Occupy Wall Street has come up with a novel idea: buy distressed debt and forgive it:
OWS is going to start buying distressed debt (medical bills, student loans, etc.) in order to forgive it. As a test run, we spent $500, which bought $14,000 of distressed debt. We then ERASED THAT DEBT.Fantastic, surely? We can sort out the USA distressed debt at a stroke!
Not quite so fast, though: a commentator puts his finger on the wrinkle:
But I do have a question. If you can buy debt, can individuals buy debt, even our own debt?Yes. You can buy your own debt. If you owe $14,000, and the debt holder only thinks they are going to get back $500 net after their expenses in hounding you, they will sell your debt for $500 and not care who pays that. Except - well, except that if you have $500 free and clear to spend buying back your debt without selling off any goods, the debt holder is going to think that they can get back more than just $500. So they will want (say) $800 instead. And around we go.
Just curious. It would seem to me to be a great Idea for us to buy our own debt, then forgive it.
If Occupy Wall Street went into this business in a big way, they'd increase the demand for purchase of distressed loans. So the price of distressed loans would rise. So the debt holders wouldn't be willing to sell $14,000 of distressed debt for $500 any more. In fact, it would be in the debt holders' interest to exaggerate the expected return from the loan (say, if they didn't really expect any money back after their expenses), and get $500 for free from Occupy Wall Street. Oopsie! Once again we see that asymmetric information is a bitch.
There's also the not inconsiderable problem that the person owing $14,000 has just received an effective gift of $14,000. Guess what? That's taxable! Say, 25% federal tax plus 2%(?) FICA plus 5% state tax - he now owes nearly $4500 in taxes. And since he's unlikely to have $4500 in assets if that debt was only values at $500, where's that going to come from? If you thought a bank holding your debt was bad, wait until it's Uncle Sam instead.