Calling America's rogues and entrepreneurs

An attempt to discourage the abuse of bankruptcy could discourage initiative just when it is sorely needed.

The key to arresting an economic slowdown is liquidity. Liquidity is not simply a matter of interest rates, although the Federal Reserve's rate cut last week certainly had a buoying effect. Nor is it confined to loans for commercial borrowers. What matters too is something more intangible - the feeling of liquidity.

Freedom to spend and invest for consumers is part of that story. Thus President Bush is casting his tax cut as a move to "give cash back" to the average citizen. At this hour of economic fragility, the White House argues, animal spirits must be sustained. "You see," the president said recently, "the great strength of America are the people of our country, the dreamers and doers and people who can accomplish things."

All the more peculiar to find the same administration pushing for tough new bankruptcy restrictions that would clamp down on both those frisky risk-taking souls and their pocketbooks. Calling for "a culture of responsibility", the White House is backing a bill to curtail Americans' treasured start-over device: personal bankruptcy under Chapter 7 of the US code. Within months, the bankruptcy restrictions are set to become law - just in time, pessimists say, to encourage lay-offs, the collapse of home values, and recession.

But the failure here is not primarily one of bad policy. Financial responsibility is an important precondition for the healthy functioning of a free market. The lesson is rather one of the perils of political scheduling.

A few decades ago in America, personal bankruptcy still carried some of the traditional stigma it does in continental Europe or the UK. Then two things changed. In 1978, lawmakers revised the bankruptcy code, making it easy for citizens to walk away from credit card debt and other unsecured obligations. Citizens found they could write off onerous bills to Visa or MasterCard and start anew - usually without jeopardising their home ownership.

Then came the credit card revolution. Credit cards had been the privilege of high earners but now their purveyors started to make them available to everyone. The card companies spread their nets out to catch the very smallest of fish.

Combined with the new bankruptcy code, that triggered an epidemic of personal bankruptcy. American Bankruptcy Institute data show that consumer filings quintupled to 1.4m in 1998 from 288,000 in 1980, while business filings remained flat. By 1998, 96 per cent of bankruptcy filings were from consumers.

Most of these delinquents were not internet innovators or venture capital hot dogs but humble wage earners. Still, easy credit and easy bankruptcy played their role in the economy's 1990s growth. For the venture capitalist and the profligate secretary share a common culture: the carefree culture that says if you spend all - and risk all - tomorrow will take care of itself. In America, the rogue is brother to the entrepreneur.

Anyone doubting this connection need only delve into one of the personal finance handbooks on the market today. Thus The Complete Idiot's Guide to Beating Debt (Alpha Books, 2000) on bankruptcy: "Maybe it's time for a fresh start. Luckily, we live in a country that believes in second chances (Just ask Bill Clinton!)."

The same volume goes on to argue that bankruptcy can be "a blessing". Bankrupts, it notes, are in good company: Burt Reynolds and Donald Trump have sought bankruptcy protection. Finally, the book reassures debtors that they may ignore their obligations. After all, credit card companies "have made a fortune off you already" through high interest rates. "You have been subsidising other people's bankruptcies for years," it says. No mention here of honouring contracts.

As a result, the critics of bankruptcy built up some moral steam of their own. Lawmakers such as Senator Phil Gramm pointed out that savvier debtors were taking advantage of the system to improve their personal situation - "going by the real estate office on the way to the lawyer and laughing at their creditors". Subsidised by campaign contributions from credit card companies, Republican lawmakers spent the mid-and late 1990s penning reform. Under at least one version of the new legislation, home equity would no longer be exempt from consideration when debts are reckoned. And higher earners would have to pay back some of their unsecured debt. There is also a new restriction for business: small firms will have to meet tougher requirements to make it through Chapter 11, the section of the code that governs their reorganisation.

Arguably, there was a perfect moment to promulgate the new bankruptcy act: 1998 or 1999, when the strong economy cushioned individual economic setbacks. But the political weather was not auspicious. President Clinton blocked the legislation, maintaining that the fault lay with predatory credit card companies.

But then came the Bush presidency. The bankruptcy restrictions accorded with the Texan's notions of individual responsibility, and Republicans seized the day. No matter that in the past three years personal bankruptcy levels have begun to drop or that the economy has darkened. After all, the moral and property rights case for the change remained. What's more, the legislation's defenders note, their bills contain provisions to ensure the poorest are spared its harsher measures.

Still, the shift sends an unfortunate signal. In continental Europe and the UK, where bankruptcy law has for years been heading in the opposite direction, the US decision to tack away from borrowers and towards creditors must look perverse.

The message here is not American but universal: what seems a wonderful plan for legislation on the drawing board can often morph into a dangerously destructive law.

© Copyright 2001 Financial Times

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