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When Everyone Has Bad Credit…

I’ll give them heroics. I’ll give them the most spectacular heroics they’ve ever seen! And when I’m old and I’ve had my fun, I’ll sell my inventions so everyone can be superheroes! Everyone can be super! And when everyone’s super, [laughs maniacally] no-one will be.

                                                                    ~Syndrome from The Incredibles

In a recent post on Business Insider,  Henry Blodget  (yes, that Henry Blodget)  laments the fact that no one is talking about “An Easy Fair Solution to the Global Debt Crisis.”

That solution is Bankruptcy. As Blodget puts it “Since the dawn of time men have been lending other money (or other things of value) and not getting paid back, but it is only recently that the solution to this state of affairs has gotten so complicated that even PhD economists can’t figure it out.”

While there may be a reluctance of society at large to accept or embrace bankruptcy, default and foreclosure; the good news is that there is a growing discussion and acceptance of the problem at hand:  The global financial system is awash in an ocean of debt that is unlikely to be repaid.

Blodgett is slightly off mark in failing to note that the preferred political solution is to bypass bankruptcy and simply inflate away the debt.  In the age of information however the general populace has caught on to the deceit of inflation, and the politician’s preferred solution may not be politically feasible.

With the growing acceptance of the problem at hand and the accompanying realization in that the debts are not going to be paid back, the questions becomes now what?

In The Great Haircut, Reuters’ reporters Jennifer Ablan and Mathew Goldstein discuss the idea that in response to a consumer debt trap “many economists are calling for a radical step: massive debt relief.”

The ideas range from a type of brokered “out of court settlement between institutional bond investors, banks and consumer advocates,” to a more radical “Debt Jubilee to forgive excess mortgage and credit card debt for some borrowers.”

The Reuter’s report cites real estate data and analytics company CoreLogic in noting that 22.5 percent of U.S. homeowners owe more on the mortgage than the house is worth.  A number of those advocating debt forgiveness  suggest that mortgage balances be re-worked or rates be re-financed for homeowners who are seriously delinquent.

What is left unsaid is how this is “fair” or appropriate for those homeowners who are upside down, but are still making payments.

Even some of the more reasonable “brokered” solutions akin to a mass reorganization or restructuring, mentioned in “Haircut” would likely be deeply flawed by the political process.

Why not just let the process play out?

As Blodgett says of the fore-mentioned bankruptcy solution: “both parties get hurt by the process…and that’s as it should be.  Because they are both responsible for the mistake.  The borrower borrowed too much and the lender loaned too much.  And they both paid the price for their optimism and/or greed.”

David Stockman writing of the of 13 million underwater homeowners, observes that “likely default [would relieve] them of a lifetime of debt slavery, even as they reverted to the status of credit impaired renters.”

Which begs the question: what is so wrong with bankruptcy or default?  Once the stigma of foreclosure or bankruptcy is removed, as Stockman writes the “homeowner” (and economy) are free to move forward, and be better for the ware.

Corporations declare bankruptcy all the time and no one judges the morality of the decision.   In the case of foreclosure there is no contract that is being violated.  The deal is if the homeowner doesn’t make the payments, the bank takes the house.  If it is in the borrower’s “strategic interest” to default, what better repercussion to the lenders who should have known better.

So the banks go belly up?  Good, and as Blodget says, there is a process for that.

So investors who didn’t pay any attention to what they were buying take a loss?  That is how the game is supposed to work (even if the investor is China).

For those who think this would be too catastrophic and shocking:  would you rather rip the bandage off quickly or peel it back slowly and agonizingly.

Will the process result in a cascade of foreclosure, bankruptcy and default and chaos?

Maybe, maybe not.  In yet another piece Stockman takes on crony capitalism and “the urban legend …that in September 2008 the payments system was on the cusp of crashing, and that absent the bailouts, companies would have missed payrolls, ATMs would have gone dark and general financial disintegration would have ensued.

No doubt there would be a lot of pain, and credit ratings for consumers and borrowing rates for corporations and governments will be affected, but then again everything is relative.

As the Super wannabe Syndrome from “The Incredibles” taught us:  When everyone has bad credit… one will have bad credit.

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DISCLAIMER: Nothing in this article should  be construed as a personal recommendation or investment advice.  Nor should anything in this article be construed as an offer, or a solicitation of an offer, to sell or buy any particular investment security.   Investors should conduct their own due diligence and seek the advice of a financial and/or investment  professional before making any investment decisions.

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2 Responses to When Everyone Has Bad Credit…

  1. Kim S December 2, 2011 at 10:41 am #

    I personally declared bankruptcy after losing my small business to the poor economy in 2009-2010. What a relief! And, super-easy to do myself (saving a ton of money in attorney’s fees). I currently work in car sales, and see tons of customers who would be better off voluntarily surrendering their “negative equity” cars, and declaring bankruptcy on the rest of their debt. For those who’ve been smart enough to make this move (like myself), life moves on rather quickly. Many of us have moved to cash-only purchases. I had almost 60% of my customers in the month of November 2012 slap down cash for their purchases ($20,000-$50,000). Still, the fools are out there, and they’ll get themselves right back to where they started just a few years down the road. Better to keep the gov’t out of promoting ‘bankruptcy’ as a viable debt relief option, since the idiots will just keep doing it over, and over, and over again. The smart ones will do it once, and move on to a more solid financial future.

  2. Jim Boy Bob December 2, 2011 at 3:06 pm #

    Seems that if filing bankruptcy once is smart, filing bankruptcy twice would be 2x as smart. Do it a 3rd time and well, you’re just a genius! After all, it’s a big relief and it’s super easy.

    I would suggest that a poor economy didn’t cause anyone a bankruptcy. People file bankruptcy because they have too much debt. They have too much debt because they borrowed too much. They borrowed too much because their business didn’t have enough sales volume.

    So, when all those people voluntarily surrender their cars back to the finance company, is there a chance these “stupid” finance companies will then turnaround and try to sell the cars..for dirt cheap? Kind of like the current foreclosure problem that exists in real estate. Gee, what impact will that have on new car sales? Ask any homebuilder how that’s workin out for them.

    The bankruptcy that Mr. Blodget is referring to is that of the major banks. The government is not advocating bankruptcy, it’s prevented i! Anyway…

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