Changes in U.S. bankruptcy law are wending their way through Congress in what has been an off-again, on-again process for the last three years. The Republican majorities in Congress generally favor the bill, which will make bankruptcy somewhat more onerous for those filing. Minnesota Senator Paul Wellstone, perpetual defender of the poor and downtrodden, has vowed to stop the bill in the Senate.
Whatever the outcome, it does not appear that anyone is thinking too deeply about the broad question of how much protection debtors should get from the point of view of society as a whole.
The impetus for change has largely come from the consumer credit industry, which is shocked, simply shocked, that some people treat their creditors so cavalierly. Consumer groups generally oppose the proposed changes on the grounds of unfairness to households that have gotten in over their heads.
But much of the money and lobbying muscle directed against the bill comes from attorneys who specialize in bankruptcy, a lucrative field of law for many. In other words, anyone who is cynical about the role of special interest groups in politics will find additional food for their cynicism.
Allowing people to discharge their debts through bankruptcy is similar to giving inventors 20-year monopolies on marketing their innovations. Both institutions can help to foster economic efficiency as well as fairness. But with both, it is hard to strike the right balance between opposing interests in a way that benefits society as a whole.
People have long argued for some bankruptcy protection on the grounds of justice and fairness. Indeed, the sacred writings of Christianity, Judaism and Islam all found wrong in creditors having too much power over debtors who cannot pay. But there is also a justification on the grounds of economic efficiency.
If society makes the penalty for financial failure too severe, people will be less willing to take risks than are good for society. Innovation and economic growth depend, to a great degree, on the willingness of people with a good idea to stick their neck out with a new product or enterprise.
If failure is too traumatic, less innovation and less growth will occur. Some point to Germany and Japan, two countries where bankruptcy still carries a lifetime stigma, as examples of this problem.
On the other hand, creditors are hurt when debts are discharged in bankruptcy court. This is why the topic is more sensitive in small towns, where creditors include small-business owners who may enjoy more modest lifestyles than those seeking protection under Chapters 7 or 11. Hence, many perceive bankruptcy as unfair swindling of creditors. That sentiment is less strong in cities, where the debtors are more apt to be impersonal corporations.
Economic efficiency can also suffer if bankruptcy is too easy. The less power that creditors have to recover money owed them, the less willing they will be to lend overall. This reduces funds available even to creditworthy borrowers and increases the price. That also slows economic growth.
Thus bankruptcy laws require a careful balancing of the needs on all sides, not just creditors and debtors, but of society as a whole. Unfortunately such careful balancing seldom takes place. Rather, changes in the law seem to be a swinging pendulum. It is now swinging in favor of those who lend to consumers.
Such lenders complain that their losses on unsecured credit card and revolving charge accounts are high and rising, and that other borrowers ultimately bear the cost of such write-offs. True enough!
But any member of the middle class who gets unsolicited credit card offers in the mail on a weekly, if not daily, basis is apt to feel little sympathy for consumer lenders. Never in the history of the world has any society been pressed to borrow as is ours.
For many, firms that send unsolicited cards to 19-year old college freshmen and then complain that Americans are too casual about meeting their obligations are beneath contempt.
One proposed change, unfortunately not included in the bill before Congress, would establish a list of priority among unsecured creditors, based on the circumstances in which they extended credit. A bank that sent an unsolicited credit card with a $4,000 credit limit to a young person who already had $20,000 in debt would be placed much lower in priority than another that had extended the first $1,000 four years earlier.
Whatever the outcome of this bill, bankruptcy is an issue that is never going to fade away. It is one of those necessary evils that makes a society somewhat more fair and an economy somewhat more efficient. But few who ever get caught up in it on either side will ever deem it one of the great experiences of their life.
© 2000 Edward Lotterman
Chanarambie Consulting, Inc.