Archive for the 'debt' Category

Order in Default

Sharon June 25th, 2009

This post is going to get me in some trouble, I suspect, as it ignites the ever-present discussion of whether ordinary people who incurred debts should do anything in order to avoid default or not.  I’m sure I’ll get accused of encouraging people to default, although that’s not my primary intention here.  Instead, what I want to do is give people who are already facing default a rational way of approaching the issue – because I think this is increasingly the reality for many people, as they exhaust their unemployment benefits, use up their savings and still have no hope of a job or income. Yes, it would have been a lot better for those who lived profligately (and some of these people were never profligate, and are merely unlucky) not to buy houses, build up debt, etc… but having done so, they now are facing default or bankruptcy, and it might be wise to know how to navigate that situation.

The reality is that a study recently suggested that if you calculate debt interest payments into cost of living, there are 4 million new poor people just this year in the US, people who are experiencing debt poverty, and whose debt is preventing them from meeting basic needs. 

So let me be clear – I am not advising default, or encouraging you to run up debts and default -  I believe people should pay their bills.  I also live in the world as it is, not as it should be -   if you face an inability to pay your bills, there are ways to minimize the harm to your family. I have no ethical difficulty with minimizing that harm for most people - enormous investments are being made to soften the blows for banks, while nothing is done for ordinary people, many of whom took on these debts not because they were stupid or evil but because they were falsely promised things that were never delivered – I find it hard to blame 17 year olds who signed on for college debts they were told were their ticket away from poverty, or elderly folks whose retirement savings have vanished and medical costs skyrocketed.  If this also helps some jackass who was speculating in Las Vegas real estate, well, it isn’t my goal, I’d rather not, but I can live with it if it does some good to those who, through no fault of their own, are unable to meet their debts.

 The first question is “bankruptcy or default” – although for many poor people, this may not be a question at all.  Legal services are now overwhelmed with bankruptcy cases, and it can be almost impossible to get legal help to file, and many low income families can’t afford the fees to declare bankruptcy.  Moreover, many of the working poor already have trashed credit ratings – and the primary virtue of bankruptcy is that it allows you to obtain credit down the road – but if you have no hope of viable credit in the longer term, it may not be worth the price.  Bankruptcy now means paying creditors gradually – but even gradual payments may be infeasible for many people.  Finally, some debt can’t be vacated by bankruptcy proceedings – student loans among them.  If they are your primary problem, bankruptcy won’t help.  If you do want to declare bankruptcy, find a lawyer, since this is not a home project.  Bankruptcy is almost certainly the best choice for the formerly middle class, anyone with money and anyone with a business. If there’s no money at all, default may be the only choice.

If, however, you need to default, you should know the risks of defaulting on each kind of debt.  What you default on, and in what order if and when you must, depends on your circumstances.  The question is how to minimize harm.  Before I wrote this post I consulted with Stoneleigh and Ilargi over at The Automatic Earth, and got their advice as well, which I’ve included here.

The first thing every person should seriously consider dumping are luxury items – second cars (yes, I know, you need it, you absolutely need it – and that’s true of a very small percentage of the people who think they absolutely need it), second homes, boats, RVs that you don’t actually live in full time – if it costs a lot of money and you don’t absolutely need it, get rid of it.  Yes, it might be inconvenient, and the item will be repo’d.  But you are better off without it anyway.

This first point seems really obvious to me, but I think it escapes people – it is surprising how often the attempt to maintain some kind affluent norm leads to people losing more in the end than they had to – at first everyone rationalizes “oh, I’ll find another job, we’ll be fine…” – this trying to maintain the lifestyle ends in disaster all too often, as the cascade of problems hits harder than it would if all the extra luxuries were immediately jettisoned.  So dump them now.

After that, the question of what to default on first becomes more complex, and depends on your circumstances.  Are you applying for a job that requires official transcripts?  In that case, don’t default on your student loans, since you won’t be able to get them.  Did you buy your house at the peak, and does it require both you and a partner to have  full time jobs?  Consider getting rid of it by sales or if necessary walking away?  Do you have low payments and lots of equity?  Maybe it would be preferrable to get rid of everything else before the house.  I can’t choose for you, I can only tell you the consequences and advantages of each.

1. Student loans – the good part of defaulting on these is that no one can take away your education.  The bad part is this – you will never be able to get a transcript, your tax return will be taken away forever, and some federal and state jobs won’t hire you.  I admit, of all the ethical issues involved in default, I have the least difficulty with this one, since I think student loan purveyors prey upon very young people who simply don’t understand the implications of the choices they are making – they are told over and over again that they must have a college education at any price, and they then take on loans that keep them in debt slavery for decades.  When the credit card industry preys on teenagers, we complain – but not when the student loan industry does.

2. Medical debt – the bad news about this one is that they can take your house for this.  The good news is that once you have your health, they can’t repo it.  It is usually better to enter repayment plans, however difficult, than to default on medica debt, however.  If you can’t avoid it, and the debts are substantial enough, you will probably lose your house as well, if you have one, so you might want to make provision for moving to a rental before your credit rating is tanked.

3. Your house – for many people who bought from, say 2003 on, this might be the first thing to give up.  Most loans are non-recourse loans – that means if you send the keys back to the bank, you can’t be dunned for the rest.  You will see a cost on your credit rating – and since credit scores can be so essential to getting access to rental housing, you will need to have your rental apartment lined up before you do this. 

Ilargi, Stoneleigh and I disagree on this one somewhat – their general case is that housing prices will fall sufficiently that most people should sell or walk away now, relieve themselves of their debt burden, rent for a while and then buy later.  And they may have a point from a purely economic standpoint.  I tend to lean, if one has reasonable equity and low payments that can be made on one income, to moving more people in and otherwise making your house more sustainable, simply because the land itself, the stability and security have value to most people. I agree with them that we all ought to do a hard analysis of whether we will have a future in our homes, and it can be hard to be honest about this.  That said, however, built up soil, fruit trees and neighborhood community are tough to maintain if you keep moving.  Rental housing is also vulnerable to disruption – landlords lose their houses too, or want to move their relatives in.  My feeling is that if your home can be used to partially sustain you – to develop a cottage industry, to feed and otherwise meet your needs,  and if your costs aren’t too high, it is worth trying to keep it.

4. Your car.  This is a tough one for a lot of people in rural and exurban areas – and yet, far more people could live without cars than do.  Certainly, if you have any kind of viable public transportation system (and yes, buses count) in your area, or even if most people in your community commute to one or two central areas for work, you could probably live (not conveniently or easily) without a car, paying to share someone else’s for essentials and staying at home a lot more.  You’ll have to do the calculation on cost.  At a minimum, however, if you are paying a car loan and can do any car maintenence, get out of your loan immediately and buy a beater – if you are paying for pretty, or even mileage, you probably will do better with something cheaper and fewer trips.

5. Unsecured credit card debt.  Your credit rating will get trashed, but there’s not much that can be done about this – now.  Stoneleigh and Ilargi were both inclined to argue that if you are going to default on this, do it soon – that eventually the penalties for default will get higher and nastier, and I think I agree.  Right now, there’ s not much that can be done – whether it will stay that way is another question (and goes to all of these kinds of debt).

6. Your utility company.  My preference would be that all of us simply learn to get along without these people. I suspect that utility company defaults and shutoffs are going to mean many, many more people lack what we think of as basic resources like lighting, heat and refrigeration, and that it is wise to prepare now to live without them. This is more feasible for some people than others, but if you have invested a lot of energy and time into making your house power outage proof, and are in dire economic straits, letting the electric company turn you off is not the worst thing that could happen.  Other than shutting you off and trashing your credit rating, there’s not much they can do.

There’s another kind of debt I haven’t mentioned here, because I think default on that is completely unethical. In each of the above cases, the hurt from default (which is real and I do not minimize) either falls on many broad backs (ie the taxpayers, and yes,I agree they don’t need more on their backs, but I don’t see a lot of ways around it), or on corporations who can often write off  their losses, or at worst, who find themselves dissolved.  I think those kinds of hurts, while not-trivial, are less serious than direct personal debt.

If you continue to pay none of your debts, the one you should continue with is CHILD SUPPORT – let me be clear, I realize that it is often very difficult for people who have lost jobs, have other families, etc… to continue paying child support. I also realize that in some cases, the onus of child support is unfair in some measures.  But the truth is this – these are your kids.  If you can’t pay, go to court and get it refigured, or work it out with your ex.  But I know too many children whose ability to eat dinner depends on Mom or Dad coming up with the cash to have any respect for someone who shorts out on child support when there is any other possible avenue to survive. 

I would also strongly advocate paying local suppliers and anyone you have an actual relationship with that supplies you with credit – those are people you do not want to cut off.

There you have it.  Now the flames and debates about the justice and ethics of this will start, and I agree, default, if there are other choices, is usually unethical.  But unfortunately, so many people’s backs are against the wall that I don’t see a lot of viable other choices – and I also believe that so much of this situation has been mishandled by unethical leaders that the ethical failings of most ordinary people are reduced to peccadillos in comparison – and that deserves oure primary attention.

 I hope this provides some small help – it is little enough for those in desperate circumstances.