The IMF Has Said That Targeted Household Debt Reduction Policies Can Deliver Significant Economic Benefits.Posted on April 16, 2012 by Pat DonworthI believe the IMF’s current discussions about “debt forgiveness” are highly significant, so I am posting another article, this one from RTE. RTÉ.ie is the website of Raidió Teilifís Éireann, Ireland’s National Public Service Broadcaster.RTE | April 10, 2012The IMF has said that targeted household debt reduction policies can deliver significant economic benefits.The IMF has said that targeted household debt reduction policies – including mortgage write-downs – can deliver significant economic benefits.The International Monetary Fund made the comments in its latest World Economic Outlook.The IMF said such policies can substantially mitigate the negative effect of household deleveraging on economic activity.The report noted the well established link between high levels of household debt run up during a housing boom, and the effect of a high debt overhang on economic recovery. It found that countries, like Ireland, that saw house prices and household borrowing skyrocket, saw a longer than average period of recession after the bursting of the housing bubble.A large part of this protracted recession it said is due to households trying to reduce their debt levels, which in turn leads to less spending in the economy, driving the recession deeper and further.“Because debt is acting as a brake on economic growth, it is important to unstick the brake” said the report’s author Daniel Leigh.The IMF has studied the response of a number of countries to situations where large parts of the population are burdened with high mortgage debt in a recession, and finds that such programmes can help prevent self-reinforcing cycles of falling house prices and lower aggregate demand.“Such policies are particularly relevant for economies with limited scope for expansionary macroeconomic policies and in which the financial sector has already received government report”, notes the conclusions. Ireland meets both these criteria.The report highlighted what it calls the “bold ” household debt reduction programmes implemented in the US in the 1930′s and in Iceland in this crisis, which it said can “significantly reduce the number of household defaults and foreclosures and substantially reduce debt repayment burdens”.It contrasted these examples with others that have not been successful, such as the current response to the crisis in the US and Hungary, and the policies pursued in Colombia and the Scandinavian countries in the 90′s.As well as the “bold” approach, it said that ensuring a strong banking sector is crucial during the period of household deleveraging. It stated that the policies in Colombia and Hungary were not a success as they placed too much burden on an already fragile banking sector.It also said the policies must be designed to have incentives for both banks and borrowers to participate, notably by offering a viable alternative to default and foreclosure.The IMF noted that government support for household debt restructuring programmes involves clear winners and losers. “The friction caused by such redistribution may be one reason why such policies have rarely been used in the past, except when the magnitude of the problem was substantial and the ensuing social and political pressures considerable”,’ it stated.It cited another study which found that political systems tend to become more polarised in the wake of financial crises, and raised the question of collective action problems – that distressed mortgage borrowers may be less politically organised than banks – and this can hamper efforts to implement household debt restructuring.In the US in the 1930′s the Roosevelt administration introduced the Home Owners Loan Corporation, which bought distressed mortgages from banks with government bonds, with federal guarantees on principal and interest. It then restructured these mortgages to make them more affordable to borrowers.80% of the restructured loans (some 800,000) were protected from repossession by the measure, and the mortgages were subsequently sold on over time for a nominal profit at the time the programme was brought to an end in 1951. The mortgage purchases amounted to 8.4% of 1933′s GDP in the US.The IMF said “a key feature of the HOLC was the effective transfer of funds to credit constrained households with distressed balance sheets and a high marginal propensity to consume, which mitigated the negative effects on aggregate demand” caused by the recession and need for household deleveraging.The main mechanism to make loans more affordable was to extend the term of the mortgage – sometimes doubling the term – and converting it from a variable to a fixed rate. In a number of cases the HOLC also wrote off part of the principal to ensure that no loans exceeded 80% of the appraised value of the house.In the case of Iceland the situation was more difficult, due in part to the much bigger proportion of the population that was affected, and to the wide presence of foreign currency mortgages.The government and the newly constructed Icelandic banks developed a template to be used in case by case restructuring discussions between borrowers and lenders. The templates facilitated substantial debt write-downs designed to align secured debt with the supporting collateral (i.e bring the loan into line with the value of the house) and align debt service with the ability to repay.The IMF found that such case by case negotiations safeguard property rights and reduce moral hazard, but they take time. As of January of this year, only 35% of the case by case restructuring applications had been processed. To speed things up, Iceland has introduced a debt forgiveness plan which writes down deeply underwater mortgages to 110% of the households’ pledgeable assets.It noted that only when a comprehensive framework was put in place and a clear expiration date for relief measures announced that debt write-downs finally took off. As of January 2012, 15 to 20% of all Icelandic mortgages have been or are in the process of being written down.However, it said the jury is still out on Iceland’s plans, and said the extent to which Iceland can put its citizens back on their feet and minimise moral hazard remains to be seen.Source:http://www.rte.ie/news/2012/0410/imf-says-targeted-debt-reduction-policies-can-work.html via soundofheart.org
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