A debt writedown -- whether on some mortgages, all mortgages, or the most equitable and fair proposal, a haircut on all debt of any kind -- will hurt the banks significantly. They deserve it, you might say. The banks may indeed be deserving of the pain, given their greed for fee income from making risky and otherwise questionable loans and mortgages in the go-go days of 2002-07; certainly more deserving than many borrowers. However, people should think how they would feel if they lent money to someone and then had a third party -- like the government -- come in and order that the debt be written down to a fraction of the original principal amount.
If that happened to you, just think how you would feel, being forced to accept one-half of the amount you lent, as full satisfaction of the debt. Not only would you feel shortchanged, but how likely would you be to lend to anyone else every again? You'd face the constant threat of being forced to take a loss.
Who in their right mind would lend under such circumstances? Me neither.
Well, that's what would be in store if the people pushing a one-time debt forgiveness / principal reduction plan have their way. While the concept is undoubtedly more fair, treating all borrowers the same, and remedies the current unfairness and moral hazard of banks forgiving some of the principal of the least-deserving, worst repayment risks and most irresponsible borrowers, the danger remains that future lending may be sharply and understandably discouraged.
Our economy, and much entrepreneurship, depends largely on the use of credit and finance -- in short, the use of Other People's Money (OPM). A strong dampening of the impulse to lend -- or a sharp increase in interest rates to compensate lenders for the risk of government intervention to mandate future principal reductions and thus guaranteed lender losses -- threatens the most severe of consequences to future economic growth and could inhibit or outright stifle much private investment in this country.
Universal principal reduction might temporarily stimulate consumer spending as people, relieved of their debt burdens (or a portion thereof), feel richer. In fact, that would be true; debt forgiveness is the equivalent of a handout of hard cash, having an equal effect on the personal balance sheet. But the root problem is the economy's dependence on American consumers' consumption, the requirement that we spend -- no matter where the money comes from, whether from current income, credit cards or asset sales -- in order to keep the economy going.
True economic growth requires meeting the demand side of the equation. We need to make -- to manufacture -- things that meet the demand of a global marketplace.
Eric Dixon is a New York investigative lawyer who hanles business due diligence and litigation-related stress counseling.