Hoping in Vain for Secured Creditors to Cede Control


ISI_logo_FinalInitial results of the bargaining process in the new Irish personal insolvency system have been unsurprisingly disappointing. This is particularly true with respect to the most pressing problem for which the system was designed: bargaining with secured creditors over distressed home loans. The new system provides a framework for debtors and their secured creditors to negotiate a so-called Personal Insolvency Arrangement, or PIA, to reduce and/or otherwise restructure home loans and other secured (and unsecured) debt. Someone by the initials JK colorfully predicted in April 2012 that the new "PIA is DOA." I was wrong about this, but not too far off the mark.

Since the September 2013 launch of the new regime, 533 debtors have applied for a PIA, but since the first plans started rolling in (or not) in January of this year, only 32 PIAs have emerged, and goodness knows how many (few) of these will succeed (see the ISI stats here). The median writedown of secured debt is only 17%, with a range from zero to just over 60%. The newspapers are having a field day criticizing this nascent insolvency process, with one observing that if there is a light at the end of this tunnel, "it is very dim indeed," and noting that at the current rate of PIA adoption, "it would take at least a century to work through the estimated number of people who need to avail of" the relief this system was designed to offer. A recent Finance Committee report criticizes banks' refusal to write down secured debt, as "this stance is in direct contravention to stated Government policy." Apparently, the Government has already prepared a legislative reform to resolve the "ambiguity" that allowed the banks to all but utterly undermine this process.

Ambiguity? What did they realistically expect? As Jay Westbrook observed a decade ago, in a situation of general default, contractual secured credit is a powerful source of control of wealth (control over both the collateral and perhaps the entire resolution process). And banks can't be expected to exercise that control in a way that most policymakers would favor. Banks understandably want complete control over the future value potential of the collateral, as brilliantly revealed by the latest side-deal between two large banks (AIB and KBC) and the Irish Mortgage Holders Organization:  In return for turning over their houses, debtors can expect a standard PIA from these banks that forgives the (unsecured and mostly likely uncollectable) remainder of their debts after a mere three months.

Banks want control, and secured credit gives it to them. Legislators cannot expect banks to give up that control in response to invitations to bargain with distressed debtors. Give them control of the collateral, and perhaps you can strike a deal. Try to implement a process that undermines their control, and the banks will understandably exploit every weakness in the system to regain control. The Irish system began with a glaring weakness in this regard. I will be very interested to see what the legislature does with the Government reform bill to fix this "defect" in the forthcoming term.