Bankruptcy Is Unfair and Necessary

Sink and Swim
Megan McArdle, The Atlantic, June 2009, p. 30

Far too many Americans are more concerned with fairness than a reasoned pragmatic approach to social and economic problems. Bankruptcy is one of the areas with which many of us would like to punish irresponsible behavior despite the obvious negative results of such policies.

This article enumerates several reasons why the punitive strategy to financial irresponsibility is ill-considered. Our “free-and-easy, all-is-forgiven model” of bankruptcy is vital for a healthy agile economy.

Our leniency toward those with unsustainable debts helps not only profligate debtors, but the rest of us as well. Less onerous bankruptcy procedures boost rates of entrepreneurship: reduce the cost of failure, and people become more willing to take risks. America’s business environment is much more dynamic than that of Europe or Japan, for many reasons—and our generosity to capitalism’s losers is one of them.

“But that isn’t fair!”, you protest.

By the time someone is in bankruptcy, the time for fairness is already long past. Bankruptcy is the legal recognition that someone lacks the resources to meet financial obligations. Our system works so well precisely because it mostly sets aside our instinct for just deserts, and instead focuses on minimizing the costs to everyone. It lays out clear and predictable rules for lenders and borrowers, so that they can plan for disaster, and escape as quickly as possible if it arrives.

“But tough bankruptcy policies act to deter financial irresponsibility.”, you assert. Any student of psychology will know this argument is poppycock.

If you’re the kind of person who buys now and worries later, the idea that government is making your inevitable bankruptcy filing slightly more annoying won’t discourage you. Actually, a higher hurdle to bankruptcy will make things worse, because banks will offer to lend you more money if getting the debt discharged is harder for you—money that you will happily, and irresponsibly, borrow and spend. The people who are most likely to be deterred from borrowing are the people who are taking the rationally contemplated risk of starting a company or buying their first home.

“How is a lenient bankruptcy policy good for everyone?”

Bankruptcy’s greatest boon is orderly liquidation of past failures so that banks and borrowers and insolvents can trust in their futures, invest in them.

Bankruptcy protection is unfair. Yet it is necessary. Like everything else in life, we should take a broad, pragmatic, scientific approach when determining policy. The worst thing we could do is pass knee-jerk reactionary legislation based on the opinions of an under-educated mostly-uninformed populace who is bent on fairness and short on reason.

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