer debt losses, structuring a consumer debt resolution scheme will not be easy.

Owing more than €185bn in personal debt of which €147bn is in mortgage finance Irish consumers are the most indebted in Europe. Without counting personally guaranteed small business debts. Over 250,000 households are probably by now in negative equity, 440,000 are unemployed and many more are on short time or have suffered income reduction. Along with increased taxation people are now facing higher interest rates caused by deflation and banks increasing their lending margins and charges. While incomes and living costs are declining, loan balances are not and the cost of financing their repayment is rising. Financially vulnerable households experiencing and anticipating problems accounted for over a third of the population last year. Tens of thousands of registered unemployed are on mortgage interest relief subsidies. No one knows how big the problem is and how much will inevitably have to be written off by the banks. If loan losses are 10% then the write offs will amount to well over €18bn.

There are two components of the consumer credit crisis. Home mortgages and other personal and personally guaranteed debts. Both require different solutions. The Law Reform Commissions proposals for a personal insolvency regime exclude mortgage debt and are based on the internationally accepted principle of debt forgiveness which is earned over time. It is also based on the principle that people pay what they can and lenders write off the rest.

Mortgage debt is complex and there are no easy solutions nor is there a one size fits all approach that will work. Solutions will have to allow for a continuum of un-affordability, from people having temporary short term repayment difficulties to those who are hopelessly insolvent. The current moratorium on legal action and other reliefs are insufficient. As many homeowners have mortgage and other debts, the overriding principle of any scheme will be to prioritise family home protection.

While consumer debt forgiveness may not be on the agenda – for now - it will be in time. You cannot expect people to pay debt they manifestly cannot afford to pay.

Whatever the expert group proposes does it should do it transparently and report on its findings particularly the scale and depth of the consumer credit crisis. To date no one has been tasked with understanding the causes of the consumer debt crisis.


A version of this article appeared in the Irish Examiner, Business Section, Monday 1st March 2010