Monday, June 6, 2016

Real Debt Forgiveness

You're all forgiven!
--The Who

Article discusses a talk show host who bought nearly $15 million in distressed medical debt and then forgave it all. Assuming that the transaction was done with cash or with someone else's 'real' (i.e., not printed) savings (not necessarily a good assumption here), this demonstrates the economics of debt forgiveness.

In order to forgive  debt, creditors have to eat a loss--in this case the capital that the host paid to buy the distressed debt + the capital that the original lenders were out when they sold the debt at a discount to the host. The balance sheet of the debtors improves (less leverage), But the balance sheet of creditors gets worse--higher leverage and loss of an anticipated stream of real economic resources to be repaid plus interest.

The prospect of recouping resources lent in the past has declined, thereby weakening overall  position of the economy. How so? Well, creditors no longer have that stream of resources that they can count on. The prospect of ever recouping those resources previously lent out has left the system.

If anticipated by borrowers, then debt forgiveness of this sort is also likely to create a moral hazard that encourages undue risk taking. I would think it should also lead to higher rates ahead (less supply of capital available to lend).

Stated differently, real debt forgiveness is likely to be a drag on economic growth. It might however, be a positive for spiritual growth as it can be construed as a form of charity.

There can also be what we might call 'artificial' debt forgiveness, where an entity with the wherewithal print money out of thin air buys debt with printed money and then 'forgives' it. This is a different animal that will  attract attention in future posts.

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