Household debt amnesty?
It’s Saturday morning, which means it’s time to conduct a thoroughly absurd thought experiment just for the sake of argument. Today I want to consider the idea of a widespread household debt amnesty: everyone who owes money on their credit cards and payday loans and also perhaps mortgage will be forgiven their debt (although mortgages would have to be rewritten rather than forgiven). What would happen next?
I was discussing this very question, and David Graeber’s book (still not finished- it’s long!) with a friend of mine, specifically how Graeber cites ancient Sumerian civilization as having periodically enacted household debt amnesties to avoid the collapse of their cities (specifically to avoid the debtors from fleeing the cities to avoid their debt problems).
One thing that I realized in that conversation is that, whereas Graeber mentions that it was historically an amnesty for household debt only, so didn’t involve commercial debt between companies and merchants, what we’ve seen in this country in the past 3 years is something like the opposite of that concept. Our (large financial) companies have been granted special considerations while the people who had made the mistake of entering contracts with them have not. And the so-called mortgage modification process has not been sufficiently widespread yet to really consider it an example of this. There is an excellent article here which makes this point, although not in this context.
The objection my friend had to the idea of enacting such an amnesty was that it would be pouring good money after bad; he’s European so he cited the example of Greece, and how the more money Greece gets the more money they spend, so it’s an impossible situation.
Actually I think this is an appealing analogy to make, but it’s a false one. Greece has a large-scale system in place, and giving them money without changing that system clearly isn’t going to solve any long term problems- it just kicks the can down the road.
However, it’s really different with consumer debt (credit cards etc.). Namely, the “system” that a given consumer enters into is a simple relationship (contract) with the credit card company in question. If the debt is forgiven, then the credit card company doesn’t have any obligation to extend more credit to that person. And in many cases, it wouldn’t.
I think the consequences of a household debt amnesty would be something along these lines:
- People who were previously in debt would have some cash on hand and would be able to spend it on consumer stuff (that they can actually afford with no credit) instead of spending it all on minimum payments to old credit card debt
- Credit card companies, burned from their losses, wouldn’t give them new credit cards, or would change the payment arrangements to make sure they got their money back faster
- Since they have no credit, those people who essentially be living in a cash-dominated society. This may actually be a good thing, because it would force people to budget in real time.
- Eventually people could rebuild a credit score over time if they decided to try credit again
In other words, that’s really not so bad and would get money flowing through the system again, which might help with our current recession.
Of course not everyone would be happy about a household debt amnesty. In particular the people who aren’t debtors would feel pretty burned that they’ve been careful (or lucky) with their money and aren’t getting a free ride. And the credit card companies would have to eat a lot of loss. On the other hand they’re going to eat (and have eaten) a lot of loss already, and the slowness of this process is killing the economy.
Is there a way we could set it up to make this work? Even if we ignore the political obstacles?
mathbabe 
My quick response is “no fucking way, man!”
First, as you know, I have no hesitation about taking the banks and the Fed to task for their side of what happened. HOWever, two wrongs do not make a right and the facts remain that:
1. A lot of people took out mortgages for houses there was no way they could pay back and lived beyond their means on credit card debt.
2. There were a lot of other people who lived within their means and bought only the house they could afford.
If you have a mass forgiveness of debt, you’re creating a mass transference of wealth from group 2 to group 1. Think there’s no way around the reality of that analysis, and it’s massively and fundamentally unfair.
(EW writes extensively about how a lot more people in group 2 are in debt/bankruptcy than you might think, but there are still a lot more people and higher levels of debt in group 1.)
I know many people who saved for 5-10 years to get a down payment for a house, bought a house where they could comfortably cover their mortgage (i.e., a much smaller house than the bank was willing to loan them money to buy), and then had someone move in next door to a comparable house who hadn’t saved a penny and got a 0% down ARM with nowhere near enough income to pay the mortgage.
How is it in any way fair for the person who saves for five years and thinks about taking only what they can afford to pay for to get the same house as the person who didn’t?
FoW
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Also just saw this: recent data on bankruptcy filings.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1925006
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Well I *did* mention that it would have to be a “rewrite” for the sake of mortgages. And yes, it would strike me as unreasonable for someone who got a house with nothing down to be then given the house. But on the other hand there are lots of totally unreasonable contracts out there, still in effect, which could and should be rewritten.
Otherwise put, isn’t it at least worth considering how we could develop a system which is more fair than blanket amnesty but still allows people to get out of their debt prisons and gets cash into the system?
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One issue though is that with the new bankruptcy laws, it has become more difficult to declare bankruptcy. There should be another source to explain the distribution of the people who are informally going bankrupt.
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I think it’s important to differentiate between helpful and unhelpful cash-flow. If I pay a “luxury dog poo” manufacturer $1000 to deliver goods to my house, and then he spends $1000 on my “luxury cat poo”, society sees no benefit, and in fact both parties wasted time that could have been spent creating real wealth.
About 10 years ago an irrational friend of mine declared bankruptcy due to credit card debt. After being absolved of debt, she immediately fell in love with a new sparkly car, and got into a terribly expensive lease…I don’t see any value added to society by letter her, rather than the credit card companies, have her interest payments. The people I know who have fell into major debt trouble like to spend their money on luxury products that add nothing to productivity. I’m guessing that responsible people tend to spend proportionally more money on items that increase their own productivity.
There are exceptions to this of course. There are bankruptcy and welfare systems to try and help in these situations. How well they work is another question.
In summary, I’m not overly excited about transferring money into the hands of irrational spenders.
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I think you’re missing my point. My point is that spenders that have proven themselves irrational shouldn’t be given more money! If I’m the bank that lent that friend of yours money to buy the car then I’m the asshole, not her. In fact you could say she’s alot smarter than the bank, and perhaps you as well, since you didn’t get a new car.
Of course luxury products are stupid and useless, but they’re also irrelevant to this argument. People who want to buy luxury products and who can afford should be able to, and people who overspend for whatever reason will not find new banks willing to offer them more credit.
Out of curiosity, what is going on with that friend now? Has she paid off her car?
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And by the way, the top two reasons people are in serious debt is through medical bills and because they lost their job, not because they bought extra cars. That’s not to say that people are any good at budgeting for emergencies, they aren’t, but it’s definitely more complicated then just saying, we shouldn’t bankroll everyone so they can splurge on luxury items.
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I’m going to agree with Cathy (and channel EW) that luxury spending isn’t really as prevalent as a source of bankruptcy from a statistical perspective as it’s perceived to be and presented to be in the media. A lot of bankruptcies (perhaps the majority?) are through nothing that I would view as a “moral fault” (profligate spending) of the person declaring bankruptcy, although there are some subtleties (is buying a house in a neighborhood you feel is ‘necessary’ for the level of public school education you want for your child a luxury or a necessity?).
BUT, those profligate people do, in fact exist (Ian L knows one, and most people know or have heard of one), and when you talk about washing away debt you’re talking about a windfall gain for them, not to mention encouraging the same behavior and giving the people who “played by the rules” and didn’t go up to their eyeballs in debt a deep feeling that the system is screwing them for doing things the way they were supposed to do them (and that deep feeling is accurate: they *are* being screwed).
I’m not sure what a “rewrite of the mortgage” is–what were you thinking specifically? If it’s principal reduction, then it’s a transfer of wealth. The deep problem with this is that there’s nothing (at least nothing I can think of) that really helps the people who got in over their heads in mortgage debt that doesn’t constitute a transfer of wealth from non-borrowers to borrowers.
Why should a non-borrower give money to a borrower if both have the same income?
FoW
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Cathy–this should go without saying between you & me, but I’m responding because I think there are some problems with the idea, not because I think the idea is crazy–it may be radical, but these are crazy times.
I also think you’re right to bring the conversation back around to bankruptcy rules. Bankruptcy and debt are intertwined through the discharge/modification of debt in bankruptcy. It has gotten harder, and yet the number of bankruptcy filers has regained the levels pre-rule change. See here: http://www.calculatedriskblog.com/2011/01/consumer-bankruptcy-filings-increase-9.html.
Does Graeber discuss the bankruptcy rules in existence during historical debt amnesties? If debt was not dischargeable in bankruptcy and debts could pass down from generation to generation, then perhaps the blanket debt amnesties were something of a substitute for our modern system of bankruptcy in a sense?
FoW
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Totally understood. I like provocative ideas, especially if they are productive, and especially because I don’t think the system is working right now. And I know from the experience of trying to help someone declare bankruptcy since the rules changed, that it’s far more stringent than you’d think, and in the end doesn’t necessarily help the person enough. However, it doesn’t keep anyone from just stopping payments, which I refer to as informal bankruptcy.
I haven’t finished Graeber’s book, but he certainly discussed inherited debt, but the blanket amnesty discussion was not, I believe, in a culture with inherited debt per se. However, it was in the context of having to sell everything, and I mean *everything*, to clear your debt, as in selling your wife and children to slavery. So in that sense it was, of course, inherited. So you can see why people would flee their homes to avoid this.
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By the way, total consumer debt is 11.4 trillion dollars in the US, vast majority mortgage debt.
http://www.calculatedriskblog.com/2011/08/ny-fed-q2-report-on-household-debt-and.html
-FoW
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Cathy, I don’t keep in touch with my “shiny car luvr” friend (except facebook).
One point that hasn’t been brought up is possible contagion due to failing credit-card companies.
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While a complete consumer debt amnesty might kill too many financial institutions, a year’s consumer debt interest holiday might be more amenable. You would need the state to pay fees to the institutions, ostensibly to pay for scheme administration, but actually so that the well run ones survive the year.
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Contagion would be an understatement.
11.4 trillion dollars would wipe out not only the market cap of every single financial institution out there, but most of the bonds issued by financial institutions. Domino effects would be decimating pension funds (public and private), 401(k) accounts (any bond fund you hold and those lifecycle balance funds) and possibly cash sweep money market accounts.
On the other side of the coin, an “interest holiday” is a bit what we currently have on a de facto basis, between banks being unwilling (or unable legally) to foreclose on mortgages and the Bernack keeping interest rates near zero asymptotically. Unfortunately, it’s just not enough. Default rates and delinquency rates just keep climbing despite this–it’s just too much money owed.
FoW
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It sounds more like you want to allow something like “no-hassle bankruptcy” rather than true “amnesty.” The word “amnesty” makes it sound like a total free pass, as if credit histories would be wiped clean or something, which is not at all what you are talking about.
I agree with you that personal bankruptcy should be simple and easy. I see absolutely zero downside for this on society. A proper loan should be properly *secured*, which means that that the debt holder shouldn’t be hurt too much by default. An unsecured loan is just a gamble. The debtor’s only motivation for paying it back should be to protect his/her good name (i.e. credit score). That’s what justifies the high interest rates. The only losers would be credit card companies. Of course, this is precisely the reason why bankruptcies keep getting harder to do rather than easier.
On a side note, it drives me nuts when I hear that personal bankruptcy drives up everyone’s interest rates, as if people with good credit should be offered the same interest rates as people with bad credit.
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Agree it is a huge problem that many households have high debt, are underwater on mortgages, etc. This causes many hardships and we may be seeing the paradox in thrift in action, resulting in a worse economy.
Amnesty could offer huge relief to those in bad situations, but there are pretty big negative consequences more broadly. Bad as things are, we don’t seem near the state where this makes sense.
People already hit on bankruptcy as a resolution — this is a framework that is already established and has a long history, and offers relief when needed with fairly predictable consequences. There is definitely a stigma, but I think there is a lot of reason to make function better.
(1) I think cram downs for residential mortgages in bankruptcy make a lot sense now.
http://www.calculatedriskblog.com/2007/10/just-say-yes-to-cram-downs.html
(2) I can also see where student loan debt could be an enormous burden for some people who now have poor prospects to ever pay it off. Unfortunately, it is generally very hard to discharge student loans in bankruptcy. Some special protection is probably necessary so that lenders don’t fear a new graduate will immediately declare bankruptcy to clear the slate before even beginning a career, but the protection seems too strong now.
I don’t have a good sense where the costs for these would be paid — clearly a mix of banks, GSEs, and taxpayers. To some degree, costs are already baked in, and streamlining things will just bring the date that losses are realized nearer. Would be interesting to hear of more obstacles and potential solutions.
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Even in 2008-2009 credit dried up over a much smaller event where banks were concerned about recouping their loans. If household debt were just waived, then banks basically would never lend again to most people; they’d have a major risk of getting 100 percent loss on their loans. Car companies would collapse as sales plummet due to low financing available; I guarantee GM would be finished given where it is now. And forget about lending for mortgages. Already mortgage lenders are struggling (or defunct) over a much smaller default rate.
Basically, household debt amnesty would create a far worse version of the 2008 financial crisis. Losing 100 percent on a significant portion of its loans would annihilate financial institution after financial institution. Government bailouts of the necessarily size wouldn’t be feasible here.
Besides, why should people who were incompetent with their money get a free pass? They’d effectively be getting paid for spending recklessly. This is not really a wise transfer of money. Once they got away with it before they’d do it again most likely, if they got a bailout before.
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I’m not really saying we should do this (esp. not for mortgages), but let me argue that you can’t both claim that “banks basically would never lend again to most people” AND that “Once they got away with it before they’d do it again most likely”. The whole point is that banks would take the risk of losing their money more seriously so they WON’T LET people do it again.
As for how bad it would be, we have already been through one crisis, and the resolution failed to actually improve the situation. I think this kind of resolution would at least make banks take risk more seriously. Again, I’m not claiming it’s a perfect idea, but it is interesting and worthy of arguing as a starting point. In fact a previous commenter mentioned that what I really want is an easier way to declare bankruptcy, and I think that’s true; I’m not saying that banks shouldn’t know who defaulted and who didn’t.
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Well, let’s put it this way.. people would do it again *if they could*. Which means banks would be highly hesitant to lend to them. And if reckless people were able to find further sources of credit (something many are pretty resourceful at) they would be even more likely to overspend than before. A classic example (which I have actually witnessed) is people enrolling in for-profit universities for the express purpose of taking out student loans to pay for other things they want in the immediate future. Now you could argue that they might not be able to get student loans either… but think of the effect that would have.
Basically, there would be some convex combination of people not being able to get credit and people overspending. Most likely the former would prevail. And I think the economy would collapse in a more serious version of what happened in 2008-2009.
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I don’t think it was ever being suggested that banks just throw away all their mortgage documents and pretend no one owes them any money.
As someone who saved for several years to buy a house with a down payment, and who has an income sufficient to cover my mortgage, I have to say that while forgiving (some portion of) people’s debts seems unfair in all the obvious and previously mentioned ways, it also seems like it would improve my financial situation.
Perhaps banks could write down mortgages to different degrees, say forgiving a fraction of my debt that is proportional to the fraction of foreclosures in my neighborhood. (Or something.) This would (a) return valuations to something closer to “reality,” (b) allow more people to stay in their homes, which makes my life better if I live in a neighborhood where other people are foreclosing, (c) force the banks to eat it a little, which they certainly deserve, and (d) leave people with mortgages they can afford but still have to pay off.
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Actually, there was a story in July about Chase offering principal reductions on some of its portfolio mortgages, even ones in good standing. You can chase links from mathbabe’s post to get to Felix and his NYT source article.
But I think that’s rare. Much more often, it’s only mortgages in some stage of distress that can get a modification when it makes financial sense to both sides.
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Hey, I know this is like a month after Cathy originally wrote this, but I had some thoughts on implementing it.
It is worth noting a lot of top economists want to forgive mortgage debt in some way. Ken Rogoff and Carmen Reinhart ( who did a big volume on the history of financial crises), Paul Krugman, and Vernon Smith have all advocated for debt forgiveness, particularly for mortgages. Of interest, Reinhart mentioned that recoveries with debt-writedowns are much healthier than those without them in one of her interviews.
http://www.ft.com/intl/cms/s/0/a735bd32-e84b-11df-8995-00144feab49a.html#axzz1a4ZSz7TD
http://www.kiplinger.com/columns/dekaser-practical-economics/archives/carmen-reinhart-shares-grim-outlook-for-US-economy.html
One solution is to write down mortgages to reflect today’s values in exchange for appreciation down the road.
In terms of doing this through cram-down and your friend’s objections, some (McArdle at ‘The Atlantic’) have raised the point that a bankruptcy judge would probably put folks in a situation where they have to be disciplined in spending.
Another interesting point Cathy raises is the irresponsibility of bankers. A lot of people talk about debtors negatively and creditors in a warm-fuzzy way, despite the fact that some creditors were quite irresponsible.
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