Friday, April 4, 2008

Bankruptcy Laws and the Economy

An article in the latest New Yorker, Going for Broke, tells the tale of bankruptcy law in the US and how it may or may not have contributed to the current economic meltdown.

The credit crisis has turned into an economic alluvion, with no dry land to be had. The link between the sub-prime mortgage fiasco and the 2005 Bankruptcy Law is interesting, and something I wouldn't have made on my own. But that's why I read Surowieki.

Bankruptcy law is one of those hot button topics, like sub-prime mortgages, that sends people into orbit with a they-did-it-to-themselves ire. It's not as if this anger is without a point. I know that to live below your means is sometimes about as much fun as having 2 cents in a 99 cent store, basically broker than broke, and I have little time for someone complaining about money problems when they have a flat screen TV with TiVo and Wii. And I'm perfectly content with these feelings, but I also know they are reactionary. I am reacting to the a$$hole who just cut me off in his leased SUV that sucks up 50% of his disposable income. And when viewing politics and the economy, reactionary just doesn't always work.

Because as Surowieki points out in the article, there is plenty of bailing out going around, just not for those at the bottom of the economic food chain.

In recent months, a lot of people have been handed financial get-out-of-jail-free cards. C.E.O.s who presided over billions in losses have walked away with tens of millions in compensation. The Federal Reserve has showered cheap money on banks and brokerages. Even Bear Stearns caught a break when, last week, J. P. Morgan agreed to quintuple the price it will pay to take over the firm. But there’s one group for whom forgiveness has not been forthcoming: ordinary consumers struggling with piles of credit-card debt. For them, escaping the burden of their bad decisions and their bad luck has become much harder.

It's important to remember that, I think, because it is too easy to blame things that are easier for us to see, like when the news is full of these after-the-fact interest rate breakdowns on sub-prime mortgage loans. I think that there's probably a lot more transparency after you're f*cked than before you are. Which just might be one of the ways they f*cked you over in the first place. But what do I know, I actually read the fine print and every word on a shampoo bottle because, well, I am a compulsive reader. For example, did you know that the wording on a toothpaste box is concise and grammatically correct, which is more than I can say about Citibank's fine print. Anyways, I digress.

So the 2005 Bankruptcy law. Basically, you couldn't declare bankruptcy over credit cards anymore.

One might say: so what? Even if bankruptcy is sometimes precipitated by bad luck or by an economic downturn, it’s always the result of people living beyond their means, and why should they get away scot-free while the rest of us pay our bills? It’s a fair question. But there’s a reason we did away with debtors’ prisons: having millions of people enslaved to their debts is a bad thing for an economy. Putting people into Chapter 13 essentially means they pay a heavy extra tax that goes straight to the credit-card companies. That creates a disincentive for debtors to work, since the more they earn the more they pay. It also takes away spending power—not the best thing during a recession. Making it harder for people to discharge their credit-card debts has other drawbacks as well. Homeowners would once do almost anything to keep up payments on their homes, even if it meant falling behind on other debts. In the past year, though, economists have reported an increase in the number of people who are just walking away from their homes, because it’s now often easier to abandon a mortgage than a credit-card bill. (The practice has even been given a name—“jingle mail,” because people simply send their keys back in an envelope.) So the new law may very well have exacerbated the housing crisis.

He goes on to connect bankruptcy laws to entrepreneurship (more than 15% of personal bankruptcies are from a failed business), self-employment, and learning a new trade.

In the meantime, bankruptcies have plummeted 62% between 2004 and 2006, and credit card companies' profits rose over 30% between 2005 and 2007. That's all fine and good, but don't tell us you did it for good people like us who pay higher interest rates and fees. Because I know my rates and fees didn't go down, did yours?


Anonymous said...

Creditors-debtors relationships in a given economy are affected by the ability of creditors to obtain information about fundamentals and the managers' ability to strategically use their private information. An optimal bankruptcy law utilizes creditors' information, while minimizing managers' use of strategic information.

Anonymous said...

I believe that the 2005 bankruptcy laws are the straw that broke the camel's back. The system ran in this manner for many years, and that is how the US maintains its international economical power. Let's face it, this whole thing started by home foreclosures, which would have been avoided under the pre-2005 laws. I am astonished that the media and analysts have not connected the two!!
Even more concerning, we bail-out the ones that created the problem and abandoned the victims. I understand that funds from the government had to be pumped into the economy, but why are we bailing out the banks that want the money and not the individuals that owe the money? The direction of the funds is concerning because they may end up in another CEO's bonus!!! Until when??? Our international position as Americans has already been weekend as a result of the Iran war. We can not afford loosing out economical edge. I am truly angered and concerned by our decisions as an advanced country.