Most people don’t understand how bankruptcy works. It’s not an end—it’s a new beginning. Bankruptcy is good for both the individual and society at large.
We all have a point of view that colors our perception of events. As a character on one of my favorite TV shows often said, “When you are a hammer, the whole world looks like a nail to you.” My political philosophy is Libertarian. Libertarians believe government is a necessary evil, and its purpose, as stated in the Declaration of Independence, is to provide an orderly environment so that individuals may exercise their “inalienable rights,” which include “Life, Liberty, and the Pursuit of Happiness.”
Nobody is guaranteed to succeed in their pursuit. In fact, nature seems to abhor equality of result. If the world were truly fair and equitable, I believe I would have been born with the athleticism of Michael Jordan, the good looks and charm of Paul Newman, the money-making skills of Warren Buffet, and the compassion of Mother Teresa. When they made me, they checked the box “none of the above.”
As a Libertarian, I favor free-market capitalism over all other economic philosophies because I believe it provides incentives and rewards that result in the greatest productivity possible. Strong innovation and productivity result in the maximum amount of goods and services available at the most reasonable prices. That generally results in the highest possible standard of living for the society as a whole. Everyone ought to agree that is a good thing.
In free-market capitalism, at least theoretically, success is rewarded with financial gain while the risk of failure is borne by those who don’t deliver the goods or services demanded by the marketplace.
Who’s to Blame?
Over the last couple of years our financial system has experienced extraordinary stresses, with the worst recession since the 1930s. Many have said this is a failure of free-market capitalism. In fact, our financial crisis was a failure of government policies.
Government policies that encouraged banks to lend money to people who could never qualify for a mortgage resulted in an unsustainable housing bubble and the sub-prime mortgage fiasco, which in turn resulted in a fiasco beyond historic proportions.
A number of terrific articles and books have gone into great detail about how and why that occurred. For our purposes we just want the record to read there are villains all over the place. They include Presidents Carter, Clinton, and Bush, who forced banks and the GSEs (Fannie Mae and Freddie Mac) to lower lending standards for the “noble purpose” of increasing the percentage of Americans who could own their own home. This unleashed demand for 20 million new dwellings, driving up prices and creating a bubble.
Blame the Fed, which kept real interest rates negative, encouraging rampant leverage and speculation. Blame the SEC, which allowed Goldman Sachs, Bear Stearns, Lehman, and two other investment banks to leverage up their balance sheets to 40:1. Blame the investment banks and the ratings agencies that packaged up sub-prime garbage and rated them AAA. Finally, we can also blame the greedy consumers who bought houses or condos that they could not afford because they knew that house prices would never go down and that they could get rich by “flipping” them.
When home prices declined and people began to default on their mortgages, the fallout was immense. Politicians claimed it would be the end of the world if they did not step in to “bail out” the big banks, investment banks, AIG, GM, Chrysler, and others. I believe this was a huge mistake. They should have let them all declare bankruptcy, because bankruptcy is a beautiful thing.
Individuals get into excessive debt for a variety of reasons—some are irresponsible and profligate, while others lose a job or have a health crisis. Personal bankruptcy allows the individual to get a clean slate and start over without the burden of excess debt. Lenders lose money, but lending is risky, and if you lend to the wrong party, the losses are not unfair. When a person goes bankrupt, he or she does not cease to exist. His or her education, talents, and work skills remain to be better used without the overhand of debt.
It is (or should be) the same for corporations. Airlines have periodically gone bankrupt. They don’t stop flying. The airplanes do not disintegrate. What happens is that capital is more efficiently deployed, and onerous debt or labor contracts are eliminated or renegotiated. The shareholders lose their money, as it should be, and debtors, depending upon whether they are secured or not, lose money. The general public benefits because the re-organized airline has lower costs and can charge lower fares. (The healthy, non-bankrupt airlines do suffer from having a lower-cost competitor, but we have to chalk that up to collateral damage.)
Why Bankruptcy Works
During our recent financial collapse, the government believed that there was “systemic risk,” so instead of allowing AIG, Goldman Sachs, Citicorp, and numerous other financial institutions to go bankrupt, they “bailed them out.” (We will ignore the GM situation in which Obama turned bankruptcy law and the U.S. Constitution upside down in order to save union jobs.)
I believe that government was wrong because bankruptcy is a beautiful thing. We can only hypothesize about what would have happened had the government let all these companies go into bankruptcy. No doubt there would have been a credit crunch and substantial short-term dislocation, causing loss and pain to many people.
But I would argue that in the long run we would have been better off. The U.S. is not Zimbabwe. Even in Zimbabwe, with a total breakdown of the financial infrastructure, people still get food, electricity, and even gasoline. We would have recovered and set the stage for a much brighter future.
If Goldman Sachs went bankrupt, its shareholders would have been wiped out, as they should have been, and as they deserved to be. However, their computers and trading skills and management skills would not have gone down the drain. In a reorganization they would have become more efficient and less willing to take stupid risks. If Goldman, AIG, and Citibank all went bankrupt, their shareholders, Preferred Shareholders, and certain other creditors would have been wiped out—but I would argue they deserved to be. As these companies emerged from re-organization, smarter people would have re-funded them and brought in better management—and the world would have been a better place.
I welcome all feedback, especially critical, as it gets me to thinking. Feel free to email me at firstname.lastname@example.org.
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