The moral justification for bankruptcy

A lot of people seem to feel that filing bankruptcy is a moral failing and for this reason many people who would benefit from bankruptcy foolishly refuse to take advantage of it. This also explains why anti-bankruptcy laws favored by lending institutions have recently been able to get through Congress.

Bankruptcy is best compared to auto insurance. You can purchase insurance that will pay for damages to your car and yourself even if the accident was your fault. Few people would have moral issues with collecting on this insurance money, because they paid in advance for a comprehensive policy.

Now imagine that, when applying for a loan, you are given two options. The first option has a lower interest rate. The second option offers a higher interest rate, but the loan has a clause that states that, in case you get into economic trouble and are unable to pay the loan, the loan will be forever forgiven. When framed this way, I doubt that people would have moral issues with avoiding payment of the loan, because they paid extra for this loan insurance.

In essence, Congress has determined that the first type of loan is illegal, and all loans by default include this loan insurance. This insurance is calculated into the interest rate that lenders charge. The banks and the credit card companies make money despite the fact that a certain percentage of loans are lost to bankruptcy. There is no need to feel sorry for them. People who are eligible for bankruptcy should have no moral issues with taking advantage of it, they already paid for the insurance.

Now some would say that people should be given the freedom to enter into the first type of loan and thereby lower their interest rate. The problem here is that some people would foolishly enter into loans that they have no business getting involved with, and unscrupulous lenders would take advantage of such individuals. Bankruptcy laws create a moral check on the activities of lenders. Society is better off if people are given a fresh start rather than be forced into an unproductive life of quasi-indentured servitude.

Comments

[Austrian]

Society is better off if people do not have to pay for the consequences of their actions? Oh yeah, that's leading us down a great path...

You are so close; you see that all have to pay more in interest due to government-mandated bankruptcy legislation, yet you are still attached to this undefined "society" which is somehow better off when people are given less choice. If people are too stupid to be responsible for taking out loans, they are certainly too stupid to have a say in their government.

[Half Sigma]

Even back in the 1700s, the men who founded our Constitution saw that bankruptcy was important for a free country. One of the few powers specifically granted to Congress was the power to enact bankruptcy laws.

[Austrian]

Half-Sigma,

To establish a uniform rule of naturalization, and uniform laws on the subject of bankruptcies throughout the United States

Do you know the kind of laws they had for bankruptcy back then? Essentially pay what you owe or go to prison.

It's not a question of moral failings; we are all fallible and make mistakes. It's a matter of having to deal with the consequences of your actions, and not leaving others worse off because you cannot fulfill your obligations. There's nothing noble about theft, which is what a government-imposed debt forgiveness scheme is.

[Half Sigma]

The framers of the Constitution weren't all the same people as the members of our early Congresses. By the turn of the last century, hardly a liberal time at all, Congress had passed bankruptcy laws that are similar to what we have now. Bankruptcy is a better way.

[Austrian]

By the 1900s you mean? Hardly relevant with regard to original Constitution intent. And "Bankruptcy is a better way" isn't exactly an argument. Considering your fascination with IQ, you must have scored high on those tests. So don't squander it, come up with justifications for how it is moral to evade responsibility and commit theft.

[JohnGaltLine]

"The problem here is that some people would foolishly enter into loans that they have no business getting involved with and unscrupulous lenders would take advantage of such individuals."

What about unscrupulous borrowers who are less responsible because they have the safety net of bankruptcy?

Let's look at this part again:
"The problem here is that some people would foolishly enter into loans that they have no business getting involved with"

Here's what the late Harry Browne said about that sort of reasoning:
"Government seems to operate on the principle that if even one individual is incapable of using his freedom competently, no one can be allowed to be free."

Is that what you're saying, Mike?

[Half Sigma]

"What about unscrupulous borrowers who are less responsible because they have the safety net of bankruptcy?"

Theoretically the bankruptcy law takes care of this by not allowing loans taken without an intent to repay to be discharged in bankruptcy.

All insurers face the problem of assymetrical information: the person taking out the insurance is more likely to know if he is going to need it. This hasn't made the insurance industry go away.

Lenders who don't want to deal with the problem can simply go into another line of business.

Even without bankruptcy law, most bad loans would wind up not being repaid because if the person has no money, he has no money, bankruptcy or not. Without bankruptcy, the person in debt might not have any incentive at all to go get a job because all of his money would be taken away and given to creditors. This is bad for the economy, so bankruputcy law makes the economy more productive.

[JohnGaltLine]

"Theoretically the bankruptcy law takes care of this by not allowing loans taken without an intent to repay to be discharged in bankruptcy."

But in practice we can't measure "intent." And, of course, the actions of someone who "intends" to pay under the protection of bankruptcy are probably different from the actions of someone without it.

"Lenders who don't want to deal with the problem can simply go into another line of business."

I'm just searching for the truth here: Why couldn't that same reasoning apply to borrowers...?

[Half Sigma]

A civilized society doesn't believe in slavery, and forcing people to work to pay off debt is too close to slavery.

Saying that it serves people right for borrowing money they couldn't repay doesn't cut it.

[JohnGaltLine]

Yeah, right: If we "give people the freedom" to make their own borrowing decisions it would be "too close to slavery."

A person who has had debts discharged enters a period where he can no longer seek bankruptcy protection. Are you saying that such a person lives on the brink of "enslavement?"

By your reasoning, this period -- when a person is no longer eligible to declare bankruptcy -- presents a moral problem. Does it?

Or are you saying the "morality" changes depending on whether someone has already had his debts discharged? I think not.

Going through a bankruptcy forces someone to reevaluate his commitment to his various obligations. In the end, he emerges with only those debts he truly intends to pay.

I'm curious why you think people should not approach all their debts with exactly that level of commitment.

[JohnGaltLine]

Why can't child support be discharged under bankruptcy? How does that fit into your moral model?

[kego]

Correct me if I’m wrong, but I thought bankruptcy was mainly implemented to encourage people to start up small business, help expand the economy, and protect people from catastrophic events. If you take your best shot at starting up a business and it doesn’t work out, you can still have a life afterwards and still be a productive member of society. How are you supposed to pay off debt if you get sick, like cancer or AIDS, and cannot work? Did you know that over half of the people that file personal bankruptcy do so because of medical bills on their credit cards?

Sure, I understand that many people take advantage of the law. No matter what laws you implement, there will always be someone who abuses them. But you have to understand that the vast majority of the people that go bankrupt are NOT abusing the law. They are just everyday people who tried to take a shot at a new business and it didn’t work out.

Why punish the majority for the actions of the few who abuse these laws? Especially to fill the pockets of rich credit card companies (one of the most profitable industries in the world). I think they can handle a few people swindling them out of a few dollars when they are making so much money off everyone else. No, I don’t feel sorry for the banks, especially when they throw credit cards a people that they probably know can’t afford them or manage them.

[Austrian]

kego, the interesting thing about emotional arguments is that they usually aren't relevant to the issue at hand. It is unfortunate if someone has mounting medical bills, but the question is, how does this unfortunate fact justify government-sanctioned theft? If I sign a contract with you, to promise to pay you 10000 in two years for 5000 today, and then I renege on that contract, does the reason why I am not paying change the fact that you are out of 10000? What if you were expecting that money to pay for your child's education, or medical bills of your own? Of course you may personally find some reasons so compelling that you agree to forgive the debt (or part of it) - but what if government forced you to forgive it?

If you didn't have bad laws, then you wouldn't have to worry about people abusing them.

[Half Sigma]

"If I sign a contract with you, to promise to pay you 10000 in two years for 5000 today, and then I renege on that contract, does the reason why I am not paying change the fact that you are out of 10000?"

The contract includes an implicit clause that the debtor doesn't have to pay if he runs into financial difficulty, and both parties agree to it, so there's nothing immoral going on here.

[kego]

Well, I can see your point, but I would simply say that if go into a contract with someone for $10000, it is up to you weather you want to take a chance on that person or not, knowing that they could go bankrupt. It’s a two way street. You can make money off people by loaning it to them, but you run the risk that they may go bankrupt. Banks do this everyday and still make huge profits because, again, most people pay them back.

If a bank wants to throw credit cards at high risk people, then they deserve what they get from them, which may be bankruptcy or refusal to pay. They are obviously making money off lots of people who shouldn’t have credit cards to begin with, so they are willing to take the risk. That is their choice and they should suffer the consequences of those actions. If they don’t like it, then don’t loan money to the people. But my point is, they DO like it, because they make money still. Lots of money. And now they want even more? It was the banks that lobbied for this bill to be passed. If the banking industry was hurting, like the airline industry is, that would be different. But hell, they are making LOTS of money with the way the rules are now. Why do we need to completely screw over thousands/millions of honest people so that they can make LOTS MORE money?

[kego]

From a moral perspective, I don’t think one should feel guilty at all if it was an agreed upon contract between both parties and both parties consented.

It’s like me selling you a box of a dozen eggs that have a label on them stating: “Warning: some eggs in this box may have broken during shipping!”. If you buy the eggs anyway, and get home and find that half of them are broken, is it my fault? Should I feel guilty? Hell no! You knew the risk when you bought them. You were willing to take that risk in order to save money.

Banks do the same thing. They are willing to take that risk so they can MAKE money. Nobody made them do business with you and they knew what might happen.

[Austrian]

Half,

"The contract includes an implicit clause that the debtor doesn't have to pay if he runs into financial difficulty, and both parties agree to it, so there's nothing immoral going on here."

You really did go to a 2nd-rate law school. You just begged the question. There is an "implicit clause" by virtue of the government bankruptcy laws. Which you were trying to find a moral justification for in your first post. See the problem?

Would it be ok if government decided that someone could file bankruptcy for any reason (let's say one free pass per citizen)? What do you think this would do for interest rates and insurance overhead (to mitigate the loaner's risk)? Would that also benefit society?

[keltonbaker]

Bankruptcy in and of itself is not a moral failing.

Bankruptcy traditionally has been an opportunity for creditors to obtain remedies also, that's why there's something called involuntary bankruptcy.

But in these days of loose monetary policy and fractional reserve banking; (lending out money that didn't exist prior to funding is itself an activity of highly questionable morals) well, banks just don't put borrowers through quite the screening and routine follow-up that they once did. Why else is bankruptcy, as well as identity theft such the relatively common phenomena that they are today?

But like I said, bankruptcy in and of itself is not a moral failing, neither is the insolvency that preceeds bankruptcy necessarily immoral.

Insolvency can happen to even the greatest and most moral people with all the best laid plains. Incapacitating illness, natural disaster, being the victim of embezzlement or fraud, or even being the victim of ambitious government employees or absurd laws. Misfortune is capable of striking anyone and can reach behind any shield we may place against it, whether it be the foreign account or a mountain of insurance policies covering every known contingency.

I think that the profitability of the lending industry is irrelevant to the question of whether bankruptcy is moral. High profit usually comes with high risk, and for a good reason; but so what? Better to let the market decide who deserves reward or punishment for their product and price offerings.
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The way I see bankruptcy is this:

The state, the government, (the federal government in our case) is given a position of being the practically ultimate legitimate enforcer of contracts and property rights.
The state is to execute this duty in the process of administering justice to all citizens. But when the situation becomes one that the obligatee is unable to perform and the reality is that the investment has failed, and not due to fraud, then the duty of the government as enforcer and protector loses some object purpose.
So, in its most basic and essential function, bankruptcy is not a free giveaway program for debtors, it is simply a discharge of duty by the state to limit or negate enforcement of any prior contracts in the bankruptcy. After all, bankrupt individuals are still perfectly free, after the initial proceedings, to pay-back their creditors, if they feel so obligated, they are just no longer required to do so by law.