Last week I wrote an article Banks Agree to Wipe Out Up to 40 Percent of Credit Card Debt But Watch Out but more information has come to light since then.
While consumer advocates are happy about the possibility of getting banks to write off as much as 40% of the debt in order to help consumers avoid bankruptcy, this is a well intentioned plan that is still half baked.
Proponents of this initiative have not clearly thought out all the issues and appear to not be spending time learning from what has and has not worked from outside the United States fence. On first glance, an effort that would wipe out a large portion of debt seems like a blessing but from personal experience in helping people in the U.S. and the UK. These are the important areas we need to focus on.
- Creditor Voting – I have not read or heard any discussion about the 40% plan becoming binding on all unsecured creditors if the majority of creditors, by debt, agree to the plan. Unless all creditors are bound to the plan all it takes is one creditor to not participate and the entire solution blows up. The reality of getting all to agree is unreasonable so a 51% acceptance of the plan should be sufficient.
- Fast Track Individual Voluntary Arrangement (FTIVA) – In April, 2009 a new process will come into effect in the UK. The FTIVA is designed to allow 90% of insolvent debtors who would normally seek bankruptcy protection, to enter into a payment plan upon a 51% acceptance by creditors. The extensive research and framework of this plan is something that we should closely study and consider emulating before the U.S. goes off and learns the mistake lessons like the UK already has from the more formal IVA already in place since 1986. UK Fast Track IVA Review
- Make Life Allowances – Not only does this repayment plan need to be binding on all creditors upon a majority vote but it needs to have allowances and processes built-in to handle an unexpected financial hardship for a consumer enrolled in the plan. Already, consumers are seeking bankruptcy protection secondary to unexpected life events which create hardship. If a consumer is enrolled in the 40% plan and three years into the plan they have an unexpected financial emergency, we don’t want the plan failed and creditors to go back after the entire debt and all the fees and interest they can heap on. We need to create some fail safe mechanism that does not leave, the consumer that has made their best effort, stranded after so much effort. Otherwise, why not just go bankrupt to begin with and avoid the possibility of wasting three or four years of repayment only to fail due to an accident, illness, downsizing, etc.
- Provide Incentives For Hard Work and Extra Effort – A lesson to be learned from the UK system would be that we need to provide consumers with an incentive to end their 40% plan early if they work hard, increase their income and can pay the plan off early. Accelerated repayments benefit the creditors and the consumer since it gives them motivation to improve their financial standing during the time in the plan. In the UK it is far too common for a consumer to get a raise or increase income only to have it taken from them as a windfall and poured into the plan. We need to fix the total amount due under the plan at the start so that the consumer clearly knows the total debt to be repaid and let them be hungry to pay it off early through grit and determination.
United States consumers have been long abandoned and left without new and more progressive ways to repay their debt outside of bankruptcy. This is our opportunity to remedy this situation and give good people with bad debt a way to effectively repay their debt with more protections than a credit counseling plan can give and without the big gun of bankruptcy.
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You’re right. IVA’s are a life-line to growing numbers of people in the UK looking to avoid bankruptcy. One of the most common users of the IVA are famlies who may lose their home under bankrutcy. It’s also a debt solution that makes insolvency practitioners significant and where there is profit there’s an opportunity to miss-sell. If you so adopt the IVA as a solution in the US, make sure there’s a good regulatory system to support it.