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June 28, 2014

As noted by the “anti-economist,” Jeff Madrick, in The Scarlet Debtor, an article he published last year in Harpers, bankruptcy was unknown at English common law and is therefore entirely statutory. Our Constitution gives Congress sole and explicit authority to enact “uniform laws on the subject of Bankruptcies throughout the United States,” but the Congress was in no hurry after the Constitutional Convention to use such power, and early bankruptcy acts were short-lived and provided mostly for involuntary proceedings initiated by creditors, not debtors; it was a collection tool at the federal level, like, if you don’t pay me, I will gather up your other creditors and throw you into bankruptcy – a powerful collection tool indeed.
There was another reason for congressional inaction; we still had people sent to jail for failure to pay their debts until 1833 (another powerful collection tool at the federal level), at which time federal debtors prisons were eliminated. Till then, and mimicking the English use of debtors prisons which famously sent the father of Charles Dickens to jail for a year (among other notables), those who did not pay or were slow in paying their debts were both subject to further penury by either incarceration or involuntary proceedings in bankruptcy. Strict lending standards for credit were in place, and rightly so since the punishment for non-payment involved both the loss of liberty as well as homes and businesses and everything else in which the debtor may have had an interest. We never really had anything approaching a lasting and modern bankruptcy act until the Nelson Act in 1898, scarcely more than one hundred years ago. (Perhaps strict credit standards enforced by bankers had something to do with that in that the bankers policed the creditworthiness of prospective borrowers but good.)
Critics of voluntary bankruptcy then and now assign a moral dimension to its use. The sense is that petitioners in voluntary bankruptcy are gaming the system, beating the rap etc. with such an economic/legal Get out of Jail Free card. That is not true, as Elizabeth Warren’s massive research demonstrates in her new book, A Fighting Chance, where she finds that 90% of the major causes of individual voluntary bankruptcy are medical bills, job loss and divorce or death.
She also reports that more than a million such individual petitions in voluntary bankruptcy are filed each year. These people are hopelessly broke, not immoral; we need not punish them further since, after all, their petition and the circumstances and creditors’ schedules they must file are subject to the scrutiny of the court. They don’t just file a petition and take a walk; bankruptcy courts can and do deny petitions for relief that do not meet their criteria for relief. I have filed several chapter 7 petitions for relief on behalf of clients, none of whom was immoral in filing and all of whom were hopelessly broke. As an ethical counselor, I would not represent a potential petitioner who was wrongly trying to “beat his/her creditors,” which represents another welcome roadblock to such filing by those who would deceive. No system is immune to occasional deception, of course, especially a system in which more than a million new petitioners per annum are added to the bankruptcy courts’ already overcrowded dockets.
The immoral charge laid on debtors by angry and disappointed creditors is nothing new. In anthropologist David Braeber’s book, Debt, The First 5,000 years, the author observes that in many languages the word debt is a synonym for “fault,” “sin,” or “guilt.” Such word associations are, of course, to the great benefit of lenders designed, as they are, to leave borrowers with the belief that they have an obligation to pay what they owe. Graeber argues that strict enforcement of debt contracts is in fact class warfare (which at first look appears to be a stretch).

Leaving the historical for the fault-line in this essay, why is it we always blame the debtor for his/her over-indebtedness which drives him or her to file a petition in voluntary bankruptcy? Just who is responsible for excessive debt? Madrick feels that in a financial world shaped, as ours is, by bankers’ desire for performance bonuses, borrowers are often coaxed into taking out unnecessary loans. He writes that in times of crisis the lender who overextends the loans made during periods of financial speculation bears as much responsibility as the borrower whose terms were made so enticing, but it doesn’t work out that way. It is invariably the borrower who is deemed profligate and who is expected to pay the price when the system collapses (as ours did during the Bush catastrophe of 2007-2008 with its bailout of lenders and wipeout of borrowers where Wall Street big banks were the poor insolvent lenders and foreclosed and bankrupted citizens were the immoral borrowers. Yeah, right).
Graeber writes in such connection that the remarkable thing about the statement that “one has to pay one’s debt” is that according to standard economic theory, it isn’t true. It isn’t true because a lender is supposed to accept a certain amount of risk. A loan involves two or more parties and all bear responsibility for its terms, and to some degree, its repayment.
Madrick’s view that it is a 50-50 deal in terms of lender-borrower responsibility for repayment during the Bush fiasco when lenders abandoned credit standards may be a fair assessment, but that assessment is suspect when lenders have in fact loaned money to borrowers who met the tighter credit standards most lenders would invoke these days to determine the creditworthiness of a prospective borrower. As a referee, I would assess the relative responsibility for repayment of such a loan on a sliding scale, perhaps, and depending on the evidence adduced at hearing, order a loss of interest and/or reduction in principal as the lenders’ share in responsibility for repayment.
I have written or have had clients who were subject to contracts calling for liquidated damages. These are agreements that specifically set forth what the money or other damages are in the event of breach, which helps the process in that no proof of damages is required at trial. Perhaps something on that order could become standard in the lending industry, but don’t hold your breath. Usurious bankers are unlikely to go along with any admission of liability in the formation of a lending contract such as that, especially when in the Bush era they were loaning huge sums to lenders where they had to know repayment was at best uncertain but were making huge profits in commissions and fees in making such shaky loans. Greed wins; responsibility loses.
I will expand the issue of responsibility for repayment and/or partial forgiveness of debt to nation states in Part II – which will include the defaults of Argentina and Iceland and our forgiveness of the WW II postwar debt of Germany which some say led (along with the Marshall Plan) to its miraculous recovery – while others say it was a forgiveness of the Nazi military debt in retrospect). Stay tuned. GERALD E

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