Thursday, October 30, 2008

Yet Another Reason to Hate the IRS (and OCC)

Photo by SC Fiasco

As if it weren't hard enough to get banks to offer workouts to overindebted consumers! While I find the premise of the following story hard to believe, apparently major credit card lenders want to forgive significant portions of credit card debt that borrowers can't currently repay, but the Office of the Comptroller of the Currentcy and the IRS have conspired to prevent this.

Currently, when overburdened debtors (or their counselors) call up asking for a workout, credit card lenders will generally only agree to reduce interest rates and penalties and perhaps extend repayment terms to reduce payments. I had always attributed this to avarice and irrational refusal to accept the economic reality that borrowers would repay more if only they were given a bit of a break. As it turns out, I might well have been wrong, as explained in this letter describing a new pilot program to expand credit card debt forgiveness. According to the Financial Services Roundtable (whom I don't trust, by the way) and the Consumer Federation of American (whom I emphatically do trust), lenders appreciate the economic reality point, but the OCC and IRS inhibit lenders from offering significant reductions of principal. They do this by (1) requiring OCC-regulated lenders to demand payment of reduced principal amounts (and book the loss) within three to six months maximum, which (2) triggers a requirement that lenders send a 1099-C "Cancellation of Debt" tax form to borrowers, which in some cases might require the recently forgiven debt to be recognized as taxable income to the hapless debtor [NOTE: most debtors in this position will have been insolvent before (and probably still after) the forgiveness, in which case the COD/forgiveness "income" is excludable from taxable income, see IRS Pub 4681].

For decades we've been trying to convince lenders to act more reasonably in extending workout terms to borrowers WAY over their heads in debt, and now this. Just when you solve one problem, the IRS and some other regulatory agency create another one.

Though the accounting principle in play here doesn't strike me as so intrusive as to have prevented realistic debt forgiveness by banks, I nonetheless hope the OCC and IRS go for this proposal to eliminate the problem, however slight. The FSR/CFA letter promises that "virtually all of the largest national credit card banks" have agreed to offer "significant reductions in the principal [credit card] debt owed" to see if collections increase (my bet: they will!). Speaking as a proud paternalistic supporter of government intervention, I really hope the OCC and IRS get out of the way on this one!

Update 11/12/08: The proposal was rejected in what seems to me like record time for government bureaucrats. Hmmm.

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