September 30, 2012

Forgiving Mortgage That Is Not Debt

If you were a bank and under pressure by regulators to reduce debt owed you by mortgagors coming from the collapse of the housing market in 2008 what would you do? A good strategy would be to "officially" forgive the debt that you have already written off or know is highly unlikely to be repaid. In this manner you comply with an agreement entered into with the government requiring you to provide retribution for partially causing the calamity in the first place.

This is exactly what is being done by JP Morgan Chase and Bank of America.¹ They are notifying borrowers who have completed bankruptcy, or the bank has already provided for a loss reserve, that their debt is forgiven. The banks are getting credit towards the $25 billion they agreed to pay back in February as retribution for contributing to the mortgage meltdown of 2008.² Further, the government is getting credit for coming down on the banks. These losses should be already recognized on the banks books; therefore, banks are getting credit for something they would have done anyway without the government settlement mentioned above. To make matters worse, this forgiveness of debt by the banks could result in negative tax consequences for the debtors. The government should consider passing a law that would exempt such loss forgiveness as a taxable event.

The one benefit that is accruing to the mortgagor is the debt owed to the bank is eliminated from his credit record. This is significant, but let's not pretend that this settlement cost the bank anything that was not already incurred and recognized.

Footnotes
¹ How to Erase a Debt That Isn’t There, New York Times, September 29, 2012
² The Deal Is Done, but Hold the Applausee, New York Times, February 11, 2012

1 comment:

  1. "this forgiveness of debt by the banks could result in negative tax consequences for the debtors", that's the way it goes. Those debtors might be forgiven; however, they will be having a hard time applying for the next loan because it will be written in their history.

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