Insolvency regime comes of age

One of the most revolutionary developments in finance in recent years has been the rise of behavioural economics. Its new preeminence has reached something of a zenith this week with the publication of “Misbehaving: The Making of Behavioural Economics” written by the godfather of the subject, Richard Thaler.

The premise behind behavioural economics is that while conventional economics is replete with formal, mathematically-based models, the fact that it relies on human beings behaving rationally very often renders this rigour obsolete. In fact, human beings habitually make disastrous economic and financial decisions: indeed they are hardwired to do so.

Very often the focus of the effect of behavioural economics is the consumer; their vulnerability when faced with an array of financial product choices is recognised by bank regulators worldwide.

But the decoupling of rationality from financial decision-making goes just as hard with the financial industry – very few predicted the financial crisis.

And in Ireland, with the arrival of the personal insolvency regime, we have until now been presented with a case study in irrationality on both debtor and creditor sides that is only now being corralled into order by the forthcoming reforms as disclosed by the government earlier this month.

Following the anticipated passing of new legislation before the Summer recess, the power of the mythical bank veto to scupper realistic and sustainable insolvency proposals will be confined to the past thanks to the proposal that gives power to the Courts to review and, where deemed appropriate, to approve proposals that have been rejected by the banks.

Whether this will have a material impact on the throughput of cases from present disappointing levels remains to be seen but in terms of public perception alone the shift in power should be telling – and perception is everything where human behavior is concerned.

It is simply a fact that there are tens of thousands of individuals who continue to struggle with unsustainable and unnecessary repayments well in excess of what would be required under the legislation that protects minimum living standards; individuals who pass on the availability of more or less instant relief. That’s not rational.

But the issue is even more pronounced on the creditor side. The government’s action was spurred by incontrovertible evidence of the rejection by some banks of sustainable solutions offering a superior outcome for creditors than the alternative of bankruptcy.

It is difficult to understand where this impulse towards irrational behavior comes from. Presumably it is rooted in the traditionally punitive nature of our bankruptcy legislation and societal disapproval of the errant debtor. Under than thinking, punishment rather than debtor relief was the reflex movement of the creditor and society in general.

It took a financial holocaust of the proportions of that recently experienced to change attitudes somewhat but one can recall newspaper reports in the early days of families in negotiation with banks being invited to consider parting with the family dog better to meet their repayments.

For some banks, the change in legislation will have no effect: they are the banks who recognise the irrefutable laws of arithmetic rather than clinging tenaciously onto some censorious, outdated and arguably vindictive attitude.

Every bank should welcome the arrival of the letter of appointment of the Personal Insolvency Practitioner (PIP). If a bank hires a valuation consultant, a lawyer or an auditor, it presumably does so intending to act on that advice. Banks need to rely on PIPs in similar fashion as the arbiter in the only framework where the creditor can achieve an outcome that is better than that available under bankruptcy.

And so another consequence of the reforms is that we will now see consistency across the country in personal insolvency cases: to date, the discrimination and differentiation between banks has been marked and has undermined the regime.

Under most scrutiny will be the vulture funds that have acquired substantial loan books. These funds are now overseeing financial contracts often originated through mutual societies and intended for a lifespan of 20 years plus. Vulture funds, on the other hand, have a far shorter time horizon – probably less than 20 months. Some evolution in thinking here will certainly be required.

Coupled with a number of administrative and procedural changes that should allow for speedier and more efficient processing of cases, as well as improved public information, the outlook for personal insolvency seems brighter than at any time since inception from the perspective of all sides. In many ways, if participants can keep their rational heads on, the regime has now come of age.