Financial Life and Death — and Something in Between

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January 17, 2008 5:49 p.m.

The Brits, in their understated way, are on the fast track to revolutionizing the relationship between the debtor and the creditor. Legally speaking, we have had a two-choice world — make payments as they are due or file for the protection of a bankruptcy court. With no public fanfare, the British Ministry of Justice announced a plan for debtors to stop making payments on credit cards for up to a year if they had a change in circumstances, such as a job loss or divorce. In Britain, there may now be a place between financial life and death.

So far, there are no reports of mass heart attacks by lenders, no threats to halt all consumer lending, and no repeal of the law of gravity.

Britain is considering a legally-protected space between regular repayment and bankruptcy — a cessation in payments based on changed circumstances. During the time the debtor has the one-year stay in effect, interest will accrue, but not at penalty rates. The debtor will have to show that he/she will be likely to resume payments at the end of the year. There is some court intervention and some fact finding, but because there is no discharge, the intensity of the inquiry may be considerably less than there might be in a typical bankruptcy.

This is a not-quite-bankrupt state. It’s worth noting that even the tests for qualifying for the program match the reasons for filing bankruptcy. (Job loss, medical problems and family break up are involved in 90% of U.S. bankruptcies.)

The British plan raises some interesting empirical questions: If debtors have a not-quite-bankrupt option, will total payments go up? If they can suspend payments, but not get hit with ruinous penalty fees and penalty rates of interest, can they eventually pay off their credit cards? If they can quit paying for a while, will they be able to stay current on home mortgages and car loans?

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To ask these questions is a reminder that the world we often describe as debtor versus creditor is, in fact, often creditor versus creditor. Suspension of payment to one group of creditors may help another. In fact, it may mean more payments for everyone.

If the British give consumers this option, the debt paradigm around the world shifts just a little. No longer will Americans be leading the way on how to think about financial death and rebirth. Instead, the new paradigm may be to think about how to help a debtor avoid bankruptcy altogether by finding a that’s somewhere between financial life and death.

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