Is harsher punishment for financial default really the answer?

The current financial crisis has highlighted the need to ensure security of credits, on one side, while at the same enhance a system of control and punishment. The question is: What punishment?

Pressed by a public opinion severely irritated by the misconduct of many a bankers and high-level financial and industrial managers, many governments have introduced harsh penalties for those who faulty default their credits. A paper by Kartik Athreya, researcher at the Federal Reserve Bank of Richmond, Xuan S. Tam and Eric R. Young, University of Virginia, examines the issue of how society might ensure credit is allocated to those who lack meaningful collateral and the answers given so far.

Their findings suggest punishment harsh enough to guarantee all debts are repaid has positive impacts on welfare. As far as security of loans, these measures are useless, when not even substantially negative. Overall, the authors of the research define current answers to default – harsher punishments – as “likely to be counterproductive”.


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