Why We Need Regular Debt Forgiveness

Ben Gibran
Aug 9, 2020 · 5 min read

Or the economy will regularly implode

Image for post
Image for post
Photo by Egor Myznik on Unsplash

Recently, there have been calls by some economists for a ‘debt jubilee’, which essentially means the cancellation of debts (either by debt forgiveness, acting as if the debt never existed; or third-party redemption, where someone other than the lender or borrower — such as the government — pays off the debt). This was proposed as an ad-hoc solution to a growing worldwide crisis in personal and government debt, which together threaten a new global depression, especially after the economic havoc wrought by COVID-19 lockdowns. Some of the more recent voices in support of this idea were Stephen Roach, former Chairman of Morgan Stanley Asia, and Michael Hudson in the Washington Post.

The problem with ad-hoc debt forgiveness is something called ‘moral hazard’, that borrowers will expect another cancellation when a future crisis looms, and will therefore borrow more recklessly in anticipation. But moral hazard isn’t a problem if debt forgiveness is a regular thing. For example, if by law, all loan contracts have to state “If this debt is not paid by this date, and/or the borrower defaults on a payment X times in a row, the debt will be forgiven”. I call this ‘regulated debt forgiveness’, because it’s a regular thing, and it’s regulated by the state or central bank. It also sounds crazy, but is it?

It would give lenders more incentive to ensure that borrowers can actually pay off their debts, thereby preventing something like the subprime mortgage crisis that contributed to the 2008 global recession. A ‘subprime’ mortgage is basically a housing loan to someone who’s unlikely to pay it all back. At a time of rising house prices (like in the US till 2008), it didn’t matter if mortgagees defaulted on their loans, because the bank could always seize the house, sell it, and probably get more than the loan back. More likely, the borrower would sell the house first to pay off the mortgage.

So there was little incentive for banks to ensure that mortgagees could really pay off their loans. A lot of folks were just ‘flipping’ houses, buying homes to sell when the price rose. This contributed to a speculative ‘property bubble’, which exacerbated the subsequent house price collapse. Just before the 2008 crisis, the bubble burst and US house prices started tumbling. That set off a domino effect where mortgagees were defaulting (because the banks lent recklessly to begin with), but the banks/borrowers couldn’t get all their money back from selling the houses.

Image for post
Image for post
Chart showing the dip in US house prices in 2008. Image by US Census Bureau via Wikipedia (public domain)

To make matters worse, the banks had bundled their mortgages and sold them as securities, which were then re-bundled and resold several times over. Large financial institutions worldwide invested heavily in these, so the domino effect reached all the way to the top and out to the world, helping bring down the global economy in 2008. A similar thing happened in the Asian Financial Crisis of 1997.

Now, if banks had been forced to insert a debt forgiveness clause in every loan agreement, neither crisis probably would have happened, or they would have been less serious. What would have occurred is banks wouldn’t lend to bad borrowers, because if the loan wasn’t being paid off… Poof! The debt disappears, and the bank suffers a loss, unless they swiftly re-negotiate the loan or seize the collateral (if any) early on. Neither action is in the bank’s interest, since the re-negotiated loan will include a new forgiveness clause (so back to square one, though it will buy both lender and borrower some time), and selling the seized collateral may not cover the loan.

On the flip side, reckless borrowing would decline, because borrowers who had a loan forgiven in the past would be unlikely to get approved for a second loan. So it would be harder for a debt bubble to build up, since both lenders and borrowers are likely to be more careful. If anything, the greater risk would be over-cautious lending causing a credit squeeze. But if the forgiveness deadlines were set and calibrated by the government, that would be a mechanism for the state or central bank to ensure adequate credit while preventing debt bubbles. Another lever could be a time limit on how long a forgiven debtor has to declare that status in loan applications, before it’s scrubbed from their record.

It’s not just mortgages. Personal and commercial debt bubbles — credit card loans, student loans, car loans, housing loans, plus business loans — combined with rising government debt, are a major economic destabilizer. According to the World Bank, the global economy has seen four waves of debt accumulation over the last 50 years. The first three ended in financial crises for developing nations, and we’re in the fourth now. There’s no reason to think this latest bubble won’t end in another economic meltdown.

Image for post
Image for post
US household debt. Image by US Census Bureau (public domain)

US government debt now stands at about $25 trillion, which costs several hundred billion dollars in interest payments each year; money that could have been spent on education, infrastructure, or healthcare. In 2008, 8.5% of the US government budget was spent on servicing debt. That’s expected to rise to almost 10% by 2026.

Image for post
Image for post
U.S. government debt from 1940 to 2010. Red line is government debt held by the public (net public debt) and black line is the total public government debt outstanding (gross public debt), the difference being that the gross debt includes that held by the federal government itself. Image by en:User:O18 via Wikimedia (CC BY-SA 3.0) Data source: United States Government

Much of that government debt is held by non-US lenders, and they’re rightly nervous that the US government might simply default on its rising debt, or that the US dollar will decline in value, rendering loan repayments inadequate to cover the original loan’s purchasing power. These fears make lenders more reluctant to hold US government debt, which in turn could raise the interest rate on the debt (since lenders want to be compensated for the increased risk), which means more government expense on debt servicing. In the case of developing countries, government debt is a major contributor to poverty. Of course, regulated debt forgiveness is a pipe dream (with something very questionable in the pipe). But if we talk about it enough, maybe something like it will happen. If we don’t slay the dragon of perpetual debt, we can expect this boom-and-bust roller coaster ride to continue, wiping out value, jobs, savings, and lives along the way.

Invisible Pillar

A community of writers and readers

Sign up for Invisible Pillar

By Invisible Pillar

A recap of the best pieces published at Invisible Pillar over the course of the last month Take a look

By signing up, you will create a Medium account if you don’t already have one. Review our Privacy Policy for more information about our privacy practices.

Check your inbox
Medium sent you an email at to complete your subscription.

Ben Gibran

Written by

Ben writes on the theory and social science of communication, and anything else that comes to mind

Invisible Pillar

An online publication attempting to make the place better

Ben Gibran

Written by

Ben writes on the theory and social science of communication, and anything else that comes to mind

Invisible Pillar

An online publication attempting to make the place better

Medium is an open platform where 170 million readers come to find insightful and dynamic thinking. Here, expert and undiscovered voices alike dive into the heart of any topic and bring new ideas to the surface. Learn more

Follow the writers, publications, and topics that matter to you, and you’ll see them on your homepage and in your inbox. Explore

If you have a story to tell, knowledge to share, or a perspective to offer — welcome home. It’s easy and free to post your thinking on any topic. Write on Medium

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store