Amorality play

By Megan McArdle

One of the topics that I write about with some frequency is bankruptcy. And as with the current financial crisis, what's amazing about bankruptcy is how many people are willing to spend how many hours debating whose fault it all was. Were the people who borrowed the money irresponsible, or were they taken advantage of by unscrupulous lenders? Do the people who backed the reform want to help credit card companies rape innocent consumers, or did the people who opposed it want to help deadbeats shrug off debts for the fripperies they acquired? The main object in all of this seems to be to get the mob good and mad so that we can pick up a stick and whack whatever villain we've identified.

Almost no one ever steps forward and says, you know, hey, it might not actually be anyone's fault. Sometimes, bad things just happen. And at any rate, who cares?

It's surprising how often everyone in the debate over bankruptcy loses sight of a simple fact: bankruptcy is the legal recognition of the fact that a person or corporation cannot meet their obligations. It doesn't matter whether they spent the money on worthy education or a stupid attempt to corner the Pez market, or a giant-flat screen television; whatever they spent it on, it's spent, and their current income is not enough to pay it off. Nor is it relevant that they might not have borrowed the money if they'd been smarter or better read, or whatever; the did borrow the money, and spent it, and now they owe it. I'm not talking about fraud here, clearly; any borrower who lied about their finances, or lender who misrepresented the terms, deserves whatever they get. Just normal kinds of stupidity, venality, and unlucky accident.

It matters prospectively, of course: we don't want other people to get the idea that they should borrow, or lend, without thinking things through. But the current system works pretty well. Recognizing that we don't have any very good mechanism for picking out the profligate from the unlucky (most bankruptcies involve a little from Column A, a little from Column B), we let people get rid of their debts regardless of how they were incurred. (Except for special exceptions, most of them involving the government, such as taxes and student loans). Then, recognizing that it is not a good idea to make it painless to borrow money you don't repay, we make life a little bit miserable for people who declare bankruptcy--though not very miserable; the chief result is that it's somewhat harder to get credit. It's hard to overstate how well this works. America's bankruptcy system is the most generous to the debtor, the least interested in assigning fault, in the entire world. There's strong evidence that this is one of the reasons behind our high rates of entrepreneurship; it makes it easier to take economic risks. And yet we also have (until very recently) the most robust consumer credit market in the world. Why start assigning blame, when ignoring the question has worked so well?

I feel the same thing, writ large, about the housing crisis. Most borrowers probably borrowed in good faith, and most lenders probably lent in good faith; I've seen no evidence that the anecdotal fraud was widespread. The banks that securitized loans genuinely thought they were doing a good thing by spreading credit risk; the hedge funds and others that bought them genuinely thought that they'd accounted for default risk. So who cares about placing blame? At the end of it all, we'll still have a housing crisis. We'll still also have moral hazard, but that's an argument for making things a little unpleasant for anyone we bail out, not an argument for letting them drown.

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