By Kevin D. Williamson
Thursday, May 07, 2020
In 19th-century English novels, bankruptcy is a tragedy
that just happens to people, often with no real explanation, as though
it were a natural disaster or an unexpected infection, a cartoon anvil out of
the sky over the head of some poor Wile E. Coyote in Regency garb. Bankruptcy
was on the mind of everyone from Charles Dickens to William Makepeace Thackeray
to George Eliot to Anthony Trollope, and it is a major plot point in Dombey
and Son, Vanity Fair, and The Mill on the Floss, among many
other novels. The threat of bankruptcy produces suicides in The Way We Live
Now and in Little Dorrit — such was its terror.
In our time, the economic effects of the coronavirus
epidemic will be severe, and for many individuals and businesses they threaten
to be, or already are, catastrophic. On the other hand (it’s an ill wind, etc.)
bankruptcy lawyers are going to have one of their best years ever. And here is
a sentence one does not often have occasion to write: There may not be enough
lawyers to go around. As
the Wall Street Journal reports, the bankruptcy world’s “ranks have
been thinned by a decade of economic growth” following the 2009 high-water mark
for Chapter 11 filings amid the financial crisis. Promising law students and
young lawyers have avoided specializing in bankruptcy, and the courts may not
be ready for the influx of cases. Notwithstanding the bleak prospect of being
sent to live in Delaware, it is a fantastic time to be a bankruptcy lawyer.
Because bankruptcy is associated with something that we
are deeply uncomfortable talking about — business failure and personal
financial distress — our bankruptcy procedures remain among the great unsung
achievements of American life. We have retained the Victorian terror of
bankruptcy, both the thought and the word itself — recall Donald Trump’s
avoidance of the word “bankruptcy” when talking about being forced to take one
of his struggling businesses and “throw it into a chapter,” his favorite
evasive euphemism for bankruptcy. But bankruptcy in our time is not a disaster
on par with dying in a cholera epidemic. Though it may be embarrassing and
painful, our bankruptcy process performs the invaluable service of codifying
the terms of failure. And failure is essential to the success of a free
and dynamic economy — a world without it is a world without innovation and
growth.
Failure is one of the main ways we adapt our economic
arrangements to new conditions. Sometimes, those new conditions emerge slowly,
as with the death by inches of many American newspaper publishers; sometimes,
those conditions change almost overnight, as with the coronavirus.
It is famously the case that most new businesses fail.
And that is especially true of small businesses, though it is good to keep in
mind that many of today’s corporate behemoths (Microsoft, Facebook, Apple) were
once small businesses, too. Among new small businesses, one in five fail in
their first year, and half fail by their fifth year. One wonders why
entrepreneurs bother with the risks and demands of starting something new when
many of them, being capable and energetic, might find comfortable salaried
employment at a well-established firm. The answer has to do with risk and
reward. Successful entrepreneurship is generally much more lucrative than is a
successful career managing someone else’s business: There are not very many billionaires
who made their money on salary, but even at the less rarefied levels of
business life, an entrepreneur who starts a successful dry cleaner or a
prospering coffee shop will generally earn much more than someone who manages a
dry cleaner or a coffee shop started by someone else. The upside is great —
and, equally important, the downside is not as grim as it could be.
It is amazing what can be accomplished by creative and
driven people in an environment characterized by stable and agreed-upon rules.
The financial institutions that do most of the business lending are not run by
naïfs. When big, sophisticated financial firms such as Goldman Sachs or JP
Morgan lend money to a business, they know what they are getting into. (Give or
take a subprime mortgage derivative or two — every company is capable of making
bad investments.) They know where they sit in the pecking order of creditors
and what assets are in play. They have a pretty good idea of what their
exposure to loss is and how much they stand to lose or recover if things go
wrong — and they know this because the rules generally are clear and
well-understood, with generations of precedent and established processes. Some
investors even specialize in the debt and assets of companies that are in
bankruptcy or on the verge of it, and these distressed-asset investors are
another unappreciated part of the vast financial ecosystem that keeps business
in business.
We do not have debtors’ prisons (not
for business debts, anyway), and we do not maintain arrangements in which
entrepreneurs are forever ruined by a business failure. Instead, we have a
process that encourages risk-taking and entrepreneurship, and that allows
financial institutions, lenders, and investors to make decisions in a stable
policy environment under which the rights and obligations of all parties are
clearly defined.
Doing violence to those arrangements would impose a great
social loss on our people and our economy, even if relatively few of us
understood or appreciated it. And we have developed a dangerous new habit of
risking just that. We see it in political shenanigans ranging from the thuggish
arm-twisting of the Obama administration during negotiation of the GM and
Chrysler bailouts (in which the usual rules of creditor priority were upended
in the interest of Barack Obama’s political allies) to Mitch McConnell’s
recent suggestion, uncharacteristically boneheaded, that bankruptcy procedures
be extended to the states, which have put themselves into impossible financial
positions by habitually underfunding their pension systems and taking on other
unfunded liabilities.
About the latter case: There is no such thing as state
bankruptcy law in the United States for excellent constitutional and practical
reasons; states deal with their creditors under a different set of rules, also
longstanding, and creditors and debtors both have the right to negotiate
settlements under the rules that governed the agreement when it was made rather
than under a new set of rules put into place for political reasons by Senator
McConnell and his colleagues. Pulling the rug out from underneath creditors,
changing the rules in the middle of the game, is precisely the wrong policy. We
have far too much ad-hocracy as it is.
Political actors often seek to intervene on behalf of
politically important debtors — and sometimes, though less often, on behalf of
creditors — in the belief that they can offer financial relief to an important
constituency at no cost to anybody they care about, only “greedy” bankers and
the like. What they refuse to acknowledge is that investors and lenders will
remember getting screwed and will be forced to alter their calculations to
reflect the fact that the rules are not always the rules — they may not be able
to do anything about the transaction immediately at hand, but they can
certainly take the new reality into account the next time somebody asks them
for a loan or an investment. More risk to lenders means less lending or more
expensive lending, which means less entrepreneurship, which means a less
fruitful and dynamic economy, fewer jobs, lower wages, and diminished tax
collections — lost opportunity and lost prosperity.
Bankruptcy is one of Chesterton’s fences. Of course there
is room for reform. But you should understand what you have, what purpose it
serves, and how it works before you knock it down.
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