Wednesday, December 16, 2015

Writing Off The Rising Amount Of Bad Dept!

Debt Defaults Are A Transfer Of Wealth
Writing off bad debt will be a painful process and I don't mean for the debtor, but for the creditor the person, business, or institution that holds the paper. It generally constitutes an unplanned and involuntary financial adjustment. While it appears much of the financial community is relatively unfazed by the mountains of debt growing throughout the world we as individuals should be concerned as to the many ways it might spillover and affect our lives. Clever sounding terms like "transitory" are often used to mask growing problems and to inject a bit of sophistication to this problem while trying to brush reality aside. Sometimes a person presenting the case growing debt is under control will even go so far as to explain that some of it is good debt or boast how we are enjoying the positive effects of the loose lending standards.

Debt Hangs Above Us Ready To Explode!
We should remember debt takes many forms and shapes, it is not contained in auto and student loans. With low interest rates many companies have borrowed a great deal of money to buy back stock, this has been one of the forces driving the market ever higher. A comment from a reader several months ago highlights this and why it might be a big problem when he wrote;  It is fairly obvious that not all IOU's are deemed as trustworthy, and as trust drains from this over-indebted system, shakiest issuers' debt will lose value fastest. Junk debt is thus a Hindenburg in search of a spark all its own. Wait until corporations discover how difficult it may be to roll over all this share-buyback debt of the last few years.

Artificially low interest rate tend to skew all markets especially the credit and debt markets. This creates a debt explosion that extends into everything including consumer spending and the statistics surrounding their effects on the economy. A great deal of what is being seen as deflation flows from a loop being created from lower interest payments on things like autos, sadly this is a one-off and only goes to mask deeper trends developing under the surface. The fact is debt that cannot be repaid tends to be hidden away and corrupts the true worth of those owed what often amounts to non-collectable sums. Even now we are hearing calls by many people to write off and forgive student debt without any real understanding of the implications such a policy would entail.

Again, I caution those who think this writing off of debt will be an orderly and even process. By that I'm saying not all debt is created equal. One major difference is whether it is backed by assets or collateral. Many other factors affect the strength or impact of defaults. One example of this is when it becomes payable, some debt is stretched over decades while other obligations are short term and paid with a balloon payment or all at one time.  Also debt is computed at different interest rates and this can affect its long-term impact. Another often forgotten issue is whom the debt is owed to and the impact default will have on their ability to honor their current and long-term obligations. I have seen several businesses forced into bankruptcy when a large customer defaults and cannot pay its bills.

It is important to consider how this will all play out or shake down, this is yet to be determined but the ramifications remain powerful. Often unpaid debt shifts the pain or obligation to another party and acts as a wealth transfer, usually this is not a voluntary act unless the note is being forgiven by the holder. I see bad debts on the rise and the effect to both the economy and the lives of many will be massive and undeniable in coming years. It will show its ugly side by pensions being cut, inflation edging higher, or simply lowering our overall standard of living. The fact is some way or form the piper must be paid and we will be reminded that there is no such thing as a free lunch.

The Reality Is We Have Not Deleveraged!
The world of bankruptcy and unpaid debt has become a complicated place where protection for one party can leave another totally exposed. We have seen things like "claw backs" or the government making an exception and changing the rules as in the case of shafting the bond holders of General Motors during the bailout. Yes, writing off debt can be a slippery slope. Dept that is written off takes something with it when it leaves this world and that is the wealth of someone else! In today's low interest rate easy money environment it is much easier to hide under-preforming assets and the inability to repay debt. Low Interest rates tend to foster an extend and pretend attitude that becomes apparent and crystal clear only after rates climb and put stress on the system.

Several other bad things also happen such as increased speculation that propels the creation of leverage or carry trades that multiply risk. It also tends to move demand forward and cause an increase in the improper allocation of capital, both of these action have a way of causing problems that linger for years. Across the globe since 2008 the central banks and governments of the world have played a giant game of hide the debt, much of it disguised by transferring obligations from the banks and people onto the backs of their populations and into a growing pile of public debt. The problem is massive debt still hangs above our heads as a Hindenburg in search of a spark.

Footnote; This post dovetails with many of my recent writings. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged. The two article below delve into some of the things we should of learned by now and how bad debt is absorbed and fades with time.

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