Debt forgiveness: An outline of how it would work (if I was in charge)

If I made the debt forgiveness rules… If I could make the rules surrounding debt forgiveness they would be something like this:

1. you can only seek application for debt forgiveness via the bank and not on your own. This may sound odd but doing this helps pre-qualify the case and remove moral hazard. If you go in on your own in early days then no meaningful engagement will have occurred and your credit history isn’t shot [which is a fair outcome to getting debt relief].

Banks (via the Mortgage Arrears Resolution Process) are also in an idea position to know when a loan is unsustainable. This is further described in S.39 of The 2011 Code of Conduct on Mortgage Arrears

Where ‘unsustainable’ is defined as per the Expert Group Definition. Which is where you go 18 months into arrears or after a 5yr Deferred interest scheme doesn’t work . It is important to remember that banks are legally obliged to be in contact with borrowers and attempting to find work out plans along the way.

Effectively, we shouldn’t fund a department to do the job that banks are already doing, instead there should be a single state underwriter who ensures that debt forgiveness cases are not being advanced on the basis that it is easier to deal with the case in hand via a repossession & short sale than it is to work through it with set criteria.

2. There would be a ‘loss sharing’ mechanism whereby the bank and borrower sit down and decide how much each party will lose. If the bank made a risky loan at the outset they would have to take the entire loss (determined by looking at the legacy loan documentation), if it was a good loan and the borrower simply went under then I think it would be fair to make the borrower take more of that loss – full relief is for the hopeless cases. This part of the process could have an underwriting process the same way that advancing a loan does.

It would also be sensible to have a rule that puts more loss on the borrower if they volunteer this process rather than the lender (ie: if they want to initiate it), having said that you’d also need to ensure that there is some kind of research so that the banks don’t force people to initiate so that they get a better deal.

One addendum though would be this: If the bank want to claim that a person with limited income can afford a certain loan repayment in their opinion then this case can only be qualified if they turn around and give a person on the same circumstances a loan, simply put: call them on their bullshit.

3. Rather than having a claim over the borrower for a decade it would be limited to 5 years during which they are free to go back to work minus their PAYE allowance of €1,650 per year, so they do end up paying a bit more in tax (covering the cost of the underwriter) but it doesn’t create an unemployment trap. During that time you review their situation every year to determine (if the ruling resulted in them owing something during the process) a payment schedule for the next 12 months – which, if it is adhered to will mean that after 5yrs their credit record is good, if not then it is shot for another 5yrs.
During the entire workout period there should be no access to further credit unless creditors are repaid.

4. Schemes such as taking a share in the persons home would not be allowed for reasons that I set out here.

5. A certain time-frame for a decision would prevail if a person seeks a short-sale after which no interest can be applied. At present you can be waiting for 6 weeks to hear back from collections teams, if they are not in touch within a week I would have a rule that no interest can be applied until such time as they respond with a proper response (so not a ‘we got your letter thanks’ response).

6. Banks would publish their cost of funds taking losses into account, at present we don’t know what money is costing banks, all we know is that we have ploughed in €63bn+ into saving them. If branches are unprofitable they should be closed, and loans should not be advanced at a loss (new lending), if banks don’t like this brand of transparency it then they should get a different owner who isn’t the taxpayer.

7. There would be a non-judicial process in which the case would be determined (ie: this part would not be decided by the bank), perhaps MABS could do this, or the Central Bank could regulate debt advisors and allow them to do this, it would result in a small fee to both sides (for the borrower it would be paid for via the PAYE allowance eradication. For the bank it would be up front).

8. If the bank disagree there would be an appellate procedure but if they opt for this they cannot apply any interest or penalties from the time the first decision was made, and instead there is a reversal of this at whatever rate the bank would normally charge a borrower, so that instead it eats into their potential upside instead.

some of these things have already been taken care of by the Miscellaneous provisions bill 2011 (such as s7 which reduces the time/duration of a bankrupt), and much of it will be captured in the 2012 Personal Insolvency Bill due because of the IMF bailout.

I might put more into this as I dwell on the topic, if you have any thoughts or spot holes in it then please let me know! Perhaps it is something I can send on if it grows and gets better.

One Comment

  1. Colin Murphy

    Loan securitisation was the method that most banks used to raise funds prior to the Sub Prime lending crisis in the US. The problem in a nutshell was that the assets being sold had no guaranteed value and were based on a subjective valuation which had we now know had no real basis in fact.

    Our banks still have a problem in that approximately 10% of their loan book is non-performing and if recent trends are to continue this percentage is likely to increase.

    Our banks are capitalised to take into account the fact that a certain percentage of loans will never be repaid but we don’t know the level that this has been set at.

    If our banks were able to sell their loan book, thus moving it off the balance sheet it would reduce the capital requirements and allow the banks to stop storing cash and use to to start cash flowing through the economy.

    People are also saving what they can and as a consequence the cash flowing through the economy is falling. This will continue until we reach a tipping point and as it stands there is nothing being done to halt this.

    If the mortgages were guaranteed to offer a return then it is likely that they could and would be sold. So a potential solution without the need for debt forgiveness :

    Take an example of two 35 y/o non smokers with a 200k loan with a 35 year term. If the rate on the loan was fixed at 4% for 35 years and the interest was capitalised each year for 35 years, the debt would amount to approximately 800000 by the end of the 35 years. If a life policy was taken out in the clients names for 1.3M for 40 years it would cost approx 270pm and if this premium was charged to the debt at the outset and capitalised at a rate of 4% pa the total debt would amount to 1.3M in thirty five years.

    If this debt could then be sold for 315000, the loan would be cleared from the banks balance sheet and the life premiums would be paid in advance for forty years. The company buying the debt would have the life policy assigned and if the client dies within the 40 year life term they get the proceeds and the property reverts to the clients estate.

    If the client does not die that is a risk that they take, however the mortgage now becomes a saleable commodity as it carries some risk but it is more likely one party to the loan will die before the 75th birthday.

    If that risk is too great, then the mortgage holding banks takes out a whole of life policy and prices the debt accordingly.

    The machinations of this could be worked out by an actuary but the mortgage holder lives in the property without paying anything other than property tax and potentially a benefit in kind for living in the property mortgage or rent free, it frees up their disposable income to spend on goods and services which have VAT charged on them and it allows the bank reduce their capital requirements.

    The government borrows less, the bank borrows less and the property holder spends more. Win, win, win.

    And the words debt forgiveness need never be used.

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