Editore"s Note
Tilting at Windmills

Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

February 20, 2008
By: Kevin Drum

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.

Kevin Drum 7:06 PM Permalink | Trackbacks | Comments (51)

Bookmark and Share
 
Comments

Our system is also noteworthy for its novelty in the Western world - the notion of the fresh start was a complete break with the draconian and moralistic way with which bankruptcy was conducted in Europe. Among bankruptcy profs, AFAIK, it's CW that the fresh start has always been key to our booming economy.

Posted by: jpe on February 20, 2008 at 7:21 PM | PERMALINK

William: Then why did so many DEMOCRATS vote for the 2005 Bankruptcy Bill?

Because the Democrats aren't, and never have been, the good guys. Politics in the US never has been a struggle between the good guys and the bad guys; it has been a struggle between the bad guys and the worse guys. Some people are only now coming to terms with quite how much worse the worse guys really are.

Posted by: Alan Bostick on February 20, 2008 at 7:22 PM | PERMALINK

That was exactly Paul Wellstone's argument. That Dems did not support him, or his memory, on the bill is a disgrace.

We might also consider that the bill eased the way for all those sub-prime loans, too.

Posted by: Will Divide on February 20, 2008 at 7:23 PM | PERMALINK

this bill never would have gone anywhere had Bush not put it at the top of his agenda at the beginning of his first term. Why? Because one of his top campaign contributors was MBNA.
Tells you where his priorities were and always have been--a scumbag in bed with other scumbags.

Posted by: haha on February 20, 2008 at 7:25 PM | PERMALINK

Alan Bostick's got it.

And that list of Dems includes mostly repeat offenders at Republicanizing. Several of these people need some good primary challengers, not that solid Dems are likely to get elected in some of those states.

So, yeah, Alan's got it, but I never give up hope that we can do a little better. :)

Posted by: shortstop on February 20, 2008 at 7:32 PM | PERMALINK

When failing is less risky, people are more willing to try.

...For wise people. Foolish people who don't know the difference either way are the ones the banks opened up extra windows for. Great. Corporate giveaway it is. Now Warren Buffet's term "dumb money" has even more meaning.

Posted by: Doc at the Radar Station on February 20, 2008 at 7:33 PM | PERMALINK

Dems voted for the bill because Dems need campaign contributions, too. Dems vote the wrong way 50% of the time. Repubs vote the wrong way 100% of the time. That's a big difference.

PS- it's nice of McMegan to conclude that the bankruptcy bill was bad because it stifles entrepreneurship. How about noticing that it's bad because it turns middle class people into poor people? Smashes up families? Impoverishes children? Ah, well. You take what you can get.

Posted by: Bloix on February 20, 2008 at 7:33 PM | PERMALINK

Not between bad guys and worse guys, each side has those, Will, but the last 8 years have seen a battle in Congress between corporate interest versus constituency interest. Lately, corps have all the wins, the people have very few. Look at telecom immunity as well as BK law, both are tough on the citizenry but great for corps. When was the last time legislation went the people's way. Rarely these days. And now, big banks are hurting, so they run to congress to get the people to pay. Hopng the next Dem isn't completely in bed with big business. That is why its encouraging to see so many small donation to Obama. While Hill is getting help for "big Donors." http://www.latimes.com/news/politics/la-na-spend21feb21,0,6685850.story

Posted by: The fake fake al on February 20, 2008 at 7:36 PM | PERMALINK

That list of senators is chilling. One can't be progressive and re-institute debtors prisons. No escape for the poor, lower risks for the wealthy. Recipe for a freaking economic disaster. Which we are in.

Posted by: Sparko on February 20, 2008 at 7:41 PM | PERMALINK
Given that, my question for the bankruptcy reformers was: what problem does this change solve?

It solves the problem of credit card companies doing their best to see the Congressional "bankruptcy reformers" opponent's elected in the next election, and the problem of the "reformers" not being able to get jobs as lobbyists for the banking industry should they lose their seats for some other reason.


Posted by: cmdicely on February 20, 2008 at 7:54 PM | PERMALINK
PS- it's nice of McMegan to conclude that the bankruptcy bill was bad because it stifles entrepreneurship. How about noticing that it's bad because it turns middle class people into poor people? Smashes up families? Impoverishes children?

The people in the electorate that care about middle class people turning into poor people, smashing up families (except by allowing gay marriage, however that works out), and impoverishing children already opposed the bankruptcy bill from the beginning.

Its the people in the electorate who don't care about those things, or at least don't care most about them when they are rhetorically placed on one pan of a balance with entrepreneurship on the other, that were happy enough with the bankruptcy bill, and would be be the most natural base for the narrow interests that directly benefit from that law to turn to to defend it if it was threatened.

Therefore, while the effect on entrepreneurship may not be the single most important negative effect of the bankruptcy bill, it may be the politically the most important one to draw attention to, since it is the one that appeals to the constituency that might otherwise be inclined to defend the law were there to be a move to repeal it.

Posted by: cmdicely on February 20, 2008 at 7:59 PM | PERMALINK

The fake fake al: That is why its encouraging to see so many small donation to Obama. While Hill is getting help for "big Donors."

Obama is as much a bought-and-paid-for Democrat as Hillary is:

http://www.theleftcoaster.com/archives/011993.php

Until we have real public financing, including primaries and extra funds for opponents of the heavily bribed, we'll continue to have the best government money can buy.

Posted by: alex on February 20, 2008 at 8:01 PM | PERMALINK

Well, this is a sticky issue and I wonder how many people are declaring bankruptcy in order to stop foreclosure. Apparently not many.

Posted by: Jet on February 20, 2008 at 8:06 PM | PERMALINK

Megan McArdle strikes me as a very strange type --- both extremely smart and ridiculously naive.

How can someone who has spent as much time as she has studying economics and politics be surprised when it turns out that, gee, just like those lefties claim, moneyed interest run large aspects of US politics and that the results are their wangling make no sense in the large picture, but they do make sense in the short term?

Yet these occasional insights she has into reality never seem to dimish her core faith. I imagine that soon she'll be giving us yet another article on why the free market will handle global warming (or healthcare, or crumbling US infrastructure) successfully because businesses, regardless of whether they are evil or not, plan for the longterm. After all, that's what economic theory says, and so it must be true.

Posted by: Maynard Handley on February 20, 2008 at 8:20 PM | PERMALINK

The strongest argument in favor of the Republican's mantra of "small government" is the many ways we see both Repubs AND Dems abusing government to take from the poor and helpless and give to the rich and powerful. Thomas Jefferson believed in small government too. The only question is what, in a given era, is small.

BTW, how did Clinton and Obama vote on the Bankruptcy bill?

Posted by: MarkH on February 20, 2008 at 8:25 PM | PERMALINK

Generous bankruptcy rules make credit card companies afraid of lending money because they fear the customers will never pay it back.

HAHAHAHAHAHAHAHAHAHAHA!!!!! Whew, I needed a good laugh. You sure you're not the fake Al just trying to make the real Al look more foolish than he usually does?

Posted by: Thumb on February 20, 2008 at 8:28 PM | PERMALINK

MarkH

According to the records Obama voted against and Clinton missed the vote.

Posted by: Corpus Juris on February 20, 2008 at 8:36 PM | PERMALINK

Well, this is a sticky issue and I wonder how many people are declaring bankruptcy in order to stop foreclosure. Apparently not many.

With the change in the laws, it's now harder to default on your credit cards than it is to default on your mortgage. So people are keeping current on their credit card payments and letting their mortgages go into foreclosure -- or, as Atrios calls it, putting their keys in the mail to the bank and walking away.

You can't get blood from a stone, so if you set up punitive terms on one kind of credit, people will default on the other. Too bad the banks realized this simple rule too late to stop financial collapse.

Posted by: Mnemosyne on February 20, 2008 at 8:47 PM | PERMALINK

Dammit. Are we so like the Roman empire? Are we not able to come up with anything that is NOT a corporate giveaway instead of a vital reform? And by "we", I mean Congress, the President, and all the lawyers and rich fat cats who support one or all of them. It's too bad that money goes with power in our society, because it's clear that power corrupts and money corrupts absolutely as a result.

Posted by: wally on February 20, 2008 at 8:54 PM | PERMALINK

or, as Atrios calls it, putting their keys in the mail to the bank and walking away.


I agree and have discussed,lonely as it was, on my blog where people with good credit and jobs are walking away from their homes. http://manifestlyso.wordpress.com/2008/02/20/take-this-house-and-shove-it/

Posted by: Jet on February 20, 2008 at 9:04 PM | PERMALINK

>"Are we not able to come up with anything that is NOT a corporate giveaway instead of a vital reform? "

Well, nothing really comes to mind. Funny, I was just trying to remember anything Bush II said that was truthful... seem to be coming up empty there too.

Posted by: Buford on February 20, 2008 at 9:10 PM | PERMALINK

There is a lesson to be learned from countries with no or severe bankruptcy laws. As I understand it, in Japan you can't go bankrupt which leads to higher suicide rates. To compound the injustice, the debt is passed on to your survivors.

If I'm wrong on this, I apologize but I don't have the time to vet this now.


Posted by: rmp on February 20, 2008 at 9:14 PM | PERMALINK

And another thing, .... as I understand it, the credit card companies build in the cost of the defaults so what was the reason again for this pressing reform?

Posted by: rmp on February 20, 2008 at 9:36 PM | PERMALINK

(blog years are like dog years)- kd

that's the best one i have read all day.

Posted by: benmerc on February 20, 2008 at 9:50 PM | PERMALINK

They do build in a default cost rmo, but a credit implosion [sub-prime] messes up the default charts.


Posted by: Jet on February 20, 2008 at 9:51 PM | PERMALINK

A very bad bill, benefiting the credit industry, and adversely affecting the middle class...too bad, Hillary--you messed up with this one

Posted by: anon today on February 20, 2008 at 9:51 PM | PERMALINK

Jet, But the bankruptcy bill was way before the sub-prime mess wasn't it.

Posted by: rmp on February 20, 2008 at 10:01 PM | PERMALINK

"When failing is less risky, people are more willing to try."

This is a good argument for universal health care too, since lots of people can't risk giving up their health insurance.

Posted by: Ted on February 20, 2008 at 10:07 PM | PERMALINK

Off topic--

There's an interesting thing about Obama's life on MSNBC right now.

Posted by: Swan on February 20, 2008 at 10:08 PM | PERMALINK

Re: the first three or four comments--

If you think the Democrats in congress are bad guys, you should take a look at some of the people you shop and share the road with and share your community with every day. Politics is an expensive business, and good-faith liberal politicians often pay a price to go to a legislature and argue for the people. If it's making things a little easier for some greedy corporations sometimes, so be it. Our goal as a nation should be to preserve freedom; seeking perfection at this point is taking our eyes off the prize. It's like a star high school basketball player dreaming about the NBA all day long when what he should be focused on is the big state championship game coming up in a few weeks. No big high school or college successes = no great NBA career later on.

I totally agree the bankruptcy bill was a bad thing, but let's not hold the Democrats up to an unrealistic standard based on what they are facing. I'm sure most of us can think of at least one or two things about our parents we abhor; we don't disown them for most of those faults, though. And they protected us and provided for us.

Posted by: Swan on February 20, 2008 at 10:17 PM | PERMALINK

In 2005, she really liked the new bankruptcy bill. She wrote a few posts at her old home about how good it was.

Now that it has turned out to be horrible for the economy, she is against it. Ideology first, thinking second.

Posted by: mickslam on February 20, 2008 at 10:27 PM | PERMALINK

What I really want, like the rest of you, is a world where corporations don't wield too much influence.

But right now, I think that going on liberal blogs and writing comments that say that all the Democrats in congress are a bunch of crooks does more to take away the enthusiasm and focus we need to make the world a better place than it does to help us. Right now, we need more people getting involved in practical politics within the system, and less dreamers or people who have totally given up on the system.

Posted by: Swan on February 20, 2008 at 10:35 PM | PERMALINK

Let me tell you how things look on the front lines of the bankruptcy war.

Despite all the changes lots of people are still going bankrupt. The rules haven't changed all that much for folks whose incomes are below median. For half the population the new law just made going bankrupt more expensive.

For those above median lots and lots of people are still going bankrupt. Although it is more difficult many find they can qualify to file Chapter 7.

Of course the most difficult provisions of the new law are aimed at people who primarily have consumer debt. People who primarily have business debt don't have to avoid the presumption of abuse attributed to folks above the median income.

The two groups who won big in the bankruptcy bill-- former spouses and motor vehicle lenders.

Lots of people are still filing Chapter 13 to save their homes.

In my district, Chapter 13 filings are only up a little bit, and Chapter 7 filings are back up to 2000 levels and rising.

The reason folks aren't filing bankruptcy to stop foreclosures is the are upside down in their houses and their mortgage payments are beyond their budgets. Rather than pay more than they can afford they just walk away.

Giving bankruptcy judges the power to restructure mortgages could be a blessing for both homeowners and mortgage lenders.

That is how things look from the front lines.

Posted by: corpus juris on February 20, 2008 at 10:36 PM | PERMALINK

The CC companies may have factored into their business model the expected default rate, but if they could get laws that reduce the defaults, that would be a windfall for them. How did financial services become more than 20 percent of stockmarket capitalization? By getting laws structured so that they could make outrageous profits. You can bet the CEOs had a good time with their stock options, as the market value of their companies rose to reflect the better expected results.

Posted by: bigTom on February 20, 2008 at 10:44 PM | PERMALINK

FYI, I just looked up the vote: 74-25. Once again, the Dems who voted nay are the same liberal members of the Senate that tend to vote en masse on most legislation. Liberal Dems currently compose about 50% of the Dem membership. (I don't think it's gotten much better than that since 2005.) If you want to see how the cookie crumbles, here you go:

Roll Call Vote on 2005 Bankruptcy Bill

Posted by: nepeta on February 20, 2008 at 11:07 PM | PERMALINK

The '05 bill was called "The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005." A risible, insulting misnomer. Just another example of a president and Congress, beholden to big-spending monied interests, pissing on America's leg and telling her it was raining.

Posted by: kc on February 20, 2008 at 11:26 PM | PERMALINK

Really incisive analysis.

Let me save some time for anyone interested in national legislation.

Almost every single thing that the congress does is a corporate giveaway.

If and when America has some kind of health insurance for everybody, it will be a corporate giveaway.

Bush, the Republicans and quite a few Democrats cannot conceive of a FISA bill that is not a corporate giveaway.

The congress is the tool of the ruling class. No more, no less.

Posted by: James E. Powell on February 20, 2008 at 11:37 PM | PERMALINK

James: Man that was harsh. But damned if I can cite an example that might take down your cynical appraisal of the last few Congresses. I don't recall so much as a bill to enhance dog walking getting through the meat grinder lately. And they didn't even give us peace. The Romans had a better track record in the Inkitatus era.

Posted by: Sparko on February 20, 2008 at 11:44 PM | PERMALINK

No, actually, I was always against it.

Posted by: Megan McArdle on February 21, 2008 at 12:06 AM | PERMALINK

"The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005."

kc, yes, what an Orwellian name. When I was searching for the roll call vote it took me a while to realize that such a fine-sounding bill could be THE bankrupcy bill I was looking for.

Posted by: nepeta on February 21, 2008 at 12:29 AM | PERMALINK

I work for an organization that helps homeless teenagers. Occasionally I have to sort the mail that arrives for the kids. I would say that on any given day, we get about 6 pre-approved credit cards for young homeless kids.

Posted by: Jay on February 21, 2008 at 2:37 AM | PERMALINK

What's interesting, though, is why people like McArdle are now souring on the new law.

It has nothing to do with rates of entrepreneurship, etc. as she claims.

What's really happening is that the banks are having an OMG moment: they're realizing that the new law, by making it impossible for middle-class people to discharge credit-card debt via bankruptcy, is now encouraging those same middle-class people to walk away from their home loans in order to keep their consumer debt current. (In many states, like California, the lender of a secured loan like a mortgage can take the home but has no "recourse" to demand more from the borrower, even if s/he owes more on the mortgage than the lender can recoup from selling the house.)

Lenders are finding that whereas in the old days they might lose, say, $10,000 on a borrower's credit-card debt in bankruptcy, with real estate in the tank they are now looking at losing $50,000, $100,000 or more on that same borrower's defaulted home loan.

"Be careful what you wish for; you may get it!"

So now they are looking for a pretext for walking back the new bankruptcy bill, and McArdle is giving them one. They are just concerned with the economy; sure.

Posted by: Nancy Irving on February 21, 2008 at 2:40 AM | PERMALINK

Well, actually, Nancy, Ms. McArdle was sour on this law from the moment it was proposed, as were many people of a generally Hayekian disposition. It's really pretty simple. There are two ends of the spectrum regarding the role the state can play in the relationship between debtors and creditors. On one end, the state can build debtor's prisons, and fill them when people default on loans. On the other end, the state can decide to do nothing to enforce loan contracts.

For many people, and I am one of them, it's pretty apparent that being decidedly on the latter end of the spectrum is preferred, because lenders are much more likely to exercise prudent judgement when they know that the state is not going to expend a lot of power in enforcing loan agreements. The prospect of a relatively easy chapter 7 filing concentrates the mind of a lender nicely, and that's a good thing.

It basically comes down to the fact that for the same reason it doesn't make sense for the state to be heavily involved in the allocation of industrial capital, because such heavily centralized decision-making cannot capture knowledge as well as millions upon millions of decentralized decisionmakers, it doesn't make sense for the state to become heavily involved in the allocation of financial capital, via very forceful enforcement of loan agreements, because lenders who come to depend too heavily on the power of the state to recover their loans start suspending their specialized judgement of an individual borrower's likelihood to repay. People who need very strict bankruptcy requirements to make profitable lending decisions should not be in the business of stewarding capital, and that is a position that a lot of us have held for a long time.

Posted by: Will Allen on February 21, 2008 at 10:26 AM | PERMALINK

It is not just entrepreneurs who benefit from bankruptcy. Consumers greatly benefit from it too. When people are burdened with insurmountable debt, they stop being the affluent consumers our economy depends upon. When everyone stops consuming in order to pay off debts, that is what a depression is.

Posted by: Brojo on February 21, 2008 at 11:54 AM | PERMALINK

just heard a radio show (NHPR) with two bankruptcy lawyers saying personal bankruptcy is still an excellent option for people with debt problems -- it just requires a little more paperwork than before -- but it's no less available than before. (Many of their clients were under the mistaken impression they could no longer go bankrupt). The main effect of the bankruptcy law seems to have been in disseminating misinformation.

Posted by: dukej on February 21, 2008 at 11:58 AM | PERMALINK

This may be stupid question, but I'll ask it anyway. If Ch. 7 is fairly easy to obtain, what force is there to compel anyone to pay off their debt? I ask this as someone who has excellent credit, by the way, and who doesn't take out loans I can't repay, keeps a single credit card, makes payments on time, etc. Is there any good reason to do so?

Corpus juris, I'm particularly interested in your answer to this question, as I know a few people who have defaulted on home and student loans and gotten released from credit card debt with no apparent consequences in their lives. Isn't it true that those of us who do pay are paying for those who don't?

Posted by: Gaia on February 21, 2008 at 2:05 PM | PERMALINK

those of us who do pay are paying for those who don't?

It is not true. Almost all people who take out loans expect to pay them back. Something occurs like a lay off or a health problem that prevents them from paying back those loans. If these people are unable to unburden themselves with these insurmountable debts, they stop economic activity and withdraw from the economy, which hurts us all and makes us all a little bit poorer. When people can unburden themselves of insurmountable debt, through bankrupcty protection, they reenter the economy, which makes us all a little bit richer.

Soon many people will be withdrawing from the economy. When enough people withdraw from the economy markets fail and ecomomic transactions cease. We call these market failures depressions. When economies become depressed, even people who managed their debts well and have excellent credit will be waiting in bread lines to eat.

Posted by: Brojo on February 21, 2008 at 4:25 PM | PERMALINK
just heard a radio show (NHPR) with two bankruptcy lawyers saying personal bankruptcy is still an excellent option for people with debt problems

One might consider that bankruptcy attorneys have something of a vested interest in people thinking that bankruptcy is an excellent option.

(I'm not saying they are wrong, you understand, just suggesting that you not consider their expertise without also considering their possible bias.)

Posted by: cmdicely on February 21, 2008 at 5:03 PM | PERMALINK

Thanks, Brojo, for your excellent and concise response. I have to tell you, though, I have heard two people say they had no intention of repaying student loans, and another took out a home loan that she should not have once she saw that her mortgage payments would be 70% of her monthly income! (The very next month, she lost her job and subsequently wiped out all her resources before she was employed again.) I am sure these are unusual cases. I hope so.

But it seems that we do all pay if, as you say, we'll all be standing in the same bread lines. And if that's the case, I really do wonder what compels any of us to play by the rules?

Posted by: Gaia on February 21, 2008 at 5:46 PM | PERMALINK
If Ch. 7 is fairly easy to obtain, what force is there to compel anyone to pay off their debt?

Most people like keeping assets: Chapter 7 liquidates them. The future ability to secure credit is important to many people, Chapter 7 constrains that.

Isn't it true that those of us who do pay are paying for those who don't?

Sure, that's true whether or not the way people don't pay is through legal discharge in bankruptcy or through simply losing assets and the ability to earn income without being able to discharge the debt in bankruptcy. If people who are bankrupt from a practical standpoint are able to file legal bankruptcy, creditors get whatever minimal amount they are going to be able to get sooner, and the debtor is more likely to recover sooner.


Posted by: cmdicely on February 21, 2008 at 6:24 PM | PERMALINK

Wow, Megan McArdle wrote something smart for a change.

Posted by: nemo on February 21, 2008 at 8:19 PM | PERMALINK




 

 

Read Jonathan Rowe remembrance and articles
Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

Advertise in WM



buy from Amazon and
support the Monthly