Why Can't We All Just Agree?

One of the implicit assumptions behind the new pre-bankruptcy credit counseling requirement seems to be that many individuals could convince their creditors to work something out if they were just routed in that direction and supported by trained, relatively neutral counselors (read:  negotiators).  I must admit that I had often felt that creditors, acting in an economically rational way, could be expected to accept a disinterested third-party mediator’s evaluation of the debtor’s circumstances and abilities and agree to voluntary workouts if only they were asked.  I felt this way before I started looking at how pre-bankruptcy negotiations work out in Europe.

In France, for example, for the longest time, renegotiation was the only option for individuals.  It took years of prodding and concerted pressure from the the primary administrator of this system, the central bank (the Banque de France), to get creditors in more than a majority of cases to agree to quite modest concessions (e.g., short payment extensions or deferrals, reduction of accruing interest, to say nothing of minor remission of accrued principal and interest).  Even after coercive relief was introduced in 1999 and then strengthened in 2004, many creditors continued to resist the most basic of concessions—even after a neutral administrative commission had assured them that these minor concessions were the debtor’s and creditors’ only reasonable alternative.  To this day in France, in about 33% of the cases in which some form of coercive relief is offered (either a Chapter 13-type payment plan or a Chapter 7-type immediate discharge), creditors have seemingly irrationally refused the recommendation of the neutral administrator for a workout plan with minor concessions—knowing full well that the recommendation will almost inevitably be “crammed down” on them by the court in the next step of the process.

A similar story played out in Sweden until quite recently.  Like in France, the personal bankruptcy system in Sweden is administered by a neutral state administrator (actually, the state debt collector!).  Once debtors clear some rather high entry hurdles, the administrator applies standardized expense guidelines to hammer out a workout plan.  Before the revision that went into effect in January of this year, the administrator could only propose this standardized plan to creditors—but again, creditors knew full well that the plan would in virtually every case be crammed down on them by the court if they refused it at this stage.  Nonetheless, a noticeable percentage of cases were hijacked by one or more creditors who refused to cooperate.  Some creditors refused to negotiate on the simple basis that they rejected in principle the notion of allowing debtors to evade their obligations.

As anyone who has been on the inside of debtor-creditor negotiations knows, emotion plays a far greater role in these situations than outsiders are willing to admit.  Sober economic analysis often fails to capture this dynamic.  While forcing debtors at least to consider a “sit down” with their creditors before seeking bankruptcy relief seems to make sense from a rational economic perspective, I’m afraid there’s much more at play here than rational economics.  Will U.S. creditors behave more economically rationally than their French and Swedish counterparts?  Pre- and post-reform indications from U.S. credit counselors suggest that we’ll face the same problem on an even greater scale here.  We can’t all just agree on the answer because the question is much more complex than simplistic economic analysis suggests.