Debt reduction can work - IMF

 

"Bold" household debt restructuring programmes can help prevent recessions becoming deeper and more protracted, according to research by the International Monetary Fund.

In its bi-annual assessment of the health of the global economy, the fund cites evidence from a range of countries where mechanisms have been put in place to cut debt levels.

The study said restructuring household debt “can significantly reduce debt repayment burdens and the number of household defaults and foreclosures.

Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.”

In a chapter of the World Economic Outlook report entitled “Dealing with household debt” the IMF economists find that recessions preceded by periods in which households have run up large debts tend to last “at least five years”.

A number of the case studies cited in the paper may have relevance for the Irish situation. A large and growing proportion of mortgage holders are not meeting their repayments.

The report specifically cites on-going debt reduction efforts in Iceland. The IMF had a significant input into the design of these mechanisms as it was the main source of funding to the north Atlantic state when it was unable to borrow internationally after the collapse of its banking system in 2008.

The report notes that the case-by-case approach in Iceland to writing off debts of households who had little of no chance of repaying them proceeded slowly.

In order to accelerate the process, a blanket scheme was introduced whereby all household debt in excess of 110 per cent of household’s “pledgeable assets” was written down.

The report said that as of January this year, 15 to 20 of all mortgages have been, or are in the process of being, written down.

The study concludes with a comprehensive framework and an explicit timeframe are necessary for restructuring programmes to be effective.

Mirroring the situation in Ireland, the report finds that “strong capital buffers may be insufficient to encourage banks to restructure household debt on a large scale, as is evident in the US today.”

The report acknowledges that government-supported restructuring schemes do involve one group in society effectively subsidising those who benefit from the scheme, but the case for doing so depends on the net cost/benefit for the economy as a whole.