Creditors Benefit From Debt Forgiveness Plan

A number of visitors to Credit Card Debt Law recently have been looking for additional information on the Credit Card Debt Forgiveness Program that has been discussed in various newspapers recently after the Consumer Federation of America and the Financial Services Roundtable sent a letter to the Office of the Comptroller of the Currency in the United States government requesting approval for the creation of a pilot program surrounding the issue of partial debt forgiveness.

Under the current system, consumers working with a credit counseling agency that meet certain financial conditions may qualify for partial debt forgiveness by the banks holding their credit card debt if they can pay the balance of the remaining debt owed to the bank back over the next three to six months. The bank, which benefits from the acceleration of the debt payments, is penalized because it must recognize a loss on the debt forgiven over the same three to six month time frame. The consumer is then forced to pay taxes on the amount that it was obligated to pay but did not, since it received a financial benefit from the credit card issuer.

The debt forgiveness program, as I understand it, would allow the time frame for the repayment of the balance of the debt owed to be negotiated beyond the current three to six month period. The banks would be free from the obligation to recognize the loss from the bad debt during the initial three to six month period as well.

What’s the catch?

That’s the question that David Lazarus asked the chief lobbyist for the Financial Services Roundtable, and he proclaimed that there was no catch. But that’s not quite true, as I see it.

There are three reasons that I can think of that the credit card companies are willing to test this plan.

First, they hope that they will increase the amount of money that they collect from debtors. Although I haven’t researched the standards applied to debt forgiveness by the banks, my supposition is that the banks are only willing to accept a lesser amount than they are owed if they do not believe that you will pay back the total debt owed. In short, you have stopped paying your credit card payments and they do not believe you will restart payments, they will not be successful in collecting on the debt, or they believe that you are likely to declare bankruptcy and they will receive less than if they forgive a portion of your debt.

Second, banks facing the capital crunch do not want to charge off your debt after six months because it hurts their balance sheet. In a time that banks are facing pressure to raise capital amidst perhaps incalculable risk in the financial industry due to residential and commercial mortgage backed securities, construction loans, and credit default swaps - they want to keep the money owed by you on their books as an asset. If they have to write down your debt, they may have to raise additional capital to maintain their leveraged loan portfolio.

Third, there is also a sense that the plan is the financial institution alternative to bankruptcy or credit card reform. Although bankruptcy reform hasn’t yet recieved congressional consideration, I would be shocked if credit card companies don’t internally expect both credit card reform and bankruptcy reform in the coming years of the Obama presidency. If the program is a success, it will strengthen the coming argument from business leaders that the market is self-regulating.

So, if the program benefits business, will it benefit consumers?

And that … i’ll examine in another post …

In the meantime, if you are interested in learning more about the partial debt forgiveness program, as well as the arguments for and against its adoption, then check out the following news articles and blog posts: