Before Sept. 11, the federal government was on the verge of significantly increasing the burdens on those who seek relief through bankruptcy. But after the attacks on the World Trade Center and the Pentagon, and after the dramatic slowdown in the American economy became more apparent this fall, congressional leaders put passage of the Bankruptcy Reform Bill of 2001 on hold, largely out of fears that legislators not seem anti-consumer amid growing unemployment. They would do well to keep the bill bottled up in conference through the rest of 107th Congress.
The Bankruptcy Reform Bill of 2001, versions of which have passed both the House and Senate by large majorities, seeks to channel a greater percentage of individual bankruptcy applicants into Chapter 13, where they would still have pay a percentage of their debts. It also would give creditors new legal weapons with which to contest both personal and commercial bankruptcies, and would make it more likely that financially troubled businesses would face liquidation rather than reorganization.
Press coverage of this legislation has generally stressed the lobbying efforts of the credit card industry, which stands to gain handsomely from its passage. But the intellectual basis offered for bankruptcy revision also deserves scrutiny, especially in light of Americas experience with bankruptcy law. Congressional supporters of the pending legislation, mostly Republicans joined by Democrats from all wings of the party, argue that America is experiencing a bankruptcy epidemic. They note that between 1980 and 1998 a period of considerable prosperity annual filings grew more than 350%, reaching a high of over 1.4 million, or more than one in a 100 households.
They further maintain that this dramatic expansion has resulted partly from the aggressive marketing of bankruptcy as a financial planning tool by lawyers and accountants, and partly from a diminished social stigma associated with the failure to pay ones debts, leading ever more individuals and businesses to game the system. Finally, advocates of the pending bankruptcy revisions insist that they do not weaken Americas longstanding commitment to furnish fresh starts to honest bankrupts. When put in their historical context, each of these assertions is open to serious question.
Consider the claim that something must be amiss, because bankruptcies have risen so much during good economic times. Throughout the 20th century the fastest growth in the rate of personal insolvencies has typically occurred during economic booms, especially when businesses have embraced new mechanisms of consumer finance and have been willing to extend credit to an ever larger proportion of the population. Before the recent uptick in bankruptcy applications, two similar periods of mushrooming insolvencies have occurred one during the roaring 20 and one during the 20 years of general prosperity that followed World War II. In the 1920s department stores generously offered credit to customers and millions of Americans bought electric appliances and automobiles for the first time, usually through installment plans. In the 1950s and early- to mid-60s millions more Americans borrowed heavily to buy homes and cars, while the credit card greatly expanded the world of consumer credit.
Contemporary analogies abound, including the extension of credit cards to segments of the population that previously could not get them, a surge in subprime lending, the emergence of the no down payment mortgage, and the explosion in medical care provided on credit to individuals without insurance. Rather than constituting an anomaly, the recent explosion of consumer bankruptcy fits within a larger historical pattern.
The historical record similarly casts doubt on the assumption that the social costs once associated with bankruptcy have all but vanished. For close to two centuries critics of Americas approach to bankruptcy have been lamenting the lessening of the stigma associated with failure to pay ones debts, particularly during periods when credit flows expanded rapidly. In 1830, the radical banking theorist William Gouge sounded much like present-day politicians, arguing that in olden time, insolvency spread as much gloom over a family as death, but that we have become so accustomed to this system of breaking, that we begin to consider it a part of the system of nature.
Yet throughout the past 200 years, bankruptcy has continued to exact substantial psychological and economic costs for the great majority who experience it. Debtors prisons, of course, no longer confront heavily indebted Americans, but incessant dunning letters, court judgments, and now telephone entreaties from bill collectors take their toll, especially in a society that has always lauded personal success. Sustained financial difficulties have not ceased to threaten friendships, wreck marriages, or contribute to individual depression. And a personal history of insolvency continues to damage access to credit, as it has done throughout our past, forcing most former bankrupts to accept much higher interest rates for post-failure loans or keeping them from getting access to credit altogether.
The enduring impact of bankruptcy on perceptions of creditworthiness suggests that very few bankrupts have ever received a completely fresh start. No bankruptcy discharge can truly cast the mantle of oblivion over the past conduct of the debtor, as one senator argued in 1840. (Even in that period early credit reporters kept careful track of bankruptcy notices in the nations newspapers, adjusting their assessments accordingly.) Nonetheless, the ability to gain releases from previous obligations has enabled millions of Americans breathing space to rebuild their finances, and not infrequently, as in the case of P.T. Barnum, Roland Macy, and Henry Heinz, to develop innovative and extremely profitable businesses.
Todays advocates of a tougher bankruptcy system confidently predict that their legislative overhaul will only constrain the sharpsters who have made bankruptcy a lifestyle choice. But by making the process of filing for bankruptcy more difficult, time consuming, and costly for everyone, and by making it easier for creditors to oppose applications by all debtors, the Bankruptcy Reform Bill will almost certainly limit access to bankruptcy relief for many deeply indebted Americans. At the same time, by enlarging the range of debts that will not be dischargeable in bankruptcy, the legislation may very well curb the provision of financial assistance to bankrupts by friends and relatives. Such aid has historically helped insolvent Americans to begin anew, but has flowed most freely after they have received full releases from their past debts.
It is even possible that strengthening the position of creditors in bankruptcy proceedings will lead to even greater numbers of Americans who cannot pay their bills. Businesses almost certainly will respond to the new legal environment by loosening their criteria for the extension of credit, which, over time, may very well yield higher rates of defaults. This dynamic seems to have occurred after the last tweaking of the bankruptcy code in 1984, which tilted the legal balance between debtors and creditors toward the latter group.
In this years earlier congressional deliberations over bankruptcy, several senators signaled that they stood ready to revisit this issue if the Bankruptcy Reform Bill of 2001 did not achieve its intended goals once enacted and implemented. The history of bankruptcy in the United States suggests that they would do better to engage in some sober second thought and keep the legislation from going to the Presidents desk.
Mr. Balleisen is Hunt Family Assistant Professor of History at Duke University and the author of "Navigating Failure: Bankruptcy and Commercial Society in Antebellum America" (University of North Carolina Press: 2001).
