Modern pillories: Overdue debts of the poor

Edina Berlinger, Katalin Dobranszky Bartus

Keywords: overdue debts, debt relief, debt renegotiation, soft budget constraint

TL;DR: why poor people cannot get debt relief

Abstract: We develop a moral-hazard model and derive a feasibility condition for private and public debt relief programs. We find that lenders have no interest to offer payment reductions if nonperforming borrowers are few, have small debts, and are difficult to reach – precisely the characteristics of the poor. In this situation, poor debtors serve better as deterrents, similarly if we put them into a pillory. We calibrate the model parameters to survey data on poor households struggling with overdue debts in small villages in a disadvantaged rural region in Hungary. We find that in normal economic circumstances, private debt relief programs are not feasible. State intervention can be justified by positive externalities and moral considerations.