A Capitalist’s Love Ballad to Bankruptcy

In Burt’s recent FP post, he takes a hypothetical bankruptcy scenario posed by Randy Harris and teases out the personal and professional ethics of the fictional players. If you haven’t read it yet, you should do so now. Burt’s unerring ability to keep separate the strands of morality, professional ethics, and his knowledge of the law while still weaving them into a whole fabric is one of the great delights of his writing, and he does not disappoint with this latest post.

In part of the threads, however, the conversation veers off of Randy’s hypothetical scenario and takes aim at bankruptcy in general, where it is found morally lacking. I think everyone agrees that bankruptcy is in fact the “opposite of justice.” Well, everyone but me. Bankruptcy has a pretty bad name in our society, and think this has more to do with what we as a people think of the poor than it does with bankruptcy itself.  But bankruptcy isn’t unjust, and in fact it’s something that free-market capitalists should praise.

I think when most people think of bankruptcy, they imagine someone like the woman in Randy’s hypothetical – a person who takes advantage of their creditors and then uses bankruptcy as a calculated plan to have their cake and eat it too. And surely these people exist. (Though probably not people like Randy’s hypothetical ne’er do well. I would argue her acts are criminal, in the same way that if your bank erroneously shows you have a deposit of $10,000 and you spend it, it is considered theft if you do not or cannot reimburse them. Since bankruptcy does not forgive criminal acts or debts arising from fraud, I am not sure bankruptcy would not have protected her debt.) In these cases, where people essentially get away with premeditated fraud, it seems obvious that something on the other side of the spectrum from justice has occurred. But what about for the majority of bankruptcies?

There are a lot of bankruptcies filed each year; in 2010 the number was over 1.5 million; about 60,000 of those were businesses. It is unclear, however, how much bad debt those filings represent. The assumption of most people I know is that despite their lower numerical number, business bankruptcies actually represent a substantially larger dollar amount; but I have to say that I have never seen meaningful data to back up this assumption. The vast preponderance of these bankruptcies, business or personal, are caused by people taking a financial risk that they were unable to capitalize on, which led to debts they were not able to pay. Now, most of us believe that paying our debts is moral obligation, and so it is easy to see why if we do not pay them justice has not been served. But here’s the thing:

Regardless of the Biblical and historic reasons behind bankruptcies, bankruptcy today is not a bleeding-heart liberal forgiveness tool. It is a financial instrument that is built into a system of financial instruments, and it exists to create wealth.

In our society, any business that is a debtor is so voluntarily. There is no legal or moral reason that Nordstroms, Best Buy, General Motors, or your physician cannot become a “cash only” or “pay in advance” provider. There is no reason why VISA can’t keep your credit limit to an amount of money it can verify you have in your checking account.  Any of these actions would certainly reduce (if not completely eliminate) these companies’ risk of bad debt. But they all choose not to do so, and one of the reasons for that is the bankruptcy system which gives them two wealth-creating incentives to take that risk: The first is that allows them to risk their own corporate capital, secure in the knowledge that if they really screw the pooch they will not be held criminally liable and that the shareholder’s personal assets are not at risk. Which, of course, allows more capital investment than would otherwise occur if investing in a 401k meant risking your house or jail time. The second is that it allows for a substantially greater customer base, and therefore substantially greater revenue. You might not buy that new GM car if you thought that, should you lose your job tomorrow, you might end up in prison if a few months for that purchase.

In other words, we have created a system that creates wealth from people and companies being able to risk more than they otherwise would without the universally available mechanism of bankruptcy. Of course, this doesn’t mean that it the system doesn’t sometimes feel unjust. For example, in my business we are currently dealing with the aftermath of a workers compensation carrier that is in bankruptcy. When this carrier went under, it still owed my firm a lot of money in commission revenue. Since there is very little capital after claims reserves to divvy up among the various debtors, and since bankruptcy judges do not usually make commission payments a high priority when dividing up the last of the pie, it is unlikely that we will see a penny of that money. After having personally worked hard for that money, I can tell you that this absolutely feels like the opposite of justice. But it isn’t. Both my firm and I have made a tremendous amount of money because other people have been willing to risk capital to start businesses that they might not have started were it not for the system of inherent forgiveness we all benefit from. They, in turn, have grown from having a large customer base in part for the exact same reasons.  The system that allows this risk taking to take place might have cost me with this “deadbeat” carrier, but that’s a piffle compared to what that same system of risk taking has allowed me to make.

None of this is the opposite of justice.  Instead, working with Randy’s hypothetical universe, I believe the opposite justice would be this:

An insurance carrier is allowed to make huge profits by risking money, in no small part because bankruptcy laws allow their investors and them to do so.  They have a vast customer base, because that same system has allowed others to take risks in a way that has created wealth.  But now, when a client of theirs is unable to meet their obligation, that same mechanism is denied to that person so that the insurance carrier can make just a few more bucks.

Now that really would be unjust.

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54 thoughts on “A Capitalist’s Love Ballad to Bankruptcy

  1. Awesome post Tod. One of the ideas that has been percolating in my mind is that maybe people have been too willing to take risks with their money, big insurance companies and te average joe alike. It is this constant socialisation of risk for private gain which contributed significantly to the recent credit bubble. An idea that Iwas toying with was this: instead of writing down the debt, when someone proves unable to pay it, bankruptcy should just roll over the debt. i.e. give the guy some extra time to work stuff out. Also, corporations should only be allowed to retain limited liability status if it has remained solvent for the previous 6 consecutive months. The rough idea being that if a company has been in the doldrums for some time, then there is a problem with its fundamentals. Making stock-holders personally liable for the mismanagement of their company would hopefully mak them pay attention to what is happening. Same thing if it has been struggling to keep afloat. However, sudden recessions need not send people to the poor-house as recessions should rightly be treated as exogenous shocks vis a vis any one company.

    Of course, given your post, my half baked ideas are shown to be exactly that, half baked. However, I still wonder if people and companies are taking on and socialising too much risk… Financial risk, when socialised, becomes a negative externality. It is not immediately obvious that the positive externalities of risky investments outweigh the negative externalities associated with it. The biggest worry is that because it is the worst off who tend to suffer the most from negative externalities, even if current bankruptcy law maximises utility, there is a worry that it could harm the worst off.

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  2. I agree with the utility of BK for business, that it fosters risk-taking and thereby the creation of wealth.  And when a business dies, it’s dead—the creditors pick over the bones and move on.  Everybody knew the risks going in, and indeed they were priced into the game.

    I don’t know how all this applies on the personal level, that we haven’t moved past justice to what can only be called mercy.  Nor is it clear that you shouldn’t pay back a discharged loan if someday you are able to repay.

    “The wicked borroweth, and payeth not again” (Psalm 37:21).

    or then again, the Christian Science Monitor:

    In Psalm 37, “the psalmist is talking about [cases where] borrowing money and not repaying it becomes a business strategy,” says Gary Moore, a Christian investment adviser in Sarasota, Fla. By contrast, he says, single women should not worry about declaring bankruptcy, for instance, after using credit cards to feed their children.

    “Those people ought to go to bed every night knowing that God has granted them debt relief,” Moore says. “And they’re not, because they hear this garbage [from antidebt Christians]. That’s what Jesus called placing heavy burdens on his flock.”

     

    Then again, that’s God forgiving the moral debt, not the bankruptcy court…

     

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    • Everyone understands the risks of bankruptcy whether the debtor is a corporation or an individual.  And individuals as well as corporations take risks; it’s not clear why you’d encourage one but not the other.

      Also not clear is why biblical moralizing only applies to individuals.

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    • I’m not entirely comfortable with a system where those with enough capital can have their slates wiped clean and those without have to have their debt hung around their neck, with is what I believe a “business forgiven/individuals not” system would create.

      And again, when a system of risk is created that allows an out after certain criteria are met, I’m not sure what justice is not met when it is played out.  If you sign a contract that has an exclusion, is justice lacking if the exclusion clause is breached?  BK is just an exclusion clause we all agree to before we start, and one that we can avoid as a lender or borrower if we so choose.

      In America, I think, one of the flip sides of our celebrating financial success as a virtue is that we sometimes look at not succeeding as a moral failing.  We’re all OK with the system that includes BK, but when someone fails we find them lacking, and are left wanting punishment for the wicked.

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      • I’m not entirely comfortable with a system where those with enough capital can have their slates wiped clean and those without have to have their debt hung around their neck

        Is this the justice = fairness argument?  If so, that need to be defended in its own right.

        Now then, the prob here is that when a business fails, it’s dead.  Not so for an individual.

        If you sign a contract that has an exclusion, is justice lacking if the exclusion clause is breached?

        In our system, access to BK is a right.  [Although not an inalienable one, since you have the 7-yr limit.]  Can you be held to a contract that waives your rights?  I thought that was a no-no.  [For instance, Shylock’s contract for a pound of flesh is unenforcable.]

        In America, I think, one of the flip sides of our celebrating financial success as a virtue is that we sometimes look at not succeeding as a moral failing.

        True?  See previously posted list of famous bankruptees.  I think we do judge people who drank, gambled or generally dissipated their fiscal health away with conspicuous overconsumption.  But again, that’s making a distinction between the business side and the personal.

        Besides the political demagoging of the issue, how much sympathy do we really feel for someone who bought more house than they could afford?  How much sympathy should we feel???!!  What support do we owe them as justice, not charity?

         

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        • Now then, the prob here is that when a business fails, it’s dead.

          So, by your reasoning, the fact that an artificial construct designed to insulate individuals from personal liability can be dismantled is sufficient to … well … insulate people from personal liability. Really sound reasoning there, Tom.

           

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          • It is also flat out incorrect, mind. Businesses can and do enter bankruptcy, discharge debt, restructure and then emerge from bankruptcy very much alive. In fact it’s considered a routine part of businesses; see for instance airlines entering into bankruptcy to shed pension obligations and the like.

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            • Technically that’s “reorganization,” Mr. North, not bankruptcy, but an fabulously interesting corollary topic.

              [I am tempted at first blush to file reorganization under utility rather than justice or fairness, though.  But Obama giving Chrysler over to its union pension-type creditors rather than its actual bondholding investors is an interesting argument, and one I think might go to your liking if teased out honestly.]

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              • It uses bankruptcy law Tom; seems like a very small distinction and certainly not one that is any different than the distinctions between sympathetic and unsympathetic bankruptcies on the personal level.

                I am resigned to corporate bankruptcy manuvers and I’m of the opinion that any fair minded person who allows them (like you and I) should be supportive of similar freedom for individuals to use similar legal mechanisms. I consider corporations shedding their pension obligations under the same light as unions seizing the companies (though admissable the former is massively more common than the latter).

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                • North, I’m not disagreeing except to say that corporations/businesses are all in the financial game, the costs and risks all figured in. People, persons and families are not subject to game rules.  There is a difference, and if we blur the line between the business game and the reality of a family out on the street, surely we are moral imbeciles.

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                  • Actually, the people costs are built in as well. But I’m curious…. Why is someone who owns a corporation that can’t pay it’s debts filing BK morally ok, but an individual that does not own a business that can’t pay his or her debts filing BK morally bad? Obviously we don’t agree, but I’m honestly confused… Why for you is one moral and one immoral?

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                    • Speaking for myself:
                      I don’t find debt restructuring reprehensible for either.
                      Liquidation is another story.
                      With a business, liquidation is precisely that.
                      With an individual, liquidation is, far too often, gaming the system.
                      I have seen estimates (from the website of a bk attorney) that roughly 10% of all bankruptcy have significant fraud.
                      It’s rarely caught, because our system is set up to overlook it; the courts, the DOJ, the local authorities, etc.

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                  • But the costs are built in both situations way Tom; that’s what individual credit ratings, balance limits etc are. People, persons and families very much are subject to game rules so frankly I have no idea what you’re talking about here. There is no law or regulation that forces creditors to extend credit to individuals regardless of credit worthiness.

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            • Actually, I happen to be a few thousand shares of a company that is in bankruptcy protection right now. It’s a Canadian company, and I’m not sure how different the Canadian bankruptcy laws are.
              The company is Oilsands Quest (BQI).
              During an exploration phase of one of their Saskatchewan leases, there were large deposits of some mud discovered that is high in thorium and uranium. This led to more intense exploration of the Saskatchewan leases.
              The company was selling off some of the non-core leases for capital, and they had a letter of intent from a purchaser for a bloc of leases. The purchaser wasn’t able to obtain the necessary financing, and withdrew the letter of intent. Oilsands Quest filed for bankruptcy protection a day or two after that.
              The company is still going, and the assets are intact. Trading has halted, though they are not de-listed.
              Following debt re-structuring, they should be a strong company again.

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          • Why don’t you try arguing honestly and see what happens, Mr. Stillwater?

            Now then, I was acknowledging a very good point made in this discussion, that there is a utility in business BK: I didn’t make a moral judgment—I’m seeking clarity.  The fact is that we do tolerate the fiction of a corporation, a limited liability company, exactly because it permits more risk of capital for the creation of wealth than if an individual were held personally responsible for the debt of the failed business.

            Also the good point made that the risk factor is figured into the game—I think you’ll find the rates at which [especially new] businesses must take on debt as loans or bonds tend to be higher because of the risk involved, in no small part the risk that the business can go belly-up with no human person on the hook for its debts.

            So business BK can be defended not as justice or fairness, but simply as useful—it tends to create more wealth on the whole.

            For the individual, it’s hard to say, and hard to divorce morality from the equation either on the debtor’s or the creditor’s part.  Did the debtor piss away the money on hookers and blow?  Can the creditor turn the poor wretch’s guiltless family out into the street?

            The depersonalized business game is pretty simple; the human equation is far more complex.

            [We get a very tough equation with the classic “family farm” dilemma, which is both business and personal.  The Godfather too, I guess. (The Godfather III, not so much.)]

             

             

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            • Why don’t you try arguing honestly and see what happens, Mr. Stillwater?

              I’m too imbued with Burkean caution to do anything as radical as that. I’ll stick to my comfortable mis-conceptions. Thanks for the suggestion, tho!

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        • 1. Do I think fair = justice?  No, I was making two separate points.

          2. You note that when a corp dies, it’s dead.  True enough. (Under certain kinds of bankruptcies.)  But it’s owners aren’t.  If an individual is not allowed debt forgiveness, then should the debts of the corporation not (if this is an issue of justice) flow to the owners?  Bankruptcy is part of what shields owners from this debts.  If we are going to agree that individuals should not have that shield, why should a business owner be allowed to walk away from debt?  What, he can’t go get a job?

          3. You can’t “waive your right” to bankruptcy, but you are in no way required to become either a lender or a debtor.  If you want to be a cash only business – or an individual that pays cash for everything – no one’s stopping you, and you’ll never have to worry about being on either end of BK.  But if you want all the bennies of the system that allows it, then know that it’s part of the system.  You want all the benefits of the risk system, but not the parts that might affect you negatively?  Well, tough.  No one said life’s fair.

          4. I’m not trying to demagogue; I’m trying to do the opposite.  Questioning “injustice” when people file BK is not a question of sympathy, it’s closer to a question of honoring a contract.  Our system says under circumstance X, you are forgiven debts (at the expense, it should be noted, of a lot of your assets.) It says this long before you get your first paycheck, start your business, or enter into your first credit contract.  It’s not a question of “who’s sympathetic.”   Everything we’re talking about in BK is a business issue – period.  If you fulfill your contract with me, it doesn’t really matter how sympathetic you are or aren’t, I owe you whatever my part of that agreement is.  We all benefit from the BK system.  You can’t then just start deciding, “I like these kind of people I’ve entered into contracts with, but I don’t like these others, so I’m going to honor my contracts accordingly;” you shouldn’t be allowed to retroactively decide who’s sympathetic enough to get part of a business arrangement that everyone had agreed to prior.  Business agreements are business agreements, and BK is part of everyone’s business agreement.  Anything else you bring into it isn’t “justice,” it’s just personal emotions about who you think should and shouldn’t get their pre-agreed upon legal due.

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          • Tod, I’m following your Socratic lead; I’m going with the flow of your premises, not resisting them.  ‘Twas your point that the risk is figured into the loan rates that made me tease the tangled threads out a bit.

            I do not think that in the business world that anyone who gets bit in a voluntary transaction has been done an injustice [absent overt fraud of course].  And I think it’s important to note that we abide loosy-goosy commercial lending rules precisely because we think it creates more wealth.

            [Not sure about that:  In my family there are several who have done very well, but the old-fashioned way—hard work, frugal living, slow but sure expansion of their entrepreneurial risk.]

            On the personal level, I dunno about the $$ equation.  We have gov’t rules that if you lend to Joe you must lend to Jim, and to Jean and Joan and-a who-knows-who.  We do get into “fairness” and stuff in a hurry, where one size fits all and we’re well past entering into voluntary contracts.

            And to restate, “morality” hath raised its hoary head in this.  What is the moral duty of the creditor?  With Business X, if extracting a pound of flesh is good business, then there’s no immorality in doing so.

            With an actual person—and their family—it’s far more complicated.  Jessica Lange, Sally Field, Sissy Spacek—all their farms were under threat from the bank, don’t you remember?  Why??? To turn their pieces of the American heartland into ConAgra Fritos or Exxon ethanol or condos and strip malls?

            Wal-Marts, Tod.  Wal-Marts.

            Justice.  Fairness.  Morality.  Christianity, the Bible.  Jesus Christ.  It’s all here, man, if only we can get people to see it.

            I’m counting on you, dude.  Spread the word.

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    • I think the terminology is illuminating here.  You don’t do bankruptcy, you declare bankruptcy.  By the time someone is at that point, they are unable to meet their original obligations.  That ship has sailed.  Maybe the person made immoral choices to get into this position, or maybe they were victims of unforeseeable circumstance, but by the time the lawyers are involved, there’s no real chance that all of the creditors get paid.

      The obvious question is – what happens then?  The bankruptcy process just provides a well-ordered way to iron out this dispute.  We could just let the creditors bring lawsuits against the person, which eventually turn into wage garnishments or asset seizures, but that’s messy and wasteful.  The first creditors to sue would grab any assets, so all creditors must sue at the first possible moment.  If those wage garnishments hang around forever, the person has no hope to get out from under their debt or build any wealth – so why bother earning more than a subsidence living?

      When a legal transaction occurs frequently, we write laws to define the standard procedure.  For example, marriage and divorce, standard corporation setups, and real estate transactions all have well-established procedures that are nearly “off the shelf” transactions.  Bankruptcy is no different – if there was no bankruptcy code, we would have to create one.

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      • It would be messy and wasteful, to be sure. Bankruptcy not only provides a way to cut through all that and reach closure, it also provides a way for the debtor to start over and with lessons learned, maybe even flourish thereafter. TVD calls this “mercy.” Tod calls it “justice.” I say that is “utility.” We all agree, though, that society as a whole benefits from having it, whether that benefit be economic as Tod argues here, or moral, as Tom argues.

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    • The Bible (as I understand it) is quite clear about forgiving debt.  The concept of Juilee Year permeates throughout, and was one the reasons Jesus went “postal” in the temple.

      I would think, however, that accumulating debt with the intent of having wiped clean would come under the provision of “false witness”.

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  3. I’m a bit wiped out from a long trip, but did want to get in an “I mostly agree” here. There are two things that make me uncomfortable, however. The first is that I do get uncomfortable when it comes to “The lender knew what they were getting themselves into and knew this was a possibility.” This is true, and why we need to have bankruptcy laws, but it also leads borrowers to the easy rationalization of “You fished up. You trusted us.” I suspect if we were to hash this out, we’d still be mostly in agreement. I did want to register that discomfort, though. The second thing, related to the first, is that even to the extent that we cannot legally differentiate – and we cannot always legally do so – not all bankruptcies are morally the same and for the system to work, good faith is required.

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    • This is why bankruptcy needs to be stigmatized. We need good-faith bankruptcies, but we can’t make laws that reliably distinguish between those and the other kind. The stigma makes people more likely to avoid filing bankruptcy if at all possible. Without the stigma, there’s a risk that some people will see bankruptcy as the easy way out when it’s not strictly necessary. So, yes, we need bankruptcy, but we also need the stigma it carries.

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      • “This is why bankruptcy needs to be stigmatized.”

        I’m not sure that it does.  In fact, I’m not entirely sure how much the stigma actually does.  For example, I can think of two couples I have worked with in the past.  One that filed bankruptcy was a couple whose financial collapse, frankly, surprised no one.  They might well have had a stigma attached to them due to the bankruptcy, if it were not for the fact that everyone already had that opinion of them before hand.  The other couple lived in a place in central Oregon where the housing bubble expanded really hard.  Property values and jobs were skyrocketing at a greater rate than anywhere I am aware of, and they financed to have a house built.  They were both successful at their jobs, had been at their places of employment for a long time, were responsible, and did not “spend above their means” when choosing an amount they wanted to borrow to build their house.  And then everything collapsed, and all the jobs in this town went away – including theirs.  They were left unable to make payments once their savings was eaten up, and owed $300K on a house that they couldn’t get $100K for.  (The whole area was – and still is – littered with “new” housing developments that never had an owner.)  They eventually filed BK, but I can’t think of anyone that knew this that attached any negative feeling towards them at all – everyone seems to agree that they made the only financial decision that was available to them.

        So stigma isn’t really  as much of a thing in BK as people think.  But there is a huge deterrent: if you are forced to file BK, you don’t get to be part of the financial system that we all take for granted.  This is actually a really, really big deal.  And this financial disability follows you “officially” for seven years, but the truth is when there is a gaping 7 year hole in your financial history it’s pretty obvious why, so even if your credit report “forgives” you after spending that long in the wilderness, your time of financial exile continues to some degree for a long, long time after that.

        Bottom line is this: bankruptcy is a business decision, and nothing but.  If you know someone that opened up a bakery that went out of business after four years, would you think it necessary to stigmatize that person, and have them shamed in their community?  Of course not.

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    • This is true, and why we need to have bankruptcy laws, but it also leads borrowers to the easy rationalization of “You fished up. You trusted us.”

      Will, see the answer to Brandon just above.  But to hone in more on the way you worded your statement, my problem with this is twofold:

      The first is that it seems to assume that people that file BK “get away” with something, when in fact it means that due to whatever circumstance they are going to be on the outside looking in to the financial world we all take for granted for at least a decade, which can be more than enough to screw them financially for life.

      The second is that you are creating an unfair and untrue dichotomy surrounding a business transaction.  A creditor does not advance credit out of the goodness of their heart.  They make a business decision, and they make that decision for no other reason than to create a profit for themselves.  Is it possible that the person they extended credit to might have gotten better terms elsewhere, or that they had enough cash on hand that it would have been in their financial best interests not to finance a purchase at all?  To the creditor, that’s not relevant. And it’s not their responsibility to make that case to the lender; they don’t care, nor should they.  It’s a business transaction.  The same assumption should be granted to the other party, even if that party is an individual and not a corporation.  So someone took out a loan that it turned out they could not honor?  That’s a bad thing, but it’s just business – and it’s a risk that both parties knew existed when they entered into the agreement.   Each will have negative consequences as a result, which is why it’s important for everyone that credit is given wisely.  But if it isn’t, or if situations change, that’s just business.  Not all business deals work out the way you wanted them to.

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      • I think that society, in general, loses when we view defaulting on credit as a purely business decision. The more people do it, the more it becomes necessary for the law to step in and ramp up the penalties for doing so, deny more people the option of doing so, or for businesses (including, but not limited to banks) to stop offering credit as freely. In both cases, it’s both those who can and cannot pay back loans that pay the costs. Costs, when it comes to someone who could have paid the money back but chose not to because the penalties for defaulting are insufficient, that are spread out to us all. This is one of those areas where culture does a lot of heavy lifting. When culture fails, either the law gets more involved or we all pay a price. Neither of which are desirable.

        I don’t know if “stigma” is the answer or not. I’m not sure how much stigma in this realm accomplishes. But viewing defaulting as a cold business decision, rather than an unfortunate-but-sometimes-necessary thing, definitely doesn’t strike me as the answer. The bankruptcy and credit regimes rely on a sense of personal obligation more than we realize, I believe.

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        • when it comes to someone who could have paid the money back but chose not to because the penalties for defaulting are insufficient, that are spread out to us all.

          If this is happening in personal bankruptcy much in the US, I’m not sure where. Bankruptcy is pretty hard to do for individuals these days.

          I have a real problem with this dual morality standard many people seem to hold regarding credit. Imposing stricter moral requirements on one party to a transaction than the other makes them inherently unequal actors and implies even more strict regulation of credit would be obligatory than we have now. I’d rather the credit markets find their equilibrium after everyone starts treating their finances more coldly than suggest we need even more intervention into personal lending.

          I think in general, American society has done more than a good enough job convincing nearly everyone that access to credit is so integral to life that the cultural approbation comes more from the fear of being left out of the good life than it does the whispering of the neighbors anyway.

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          • I opposed the modifications to bankruptcy policy that we underwent a while ago. That’s partly why I do get frustrated with the attitude that defaulting should be a cold business decision. Because it invites tighter restrictions in borrowers. (“If the calculations are saying that you can pay this back but it’s not in your best interest to, then we need to change the calculations.”)

            My experiences working in small business are that loans, delayed invoicing, and such are all a part of the process. It’s not just about banks. It’s about a small business being able to get some product, make some money on it, then pay them back after a short term. I believe the presumption of good faith helps us in any number of ways. People taking a chance on people. People trying to live up to the chance being taken for them. I believe we ought to be very, very careful before saying that we can do without all of this.

            (I’m not sure what you mean by “more intervention”… having tighter or looser bankruptcy laws strikes me as intervention-lateral rather than more or less intervening.)

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  4. The vast preponderance of these bankruptcies, business or personal, are caused by people taking a financial risk that they were unable to capitalize on, which led to debts they were not able to pay.

    Is this actually true? That is, how much debt discharged in bankruptcy is due to debt incurred for purposes that could reasonably be classified as investment, as opposed to consumer debt? Technically it’s true that consumer debt is debt that the consumer was unable to capitalize on, but that’s because there was never any actual plan to capitalize on it. You seem to be saying that the vast majority of bankruptcies involve mostly the former category of debt—on what are you basing this?

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    • I think you’re reading to much into that statement.  Credit itself is a risk, regardless of the intention of investment.  When my wife and I had out house built a couple of years ago, we took a risk that we would have an income of [greater than X] for a period of time.  When you buy your car (or your laptop, or your work wardrobe, or your refrigerator) you do the same thing.  There is no absolute guarantee that you will ultimately have the means to pay back that amount you financed, and that is an understanding that you and your creditor agree to when you have credit given to you.

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  5. There is no legal or moral reason that … your physician cannot become a “cash only” or “pay in advance” provider.

    One wee quibble with an otherwise excellent post.  I actually think there are moral reasons for not being a “cash only” medical practice.  Less affluent patients are less likely to be able to pay my fees in advance from their own funds.  While we are certainly free both legally and ethically to do so, I think there is a moral argument to be made for making the care you provide as accessible as possible to as many people as possible.  Obviously, in order to remain afloat we have to make some decisions that may restrict access to some.  However, there remains a moral argument to be made for accepting payments other than cash up front for a medical practice.

    Sorry to pick a nit.  Loved the post, as usual.

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    • Interesting.

      I think I agree that having the industry be cash only is not a good thing. But one doctor?

      My own doctor is sort of a cash only setup. I do have insurance, but my primary guy has an annual subscription that is over and above that, that covers his services for the year. Most likely it makes it more out of pocket, but I have his number and can call whenever. And when I schedule an appointment, he greets me and spends the entire session with me, rather than my experience otherwise of having the doctor show up for the last 5 or 10 minutes. And he works with me on a proactive wellness plan.

      All of which is to say that I’d love to see you do a post on this subject,my friend.

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      • All of which is to say that I’d love to see you do a post on this subject,my friend.

        I’ll see what I can come up with!

        In the meantime, I should clarify that I don’t think it’s innately immoral to be cash-only.  Simply that any given doctor may have a moral reason for taking payments other than up-front cash.

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    • My doctor is somewhere between “cash in advance” and “pay on credit”.

      The co-pay is certainly “cash in advance”.  Also, my doctor knows that for most procedures, my insurance will pay.   (I suppose that’s somewhat of a credit situation — Aetna could crash and burn before he gets paid. ) But I’m liable for whatever the insurance doesn’t cover, and that’s certainly a credit situation.

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      • (I suppose that’s somewhat of a credit situation — Aetna could crash and burn before he gets paid. )

        Well, there’s also that thing where the doctor and the hospital have no idea what insurance will actually pay for. (Even the insurance company doesn’t always know. Fun!)

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  6. A very good post, Tod.

    A few things worth mentioning that may help add some context here:

    1. Bankruptcy discharges are as to creditors’ in personam remedies only, not their in rem remedies.  What this means is that if a debt is secured, a creditor can generally still enforce its security interest and repossess the secured property even after the debt is discharged.  There are important exceptions and limitations on this, but I don’t think they’re relevant to the main point here.  Obviously if the value of the secured property is less than the total value of the debt, then the deficiency is unsecured and discharged in the bankruptcy, but the point is that a secured creditor can usually come out reasonably well.

    2.  So when we talk about debts being discharged in bankruptcy, we’re mostly concerned with unsecured debts. As you said, the threat of bankruptcy is very much built into the system in the form of interest rates charged, etc.  But one thing that’s interesting is just how often debt is completely unsecured, in other words, just how frequently a creditor, particularly one that provides open-ended or revolving credit, is willing to provide large sums of credit at a particular interest rate without taking any security interest.

    3.  The above suggests that these creditors would rather charge a higher interest rate than take a security interest that would leave them in much better shape in a bankruptcy.  I would assume that this is partly because debtors’ spending habits would change dramatically if they provided their creditors with such a security interest.

    4.  Not everyone who would spend less if their revolving lines of credit were fully secured winds up declaring bankruptcy.  In fact, I’d wager that most in this category do not wind up declaring bankruptcy.  Even amongst those who do wind up in bankruptcy, many will have paid enough prior to doing so that the debt will have been a significant net profit to the unsecured creditor because of the interest rates charged.

    5.  Without bankruptcy, the risks to unsecured creditors would be no less bad, if not worse.   Keep in mind that in Chapter 7,  most creditors will at least get something, even if it’s not even pennies on the dollar.  But without bankruptcy, the unsecured creditor’s only going to get something if they’re quick enough to the courthouse (with the expenses that entails) to get a judgment lien with some actual value and then enforce that lien.  What are the other creditors going to be able to get from someone with no income and no assets that aren’t already called by the creditor first to the courthouse?  Where is the debtor going to get the means to return to being a participant in the economy?  Under the heavy burden of all these liens, doesn’t it seem more likely that the debtor just throws his hands up and gives up?

    I guess my point here is that both stated purposes of bankruptcy – giving the debtor a fresh start, and providing for an orderly disposition of a debtor’s assets – provide an important service to the economy as a whole.   Giving the debtor a fresh start allows that debtor to return to being a productive member of society, the orderly disposition of assets allows creditors to maximize their average returns on the debt at the smallest cost.  Add to that what you say above about encouraging risk-taking in the form of higher consumer demand, and I think you have a pretty strong argument for how bankruptcy, on net, provides a meaningful benefit to more than just the debtor.

    That doesn’t mean that bankruptcy isn’t subject to massive abuse, nor does it mean that there aren’t significant problems with the way our bankruptcy system is administered in practice.  It just means that on net it is pretty useful.

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