Question

According to the debtors and those sympathetic with the debtors, the creditor is really to blame because the money should have never been lent in the first place. The debtor never had a reasonable chance of paying back and/or never intended to pay off the loan, the creditor knew or should have known of the debtor's intentions or inability to pay back the loan, and consequently; the debtor should not be liable to make payment. On top of that, creditors often know there is a third party (off in the wings) who will share in or cover the losses of the transaction which reduces the prudence a creditor would normally exercise when making a loan.

For example, lenders underwriting student loans know the losses are guaranteed, lenders underwriting loans to Greece know the Eurozone will be there to "backstop" them, and Fannie and Freddie knew that Congress and the taxpayer would be there to bailout their losses on bundled mortgage securities sold by the big banks.

1. Are you sympathetic with the argument of the debtors that lenders who engage in moral hazard have to be primarily responsible for loan losses? Explain.

2. Aren't debtors simply killing the "golden goose?" Aren't creditors providing a service to society by making access to capital plentiful? Aren't the debtors simply making the costs of capital more expensive?

Answer 1

1) I am not in favour of the argument that lenders have to be primarily responsible for loan losses because lenders generally perform due deligence before approving loan. The lenders check the credit history of the borrower, take a collateral just in case the borrower default and various such measures to prevent losses. If a lender approves loan without taking any such measures then the lender can be held responsible but this is rarely the case in present circumstances. Thus lenders should initiate full recovery process in case the borrower defaults on the loan.

2) I agree with the fact that " Debtors simpy kill the golden goose" . A tiny number of wilful defaulters can spoil the prospects of genuine borrowers . Debtors who dont repay loans impinge upon the creditors and this results in higher cost of borrowing and more stringent measures followed to approve loan. Thus the process of loan approval becomes complex , time consuming and difficult to access available capital.