Wednesday, October 19, 2011

Debt Forgiveness

The reason debt forgiveness or write-downs is a big deal right now is because consumers can't pick up spending if they are buried under a mountain of debt.

The Occupy movement has not called, to my knowledge, specifically for debt forgiveness, but has loosely referred to it in their declaration and elsewhere.

I am in favor of debt forgiveness because of the fraudulent way in which the loans were originally made. Much of the debt for housing taken on by home-buyers and offered by banks was simply fraudulent. The loans were predicated on house prices that were way above trend because of the speculative housing bubble and banks made them despite being well aware they likely wouldn't be paid back. To be fair, it takes two to make a loan, and consumers probably shouldn't have taken on the enormous amount of debt that they did, but when it comes to culpability, I put more of the blame on the bankers because they knew the risks and told people they could make it work anyway.

They told people that they could afford the loans they were handing out and then repackaging and selling to other banks all to make a buck. The bubble finally burst, banks were bailed out, debtors were not. The ones committing fraud were bailed out and not tried for their criminal actions and the ones who fell subject to that fraud are still being held subject to that fraud. They are still required to pay back that debt.

Bankruptcy is an option, and I don't understand bankruptcy laws all that well, but I do know that if you declare bankruptcy your credit score tanks and you've likely sealed your financial fate. Why should people who took on debt because banks gave it to them fraudulently be forced to declare bankruptcy when the banks would have gone bankrupt if not for a federal bailout?

When the government bailed out the banks, they should have also bailed out the debtors by writing down their debt or forgiving it all together. This whole fiasco is a major Moral Hazard problem on both sides and is inherent in unstable Capitalist economies.

The major point is that that debt need not exist. It was created fraudulently and should just go away. Banks will be fine without it and people will be much better off without it. It really might be the only way forward. Debt really is our problem in the U.S., but it's not the government's debt, it's private households' debt.

Consumers can then start spending again, which will increase sales, and increase employment, which will start the cycle back upward. Banks will then be willing to lend to businesses and households again.

It appears conservatives are also considering this option.

In my opinion this shouldn't be a cyclical thing (that would only increase the moral hazard). It should be a one-time write down on housing debt. The bankers responsible should be tried criminally for fraud. No one should be evicted if the bank doesn't have the mortgage and no one should be evicted if the loan was made fraudulently.

From a CST perspective, I think a write-down is necessary out of justice and for the common good. Going forward, banks and households in general need more temperance and a feeling of responsibility both toward debt. That is, a debtor should take on debt responsibly and creditors should only give to debtors responsibly. In our Capitalist economy, that is far from the case. Households often want more than they can afford and banks aren't shy giving it to them if they know they can make a buck and get bailed out if they fail. There is little to no view toward the common good in all of this and is, I think, the major underlying cause of the financial crisis.

UPDATE: I should have said that CST doesn't say anything specific about debt forgiveness. What I'm saying is 'I believe that, given the fraudulent nature of the loans, justice demands some forgiveness and that CST would agree', but it is up to you to apply CST to this situation, or to the Church to teach us how to apply her teaching to this situation. I haven't seen anything from the Church on this particular topic; if you do, please send it to me!

UPDATE UPDATE: This is my reponse to comments because the computer that I am on won't let me comment.

Darwin--I am no expert on these matters, I take my info from my professors. One is a former regulator and expert in financial law and another is a monetary system expert who has studied the workings of the Fed and the Treasury extensively. You can consult the video here and the blog posts of Bill Black at

Fr. Damien--I agree with you. I don't know that many student loans are/were fraudulent, but I do think a write down on student loans would be beneficial to the economy. The government is already actively involved in education 'investment' and investing in education is one of the best things you can do for the long run health of the economy. A big write down could be seen as an investment in our future, while at the same time improving things now by clearing consumer debt. I don't know what to do about students earning 'useless' (in terms of finding a job) degrees. That, to me, is unrelated to the fraud I am talking about.


  1. It seems to me that the question here is very much in the details, not in the standard meta narrative.

    You say:
    I am in favor of debt forgiveness because of the fraudulent way in which the loans were originally made. Much of the debt for housing taken on by home-buyers and offered by banks was simply fraudulent.

    I'm unclear that one could state that "much" of the housing debt out there is fraudulent, in part because in the current rhetorical climate I'm not sure what you mean specifically by "fraudulent". There was a relatively small number of cases where downright criminal mortgage brokers were getting people into loans that those people truly did not understand, and those mortgage brokers have generally be put out of business, and in some cases people sent to jail. But the number of in-trouble mortgages even now is relatively low. Looking around, it appears that the percentage of mortgages that are delinquent is under 1 in 10:

    Indeed, the number seems to be hovering fairly close to the unemployment rate -- perhaps not a surprising coincidence. Further, the issue is highly concentrated in a few areas of the country where people had a pretty good idea that housing values were crazy high. (As an ex-Californian I think I can attest to this pretty clearly. In fact, I moved away from there because of housing values.)

    While some people were in fact the victims of fraud, most people at most were convinced that their houses were worth a bit more than they were -- and so although they can afford their high housing payments (short of losing a job or some such) it's now hard for them to sell their houses at the going market price if the bought with little equity or took equity out.

    Giving these people some relief on their mortgage balances may look attractive in one sense, but it would very clearly be a transfer of money from those people who were more conservative in their housing decisions to those who were more profligate -- and in the end I think that would probably be wildly unpopular (not to mention being bad for the economy) once people got down into details.

  2. Hmm. Very interesting. So much more research needs to be done. As far as I know predatory lending is a crime so I think that those who were responsible should be arrested and their victims compensated. And for compensation they should be able to renegotiate their loan for the true value of their house plus a discount. Victims they might be but that shouldn't mean a free house.

    As for OWS I am surprised to see the most of the complaints are not for home loans but for student debt. I think student debt is in the same bubble as housing was. For years presidents have been saying that if a student wants to go to college they should be able to. Now students are up to their eyeballs in loans and credit cards. They were given easy loans with no way to pay it back. Yes they would get a degree, but that degree may be in Gender studies or something that is totally useless. And because of bankruptcy laws they are unable to get out. Does all of this sound familiar? I think this is also the failure of modern economics. It looks at things as a science instead of sociology. It fails to predict that people will work against their own future interest for temporary comfort. Students are borrowing money to get a degree that has no market value. To qualify for a student loans perhaps students should have to show their past grades and that their degree can be used to get a salary that will be able to pay it back. I should know, I ended up with a English Lit degree after 5 years and $36,000 debt. I could have gone back to become a teacher, but some can't do that with their degree. Luckily my diocese paid off my debt when I joined the priesthood. Or I might be down there begging for some debt forgiveness.