IMF Urges Authorities to Consider Debt Forgiveness to Restore Growth

By , Economics Editor

Telegraph, 10 Apr 2012

High levels of household debt restrain consumer spending and delay recoveries, the Bretton Woods institution concluded in an analysis of crises over the past century.

While cutting interest rates and unemployment benefits help, the IMF said the authorities should consider going further with “targeted household debt reduction policies”.

Among its proposals, the fund suggested state-sponsored debt forgiveness plans for the most hard-hit families. Although the policies might initially be expensive, they would be beneficial by reinvigorating consumer spending and helping the economy, the IMF said.

It cited the actions of the US in 1933 in the midst of the Great Depression and Iceland after its recent banking collapse.

The Roosevelt administration in the US set up the Home Owners’ Loan Corporation to buy distressed mortgages from banks in exchange for government debt. It then restructured the mortgages “to make them more affordable”.

The policy cost 8.4pc of GDP, equivalent to £130bn in the UK this year, but saved 800,000 households from repossession. The US government had made a profit, before inflation, by the time the scheme was run off in 1951.

In Iceland, banks were made to accept reductions in mortgage interest payments of up to 40pc and the most distressed households had a portion of their outstanding debt written off.

The economy there has now recovered remarkably since its bank-led collapse in 2008.

The IMF said the lessons showed that “policies can help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output” and made a case “for government involvement to lower the cost of restructuring debt, facilitate the writing down of household debt, and help prevent foreclosures”.

The IMF did not prescribe such policies to any individual countries but its warnings could be applied to the UK, where high household debt levels have caused consumers to cut spending. Household debt, at about £1.4 trillion is roughly the same as the size of the economy. Of that, £1.2 trillion is mortgage debt.

Michael Saunders, an economist at Citi, has pointed out that as recently as 15 years ago household debt was just 69pc of GDP.

The IMF added that the banks need to be strongly recapitalised before debt forgiveness is considered, and that “bold” policies would be easier to implement in countries where there had been some state intervention in the banking system – as in Iceland.

Countries that had slashed rates to zero or near-zero, such as the UK, should also consider the plan.

“These programs help prevent self-reinforcing cycles of declining 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 support,” the IMF said.

However, loading all the burden on the banks and tearing up the law so households could walk away from their debts, as attempted in Colombia in 1997, would only trigger another credit crunch, it added.

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