An Awesome Occupy Initiative: Buying and Forgiving Debt

Occupy Wall Street has faded as a movement, but it doesn't mean they are totally gone. Their Occupy the SEC branch has been thoroughly awesome and since Sandy they've been helping the victims of the hurricane get back on their feet. Their most recent initiative to purchase distressed debt for cents on the dollar and forgive it is something that caught my eye, and put a very wide smile on my face.

Normally debt forgiveness creates some serious economic incentives problems in the form of moral hazard. Moral hazard is a Very Serious problem that Very Serious People obsess over, however just because it is a Very Serious problem doesn't mean it is a very real one. In the aggregate individuals will price the probability that they will get their debt forgiven into their calculations about how much debt to take out. The higher the chance they will be forgiven, the more likely it is they will take on more debt, or enter strategic default if they are already in debt. We can quibble about the moral obligation that people attach to paying off their debt, but for my purposes I'm making the admittedly strong assumption that people are pure rational actors.

However the Occupy initiative doesn't create this problem due to the small and random nature of the initiative. Occupy isn't going to be liberating hundreds of millions of dollars of debt, they probably won't even crack the ten million dollar mark when all is said and done. This means the marginal increase in the chance that debt will be forgiven is infinitesimally small, so they won't take out more debt then they can handle. Additionally people who are already in debt and are considering going into default won't chance their decision to default or not because the chance their debt will be forgiven is still the same incredibly small amount it was before.

So far I've described a small, seemingly insignificant program, so where is the upside you ask? People who's crushing debt was going to fall into the hands ruthless debt collectors prior the program will instead see their debt wiped clean. They can go forward without a ball and chain of past debt dragging their consumption and investment down. They won't be hounded by collectors at every turn. They can focus on living their lives instead of worrying about their next bill payment. These individuals will have won a lottery, but its a lottery they unknowingly entered because they were forced into extreme circumstances.

This is of course a second best option for debt forgiveness and personal debt reduction. Cramdown on mortgages, caps based on graduate income on student debt repayments, and stronger consumer protection against predatory lending are all better long term options. However in the interim  Occupy is doing something concrete that will help the lives of those deeply in debt, and by extension the communities that these folks live in too.