Debt forgiveness is not moral hazard

Our elite public servants are refusing to face up to the unaffordable debt crisis. Regulator Mathew Elderfied, NAMA chairman Frank Daly and Justice Minister Dermot Ahern, ruled out debt forgiveness for ordinary people. All three raised the spectre of moral hazard without providing any substance to it back up. It’s a Dickensian argument for penal debt servitude that once committed people to debtor’s prisons.

About 80,000 households are struggling with mortgage debt. Most also have personal loans they cannot afford to repay. They are the tip of an iceberg, barely visible within the opaque fog of sparse official data. If consigned to debt servitude a generation of enterprising business people -job makers - may never create another job.

Instead of arguing moral hazard, what’s needed is a just, equitable and humane system to order the scale of debt forgiveness required to write off, some but not all of, the billions recklessly lent to ordinary people. The bit that should be written off represents that portion people have no hope of ever repaying. It includes their unsecured personal loans, credit card debt, personally guaranteed business loans and unaffordable negative equity.

A recently reported court case starkly illustrates why there must be a just and fair debt settlement system. The case involved a credit union pursuing a customer for repayments on €36,000. She also owes another €103,000 in bank loans. Despite knowing she suffers from a terminal illness, her credit union subjected her to the ignominy and stress of this country’s draconian debt collection system. Unable to work, her only source of income is a meagre weekly disability payment of €200 and €150 a month children’s allowance for her young son. It’s far less than required to live life with dignity. Hamstrung by the law, a humane judge set repayment at €10.00 a week and noted it would take 69 years to pay off the loan. The credit union could have written off the debt but it didn’t.

Pursuing people for debts they have no means of repaying is not unique to credit unions. Some banks and finance houses engage in a ruthless race to grab their share of wallet first, which is why court lists are burgeoning from debt recovery actions. Many outsource debt collection to specialist agents who hound people dragging them in an out of court. It is an inhumane, inequitable system known to cause significant economic and social costs.

Alternative debt settlement systems exist in other countries where the principle of “earned debt forgiveness” applies. They have organised, regulated debt settlement processes permitting people to work their way out of near hopeless insolvency. Including for debt forgiveness, their settlement programmes are far from soft on borrowers but critics of such debt settlement systems here warn of moral hazard without being able to produce a shred of supporting evidence other than to allege that free riders will abuse debt forgiveness. They also say that “good” people who didn’t over borrow will not want to bail out the “bad” people who did.

The principle of debt forgiveness means a person pays what they can and the balance owing is written off. The deal is; if they pay what they can over a specified period of time, usually five years, their lenders agree to write off the balance owing at the end of the debt settlement period. They earn the legal right to be forgiven some but not all of their debts. It’s what happens during the five years or so of the agreement that matters. People are legally required to commit every cent earned above a basic living allowance to repay their debts. During the debt settlement period, families are forced to live on near breadline incomes. But they know that if they keep to their part of the bargain they can once again participate fully in society. Business people know they can build new businesses and once again create jobs. Lenders know they will not incur debt collection costs and can plan to fund their loan write downs. And governments know the economic and social costs of unaffordable indebtedness are minimised.

Moral hazard argument that people will abusively financially plan for debt forgiveness is nonsense. Who in their right mind would plan for five years of extreme debt servitude required to earn debt forgiveness? In any event such systems are carefully designed and supervised to mitigate moral hazard risks. They also ensure costs are equitably carried by reckless borrowers and reckless lenders. As lenders can better assess and manage credit risk they pay the most.

In other countries the principle of debt forgiveness underpins their entrepreneurial business class and whole economies. Their business people know that if they fail they will not be consigned to a life of penal debt servitude. This safety net of structured forgiveness is a fundamental requirement and necessary condition for risk taking which is wholly absent here. Our debt collection and personal insolvency bankruptcy laws commit people to 12 years servitude and longer if they cannot pay the costs involved.

The cost of living in modern society is the risk that a credit bubble will cause an eruption in unaffordable debt. The problem is bigger than our neighbour’s reckless borrowing. It cuts to the heart of economic recovery.

A version of this article appeared in the Irish Examiner, Business Section, Monday 7th June 2010