x Abu Dhabi, UAEFriday 21 July 2017

Jail only makes things worse in debt defaults

Throwing individuals who default on debts in jail is a lose-lose situation: they are unable to repay their loans and consequently the economy suffers. But that is what happens too often. The result is that people in serious financial trouble have an incentive to flee the country.

When an individual cannot pay his debts, throwing him into prison will not help. But that is what happens too often. The result is that people in serious financial trouble have an incentive to flee the country, leaving their debts behind. There must be a better way.

The Business section of The National today reports on an unforeseen consequence of the way people snapped up unbuilt flats at the peak of the market. Now their properties are ready and mortgages are taking effect, but real estate values have fallen so sharply that they have lost money. The result is genuine financial distress for individuals and families.

"Underwater" mortgages are a problem in some other countries, too, but in the UAE the issue is more serious because of the relatively transient population - many expatriates might find it easier to leave abruptly than to resolve their obligations.

People have a responsibility to pay their debts, but some might argue that they have a better chance to pay from another country. There's a kernel of logic in that, because jailing debtors plunges them into a hopeless spiral: once you're in prison you can't earn money, and so you can't make payments, and so your debts increase …

The nature of the labour market means that a considerable segment of the population will be transient. And while expatriates are here, many of them want credit - consumer credit is a vital part of the economy.

Clearly there must be a mechanism to collect from those who are unscrupulous or unlucky or both. Tracing expatriates back to their home countries is slow, uncertain and ultimately impractical except when really large debts are involved. But tossing people into jail is worse.

Much of the solution rests with lenders: during the irrational exuberance that fed the bubble in the property market, how many would-be borrowers were warned about the consequences of a default? How many were approved for loans that they could not be expected to pay back? When the downturn started to bite, how many were offered credit counselling?

For that matter, how many are now being offered a chance to refinance? In many countries hit by a steep property crash, refinancing arrangements to reduce or spread out payments and lower rates have helped millions of families keep their homes.

Bank profits on restructured loans do decline. But the arrangement is still far better for everyone than default and debtor's prison.