Apparently a lot of people are unhappy with the current bankruptcy bill. I know little about the bill, except for complaints that it makes it harder to avoid repayment. Instapundit complains that credit card companies push their cards excessively, to the point of fraud, and Mark Kleiman says that too many users are not fully rational. The concerns seem to center around the issue of discharge: a bankrupt's debts are discharged. (Instapundit mentions the issue of attorney liability, but seriously, does anyone else care if a lawyer gets screwed?)
It is, however, worth noting the problems bankruptcy legislation has to deal with. Discharge is a form of risk sharing. If things go wrong for the borrower, the loss is shared with creditors. Risk sharing is useful and often highly valuable; Americans spend something like a half trillion dollars annually on life insurance alone. Discharge of debts in bankruptcy is effectively insurance. But like all forms of insurance, it suffers from two problems: moral hazard and adverse selection. Moral hazard means that borrowers take bigger risks if bankruptcy protects them from the downside. If things go well, the creditor does not get more, but the creditor takes part of the loss if things go badly. Adverse selection means that any loan offer tends to attract the worst borrowers, because they do not expect to end up paying off the loan. The more protection bankruptcy laws to bankrupts, the worse the adverse selection problem. Adverse selection cannot be eliminated simply by suggesting that lenders gather more information. The lender may know whether you have a job, and may know your credit history, if you have one. But the lender does not know a lot about your character, whether you are honest or whether you think of banks as fair game. (To Forgive or Not to Forgive, by Wenli Li of the Federal Reserve Board, is a nice survey of the issues.)
This is, of course, only a theoretical proposition. There is evidence that it is empirically significant, however. Wendy Edelberg of the Federal Reserve Board offers evidence that moral hazard and adverse selection are empirically substantial in consumer loan markets (although she focuses on mortgage and car loan markets), and Lawrence Ausubel of the University of Maryland provides evidence that there is substantial adverse selection in credit card markets.
The upshot is this. Bankruptcy is a cost of lending. Lenders can choose which markets to lend in, so each market has to pay its way. Mortgage rates are lower than credit card rates because the borrower has a house for collateral. Car loan rates are higher than mortgage rates, but lower than credit card rates, because the car is collateral, but does not last as long as a house, and the borrower can more easily depreciate it by reckless driving. So credit card borrowers, to compete for funds against house and car borrowers, have to offer an interest rate that makes credit card lending as profitable as the lenders' alternatives.
Furthermore, there is no empirical evidence that credit companies -- or any businesses involved in forms of lending -- are suffering more than ordinary cost-of-business risk from bankruptcies. This is a red herring.
he is peddling his own red herring. Making discharge of credit card debt harder makes it more attractive to lend. Moreover, borrowers who know themselves to be high risk (call them dishonest) are driven away by customers who know themselves to be lower risk (call them honest). It is Daily Kos level analysis to try to reduce this problem to us poor little helpless consumers against the big mean corporate interests.
Easy discharge of debts drives up interest rates. The gainers are the dishonest borrowers who plan to retreat into bankruptcy (why worry about the interest rate if you do not plan to pay off?). The losers are the more honest borrowers who face higher rates.
Todd Zywicki has a long article (okay, at only 78 pages, it is short for a lawyer) offering his own proposals that is worth reading.
Posted by sjostrom on March 11, 2005 10:29 AM
Comments:
The Definition of Hypocrisy
Are we really supposed to believe that the Bipartisan Campaign Reform Act has taken the special interest money out of politics and that the new bankruptcy law is in the best interest of all Americans and not mostly the financial segment?
If people who exercised poor judgment or experienced unforeseen tragedy are not to have access to the escape valve of declaring bankruptcy then why should baby boomers permit President Bush to increase the retirement age for full benefits, reduce payments and push for privatization?
If the federal government exercised poor judgment by creating the 3rd rail of American politics and embracing the new world order, why should the baby boomer generation grant debt relief by accpeting reduced benefits and increased retirement age for full benefits. What’s good for the goose etc?
When I was a young man the US was the world’s richest and most productive nation and the dollar was backed by bullion. Since then, federal politicians have hocked America, off shored most manufacturing and the US is now the world’s biggest debtor nation.
Today a 1965 dollar is worth $5.81 fiat dollars. On a personal level this means my best paying job was as a drugstore clerk in high school. I would have to make $20.33 an hour in 2005 dollars to enjoy the same purchasing power today. If social security benefits were based on the purchasing power of payroll dollars they were deducted from, I would have a wonderfulretirement!
The federal government is the biggest debtor in the world and relies on a regular infusion of foreign capital to support deficit spending. Recently foreign countries threatened to with hold their investment but Korea and China bailed the US out for now. Also, the American dollar is being challenged as the world key currency (for oil trades) by the Euro. If the dollar loses key currency status American will have to declare bankruptcy.
This is the definition of hypocrisy. We the people receive 5 pre-approved credit card offers a week and when we do what the Federal Government does .. oh well someone has to pay and it is always us!
