Scaremongering is little excuse for doing nothing

Financial institutions need to face up to debt forgiveness sooner or later, writes Bill Hobbs

Following AIB’s reference to debt forgiveness, the airwaves were full of shrill, uninformed, misleading commentary that forgiving debt is unfair, inequitable and an unbearable cost to the taxpayer. But debt forgiveness will have to be faced up to and paid for. Bankers know this. They realise there must be an organised and effective debt settlement system through which they can plan for the billions they will have to write off as uncollectible debt.

The scale of the debt forgiveness required was starkly illustrated in the Central Bank’s recapitalisation programme which provides for consumer loan losses of upwards of €12.1bn. The total sum could amount to over €20bn when other banks, credit unions, utility companies, credit card companies and finance and leasing outfits are factored in. Home mortgage losses alone could amount to a conservative €5.5bn. Translating figures into real people is difficult. With 100,000 home mortgage loans in trouble upwards of 30,000 may have to be repossessed.  Last week’s Irish League of Credit Unions’ disposable income index estimated that 735,000 people were seriously financially vulnerable.

Other countries have long provided for debt forgiveness through structured processes in which people can earn it. People negotiate a collective agreement with all their creditors to pay what they can for a fixed period of time. During this time they must live off a basic income calculated to allow them live life with dignity. The balance of what they earn is paid to their creditors. If they stick to the plan, when it concludes any balance owing is written off. Such a process has been designed by the Law Reform Commission (LRC) and should be implemented without any further delay as reforming our bankruptcy laws is part of the IMF/EU programme.

Yet AIB’s mention of debt forgiveness sparked a negative public reaction. The shrillest anti-debt forgiveness voices last week included boom time cheerleaders who now tout themselves as “experts” on consumer indebtedness. They are people who promoted and sold 100% interest only loans to first time house buyers while gagging any critique of dangerous credit products and the property boom. They are now talking up debt forgiveness “moral hazard”. They warn that people will deliberately plan to benefit from debt forgiveness. It’s a bit like saying people would willingly contract a terminal disease to get a free medical card.

Many others say “I should not have to pay for the sins of my neighbour”! But this flies in the face of reality. The vast majority who bought into our credit fuelled consumerist economy did so naively without realising the risks they were taking. Had they realised they could lose their jobs and have their incomes savagely cut, they would not have borrowed as much. Are they to be denounced as sinners for being too human? It is nonsense to suggest that people should be forced to live non-productive, miserable lives to assuage others misplaced outrage.

It’s important not to mix negative equity with loan affordability. Many can afford their loan repayments even if they are in negative equity. These people, through accident rather than design, are able to pay their way even if their neighbour cannot. As their home may not be worth what they paid for it until at least 2025, it should be possible to create a financial product through which they can manage negative equity, freeing them up to sell and move home.

If implemented the LRC’s system will allow people earn the right to get out from under the crushing weight of unaffordable debt. But its system does not deal with mortgage debt save to say that any balance owing after a house is repossessed could become part of its debt settlement process.

Current attempts to deal with unaffordable mortgage debt will fail as they do not address the core problem. People owe too much. Temporarily reducing repayments simply kicks the can down the road. The only way to deal with the problem is to write down loans to affordable levels. If people can afford to repay a loan equivalent to the current value of their home then they should retain possession. The balance could be written down through a debt settlement agreement or parked until it can be repaid. Qualifying would require rigorous stress testing using a maximum affordability level such as say 30% of gross income. Should a person be unable to make repayments then only one realistic option exists – short selling, where the home is sold for what it’s worth and the balance is written off immediately or through a debt forgiveness programme.

Whichever way you look at it, billions will have to be written off through some form of debt forgiveness programme. Moral hazard scaremongering is a thin excuse for doing nothing.

A version of this article appeared in the Irish Examiner, Business Section, Monday 18^th April 2011.