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Tuesday, October 4, 2011

Caution Urged on Debt Jubilee Universal Principal Reduction Idea

Recent stock market troubles have sparked serious consideration of a "debt Jubilee" in which all debt receives a "haircut" or permanent, one-time principal reduction.  However, this proposed solution to the current economic stagnation (recession?) might be a cure that would be worse than the disease.

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.


1 comment:

  1. While recent stock market troubles may have prompted economists to call for a "debt jubilee" or a "bondholders haircut", debtors in the third world have been calling for a jubilee for decades.

    In America: government, business, individuals are buried under a mountain of debt. A mountain of debt that will never be repaid.
    Who will borrow when they can't make the payments on the debt that they have already? The math alone calls for a debt jubilee.

    Perhaps you are just concerned about investors losing more in a rigged monetary casino that rewards usury, speculation, and currency manipulation while looting main street.

    The banks are indeed deserving pain, I would like for you to expound on that. Economies exist for human survival. People work to put bread on the table and a roof over their heads. On the other hand there are "too big to fail" institutions who want to make a killing rather than a living. Goldman Sachs, JP Morgan, Bank of America and the other oligarchs and their corporations who think that they rule the world.

    Debts should be honored. That is, debts between businesses, between individuals, between friends, debts based on solid investments where there is a rational expectation of return. These are debts that are based on realistic arrangements. However, debts that are 'odious', debts based on fraud, debts to dictators, debts based upon compounding interest that should have been written off long ago, the debts need to be cancelled in a jubilee.

    It's the taxpayers that are being shortchanged in today's economy. Bailing out speculators in programs like TARP and making the public pay for it is what? It's not free market capitalism, where those who make foolish choices lose their ass(ets), and rightly so. It's the taxpayers who are picking up the tab.

    Time for a Jubilee. Sound the trumpet! Proclaim Liberty throughout the land unto all the inhabitants thereof.