That was the reasoning behind the 2005 bankruptcy reform. Although filings spiked before the law took effect, immediately thereafter they fell off a cliff. In 2006, just 598,000 people filed for bankruptcy, the fewest since Ronald Reagan was president. Filings have increased since but are still well below the rates that prevailed in the relatively sunny economic climate of 2004.
Harsher bankruptcy rules are seemingly doing what we wanted them to do: discouraging excessive risk taking. The question, though, is Which risks?
Look at entrepreneurs. All of the business literature indicates that starting a business is a phenomenally stupid thing to do. Most new businesses fail, and not simply because most would-be entrepreneurs are actually no-hopers. Even people who have founded successful companies in the past still have a 70 percent chance of failing. All those business failures are costly—but the successes are the difference between us and Tanzania. We want people to take these kinds of risks, even if that means we write off a lot of bad debt.
Tougher bankruptcy laws don’t necessarily curb the kind of behavior we want to discourage: borrowing money you have no way to repay, in order to buy unnecessary consumer goods. The amount that households put on their credit cards didn’t fall after the 2005 reform; over the next two years, it rose 12 percent. According to Michelle J. White, an economist at the University of California at San Diego, many bankrupts are what economists call hyperbolic discounters—people who pay a lot of attention to current pleasures, and very little to future costs. That’s why a person’s debt, not unemployment or divorce, may be the best predictor of bankruptcy.
If you’re the kind of person who buys now and worries later, the idea that government is making your inevitable bankruptcy filing slightly more annoying won’t discourage you. Actually, a higher hurdle to bankruptcy will make things worse, because banks will offer to lend you more money if getting the debt discharged is harder for you—money that you will happily, and irresponsibly, borrow and spend. The people who are most likely to be deterred from borrowing are the people who are taking the rationally contemplated risk of starting a company or buying their first home.
Of course, we’ll at least squeeze a little extra cash out of the real deadbeats. Maybe. Most repayment plans set up under Chapter 13 fail. People who weren’t previously good at living on a budget don’t magically get better at it with a court order. Moreover, job losses or other unexpected events can derail the highly structured payment plans. And the costs of administering an ongoing plan are much higher than for a simple discharge and write-off.
Meanwhile, those payment plans lash people to their old lives, even though those lives weren’t working all that well; it’s hard to move, or get training, for a better job if a court has to approve the expense—and why bother, if a trustee might seize the extra income? In the worst case, the failed Chapter 13 proceeding leaves the most-vulnerable people mired even deeper in debt they can’t repay. Such outcomes start to sound less like “fairness” and more like “throwing good money after bad.” Look around. Do the banks seem sounder because we made it harder for people to shed their debts?