Bankruptcy

BANKRUPTCY….Megan McArdle reaches back into prehistory (blog years are like dog years) and explains why the 2005 bankruptcy bill was a bad idea:

There is [] substantial evidence — good, solid research, not awful surveys — that easy bankruptcy is one of the hidden strengths of the American economy. American bankruptcy law offers an interesting natural experiment; the code, meaning the rules under which debts are discharged, is national, but the details of what is exempt from bankruptcy are done at the state level. Researchers consistently find that the more generous the exemptions are, the higher a state’s rate of entrepreneurship. When failing is less risky, people are more willing to try.

Given that, my question for the bankruptcy reformers was: what problem does this change solve? It solves a problem for the credit card issuers, to be sure — but it does so by essentially allowing them to rewrite the terms under which they lent money, which was at least as unjust as any unjustice we might have been trying to rectify. The economic benefit of tighter bankruptcy restrictions is that they make banks more willing to lend, but this was hardly a problem for the economy in 2005. And the economic cost is that people are more afraid to take risks with their income.

Quite so. Credit card issuers have computer models that project delinquency rates with stunning accuracy. When, over the past couple of decades, they steadily loosened their standards for handing out cards and urged more and more debt onto less and less creditworthy customers, they knew exactly what would happen: their default rate would go up a few points. That’s a risk they decided was worth taking, but then, when default rates in fact went up, they went to Congress to change the rules.

Generous bankruptcy rules tend to be good for the economy, and as long as those rules are relatively stable banks have excellent tools for managing their exposure to them. If they voluntarily choose to increase that exposure, there’s no reason Congress should then bail them out later. The 2005 bankruptcy law was a corporate giveaway, not a vital reform.