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In America’s unenlightened past, men who couldn’t pay their debts were imprisoned. Languishing behind bars deprived them of any chance to repay their creditors, so the practice was stupid as well as cruel. During college, I came upon a trove of heartrending petitions to the Connecticut General Assembly from women seeking to have their debtor husbands released from jail. The petitions were, by and large, rejected.
Society has come a long way since, but not far enough. There is still a presumption that blood can be squeezed from a stone. That’s true in the U.S. housing market, where banks continue to insist that they will be able to collect full repayment of wacky mortgage loans that they never should have made in the first place. And it’s true in Europe, where creditor nations and banks are dragging their heels on writing down the sovereign debt of Greece, Ireland, and Portugal.
Why does this matter? Because debt—public and private, foreign and domestic—is the No. 1 issue of 2011. The perceived danger posed by debt dominates the political conversation in Washington and is the reason for the British government’s austerity program. In the absence of strong economic growth, debt burdens around the developed world will remain onerous for years to come—and yet while countries are single-mindedly focused on paying down their debts, it will remain harder for them to implement pro-growth policies. Getting the global economy moving again means accepting that some debts will never be repaid—and the sooner they’re forgiven, the better. “This will be the story going forward,” says Daniel Alpert, managing partner of Westwood Capital, a New York investment bank.
This is not an argument for welching by debtors who just don’t feel like paying up. Because the U.S. government, for example, is fully capable of covering all of the $14.3 trillion it owes, it should. And it will: The debt ceiling has been raised, albeit grudgingly, and even Standard & Poor’s still gives the U.S. a near-perfect AA+ rating. The real problem for the U.S. lies ahead. If it doesn’t bring revenues and expenses in line in coming decades, it really will be in a bad fix.
In contrast, there are some outstanding debts for which there is no prayer of full repayment. Collectively, U.S. consumers have reduced debt by more than $1 trillion since 2008, but for some, the burden remains intolerable. Start close to home, with American residential real estate. According to CoreLogic of Santa Ana, Calif., about 23 percent of mortgaged residences in the U.S. were worth less than the mortgages on them as of the end of March. In Nevada, the figure was 63 percent. Many of those homes’ owners can’t sell and move elsewhere to take a job because they can’t raise the funds to pay off the loan. In a very real sense, “an underwater home is a new version of a debtor’s prison,” says Edward Leamer, an economist at the University of California at Los Angeles.
Better options exist. Mortgage lenders could let families stay in their homes, but as renters, or reduce what people owe to around the current value of the homes. (Banks could demand to capture the upside if the home price rebounds.) Writedowns would enable people to sell if they need to. That would also lessen the chance that they simply walk away, which forces the banks to take on a vacant and nearly unsellable piece of real estate. Banks have preferred to extend terms or lower rates, rather than write down principal.
Banks resist writedowns because acknowledging the losses would leave them severely undercapitalized, and this is a lousy time to repair their balance sheets by selling equity. (Bank of America shares are down more than 40 percent this year as the extent of its real estate problems has become apparent.) To break the stalemate, Alpert says the government should let banks record the one-time hit to capital in equal installments over 10 years.
©2011 Bloomberg L.P. All Rights Reserved.
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