Bankruptcy is Good for the Economy

Bankruptcy is Good Public Policy

While the existence of the “fresh start” that can be obtained in a bankruptcy case clearly benefits the debtors who obtain a discharge, rest assured, there are also strong public policy reasons for the existence of bankruptcy.    The economy benefits when individuals are and have every incentive to be economically productive.   When an individual or family is spending every spare penny (or, more commonly, giving up necessities) to pay debt, the economy suffers.

  • Without bankruptcy, some would become completely hopeless, effectively giving up economically.    Individuals who have more debt than they can conceivably pay have little incentive (or ability) to improve their economic position through education or advancement.
  • Without bankruptcy, some would work “under the table” or in other marginal, temporary work to avoid the possibility of having their wages garnished.   Society loses the benefit of these worker’s best efforts and tax dollars.
  • In extreme cases, the burden of insurmountable debt has caused debtors to resort to criminal activity.
  • Without bankruptcy, some would continue to do without necessary food, shelter or medicine in order to pay debt.   Some have resorted to suicide.

Elizabeth Warren summarises it like this in her article “The Path to Economic Growth: Bankruptcy”

 Whether a policymaker is sympathetic to debtors or creditors, a bankruptcy system that encourages beneficial risk-taking, that keeps corporations searching out new business opportunities, that encourages entrepreneurs to form small businesses, and that gives consumers a reason to go to work every morning is better for everyone–debtors, creditors and all the rest of us.

Bankruptcy Reform, which happened in 2005, upset the long-standing balance in effect under the long standing bankruptcy law which preceded it.    By making it unreasonably difficult for some debtors to escape onerous credit card and other debts in bankruptcy, the reform act likely made the housing crisis worse.    As Christopher Farrell  points out in his November 2007 article.

But today’s growing problem in the housing market is different—foreclosures are soaring, while bankruptcies, though clearly on the upswing, are running roughly at half the 2001-2003 pace. The reason: A new bankruptcy law, approved by Congress in 2005 after  years of debate, makes it much harder for households to get out from under their consumer debt. The result: More people being forced to walk away from their homes, leaving lenders holding the bag. Perversely, a law intended to help the financial industry may be damaging the housing sector, creditors and borrowers alike. “It doesn’t matter what you think of the purpose of the new bankruptcy law. The timing is bad,” says Susan M. Wachter, professor of real estate at the Wharton School of Business.

The lenders are not the only one’s left holding the bag.   Forcing people out of their houses damages neighborhoods, communities, homeowners associations and increases expenses for local governments with a corresponding loss of timely property tax dollars in many instances.