I read with dismay this story on MSNBC about people breaking into their retirement funds to pay for housing and other debts they've accrued.
Now, understand that I work for a financial institution, a lending company. It is in my short term interest and financial welfare to recommend that people should always pay their debts, and for the most part, if you have the ability to repay, you should.
However, in cases like the story above, sometimes the responsible thing is to walk away.
Which is worse?
- Declare bankruptcy, default on your loans, and take a 7 year hit in which you pretty much are cut out of the lending world?
- Deplete your retirement, default on your loans anyway, and not only take a 7 year hit on credit, but also be wholly dependent on welfare and charity for the last 20 years of your life?
Which is worse?
The logical conclusion, the business conclusion, is to walk away from your debts. Don't think that businesses don't make that decision every day. Sallie Mae (ticker:SLM) lost a deal with JC Flowers - they walked away. There were consequences, but the consequences of walking away were weighed by JC Flowers and they decided that walking away made the most financial sense.
There's a culture encouraged by financial institutions that there's a moral penalty for walking away, and that moral pressure is one of the many forces used by companies to keep individuals in obligations, whether or not they have the ability to repay.
Here's the problem with that. It's short term thinking. For the citizens in the MSNBC story, it is in my long term interests as a taxpaying citizen of the United States for that borrower to walk away. Companies come and go, but that citizen, if he depletes his retirement, will be dependent on me and others for a subsistence lifestyle. Just as he's trading his future for the present, so are financial institutions trading America's future for the present if they continue to encourage debt holdings by consumers who simply cannot pay and will not be able to pay.
Conclusion: if you're a financial institution with a consumer who cannot repay, that loan is going to decay sooner or later anyway. (unless it's a student loan which can never be forgiven or written off by the consumer) Write it off now, preserve that citizen's retirement and savings, and help them be able to buy your services later on down the road. Think long term, think big picture.