Borrowers share the blame for our crisis

First published in the Financial Times on 5th June 2012.

If debtors can abrogate their liabilities without consequence, the system will unravel

A wise man once told me never to lend friends money: either give them the cash, or do nothing. His reason was that borrowers so often end up hating their creditors. Which means lenders are punished twice if loans go bad: first, they aren’t repaid the money they are owed; and second, those who are in debt to them become their enemies.

It strikes me that this is similar to the circumstances of Germany and the various debt-ridden eurozone nations such as Greece. Overall, the Germans are industrious, productive and prudent. Their manufactures, export prowess and commercial efficiency underwrite the creditworthiness of the entire euro project. Yet the reward for such admirable qualities is to be vilified – mostly by those who spend beyond their means, retire too early and defraud the taxman.

In life, virtue often goes unappreciated. Most of the EU takes Germany’s munificence for granted, relying on an unshakeable belief in the European project among the Teutonic political classes. But German guilt over the second world war is a wasting asset – everyone but the elderly there must wonder why they have to work so long and pay such high taxes to fund profligate, irresponsible neighbours.

Similarly, in places such as the US the banks are detested by millions of homeowners who took out mortgages they cannot afford for property that is now worth less than they paid for it. No bank ever forced anyone to buy and borrow. Perhaps a few banks were predatory lenders – but only suicidal ones would grant mortgages knowing that the borrower was unable to honour his side of the bargain. Unquestionably, some originators of mortgages were unscrupulous, confident they could pass the debt on – but in such cases the end buyers of the mortgages were the losers.

Moreover, there are legions of “strategic defaulters” across the US property landscape. These are homeowners who can afford to keep up their mortgage payments, but decide to renege on their obligations anyway because their home is worth less than the borrowings secured against it. Where is the morality in that? In many cases, the lender cannot legally pursue them or is so overwhelmed with problem loans that their case will probably become lost in the mess.

Almost invariably, those who abandon their commitments know they are behaving disreputably. In order to justify such actions, people look for someone to blame. In this crisis, the media, courts and politicians have pointed the finger at the banks – saying they did not exercise an appropriate duty of care. But arguably these inanimate institutions are easy targets. In many cases, bank boards have been sacked and shareholders virtually wiped out. Yet they extended credit in good faith, enabling citizens to buy homes and other assets. No doubt there was reckless lending – but also reckless borrowing, without which the whole merry-go-round could never have started.

It is easier to feel sympathy for the supposed underdog – the homeowner evicted from a foreclosed house, say, or nations such as Greece, suffering under a regime of “austerity”. But the entire basis of our civilisation is the sanctity of civil contracts. If borrowers are allowed to abrogate their liabilities without consequence, then the system unravels. If that happens we all suffer.

First, credit disappears – which is what has occurred in recent years, meaning industry and trade cannot obtain finance. This in turn leads to bankruptcies, unemployment and economic decline. And second, if individuals, companies and nations simply walk away unscathed from legitimate claims, then they set a terrible example to others – which feeds the cycle of insolvency and deterioration.

At heart, capitalism is deferred gratification. Investments and loans are made based on long-term understandings about returns. It involves a vast network of collaboration based on trust. It cannot function if those who supply credit are deprived of their rights, and unpaid loans are simply forgiven as a matter of course. Banks end up hoarding cash and demanding impossible levels of security, so no one can buy a home, and entrepreneurs are unable to build factories, or fund their working capital needs. To prevent this calamity, borrowers must be seen to honour their obligations – or face serious repercussions.