ECONOMY

Modern consumer bankruptcy code laid on the political table

Greece needs a modern consumer bankruptcy code that could provide relief to honest overindebted individuals and households but should avoid the trap of turning it into an unconditional financial bailout at the expense of depositors and the shareholders of banks. The main opposition socialist party PASOK, which is leading in the polls in the runup to general elections on October 4, has proposed a draft law to deal with the issue of heavily indebted individuals, that is, people who are unable to pay their installments on credit cards, consumer loans and mortgages. As is usually the case during a political campaign, this draft law has fueled opportunity for the Socialist opposition and ruling conservative New Democracy to exchange accusations. Putting aside the skirmishes, the truth of the matter is the country lacks a modern consumer bankruptcy code and PASOK’s initiative is obviously a move headed in the right direction. However, the draft law would have to be refined, as a number of its tenets remain unclear, making such a law vulnerable to abuse. This is even more likely given the pressure that may be brought to bear on legislators to make it more consumer-friendly following the interpretations of various media outlets. The interpretations about excusing debtors of their liabilities may not be binding for PASOK but definitely raises expectations and makes it more difficult politically to come up with a modern consumer bankruptcy code. Senior bankers recognize the need for a modern consumer bankruptcy code that would take into account the interests of taxpayers, depositors, shareholders and consumers. However, they point out there are difficulties in verifying that an individual is honest when he states he cannot service his loan or credit card debt, especially in a country like Greece where tax evasion is widespread and there is a sizable underground economy. Lenders are fully aware of the risks of moral hazard when a bailout of companies or individuals takes place, as it encourages those let off the hook to behave in an irresponsible way. In other words, if the law on consumer bankruptcy is widely viewed as a bailout with benign consequences, even individuals who are able to service their debts may take advantage of the provisions and file for bankruptcy. In the latter case, the banking system would be saddled with nonperforming loans, raising concerns about its financial health and transferring the risk to depositors, bank shareholders and, ultimately, the taxpayer. Even if this worst-case scenario does not materialize and the country finally establishes a modern bankruptcy law for indebted individuals, one should expect banks to be more careful in granting loans. In other words, lending criteria is almost sure to become stricter to minimize the risk of providing a loan to somebody who may eventually file for bankruptcy. At present, some banks have been turning a blind eye and accept that some households have unreported incomes from other sources in order to approve personal loans or credit cards. Experience shows, according to some bankers, that countries with more liberal consumer bankruptcy laws tend to have higher interest on consumer and other types of loans for households because it is easier for somebody to file for bankruptcy, such as in the USA. It should be noted that consumer bankruptcy laws differ from country to country, even in continental Europe, where the birth process of consumer bankruptcy started in Denmark in January 1972 and culminated with the adoption of the Danish consumer debt adjustment act, GJeldssanering slov, on May 9, 1984. This law was reformed in 2005. In other countries, such as in France, the law was enacted later, with the focus put on the overindebtedness of the consumer rather than on consumer insolvency. It should be noted that some Greek banks that have not taken the appropriate provisions on loans to individuals that are 90 days past due may be hit more from the adoption of such a bankruptcy code than others that have been more disciplined. Whatever the case, Greece requires a modern consumer bankruptcy code that would offer respite to hopelessly indebted individuals but this should not be allowed to become an unconditional bailout. Moreover, it should be clear that bankruptcy will have some repercussions on those who file such a case for a period of a few years, namely not getting a new loan during a stated period afterward.