Debt relief

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Debt relief or debt cancellation is the partial or total forgiveness of debt, or the slowing or stopping of debt growth, owed by individuals, corporations, or nations.

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From antiquity through the 19th century, it refers to domestic debts, in particular agricultural debts and freeing of debt slaves. In World War I the United States Treasury made large loans to the Allies that were postponed, reduced and finally paid off in 1953. In the late 20th century, it came to refer primarily to Third World debt, which started exploding with the Latin American debt crisis (Mexico 1983, etc.). In the early 21st century, it is of increased applicability to individuals in developed countries, due to credit bubbles and housing bubbles.

International debt relief

First World War reparations

War debt payments by World War I Allies to the U.S. had been suspended in 1931—only Finland paid in full—and American public opinion demanded repayments resume as a condition of U.S. postwar aid. Germany had suspended its reparations payments due under the 1919 Versailles Treaty and payable to Britain, [1] [ verification needed ] France and others, as well as loans due to the United States. Chancellor Konrad Adenauer decided that permanent good will required their resumption. The 1953 Agreement on German External Debts, which resumed German's war reparations, is a notable example of international debt relief. [2] [3]

Less Developed Country Debt

Debt relief for heavily indebted and underdeveloped developing countries was the subject in the 1990s of a campaign by a broad coalition of development NGOs, Christian organizations and others, under the banner of Jubilee 2000. This campaign, involving, for example, demonstrations at the 1998 G8 meeting in Birmingham, was successful in pushing debt relief onto the agenda of Western governments and international organizations such as the International Monetary Fund and World Bank. The Heavily Indebted Poor Countries (HIPC) initiative was ultimately launched to provide systematic debt relief for the poorest countries, whilst trying to ensure the money would be spent on poverty reduction. [4]

The HIPC programme has been subject to conditionalities similar to those often attached to International Monetary Fund (IMF) and World Bank loans, requiring structural adjustment reforms, sometimes including the privatisation of public utilities, including water and electricity. To qualify for irrevocable debt relief, countries must also maintain macroeconomic stability and implement a Poverty Reduction Strategy satisfactorily for at least one year. Under the goal of reducing inflation, some countries have been pressured to reduce spending in the health and education sectors. While the World Bank considers the HIPC Initiative a success, some scholars are more critical of it. [5]

The Multilateral Debt Relief Initiative (MDRI) is an extension of HIPC. The MDRI was agreed following the G8's Gleneagles meeting in July 2005. It offers 100% cancellation of multilateral debts owed by HIPC countries to the World Bank, IMF and African Development Bank. [6]

One of the targets of the UN Sustainable Development Goals, specifically Goal 17, is to "assist developing countries in attaining long-term debt sustainability through coordinated policies aimed at fostering debt financing, debt relief and debt restructuring". This will help poor countries "reduce debt distress". [7]

Personal debt relief

Origins

Debt relief existed in a number of ancient societies:

If the debtor is in difficulty, grant him time till it is easy for him to repay. But, if ye remit it by way of charity, that is best for you if ye only knew.

— Qur'an 2:280 [9]

In the United States, the first serious movements to create debt relief were rooted in debtor farmer grievances against creditors. In the early 19th century, legislators created pathways for indebted farmers to take creditors to court to erase what they owed and enable them to start over. The first federal bankruptcy law, passed in 1841 and repealed in 1843, was re-introduced and expanded in 1867. At the time, this was a comparatively radical approach to debt relief in the world, making the United States one of the most debtor-friendly countries. [10] [11]

Contemporary

In the United States of America for the years preceding the financial crisis of 2007–2008, non-housing personal debt (auto loans, credit cards, student loans, etc.) rose significantly from approximately $2.05 trillion at the start of 2003 to a peak of $2.71 trillion in Q4 of 2008. It was not until Q3 of 2012 that unsecured personal debt reached this level again. Since that time, unsecured personal debt has risen steadily to $3.76 trillion at the end of the third quarter of 2017. [12] The other large change in unsecured personal debt is that an increasing portion of it is now student loan debt, from 12% in Q1 of 2003 to 53% in Q3 of 2017.

The increasing size of the non-housing personal debt market and ease with which one can obtain personal credit has led to some consumers falling behind on payments. As of Q3 2017, student loans have the highest rates of serious delinquency (90 or more days delinquent) with approximately 9.6% of all student loan debt falling into this bucket. Credit card debt and auto loan debt have serious delinquency rates of 4.6% and 2.4% respectively. [13]

When consumers begin to fall behind on payments, they have several options to discharge the debt, either in full or in part. The first method is declaring bankruptcy, which has the immediate effect of stopping any payments made to creditors. In the United States, the two primary avenues of bankruptcy for an individual are Chapter 13 bankruptcy and Chapter 7 bankruptcy. Another option is to consolidate these debts into a single loan, commonly known as debt consolidation. Debt relief, on an individual level, refers mainly to the negotiation for a reduction of a debt by either the consumer or a debt settlement agency. Through this arrangement, consumers agree to pay the creditor a fixed amount of money (generally a discount on their outstanding debt) either in a lump sum or under a payment plan. The debt settlement industry has had significant regulatory scrutiny since its inception with changes implemented in 2010 by the FTC. [14] As the disposition of personal debt is a highly regulated industry, consumers are urged by the FTC and other trade organizations to do significant research and find an independent credit counselor to guide them through the process. [15]

In 2019, the Texas Legislature forgave an estimated $2.5 billion in debt when it abolished [16] its "Driver Responsibility Surcharge" [17] in all but driving while intoxicated (DWI) cases. This surcharge was an extra three-year civil penalty added onto certain criminal traffic infractions like DWI or driving without a license or insurance. Surcharges were created in 2003 to pay for a roadway network that was never built, and instead half the money was diverted to hospitals, which became reliant on the money, with the rest going into the state treasury. However, the majority of drivers who had surcharges assessed could not pay them. Many people who could not afford either surcharges or insurance continued to drive and racked up huge sums in debt they could never expect to pay. A little-advertised amnesty program and an indigence program that still required partial payment helped some, and were criticized by some who felt it was unfair that they paid and others didn't. [18] But local sheriffs began to complain that the law was causing the jails to fill up with people driving on suspended license, and the judiciary insisted the law was unfair and counterproductive to public safety. [19] Finally, in 2019, the Legislature found different sources to fund hospitals and eliminated the surcharge, along with around $2.5 billion in debt owed by around 1.4 million people. The same year, the Legislature eliminated red-light cameras statewide and effectively canceled those debts, and re-defined "undue hardship" in the Code of Criminal Procedure to allow judges to waive traffic-fine debt for more people. [20]

Tax treatment

In US tax law, debt forgiven is treated as income, as it reduces a liability, increasing the taxpayer's net worth. In the context of the bursting of the United States housing bubble, the Mortgage Forgiveness Debt Relief Act of 2007 provides that debt forgiven on a primary residence is not treated as income, for debts forgiven in the three-year period 2007–2009. The Emergency Economic Stabilization Act of 2008 extended this by three years to the six-year period 2007–2012.

Bankruptcy and non-recourse loans

The primary mechanism of debt relief in modern societies is bankruptcy, where a debtor who cannot or chooses not to pay their debts files for bankruptcy and renegotiates their debts, or a creditor initiates this. As part of debt restructuring, the terms of the debt are modified, which may involve the debt owed being reduced. In case the debtor chooses bankruptcy despite being able to service the debt, this is called strategic bankruptcy.

Certain debts can be defaulted on without a general bankruptcy; these are non-recourse loans, most notably mortgages in common law jurisdictions such as the United States. Choosing to default on such a loan despite being able to service it is called strategic default.

Alternatives

Historical

The sick men's ward at Marshalsea debtors' prison Sick men's ward in the Marshalsea prison.JPG
The sick men's ward at Marshalsea debtors' prison

If a debt cannot be or is not repaid, alternatives that were common historically but are now rare include debt bondage—including debt peonage: being bound until the debt is repaid; and debt slavery, when the debt is so great (or labor valued so low) that the debt will never be repaid—and debtors' prison.

Debt slavery can persist across generations, future generations being made to work to pay off debts incurred by past generations. Debt bondage is today considered a form of "modern day slavery" in international law, [21] and banned as such, in Article 1(a) of the United Nations 1956 Supplementary Convention on the Abolition of Slavery. Nevertheless, the practice continues in some nations. In most developed nations, debts cannot be inherited.

Debtors' prison has been largely abolished, but remains in some forms in the US, for example if one fails to make child support payments.

Contemporary

In modern times, the most common alternatives to debt relief in cases where debt cannot be paid are forbearance and debt restructuring. Forbearance meaning that interest payments (possibly including past due ones) are forgiven, so long as payments resume. No reduction of principal occurs, however.

In debt restructuring, an existing debt is replaced with a new debt. This may result in reduction of the principal (debt relief), or may simply change the terms of repayment, for instance by extending the term (replacing a debt repaid over 5 years with one repaid over 10 years), which allows the same principal to be amortized over a longer period, thus allowing smaller payments.

Personal debt that can be repaid from income but is not being repaid may be obtained via garnishment or attachment of earnings, which deduct debt service from wages.

Inflation

Inflation, the reduction in the nominal value of currency, reduces the real value of debts. While lenders take inflation into account when they decide the terms of a loan, unexpected increases in the rate of inflation cause categorical debt relief.

Inflation has been a contentious political issue on this basis, with debasement of currency a form of or alternative to sovereign default, and the free silver in late 19th century America being seen as a conflict between debtor farmers and creditor bankers.

Impact

A 2024 study found that debt relief for debtors leads to a large increase in earned income, employment, assets, real estate, secured debt, home ownership, and wealth over subsequent decades. [22]

Another 2024 study found that debtors who receive debt relief are more likely to support incumbent governments. [23]

In art

Debt relief plays a significant role in some artworks. In the play The Merchant of Venice by William Shakespeare, c. 1598, the heroine pleads for debt relief (forgiveness) on grounds of Christian mercy. In the 1900 novel The Wonderful Wizard of Oz, a primary political interpretation is that it treats free silver, which engenders inflation and hence reduces debts. In the 1999 film Fight Club (but not the novel on which it is based), the climactic event is the destruction of credit card records, dramatized as the destruction of skyscrapers, which allows for debt relief. The television series Mr. Robot (2015–2019), follows a group of hackers whose main mission is to cancel all debts by taking down one of the largest corporations in the world, E Corp.

See also

Related Research Articles

Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor.

<span class="mw-page-title-main">Debt</span> Obligation to pay borrowed money

Debt is an obligation that requires one party, the debtor, to pay money borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Commercial debt is generally subject to contractual terms regarding the amount and timing of repayments of principal and interest. Loans, bonds, notes, and mortgages are all types of debt. In financial accounting, debt is a type of financial transaction, as distinct from equity.

<span class="mw-page-title-main">Debenture</span> Debt instrument

In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the company's liability to pay a specified amount with interest. Although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.

<span class="mw-page-title-main">Debt consolidation</span> Form of debt refinancing

Debt consolidation is a form of debt refinancing that entails taking out one loan to pay off many others. This commonly refers to a personal finance process of individuals addressing high consumer debt, but occasionally it can also refer to a country's fiscal approach to consolidate corporate debt or government debt. The process can secure a lower overall interest rate to the entire debt load and provide the convenience of servicing only one loan or debt. Debt consolidation is sometimes offered by loan sharks, who charge clients exorbitant interest rates. Further regulation has been discussed as a result.

Title 11 of the United States Code sets forth the statutes governing the various types of relief for bankruptcy in the United States. Chapter 13 of the United States Bankruptcy Code provides an individual with the opportunity to propose a plan of reorganization to reorganize their financial affairs while under the bankruptcy court's protection. The purpose of chapter 13 is to enable an individual with a regular source of income to propose a chapter 13 plan that provides for their various classes of creditors. Under chapter 13, the Bankruptcy Court has the power to approve a chapter 13 plan without the approval of creditors as long as it meets the statutory requirements under chapter 13. Chapter 13 plans are usually three to five years in length and may not exceed five years. Chapter 13 is in contrast to the purpose of Chapter 7, which does not provide for a plan of reorganization, but provides for the discharge of certain debt and the liquidation of non-exempt property. A Chapter 13 plan may be looked at as a form of debt consolidation, but a Chapter 13 allows a person to achieve much more than simply consolidating his or her unsecured debt such as credit cards and personal loans. A chapter 13 plan may provide for the four general categories of debt: priority claims, secured claims, priority unsecured claims, and general unsecured claims. Chapter 13 plans are often used to cure arrearages on a mortgage, avoid "underwater" junior mortgages or other liens, pay back taxes over time, or partially repay general unsecured debt. In recent years, some bankruptcy courts have allowed Chapter 13 to be used as a platform to expedite a mortgage modification application.

<span class="mw-page-title-main">Heavily indebted poor countries</span> IMF and World Bank classification for special eligibility

The heavily indebted poor countries (HIPC) are a group of 39 developing countries with high levels of poverty and debt overhang. Because of these factors, the International Monetary Fund (IMF) and the World Bank have classified them as eligible for special assistance.

The debt of developing countries usually refers to the external debt incurred by governments of developing countries.

<span class="mw-page-title-main">Paris Club</span> International organization

Paris Club is a group of major creditor countries aiming to provide a sustainable way to tackle debt problems in debtor countries.

<span class="mw-page-title-main">Household debt</span> Combined debt of all people in a household

Household debt is the combined debt of all people in a household, including consumer debt and mortgage loans. A significant rise in the level of this debt coincides historically with many severe economic crises and was a cause of the U.S. and subsequent European economic crises of 2007–2012. Several economists have argued that lowering this debt is essential to economic recovery in the U.S. and selected Eurozone countries.

In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. Unsecured debts are sometimes called signature debt or personal loans. These differ from secured debt such as a mortgage, which is backed by a piece of real estate.

<span class="mw-page-title-main">Debt collection</span> Pursuit of debt payments owed by an individual or business

Debt collection or cash collection is the process of pursuing payments of money or other agreed-upon value owed to a creditor. The debtors may be individuals or businesses. An organization that specializes in debt collection is known as a collection agency or debt collector. Most collection agencies operate as agents of creditors and collect debts for a fee or percentage of the total amount owed. Historically, debtors could face debt slavery, debtor's prison, or coercive collection methods. In the 21st century in many countries, legislation regulates debt collectors, and limits harassment and practices deemed unfair.

<span class="mw-page-title-main">Credit</span> Financial term for the trust between parties in transactions with a deferred payment

Credit is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately, but promises either to repay or return those resources at a later date. The resources provided by the first party can be either property, fulfillment of promises, or performances. In other words, credit is a method of making reciprocity formal, legally enforceable, and extensible to a large group of unrelated people.

<span class="mw-page-title-main">Credit counseling</span>

Credit counseling is commonly a process that is used to help individual debtors with debt settlement through education, budgeting and the use of a variety of tools with the goal to reduce and ultimately eliminate debt. Credit counseling is most often done by Credit counseling agencies that are empowered by contract to act on behalf of the debtor to negotiate with creditors to resolve debt that is beyond a debtor's ability to pay. Some of the agencies are non-profits that charge at no or non-fee rates, while others can be for-profit and include high fees. Regulations on credit counseling and Credit counseling agencies varies by country and sometimes within regions of the countries themselves. In the United States, individuals filing Chapter 13 bankruptcy are required to receive counseling.

Debt settlement is a settlement negotiated with a debtor's unsecured creditor. Commonly, creditors agree to forgive a large part of the debt: perhaps around half, though results can vary widely. When settlements are finalized, the terms are put in writing. It is common that the debtor makes one lump-sum payment in exchange for the creditor agreeing that the debt is now cancelled and the matter closed. Some settlements are paid out over a number of months. In either case, as long as the debtor does what is agreed in the negotiation, no outstanding debt will appear on the former debtor's credit report.

A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral, and if the borrower defaults, the creditor takes possession of the asset used as collateral and may sell it to regain some or all of the amount originally loaned to the borrower. An example is the foreclosure of a home. From the creditor's perspective, that is a category of debt in which a lender has been granted a portion of the bundle of rights to specified property. If the sale of the collateral does not raise enough money to pay off the debt, the creditor can often obtain a deficiency judgment against the borrower for the remaining amount.

Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay their creditors. In most cases personal bankruptcy is initiated by the bankrupt individual. Bankruptcy is a legal process that discharges most debts, but has the disadvantage of making it more difficult for an individual to borrow in the future. To avoid the negative impacts of personal bankruptcy, individuals in debt have a number of bankruptcy alternatives.

<span class="mw-page-title-main">Debt management plan</span>

Debt management plan (DMP) is an agreement between a debtor and a creditor that addresses the terms of an outstanding debt. This commonly refers to a personal finance process of individuals addressing high consumer debt. Debt management plans help reduce outstanding, unsecured debts over time to help the debtor regain control of finances. The process can secure a lower overall interest rate, longer repayment terms, or an overall reduction in the debt itself.

<span class="mw-page-title-main">Student loans in the United States</span> Loans incurred to pay for higher education

In the United States, student loans are a form of financial aid intended to help students access higher education. In 2018, 70 percent of higher education graduates had used loans to cover some or all of their expenses. With notable exceptions, student loans must be repaid, in contrast to other forms of financial aid such as scholarships, which are not repaid, and grants, which rarely have to be repaid. Student loans may be discharged through bankruptcy, but this is difficult. Research shows that access to student loans increases credit-constrained students' degree completion, later-life earnings, and student loan repayment while having no impact on overall debt.

Debt deflation is a theory that recessions and depressions are due to the overall level of debt rising in real value because of deflation, causing people to default on their consumer loans and mortgages. Bank assets fall because of the defaults and because the value of their collateral falls, leading to a surge in bank insolvencies, a reduction in lending and by extension, a reduction in spending.

The International Monetary Fund (IMF) has operated in Malawi since 1965.

References

  1. ↑ "Why has Germany taken so long to pay off its WWI debt?". BBC News. 2 October 2010.
  2. ↑ William N. Goetzmann; K. Geert Rouwenhorst (2005). The Origins of Value: The Financial Innovations that Created Modern Capital Markets. Oxford University Press. pp. 336–38. ISBN   9780195175714.
  3. ↑ Timothy W. Guinnane, "Financial Vergangenheitsbewältigung: The 1953 London Debt Agreement" (Economic Growth Center, Yale University, 2004) online
  4. ↑ Harold J. Johnson (1998). Developing Countries: Status of the Heavily Indebted Poor Countries Hipc Debt Relief Initiative. DIANE Publishing. pp. 2–10. ISBN   9780788179228.
  5. ↑ Jürgen Kaiser (22 February 2016). "Back to square one". D+C, development and cooperation.
  6. ↑ International Monetary Fund (2009). Regional Economic Outlook, October 2009: Sub-Saharan Africa - Weathering the Storm. International Monetary Fund. p. 41. ISBN   9781451996012.
  7. ↑ United Nations (2017) Resolution adopted by the General Assembly on 6 July 2017, Work of the Statistical Commission pertaining to the 2030 Agenda for Sustainable Development (A/RES/71/313)
  8. ↑ Harms, William (1996-02-01). "Linking ancient peoples". The University of Chicago Chronicle. 15 (10). Retrieved 2009-02-26.
  9. ↑ "Islamic Relief Worldwide - Faith inspired action" (PDF). Archived from the original on 2009-12-31.{{cite web}}: CS1 maint: unfit URL (link)
  10. ↑ Waters, Michael (2024-10-30). "An Overlooked Path to a Financial Fresh Start". The Atlantic.
  11. ↑ Zackin, Emily; Thurston, Chloe N. (2024). The Political Development of American Debt Relief. University of Chicago Press. ISBN   978-0-226-83237-1.
  12. ↑ "The Center for Microeconomic Data - FEDERAL RESERVE BANK of NEW YORK". www.newyorkfed.org. Retrieved 2017-11-28.
  13. ↑ "Total Household Debt Increases, Delinquency Rates of Several Debt Types Continue Rising - FEDERAL RESERVE BANK of NEW YORK". www.newyorkfed.org. Retrieved 2017-11-28.
  14. ↑ "FTC Issues Final Rule to Protect Consumers in Credit Card Debt". Federal Trade Commission. 2010-07-29. Retrieved 2017-11-28.
  15. ↑ "Choosing a Credit Counselor". Consumer Information. 2012-11-01. Archived from the original on 2017-11-29. Retrieved 2017-11-28.
  16. ↑ Closson, Troy (2019-08-20). "Texas' Driver Responsibility Program ends next month. Here's what that means for you". The Texas Tribune. Retrieved 2020-02-13.
  17. ↑ Gritsforbreakfast (2019-06-28). "Grits for Breakfast: Driver Responsibility surcharge abolition, by the numbers". Grits for Breakfast. Retrieved 2020-02-13.
  18. ↑ Gritsforbreakfast (2010-11-07). "Grits for Breakfast: Does DRP amnesty punish those who play by the rules?". Grits for Breakfast. Retrieved 2020-02-13.
  19. ↑ Gritsforbreakfast (2011-01-10). "Grits for Breakfast: Declining DWI convictions and the unmitigated failure of the Driver Responsibility surcharge". Grits for Breakfast. Retrieved 2020-02-13.
  20. ↑ Gritsforbreakfast (2019-05-30). "Grits for Breakfast: Scaling back justice debt biggest #cjreform accomplishment of 2019 #txlege". Grits for Breakfast. Retrieved 2020-02-13.
  21. ↑ The Bondage of Debt: A Photo Essay Archived 2016-03-04 at the Wayback Machine , by Shilpi Gupta
  22. ↑ Bruze, Gustaf; Hilsløv, Alexander; Maibom, Jonas (2024). "The Long-Run Effects of Individual Debt Relief". The Review of Economics and Statistics. doi:10.1162/rest_a_01525. hdl: 10419/300943 . ISSN   1556-5068.
  23. ↑ Aidt, Toke; Asatryan, Zareh; Badalyan, Lusine (2024). "Political Consequences of Consumer Debt Relief". The Review of Economics and Statistics. doi:10.1162/rest_a_01531. hdl: 10419/265422 . ISSN   1556-5068.
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