## Executive Summary (_spn0915)

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---

### Overview / Introduction
- Household indebtedness reached historically high and likely unsustainable levels in several countries hit by the current financial crisis (Figure 1).
- Drivers:
  - Excessive credit booms in the run-up to the crisis and recent sharp declines in house prices.
  - Balance sheet effects from currency depreciation where foreign-currency-denominated loans are prevalent.
- Feedback loops and spirals:
  - Weakened bank balance sheets via increases in nonperforming loans, leading to reduced credit availability and further pressure on house prices and asset values.
  - Reduced consumption, lower growth, and higher unemployment, compressing household income and worsening debt problems.
- Note objective: propose a template for a government-supported household debt restructuring program and assess the case for government intervention.

### The Case for Government Intervention
- Guiding principles:
  - Resolving debt overhang imposes costs; policy should minimize inefficiencies associated with distressed-loan resolution.
  - Any intervention involves distortions; benefits must exceed costs and be constrained by fiscal space and public debt sustainability.
- Market failures and practical constraints justifying intervention:
  - Large numbers of personal insolvency cases can overwhelm court systems.
  - Voluntary loan workouts can suffer attrition and delay, producing suboptimal outcomes.
  - Legal costs, delays, and wealth destruction argue for an “organized” resolution strategy.
- Externalities motivating intervention:
  - Massive household defaults can cause unnecessary and costly liquidations, including foreclosures, especially where homeowners possess negative equity.
  - Financial institutions will not fully internalize negative externalities from foreclosures; continuing house price deflation expectations can prevent stabilization.
  - Foreclosures can negatively affect neighborhood values, creating multiple equilibria: a faster resolution equilibrium with stabilized house prices versus a lingering debt-overhang equilibrium with further price declines and recessionary effects.
- Conditions where private resolution may suffice:
  - Scale of distressed household debt is relatively small.
  - Banks are sufficiently sound.
  - Coordination problems are limited and foreclosures are not widespread enough to create significant negative externalities.
- Conditions warranting government intervention:
  - Scale of distressed household debt is sufficiently large to have macro implications.
  - Banks are paralyzed by insufficient capital, lack internal capacity for individualized restructurings, or face coordination failures.
  - Limited legal and institutional capacity to support individualized restructurings.
- Fiscal and banking considerations:
  - Feasibility and credibility of government financial support depend on impact on public debt sustainability and available fiscal space.
  - Debt restructuring generates writedowns that will negatively impact bank capital positions and will most likely require accompanying bank recapitalization.
  - Recapitalization programs must be calibrated to restore bank solvency after restructuring.
- Contextual examples cited:
  - FHASecure (announced August 2007).
  - Hope for Homeowners (H4H) (activated October 1, 2008).
  - Homeowner Affordability and Stability Plan (March 2009) — establishes guidelines for affordable loan modifications and refinancing, provides incentives for loan modifications, supports housing market via increased funding to government-sponsored agencies, renter assistance, grants for innovative local programs, and counseling.
  - Earlier voluntary restructuring schemes in Mexico, Lithuania, and the United States; some U.S. efforts had limited success targeting severely delinquent borrowers.

### High-level Policy Implications
- Government-supported household debt restructuring programs should:
  - Be based on sound economic principles and adapted to country circumstances.
  - Consider legal and institutional capacity, scale of distress, banking sector soundness, and fiscal constraints.
  - Coordinate debt restructuring and bank recapitalization efforts, recognizing overlap in costs and implications for public debt sustainability.
- Analysis excludes:
  - Weakening supply of credit or temporary household liquidity problems.
  - Efforts to support asset prices or banking sector resolution beyond debt restructuring design.
  - Complexities associated with links to structured credit products (for example, through securitization) in some advanced economies.

### Box 1 — Assessing the Size of the Problem: Operational Suggestions

#### Assessing the size: data and indicators
- Collect outstanding amounts of nonperforming (gross) household debt in nominal terms and as a percentage of total bank loans, by:
  - type of credit (mortgages, credit cards, car loans, and other consumer credit);
  - currency of denomination;
  - amounts and number of days past due;
  - collateral values (accounting values according to the bank records).
- Complementary borrower-condition indicators (if available):
  - loan-to-value (LTV);
  - loan-to-disposable income (LTDI);
  - original and current debt service-to-disposable income.
- Purpose: stock data provide a static framing to be compared with the broader picture of all household debt.

#### Evolution over time
- Key tasks:
  - Assess transitions in credit quality (watch → substandard → doubtful → loss) based on time overdue.
  - Track trends over time of total household debt in distress (absolute amounts and appropriately scaled).
  - Monitor shares of debt in different credit quality categories, particularly incidence of “loss” credits.
- Additional useful information: real estate prices to assess negative equity (LTV greater than one).
- Caution: NPL definitions may differ across countries; past trends may be poor guides in crises.

#### Distribution across financial institutions
- Two immediate-dimension priorities:
  - Whether affected institutions are systemic in payments/settlement or other key financial segments (spillover channels).
  - Whether affected institutions have cushions—in provisions, loan loss reserves, and capitalization—to absorb losses without triggering supervisory corrective action.

#### Impact on financial institutions
- Assess effects of restructuring strategies on banks:
  - Impact of reduced rates or lengthened maturities on cash flows, liquidity, and earnings.
  - Impact of additional provisions on profitability and capitalization.
  - Dependence of earnings on continued household debt service.
- Conduct exercises with banking experts, supervisory authorities, and lending institutions.

#### Two broad approaches to government intervention
- Approach 1: strengthen legal and institutional framework for case-by-case restructuring and catalyze out-of-court restructurings. Key legal features:
  - (i) automatic stay on creditor enforcement and debtor payments during insolvency proceedings;
  - (ii) court ability to restructure deficiency as unsecured debt when collateral market value is below loan;
  - (iii) modification of loan terms based on debtor payment capacity;
  - (iv) “fresh start” through discharge of financially responsible debtors at end of liquidation/rehabilitation.
- Approach 2: government-sponsored debt restructuring program with financial support that could:
  - provide financial support to banks that restructure;
  - establish an asset management company to purchase and resolve distressed assets;
  - provide direct support to households via debt forgiveness, interest/exchange rate subsidies, or tax incentives.

#### Design principles for government-sponsored programs
- Objectives:
  - Turn troubled loans into performing loans while mitigating moral hazard.
  - Target reduction in debt service for borrowers hit by adverse interest rate or FX shocks or to address substantial NPLs.
- Scope:
  - Be selective where feasible: target borrowers unable to meet debt service but with recoverable capacity post-restructuring.
  - Public funding must be sufficient for each qualifying participant; scope limited by public funding envelope.
- Proportionality:
  - Degree of intervention depends on problem scale, creditor/debtor loss-absorption capacity, and fiscal space.
  - Do not impede government debt sustainability; burden sharing depends on ability to absorb losses.
- Participation:
  - Voluntary participation preferred; induce (not force) banks to restructure.
  - Note: mandatory participation may be applied to banks receiving public funds.
- Simplicity:
  - Use simple rules and verifiable information to speed restructuring and reduce abuse.
  - Rules should be based on bank loan portfolio analysis; banks should share necessary information if public funds are used.
- Transparency and accountability:
  - Include monitoring mechanisms (ongoing reporting and audit requirements) when public funds are used.

#### Implementing government-sponsored programs: timing and safeguards
- Preconditions and cautions:
  - Consider ongoing bank restructuring efforts and dynamic impacts on loan portfolios.
  - Coordinate with market players to identify need and size of public intervention.
  - Avoid launching programs before macro stabilization and a bank recapitalization program that accounts for prospective restructuring losses.
  - Debt restructuring is not a substitute for sound macroeconomic policies.
- Mitigating moral hazard:
  - Design to encourage a “separating equilibrium” where only borrowers unable to repay participate.
  - Attach conditions to participation where appropriate: payroll deductions, restoration to original terms on default, upfront cash payments, reporting to central credit registers.
  - Center design on borrowers’ capacity to repay.

#### Additional elements and instruments
- Incentives for borrowers:
  - loan subsidies on restructured debt, subsidized refinancing, guarantees of payments, subsidized write-offs, insurance against future FX or interest rate changes;
  - for distressed mortgages, subsidize conversion of part of debt into equity-like instruments (e.g., shared appreciation mortgages) with possible government upside sharing.
- Incentives for lenders:
  - tax credits for restructured loans, low interest rate credit lines to banks, tie restructuring to bank recapitalization.
  - Caution: avoid temporary easing of provisioning or unusually stringent provisioning on non-restructured debt; regulatory forbearance is risky and exceptional.
- Legal and institutional reforms:
  - strengthen enforcement of creditor rights and effective personal bankruptcy frameworks for collective enforcement and debtor rehabilitation.
- Measures for foreign-currency-denominated loans:
  - consider converting debt into local currency (eliminating borrower FX exposure) but note problems:
    - likely prohibitively expensive unless costs transferred to government;
    - may worsen banks’ currency mismatches and require foreign-currency liquid assets;
    - public support could be dollar-denominated or indexed restructuring bonds to reduce banks’ currency mismatch, though feasibility depends on country circumstances and such bonds may lack sufficient liquidity;
    - avoid forced conversion through legislative fiat due to legal challenges, run risks, and undermining creditworthiness.
- Administrative measures as last resort:
  - standardized modification of distressed loans, payment moratorium, or foreclosure ban.
  - Cautions: moratoria and foreclosure bans interfere with contracts, harm contract enforcement perceptions, can incentivize default, and do not address underlying overhang; avoid deposit freezes and capital controls if possible.

#### Other policy responses and complements
- Alternatives/complements:
  - bank recapitalizations targeted to prospective losses from distressed assets;
  - government purchases of distressed loans via AMCs.
- Benefits and risks of AMCs:
  - May facilitate restructuring and incentivize banks to recognize losses.
  - Risks: transferring assets at above-market prices, excessive support, political/legal challenges in asset resolution.
  - Success depends on legal/institutional environment and design details (financing, risk/loss sharing, governance).
- Empirical note: countries typically apply a combination of resolution strategies and often incur substantial fiscal costs; policy mix is crisis-specific.

*This box was prepared primarily by Mauro Mecagni (IMF, Strategy, Policy, and Review Department).*

### Appendix I — Brief Summaries of Previous Episodes of Household Debt Restructuring

- United States (1933)
  - Established Home Owners Loan Corporation (HOLC) to prevent foreclosures.
  - HOLC bought distressed mortgages in exchange for bonds with federal guarantees; restructured loans; eligibility: mortgages with appraised value of $20,000 or less ($321,791 in 2008 dollars).
  - Approximately 40 percent of those eligible applied; half of these applications were rejected or withdrawn.
  - Of the one million loans HOLC issued, it acquired 200,000 homes from borrowers unable to pay.
  - HOLC made a relatively small profit when liquidated in 1951.

- Mexico (1998)
  - Punto Final program (December 1998) targeted mortgage holders, agribusiness, and SMEs; offered subsidies up to 60 percent of book value.
  - Discounts depended on sector, loan amount, and whether the bank restarted lending.
  - For every three pesos of new loans extended, government would assume an additional one peso of discount—combining loss sharing with incentives to restart lending.
  - Outcome: rapid debt relief at very large fiscal cost.

- Uruguay (2000)
  - Systemic and compulsory restructuring for small loans (up to US$50,000): extended maturities and gradually increasing payment schedules.
  - Largely voluntary scheme for large borrowers with strong incentives for agreements.
  - Creditor participation incentives: flexible classification system and reclassification as loss with 100 percent provisioning if not restructured within timeframe.

- Korea (2002)
  - Rapid credit card expansion led to distressed market; credit card debt reached 15 percent of GDP in 2002.
  - Commercial banks heavily exposed; lending to one large troubled issuer was 38 percent of creditor banks’ combined equity.
  - Principal resolution: loan write-offs, sales to third parties, debt-to-equity conversions; authorities allowed “re-ageing” (regulatory forbearance).

- Argentina (2002)
  - Asymmetric pesofication following January 2002 program: external debt moratorium, end to Convertibility, dual exchange regime; February unified exchange, maturities of time deposits extended (“corralón”); dedollarization at asymmetric rates—Arg$1 per dollar on assets, Arg$1.4 per dollar on liabilities.
  - Asymmetric indexation: deposits indexed to CPI; certain loans indexed to wages.
  - Fiscal cost: about 15 percent of GDP, largely due to fiscal outlays accruing to banks.
  - Losses to banks far exceeded banking system net worth; conversion of deposits led to dollar value erosion of 40 percent.
  - By 2003: banks dependent on central bank liquidity window accounted for 13 percent of total assets; loans to private sector declined to 15 percent of total assets (US$8.4 billion); exposure to public sector increased to 50 percent of total assets.
  - Deposit freeze and conversion caused depositor confidence loss and collapse in financial intermediation.

- Taiwan Province of China (2005)
  - Credit card distress affected small/specialized institutions; NPL ratios:
    - cash cards: peaked at about 8 percent in 2006 (up from about 2 percent a year earlier);
    - credit cards: peaked at about 3.5 percent in 2006 (up from about 3 percent a year earlier).
  - System-wide NPL ratio not visibly affected; profitability impact:
    - average return on equity dropped to –0.41 percent at end-2006 (from 4.58 percent at end-2005);
    - average return on assets dropped to –0.03 percent at end-2006 (from 0.31 percent at end-2005).
  - Authorities initiated a personal debt restructuring program covering 30 percent of outstanding credit card balances; restructured loans largely reclassified as performing, granting regulatory forbearance.

- United States (2008)
  - Housing bubble burst in 2007 produced rising foreclosures, depressed house prices, and household debt overhang.
  - Coordination failures and legal impediments: about 10 million U.S. homeowners reportedly have negative equity; more than half of subprime borrowers have DTI ratios exceeding 38 percent.
  - Federal homeowner programs summarized:
    - FHASecure (announced August 31, 2007; amended May 7, 2008): refinance into FHA-insured loans; lender write-off limits of 97 or 90 percent of current appraised home value depending on payment history; payments capped at 31 percent of income and total debt payments at 43 percent; delinquent borrower charges: 2.25 percent UFMIP and 55 basis points annually; current borrowers: 1.50 and 0.50 percent. Program phased out at end-2008 due to disappointing take-up.
    - Hope for Homeowners (H4H) (activated October 1, 2008): applies to mortgages on primary residences originated before January 2, 2008, and to borrowers whose current mortgage payments exceed 31 percent of gross income; lender write-off limit 96.5 percent of current appraised value; funds a new 30- or 40-year fixed-rate FHA-insured loan with payments at or below 31 percent of income and total debt payments at or below 43 percent; for higher debt loads DTI can be expanded to 38 percent but new principal cannot exceed 90 percent of current appraised value; 1st lien holder pays 3 percent upfront FHA insurance premium; homeowner pays 1.50 percent annual premium; HUD recoups “instant” equity (100 percent in the first year, declining to 50 percent after five years) and 50 percent of any net HPA on sale; borrowers prohibited from new subordinated liens during first five years except to maintain property standards.
    - FDIC IndyMac Loan Modification Program: modifies eligible mortgages to achieve sustainable payments at 38 percent DTI; no fees for borrower; eligibility: first mortgage on primary residence owned or securitized and serviced by IndyMac where borrower is seriously delinquent or in default.
    - FHFA introduced similar program for Fannie Mae and Freddie Mac guaranteed mortgages.
  - Programs focus on affordability, not negative equity, and typically consider seriously delinquent loans (FDIC: 60 days or more; FHFA: 90 days) to owner-occupant borrowers not in bankruptcy.
  - Voluntary bank initiatives (e.g., Citigroup): modifications for mortgages with DTI in excess of 40 percent (lower interest rates, term extensions, and principal reduction as last resort).
  - State foreclosure moratoriums (three-to six months) introduced as temporary palliatives.

- Hungary (2008)
  - November 2008: commercial banks signed gentleman’s agreement with ministry of finance on foreign-currency loan workouts:
    - Borrower options: convert FX loans to forint before year-end without fees; request free-of-charge extension of loan duration if monthly repayments rise significantly; request temporary easing of repayment obligations, especially if unemployed.
    - Key elements (rate of loan conversion and interest rates) left to parties to determine.
    - Conversion uptake low due to high domestic interest rates.
    - Government preparing legislation for temporary government guarantees (up to two years) on mortgage payments for unemployed borrowers; guarantees available for mortgages outstanding up to 20 million HUF on primary residence only, requiring minimum payment of 10,000 HUF a month (preliminary reports).

- United Kingdom (2008)
  - Early December 2008: U.K. Treasury announced Homeowners Support Mortgage Scheme to reduce foreclosures.
  - Borrowers with mortgages up to £400,000 and savings lower than £16,000 eligible to defer a portion of payments by up to 2 years.
  - Deferred payments rolled up into principal; U.K. Treasury will guarantee deferred interest payments for participating banks; most large lenders agreed to participate.

### Selected household indicators, pre- and post-debt restructuring (as presented)
- 193219361997    20011999    20032001   20052001200520042008
- Household income growth (in %)-25.815.15.2-1.2-3.32.33.13.7-5.48.1
- Consumption growth (in %)-21.59.76.52.5-1.52.04.93.6-5.78.94.51.3
- Unemployment rate (in %)22.714.23.72.811.315.44.03.720.710.14.43.9
- Private debt/GDP (in %)45.432.124.514.549.846.492.7   100.320.811.7

*Executive Summary from _spn0915 - Executive Summary*

### Executive Summary ......................................................................................................

### Executive Summary

### Overview / Introduction
- Household indebtedness reached historically high and likely unsustainable levels in several countries hit by the current financial crisis (Figure 1).
- Drivers include:
  - Excessive credit booms in the run-up to the crisis and recent sharp declines in house prices.
  - Balance sheet effects from currency depreciation where foreign-currency-denominated loans are prevalent.
- Household debt overhang and debt servicing problems feed into connected downward spirals:
  - Weakened bank balance sheets via increases in nonperforming loans, leading to reduced credit availability and further pressure on house prices and asset values.
  - Reduced consumption, lower growth, and higher unemployment, compressing household income and worsening debt problems.
- The note proposes a template for a government-supported household debt restructuring program and assesses the case for government intervention.

### The Case for Government Intervention
- General principles:
  - Resolving debt overhang imposes costs on the economy; policy should minimize inefficiencies associated with distressed-loan resolution.
  - Any intervention involves distortions; benefits must exceed costs and be constrained by fiscal space and public debt sustainability.
- Market failures and practical constraints that can justify government intervention:
  - A crisis can generate a very large number of personal insolvency cases, making timely court-based resolution infeasible even in high-capacity systems.
  - Voluntary loan workouts can suffer attrition and delay, producing suboptimal outcomes for the economy.
  - Legal costs, delays, and associated wealth destruction argue for an “organized” resolution strategy.
- Externalities motivating intervention:
  - Massive household defaults can cause unnecessary and costly liquidations, including foreclosures, especially where homeowners possess negative equity.
  - Financial institutions will not fully internalize negative externalities from foreclosures; continuing house price deflation expectations can prevent stabilization.
  - Foreclosures can negatively affect neighborhood values, creating multiple equilibria: a faster resolution equilibrium with stabilized house prices versus a lingering debt-overhang equilibrium with further price declines and recessionary effects.
- Conditions under which private resolution may suffice:
  - Scale of distressed household debt is relatively small.
  - Banks are sufficiently sound.
  - Coordination problems are limited and foreclosures are not widespread enough to create significant negative externalities.
- Conditions warranting government intervention:
  - Scale of distressed household debt is sufficiently large to have macro implications.
  - Banks are paralyzed by insufficient capital to absorb expected losses, lack internal capacity to carry out individualized restructurings, or face coordination failures.
  - Limited legal and institutional capacity to support individualized restructurings.
- Fiscal and banking considerations:
  - Feasibility and credibility of government financial support depend on impact on public debt sustainability and available fiscal space.
  - Debt restructuring generates writedowns that will negatively impact bank capital positions and will most likely require accompanying bank recapitalization.
  - Recapitalization programs must be calibrated to restore bank solvency after restructuring.
- Contextual examples of government or government-sponsored initiatives:
  - FHASecure program announced in August 2007.
  - Hope for Homeowners (H4H) program started on October 1, 2008.
  - Homeowner Affordability and Stability Plan introduced in March 2009, which:
    - Establishes guidelines for affordable loan modifications and refinancing aimed at reducing monthly payments to sustainable levels.
    - Provides incentives for loan modifications for borrowers, lenders, and other mortgage market participants, including through the personal bankruptcy mechanism as last resort.
    - Includes measures to support the housing market through increased funding commitments to government-sponsored agencies, renter assistance, grants for innovative local programs to reduce foreclosures, and counseling for heavily indebted borrowers.
  - Earlier voluntary restructuring schemes in Mexico, Lithuania, and the United States were noted, but some U.S. efforts met with limited success because they targeted severely delinquent borrowers unlikely to resume servicing without more generous support.

### Implications for Policy Design (high-level)
- Government-supported household debt restructuring programs should:
  - Be based on sound economic principles and adapted to country circumstances.
  - Take into account legal and institutional capacity, scale of distress, banking sector soundness, and fiscal constraints.
  - Coordinate debt restructuring and bank recapitalization efforts, recognizing overlap in costs and implications for public debt sustainability.
- The analysis excludes:
  - Weakening supply of credit or temporary household liquidity problems.
  - Efforts to support asset prices or banking sector resolution beyond debt restructuring design.
  - Complexities associated with links to structured credit products (for example, through securitization) in some advanced economies.

*Executive Summary from _spn0915 - Executive Summary*

### Box 1: Assessing the Size of the Problem: Some Operational Suggestions

### Box 1: Assessing the Size of the Problem: Some Operational Suggestions

### Assessing the size: data and indicators
- Current picture: collect information on outstanding amounts of nonperforming (gross) household debt, both in nominal terms and in percentage of the total loan portfolio of banks, and by:
  - type of credit (mortgages, credit cards, car loans, and other consumer credit);
  - currency of denomination;
  - amounts and number of days past due;
  - collateral values (accounting values according to the bank records).
- Complementary indicators (if available) for grouping borrowers by financial condition:
  - loan-to-value (LTV);
  - loan-to-disposable income (LTDI);
  - original and current debt service-to-disposable income.
- Purpose: stock data provide a static framing that should be compared to the broader picture of all household debt, whether performing or nonperforming.

### Evolution over time
- Key tasks:
  - assess transition in credit quality for household claims in distress (movement from “watch status” to substandard, doubtful, and loss categories) based on time overdue;
  - track trends over time of total household debt in distress (in absolute amounts and appropriately scaled);
  - monitor evolution of shares of debt in different credit quality categories, particularly incidence of “loss” credits.
- Additional useful information:
  - real estate prices to assess negative equity (LTV greater than one).
- Cautions:
  - definitions of nonperforming loan categories may differ across countries;
  - in crises with rapidly rising unemployment and falling house prices, past trends may be a poor guide for future developments.

### Distribution across financial institutions
- Two dimensions of immediate interest for financial stability and contingent liabilities:
  - whether affected institutions play a key, systemic role in payments and settlement, or in other key financial segments such as the interbank market (spillover channels);
  - whether affected institutions have sufficient cushion—in provisions, loan loss reserves, and overall capitalization—to absorb losses without violating prudential capital requirements or other supervisory norms that would trigger corrective action.

### Impact on financial institutions
- Assess the effects of restructuring strategies on banks, including:
  - likely impact of reduced rates or lengthened maturities on cash flows, liquidity, and earnings;
  - impact of additional provisions on profitability and capitalization;
  - dependence of earnings on continued household debt service.
- These exercises should be conducted with banking experts, supervisory authorities, and the lending institutions involved.

### Two broad approaches to government intervention
- Approach 1: establish legal and institutional framework to support case-by-case restructuring (and catalyze out-of-court restructurings). Key legal features for an effective court-supervised insolvency framework for individual debtors include:
  - (i) an automatic stay on creditor enforcement and debtor payments during insolvency proceedings;
  - (ii) when debt is secured but market value of collateral is below the loan, the court can restructure the deficiency as unsecured debt;
  - (iii) modification of loan terms should take into account the payment capacity of the debtor;
  - (iv) a “fresh start” through discharge of financially responsible debtors from liability for unsustainable debts at the end of liquidation or rehabilitation.
- Approach 2: establish a government-sponsored debt restructuring program with some form of financial support. Government support could:
  - provide financial support to banks that restructure;
  - establish an asset management company to purchase and resolve distressed assets;
  - provide direct support to households via debt forgiveness, interest or exchange rate subsidies, or tax incentives.

### Design principles for government-sponsored debt restructuring programs
- Objectives:
  - Turn troubled loans into performing loans while mitigating moral hazard.
  - Target reduction in debt service requirements for borrowers hit by adverse interest rate or foreign exchange rate shocks or to address substantial nonperforming loans.
- Scope:
  - Where feasible, be selective and target borrowers who cannot meet debt service obligations but whose capacity is likely to be restored upon restructuring.
  - Program may compensate targeted borrowers partially or in full, but public funding must be sufficient to cover each qualifying participant; the scope is subject to the public funding envelope.
- Proportionality:
  - Degree of intervention should depend on the scale of the problem, capacity of creditors and debtors to absorb losses, and fiscal space.
  - Intervention should not impede government debt sustainability; burden sharing depends on ability to absorb losses.
- Participation:
  - Participation should be voluntary; banks should be induced, not forced, to restructure debts.
  - Note: banks’ participation may be enhanced by making it mandatory for banks that receive public funds (see footnote in source).
- Simplicity:
  - Use simple rules and verifiable information to speed restructuring and reduce abuse.
  - Rules should be based on analysis of banks’ household loan portfolios; banks should share necessary information with government if public funds are used.
- Transparency and accountability:
  - Include mechanisms for monitoring progress (ongoing reporting and audit requirements), especially important where public funds are used.

### Implementing a government-sponsored program: timing and safeguards
- Preconditions and cautions:
  - Consider ongoing bank restructuring efforts and dynamic impacts on banks’ loan portfolios.
  - Coordinate closely with market players to identify need and size of public intervention.
  - Avoid introducing government-sponsored programs before macroeconomic stabilization and a bank recapitalization program that accounts for prospective restructuring losses.
  - Debt restructuring is not a substitute for sound macroeconomic policies.
- Mitigating moral hazard:
  - Design should encourage a “separating equilibrium” in which only borrowers unable to repay participate.
  - Attach conditions to participation where appropriate: e.g., payroll deductions, restoration to original loan terms on default, upfront cash payments, or reporting beneficiaries to central credit registers.
  - Above all, borrowers’ capacity to repay must be central to design.

### Additional elements and instruments governments may use
- (i) Incentives for borrowers:
  - loan subsidies on restructured debt (such as subsidized interest rates for borrowers), subsidized refinancing, guarantees of payments, subsidized write-offs, insurance against future exchange rate or interest rate changes;
  - for distressed mortgages, subsidize conversion of part of debt into more equity-like instruments (e.g., shared appreciation mortgages) with possible government upside sharing.
- (ii) Incentives for lenders:
  - tax credits for restructured loans, low interest rate credit lines to banks, tying restructuring to bank recapitalization programs.
  - Caution: temporary easing of provisioning or unusually stringent provisioning on non-restructured debt is to be avoided; regulatory forbearance is risky and should be used very cautiously and only in exceptional circumstances.
- (iii) Legal and institutional reforms:
  - strengthen enforcement of creditor rights and an effective personal bankruptcy framework for collective enforcement and debtor rehabilitation where multiple creditors exist.
- (iv) Specific measures for foreign-currency-denominated loans:
  - consider converting debt into local currency (eliminates borrower exchange rate exposure) but note problems:
    - likely prohibitively expensive for banks and borrowers unless costs are transferred to government;
    - may worsen banks’ currency mismatches and require availability of foreign-currency-denominated liquid assets;
    - public support could be dollar-denominated or indexed restructuring bonds to reduce banks’ currency mismatch, though feasibility depends on country circumstances and such bonds may lack sufficient liquidity;
    - forced conversion through legislative fiat should be avoided due to legal challenges, risk of runs, and undermining creditworthiness.
- (iv) Administrative measures as last resort:
  - standard way of modifying distressed loans, payment moratorium, or foreclosure ban.
  - Cautions: moratoria and foreclosure bans interfere with contracts, harm contract enforcement perceptions, can incentivize default, and do not address underlying overhang; deposit freezes and capital controls should be avoided if possible.

### Other policy responses and complementary measures
- Alternatives and complements to government-sponsored programs:
  - bank recapitalizations to shore up financial institutions (can be more selective and based on prospective losses from distressed assets);
  - government purchases of distressed loans, e.g., transfers to asset management companies (AMCs).
- Benefits and risks of AMCs:
  - may facilitate household debt restructuring and incentivize banks to recognize losses;
  - risks include transferring assets at above-market prices (bailing out existing shareholders), offering excessive support, and political and legal challenges in asset resolution.
  - Success of AMCs depends on legal and institutional environment as well as design details (financing, risk/loss sharing arrangements, governance).
- Empirical note: countries typically apply a combination of resolution strategies and often incur substantial fiscal costs; the policy mix is crisis-specific.

*This box was prepared primarily by Mauro Mecagni (IMF, Strategy, Policy, and Review Department).*

### Appendix I

### Appendix I

### A. United States (1933)
- Established the Home Owners Loan Corporation (HOLC) to prevent mortgage foreclosures.
- HOLC bought distressed mortgages from banks in exchange for bonds with federal guarantees on interest and principal.
- Restructured mortgages to make them more affordable and developed methods for working with delinquent or unemployed borrowers, including job searches.
- Eligibility: mortgages with an appraised value of $20,000 or less ($321,791 in 2008 dollars).
- Approximately 40 percent of those eligible applied; half of these applications were rejected or withdrawn.
- Of the one million loans HOLC issued, it acquired 200,000 homes from borrowers unable to pay.
- HOLC made a relatively small profit when liquidated in 1951, aided by declining interest rates and the government guarantee enabling inexpensive borrowing.

### B. Mexico (1998)
- Punto Final program (December 1998): government-led debt relief targeted at mortgage holders, agribusiness, and small and medium-sized enterprises.
- Offered subsidies up to 60 percent of the book value of the loan.
- Discounts depended on sector, loan amount, and whether the bank restarted lending to the sector.
- For every three pesos of new loans extended by the bank, the government would assume an additional one peso of discount—combining loss sharing with incentives to restart lending.
- Outcome: rapid debt relief but at very large cost to the taxpayer.

### C. Uruguay (2000)
- Debt restructuring scheme approved June 2000.
- Systemic and compulsory restructuring for small loans (up to US$50,000): extended maturities and gradually increasing payment schedules.
- Largely voluntary scheme for large borrower workouts with strong incentives for banks and borrowers to reach agreements.
- Creditor participation incentives:
  - a flexible classification system for restructured loans to encourage recognition of implicit losses; and
  - reclassification as a loss with a 100 percent provisioning requirement if a nonperforming loan was not restructured within the scheme’s timeframe.

### D. Korea (2002)
- Rapid credit card market expansion led to distressed credit card market with rising delinquencies in 2002.
- Credit card debt reached 15 percent of GDP in 2002.
- Commercial banks heavily exposed to troubled credit card issuers; lending to one large troubled credit card issuer stood at 38 percent of creditor banks’ combined equity.
- Commercial banks generally absorbed losses; affected credit card units merged into parent banks; standalone credit card companies were more severely impacted.
- Principal resolution methods: loan write-offs; also sales to third parties and debt-to-equity conversions.
- Authorities allowed “re-ageing” (rollover of delinquent credit card loans), a form of regulatory forbearance easing provisions and charge-offs.

### E. Argentina (2002)
- Asymmetric pesofication following January 2002 heterodox program: external debt moratorium, end to Convertibility, dual exchange regime.
- February: unified exchange regime; maturities of time deposits extended (“corralón”); bank balance sheets dedollarized at asymmetric rates—Arg$1 per dollar on assets, Arg$1.4 per dollar on liabilities.
- Asymmetric indexation: deposits indexed to consumer price inflation; certain loans indexed to wage inflation.
- Fiscal cost: about 15 percent of GDP, largely due to fiscal outlays accruing to the banks.
- Losses to banks far exceeded the entire net worth of the banking system.
- Conversion of deposits led to dollar value erosion of 40 percent.
- By 2003:
  - banks dependent on central bank liquidity window accounted for 13 percent of total assets;
  - loans to private sector declined to 15 percent of total assets (US$8.4 billion);
  - exposure to public sector increased to 50 percent of total assets.
- Deposit freeze and conversion caused loss of depositor confidence and collapse in financial intermediation; banking system severely undercapitalized.
- Depositors used exceptions and judicial rulings to release frozen deposits at market exchange rate.

### F. Taiwan Province of China (2005)
- Rapid expansion of credit card debt produced distressed credit card market; losses mostly affected small and specialized institutions.
- NPL ratios:
  - cash cards: peaked at about 8 percent in 2006 (up from about 2 percent a year earlier);
  - credit cards: peaked at about 3.5 percent in 2006 (up from about 3 percent a year earlier).
- System-wide NPL ratio not visibly affected and continued downward trend since 2000 reform.
- Profitability impact on domestic banks:
  - average return on equity dropped to –0.41 percent at end-2006 (from 4.58 percent at end-2005);
  - average return on assets dropped to –0.03 percent at end-2006 (from 0.31 percent at end-2005).
- Authorities initiated a personal debt restructuring program covering 30 percent of outstanding credit card balances; restructured loans largely reclassified as performing, granting regulatory forbearance.

### G. United States (2008)
- Housing bubble burst in 2007 led to rising foreclosures, depressed house prices, and household debt overhang.
- Coordination failures and legal impediments cited: about 10 million U.S. homeowners reportedly have negative equity; more than half of subprime borrowers have DTI ratios exceeding 38 percent.
- Federal homeowner “rescue” programs:
  - FHASecure (announced August 31, 2007; amended May 7, 2008): refinance into FHA-insured loans; lender write-off limits of 97 or 90 percent of current appraised home value depending on payment history; payments capped at 31 percent of income and total debt payments at 43 percent; delinquent borrower charges: 2.25 percent UFMIP and 55 basis points annually; current borrowers: 1.50 and 0.50 percent. Program phased out at end-2008 due to disappointing take-up.
  - Hope for Homeowners (H4H) activated October 1, 2008: applies to mortgages on primary residences originated before January 2, 2008, and to borrowers whose current mortgage payments exceed 31 percent of gross income; lender write-off limit 96.5 percent of current appraised value; funds a new 30- or 40-year fixed-rate FHA-insured loan with payments at or below 31 percent of income and total debt payments at or below 43 percent; for higher debt loads DTI can be expanded to 38 percent but new principal cannot exceed 90 percent of current appraised value; 1st lien holder pays 3 percent upfront FHA insurance premium; homeowner pays 1.50 percent annual premium; HUD recoups “instant” equity (100 percent in the first year, declining to 50 percent after five years) and 50 percent of any net HPA on sale; borrowers prohibited from new subordinated liens during first five years except to maintain property standards.
- FDIC IndyMac Loan Modification Program: modifies eligible mortgages to achieve sustainable payments at 38 percent DTI; no fees or charges for borrower; eligibility for first mortgage on primary residence owned or securitized and serviced by IndyMac where borrower is seriously delinquent or in default.
- FHFA introduced similar program for Fannie Mae and Freddie Mac guaranteed mortgages.
- These programs use stepwise decision processes focusing on affordability, not negative equity, and typically consider seriously delinquent loans (FDIC: 60 days or more; FHFA: 90 days) to owner-occupant borrowers not in bankruptcy.
- Voluntary bank initiatives: e.g., Citigroup announced modifications for mortgages with DTI in excess of 40 percent (lower interest rates, term extensions, and as last resort principal reduction).
- State foreclosure moratoriums (three-to six months) introduced but viewed as temporary palliatives.

### H. Hungary (2008)
- November 2008: Hungarian commercial banks signed a gentleman’s agreement with the ministry of finance on a foreign-currency loan workout program.
- Borrower options:
  - convert foreign currency loans to forint-denominated loans before year-end without additional fees;
  - request free-of-charge extension of loan duration if monthly repayments rise significantly;
  - request temporary easing of repayment obligations, especially if unemployed.
- Key elements (rate of loan conversion and interest rates on restructured loans) left to parties to determine.
- Conversion uptake low due to high domestic interest rates.
- Government preparing legislation for temporary government guarantees (up to two years) on mortgage payments for unemployed borrowers; preliminary reports: guarantees available for mortgages outstanding up to 20 million HUF, on primary residence only, requiring minimum payment of 10,000 HUF a month.

### I. United Kingdom (2008)
- Early December 2008: U.K. Treasury announced Homeowners Support Mortgage Scheme to reduce foreclosures.
- Borrowers with mortgages up to £400,000 and savings lower than £16,000 eligible to defer a portion of payments by up to 2 years.
- Deferred mortgage payments rolled up into principal to be paid when conditions improve.
- U.K. Treasury will guarantee deferred interest payments for participating banks; most large lenders agreed to participate.

### Selected household indicators, pre- and post-debt restructuring (as presented)
- 193219361997    20011999    20032001   20052001200520042008
- Household income growth (in %)-25.815.15.2-1.2-3.32.33.13.7-5.48.1
- Consumption growth (in %)-21.59.76.52.5-1.52.04.93.6-5.78.94.51.3
- Unemployment rate (in %)22.714.23.72.811.315.44.03.720.710.14.43.9
- Private debt/GDP (in %)45.432.124.514.549.846.492.7   100.320.811.7
- Taiwan Province of China (2005)
- United States (1933)
- Mexico (1998)
- Uruguay (2000)
- Korea (2002)
- Argentina (2002)

*Appendix I — Brief Summaries of Previous Episodes of Household Debt Restructuring*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0915.pdf_