A new study titled "Bankruptcy and Small Firms' Access to Credit" proves once again that the laws intended to protect certain sectors of society often end up hurting them instead.
The research paper by Michelle White of the University of Michigan and Jeremy Berkowitz of the Federal Reserve Board reports that unincorporated small businesses are more likely to be denied credit in states that let people keep possessions after a bankruptcy.
And when loans are extended in these states, they are likely to be smaller relative to company size than in states with tougher bankruptcy laws.
This should be no surprise.
Bankruptcy has lost much of its stigma. People who have filed for bankruptcy can still get loans, and the amount of assets protected from creditor liens can be substantial.
Moreover, many bankers report that when a borrower asks to settle for a few cents on the dollar or threatens to file for bankruptcy if denied, others who learn of this ask to have their debts reduced as well-though they could fully meet their obligations.
The only way a lender can protect itself is to be extra wary in the first place. So a law intended to help unincorporated borrowers ends up hurting rather than helping them.
Laws or proposals affecting other areas of banking can have similar unintended effects. Among them:
Usury ceilings. These are intended to make home finance cheaper and thus to encourage homeownership. But when the ceilings are below market rates, they lead to no lending rather than cheaper loans.
Credit card interest rate caps. Merchants and other vendors rose up in arms when legislation was proposed to limit card rates. They feared this would reduce the willingness of banks to give lines of credit.
ATM surcharge limits. Many lawmakers who would favor state laws that cap ATM fees ultimately vote against such limits. Though lower fees may lead to lower ATM costs for the public, they could also deter banks from installing more ATMs.
Anti-discrimination laws. Few employers are willing to talk about it, but many think twice before offering jobs to older people, minority group members, handicapped people, and others protected by anti-discrimination legislation.
The candidates thus scrutinized may be as good as or better than those who do not fit in a protected group, but there is always the fear of what to do if the employee doesn't work out. Will it be difficult to get rid of him or her, even if circumstances justify it?
And though doing so may open the company to a lawsuit, the potential employer may decide to avoid a workplace problem by not hiring the "protected" person in the first place.
The problem is not new.
The ancient Hebrews had their jubilee year-every seventh year all debts would be forgiven. But as the jubilee approached, people would become far more careful about lending or refuse to lend.
In countries where religion forbids charging interest, fees are imposed that serve the same purpose, or else no loan is made at all.
Robert Frost's poem "Mending Wall" says, "Before I build a wall, I want to know what I am fencing out and what I am fencing in."
Legislators who develop protective legislation that violates economic sense and the market's "laws" should take those lines to heart.