A Few Thoughts On Bankruptcy

This is in response to an article by Nicholas Kulish, a member of The New York Times editorial board who writes on business issues. The article, The New Rules on Going Broke In America: Forget “if at first you don’t succeed” — Changes to the bankruptcy law tell us not to try in the first place. (Talking Points, online in Times Select 15 Nov 2005, by subscription), was a critique of the new “stricter” bankruptcy policies.

This response, which addresses some details that I feel have been generally overlooked in all the “debate” (more like accusation with hyperventilation) over bankruptcy reform, was posted (alas with some of the punctuation butchered by their online submittal form) in the Reader Responses with a short and respectful note of reply from Mr. Kulish

15 November 2005

A few thoughts:

1. After positing that both lenders and borrowers have some responsibility for people getting into debt over their heads, you say “But of the two groups, the lenders – who are almost invariably large banks and credit card companies – are in a better position to absorb the loss, since they can spread it over many borrowers. Individuals don’t have that luxury.“In other words, you think the costs of bankruptcies should be spread around to all of us — that we all should pay a bit more for credit and for goods and services, in return for which we are relieved of the major risk of financial ruin. Why don’t you complete the thought and put it into terms everyone can understand and relate to: relatively lenient bankruptcy laws are a form of financial insurance. The little bit extra we pay in interest and in the cost of goods to cover others’ defaults is like an insurance premium, and the debt relief we get if we need to file for bankruptcy is the payout we get when we file a claim. Conceptually, it is no different than other government-mandated insurance programs, like Social Security (retirement insurance) or food stamps (starvation insurance) or workers compensation (disability income insurance) — or, in a more abstract, sense like the police department (crime insurance) or the military (foreign aggression insurance). The difference, of course, is in the mechanism by which payment is extracted.

   Of course, this “insurance” is mandatory — no one gets a choice about whether or not it’s worth their cost in premiums to get that protection. One might hypothesize a market for private “financial ruin insurance” (things like private retirement insurance and private disability insurance are already readily available, despite the government mandated programs; even private police protection (“security companies”) exist); and, if the new rules are as draconian as you predict for entrepreneurs, I would expect such a market to arise catering to them. But, of course, the poor, who are at the highest risk of personal bankruptcy, are also the least likely to foresee and forestall financial risks by partaking of such insurance. So some systematic form built into the law is likely still necessary.

2. One thing that has always been glossed over in any discussion of this is the role of bankruptcy judges in making whatever system we have work well.Both before and after the change in the rules, requests for protection from creditors have to go through the courts and some judge has to make an individual ruling on what form of protection is appropriate. In cases of sudden and unexpected hardship — an accident or a life-threatening disease that pushes a family over the edge — it seems it would be pretty clear that the cause of the bankruptcy was exigent circumstance. Conversely, in the case of “luxury-loving overspender, living beyond his means,” it would also seem to be fairly easy to identify the cause as irresponsibility (or downright fraud). Even in between one might presume that a fairly accurate first-order estimate of the degree of personal responsibility might be gleaned from a moderate scrutiny by a conscientious investigator. Having made that assessment, a bankruptcy judge ought to be able to tailor the relief to the circumstance.

   So why do we still hear about egregious miscarriages of justice, with the down-and-out left holding the bag and the irresponsible rewarded with relief? Have we given our bankruptcy judges that little leeway or that little investigative capacity? Have they simply refused to take on the responsibility for exercising judgment? It would seem that is the first place to look if we want to improve the system.

3. You take banks and credit card companies to task for being too loose with credit — for luring the “vulnerable” into debt — and thereby into bankruptcy — “by lending money to people they have reason to know may be unable to pay the money back”.But honestly, do you really want a return to the alternative? Who are those people that creditors “have reason to know may be unable to pay the money back?” By what criteria do they make those judgments? By income. By education. By where they live. By credit history. I am old enough to remember when banks and credit card companies were, in fact, much more stringent about lending based on those judgments and they were universally condemned from the left — from the same people who now accuse them of luring the poor into debt — for making credit too hard to get, for shutting the poor and the disadvantaged out of the American Dream by imprisoning them in a cash economy. And because — for reasons completely beyond any control of financial institutions — poverty and disadvantage in America are so often correlated with race, they were also accused of “redlining” and of racism for purely financial decisions based on credit risk.

   Which way do you want it? Opportunity comes with risk; security impedes opportunity. If you want creditors to give people opportunity, you can’t blame them for enabling risk-taking. If you want them to prevent risk-taking, you can’t blame them for denying opportunity.

© Copyright 2005, Augustus P. Lowell