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IMF: Allowing homes to restructure debt will solve crisis quicker

A new global report concludes that economic crises are worse if households accumulate more debt during a boom.

Image: Images_of_Money via Flickr

A MAJOR NEW REPORT carried out by the IMF has concluded that economies will take longer to recover if households have accumulated more debt – and that allowing it to be restructured will help a recovery.

The World Economic Outlook’s paper ‘Dealing with Household Debt‘ finds that economies see far larger contractions when housing markets collapse in periods of high household debt, including the likes of mortgage debt, credit cards and personal loans.

“Household consumption and real GDP fall substantially more, unemployment rises more, and the reduction in economic activity persists for at least five years,” the IMF said, noting that this outcome was “sobering” for economies like Ireland, where household debts peaked at more than double their annual income.

The report doesn’t say that the burden of household debt causes an economic crisis, but rather than the burdens faced by individual households means that they are less likely to wield greater spending power, which in turn hurts governmental incomes.

It suggests that broader policies – such as allowing debt restructuring and monetary easing – can help to tackle the difficulties of individual households, stating:

Government policies aimed at reducing a household’s debt relative to its assets – and its debt service payments relative to its income – could be an inexpensive way to mitigate the negative effects of household deleveraging on economic activity.

In a nod to the likes of Ireland, which has spent large chunks of public cash helping the banking sector – and which cannot act unilaterally in monetary terms, because of its euro membership – it adds:

Such policies are particularly relevant for economies today that have limited scope for expansionary macroeconomic policies and in which the financial sector has already received government support.

The report notes that similar programmes being adopted in Iceland today can reduce the number of household defaults and foreclosures on homes, which in turn helps to stop a fall in property prices and arrest an economic decline.

“But these programs must be carefully designed. If access to them is overly restrictive, they will not have the full intended impact. And if they are too broad and imposed on an already fragile financial sector, they can cause a dangerous credit crunch.”

A draft government bill approved by ministers three months ago hopes to give banks an incentive to help mortgage holders restructure their loans, as well as making sweeping changes to Irish bankruptcy law.

In full: Read the IMF’s ‘Dealing with Household Debt’ paper (PDF)

More: Government’s new debt regime may allow mortgage debt to be written off

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Gavan Reilly

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