The FINANCIAL — Microfinance in Georgia is commonly presented in a positive frame. Proponents point to increased economic activity and a reduction of poverty directly related to microfinance lending.
There is another side to this story though. Microfinance loans are typically backed by some type of collateral. This collateral might be in the form of livestock, automobiles land or house.
Now we will examine the efforts of a vocal group of people in Georgia that are against microfinance lending. This group is pressuring parliament to enact a laws that prevent microfinance organizations from foreclosing on defaulted mortgages.
In July 2013, the Georgian Parliament was presented with a law that prevents banks from repossessing homes until 2014. The noble goal of the law is to reduce the number of foreclosures by giving borrowers more time to raise money. Proponents of the law cited “a new wave of refugees” being created by banks and finance companies. They claimed that hundreds of thousands of Georgians were about to lose their homes.
The actual statistics tell a far different story. The Georgian National Bureau of Enforcement, part of the Ministry of Justice, published a statement accurately quantifying the scope of the problem. In 2013, several hundred homeowners (not hundreds of thousands) will lose their homes as a result of financial foreclosure in 2013. Less than 5% of those foreclosures are related to microfinance lending.
Losing a home is tragic for a family, in any circumstance. That such events are rare does not make the process any easier, if you are that family. The foreclosure moratorium request has fostered a discussion between industry and government, and that is a positive.
When approaching this new legislation, the parliament and ministers under the leadership of Prime Minister Ivanishvili followed the democratic principle of open dialogue. The government engaged banks, microfinance companies, economists, and lawmakers in a discussion to better understand the scope of the problem and come up with alternative solutions that would not damage Georgia in the long term. These conversations are ongoing and will likely continue for some time to come. As this discussion moves forward both in and out of the public eye, it is a great time to look at how similar situations have been handled by other countries around the world.
No one can deny the emotional appeal of halting foreclosures. Foreclosures are traumatic events for homeowners. Finance companies don’t like foreclosures either. A US Joint Economic Committee found in 2008 that a foreclosure costs a bank more than 20 times what it costs to prevent a foreclosure. Seizing a house drains a bank’s resources and ties up its assets in the court system. In a foreclosure situation, everyone loses.
During the recent US subprime housing crisis of 2008-11, in my home state of Nevada, as many as 1 in 10 Nevada homes were in foreclosure. In nearby California every 1 in 21 properties went into foreclosure. However, the US never imposed a national moratorium. Even in states where such laws were considered, like New Jersey and California, the proposed moratorium had more to do with the contested legal practices of banks than relief to homeowners. The White House successfully fought such proposals, since, as Housing Secretary Shaun Donovan stated, “a national, blanket moratorium on all foreclosure sales would do far more harm than good.” The United States decided against a moratorium in the midst of its worst housing crisis on record, when a much greater percentage of households faced eviction, because delaying all those painful foreclosures would only have prolonged the financial crisis.
Two other countries, Ireland and Nicaragua, took different approaches to similar movements. The real estate market in Ireland for example has lost 50% of its value since 2007, the largest loss of its kind in Europe. Their domestic laws make it very difficult to foreclose on homes. Because of these constraints on banks, mortgage lending in Ireland has pretty much collapsed in the past five years. New loans totaled 140 billion Euros in 2007; by 2012 they had fallen close to zero. As access to credit dried up, so did the purchase of homes, destroying the value of existing property. Now, the EU, IMF, and European Central Bank are requiring Ireland to reinstitute foreclosure in order to qualify for international loans.
Nicaragua’s 2010 Moratorium Act ordered microfinance firms to halt foreclosures and refinance defaulted loans. This law protected a few delinquent borrowers but damaged the entire economy. Only a handful out of more than 5,000 delinquent owners restructured their debts. Other current borrowers simply stopped paying to take advantage of the new legal protection offered by the government. Microfinance firms and banks collapsed, causing international funds to pull their investments out of Nicaragua. Access to credit for the average citizen of Nicaragua dried up. Entrepreneurship stalled and families across the entire country are still suffering.
When governments prevent banks and finance companies from taking expected legal action, their economies suffer. Property values decline and consumers aren’t able to secure the loans they need.
The vast majority of Georgians who risk foreclosure took out loans from unregulated private lenders. These lenders serve high-risk borrowers at costly interest rates in order to cover the high rate of default. Since private lending isn’t regulated, these mortgages are more likely to be predatory or result in failure. As we learned in last week’s article, the private lending enterprise in Georgia serves borrowers who have the highest credit risk. Microfinance serves the middle tier and banks typically serve larger loans with borrowers who have excellent income and credit.
Some have suggested to applying a foreclosure moratorium only to unregulated private lenders. However, this approach will also have a negative effect on the economy overall. Private lenders provide a safety net to borrowers who finances are in rough shape. If such lenders are excised from the credit supply, then overall credit availability in Georgia will decrease. Although the total number of foreclosures will decline, bank and microfinance foreclosures will increase, since these companies can no longer refer delinquent loans to private lenders.
The ultimate solution requires educating borrowers, but this solution is not a quick fix. People who know how to make smart financial decisions are the least likely to take out loans they can’t pay. Sadly, developing financial literacy in a country takes a great deal of effort and time. England has taken a similar approach and plans to begin financial literacy classes in 2014. Lessons will address personal money management and how government taxes raise funds.
Housing foreclosure is a problem in Georgia, just as it is in every country around the world, but a blanket moratorium will not solve it. Ireland and Nicaragua have shown that when countries prevent banks and finance companies from taking expected legal action, a broader set of individuals and entire economies suffer. Housing values drop and consumers cannot secure the loans they need. As the discussion about the best way to help delinquent borrowers continues, it is important for all of us living in Georgia to consider the long term consequences of any proposed solution.
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