Bankruptcy

From a comment by Lew Rockwell, regarding Donald Trump:

He tried to justify the theft of bankruptcy, for example.

This runs counter to my…instincts, I guess I will call it, solely because I haven’t given significant thought to the topic.  Creditors take risks; nothing is certain – not even repayment.  Is interest solely based on time?  Of course not; every interest rate also compensates for risk.  But risk of what?  The risk of not getting paid.  The creditor knows this, hence he charges a higher rate.

I don’t see this as theft; I see it as a risk inherent in entrepreneurial activity.  Perhaps it is time to examine my views….

From The Ethics of Liberty, by Murray Rothbard:

Would bankruptcy laws be permissible in a libertarian legal system? Clearly not, for the bankruptcy laws compel the discharge of a debtor's voluntarily contracted debts, and thereby invade the property rights of the creditors.

I agree with this statement as it pertains to a libertarian society.  There is no place in a libertarian society for such “laws”; the subject of resolving obligations in case of default or inability to pay can be handled completely by contract or other agreement between the effected parties. 

But…these are the creditor’s “voluntarily contracted” credits also…aren’t they?

The debtor who refuses to pay his debt has stolen the property of the creditor.

This is where I stumble; there is no commercial transaction involving the allocation of capital that is guaranteed to be successful.  Is business failure to be considered theft?  Every bankruptcy is to be considered theft?

In any case, I will wait to see how Rothbard further explains this point.

The function of the legal system should then be to enforce payment upon the debtor through, e.g., forced attachment of the debtor's future income for the debt plus the damages and interest on the continuing debt.

I am not sure why there is any need for a “legal system” in the case of a “libertarian legal system” (this being the context in which Rothbard wrote), unless Rothbard is writing of a system developed to enforce contractual provisions. 

A libertarian legal system should do nothing more than enforce the contract between the parties of a commercial transaction.  This contract may or may not have provisions in case of default (more on this to come).

In defense of the bankruptcy laws, the utilitarian economist might reply that, once these laws are on the books, the creditor knows what may happen to him, that he compensates for that extra risk with a higher interest rate, and that therefore actions under the bankruptcy law should not be regarded as expropriation of the creditor's property. It is true that the creditor knows the laws in advance, and that he will charge a higher interest rate to compensate for the resulting risk.

This statement reflects completely my view – or at least my view to the extent I have considered this matter…but that’s why I am working to further consider this matter.  It is my view not as a utilitarian economist but as someone who advocates the right to contract – more importantly, the right to not contract.

The "therefore," however, does not at all follow. Regardless of foreknowledge or forewarning, bankruptcy laws are still violations and, hence, expropriations of the property rights of the creditors. There are all sorts of situations on the market where prospective victims may be able to maneuver so as to minimize the harm to themselves of institutionalized theft. The theft is no more moral or legitimate because of such praiseworthy maneuvering.

“Bankruptcy laws are still violations” in a libertarian world.  But, regarding today’s world, the “therefore” still applies, doesn’t it?  In essence, the law is a part of the contract.  If the creditor does not like the law, he need not loan the money; or, he could ensure proper security in the contract in case of default – attaching receivables, places liens on real property, etc.

Creditors do this all the time.  They take security in many assets – land, buildings, equipment.  They take security in the working capital.  They monitor monthly and quarterly financial ratios against the required ratios in the contract.  If necessary, they can take an observer seat on the board of directors.

If the creditor has not ensured proper security, who is to blame?  Not the debtor; could be the creditor, or it could be the market (more on the latter to come).

Certainly I agree that bankruptcy law shouldn’t exist in a libertarian world.  Today it does.  If the “law” was, instead, merely another clause in the contract, would default then be considered theft?  I don’t see how.  So, why would it be considered theft today?  I don’t see how.

Please note: I am not suggesting that just because the government says something is “legal” that it is ethical.  I am suggesting that the creditor knows the contract (including all laws that might affect it) before agreeing; the creditor need not agree to the contract.  Alternatively, the creditor can stipulate liens, oversight, and remedies in the contract directly.

I am saying that if something is contractual, it cannot be theft (given a contract that involves only the willing participants).  Inherently, today’s bankruptcy laws are part of the contract.

Yet, Rothbard is writing conceptually about the libertarian world.  Should such laws exist in a libertarian world? No, as indicated.  If such a clause was inserted in a contract in a libertarian world (a clause consistent with current bankruptcy law), would default by the debtor be theft?  No, as indicated.

Moreover, the same utilitarian argument could be used about such crimes as mugging or burglary. Instead of deploring crime against store-keepers in certain sections of a city, we might then argue (as utilitarian economists) as follows: after all, the storekeepers knew what they were doing in advance. Before they opened the store, they knew of the higher crime rate at that location and were therefore able to adjust their insurance and their business practices accordingly. Should we say, therefore, that robbery of storekeepers is not to be deplored or even outlawed?

I do not see this as a parallel example.  In the case of creditor – debtor, there is a contractual agreement between all effected parties.  Did the store-keeper make an agreement with the criminals?  Not in any sense that might parallel the creditor – debtor relationship.  In fact, not in any sense at all.

The problem of defaulting debtors may be met in another way: the creditor, taking account of the debtor's honest attempts to pay, may voluntarily decide to forgive part or all of the debt.

Agree.

Voluntary forgiveness of a debt may occur after the fact of default, or it may be incorporated into the original debt contract.

Agree (and I argue that it is incorporated in today’s debt contract).

But the important point is that in these legitimate situations of forgiveness, the discharge of debt has been voluntarily agreed upon, either in the original agreement or after default, by the individual creditor.

Agree…however…even in today’s world, the creditor voluntarily agreed to extend credit knowing the bankruptcy laws.  If the creditor did not stipulate terms for security – again, liens on assets, required financial ratios, etc., shame on him.  Whose fault is this?

I will summarize my thoughts on this matter.  I agree with Rothbard: there should be no such thing as bankruptcy law in a libertarian world.  Absent such interjections into the market, creditors will develop terms in the loan that provide adequate security – corresponding to demands of the debtors.  In other words…the market doesn’t just find a clearing price; the market also finds clearing contractual terms.

However, in today’s world?  Bankruptcy is not theft.  The creditor, knowing the rules of the game, need not play.

I am not sure of Rothbard’s views on this in today’s world.  I am growing more certain of mine.