Bankruptcy
Bankruptcy is a judicial proceeding that discharges a debtor unable to pay and distributes the remaining assets among creditors. It is distinct from insolvency, which is the factual condition of being unable to meet obligations as they fall due. A firm can be insolvent for years without a bankruptcy, and a solvent firm can be pushed into one by a creditor's petition.
Why failure is not a malfunction
The Austrian treatment starts from what a loss actually is. An entrepreneur commits resources now against an expectation about what consumers will pay later, and a loss is the market's report that those resources were worth more in some other use. Nothing is destroyed by the report. The plant, the tools and the workers all still exist; what changes is who directs them and at what valuation.
Bankruptcy is the institution that carries out that transfer. Assets are re-priced at what a new owner will actually pay, claims are settled in order of priority, and control passes from the people who misjudged to the people bidding on the corrected figures. On this account a wave of bankruptcies in a downturn is not the disease. It is the malinvestment of the preceding boom being unwound, and interrupting it leaves the misallocated capital where it is.[1]
This is the standard Austrian objection to a bailout. Paying a firm's creditors from tax revenue does not undo the loss, it moves it onto people who made no such judgement, and it leaves the assets under the direction of the management whose forecast was wrong. The signal that would have redeployed them is the thing the bailout suppresses.
The contractual objection to bankruptcy law
Austrians are not uniformly friendly to bankruptcy law itself. Murray N. Rothbard argued from the title-transfer theory of contract that a debt is a transfer of ownership in future goods, so a statute discharging the unpaid balance by fiat takes property from the creditor and gives it to the debtor, whatever the debtor's circumstances.[2]
His position is not that debtors should be jailed. The defaulting debtor has committed no fraud and has stolen nothing, so imprisonment was always unjust, and Rothbard says so. What he objects to is the substitution of one compulsory rule for another. The contractual alternative is that lenders and borrowers agree in advance what happens on default, which is what a limited-recourse loan or a secured facility already does, and which prices the risk instead of socialising it across future borrowers.
Lawrence H. White made the parallel economic case, treating bankruptcy law as an intervention that alters the terms creditors and debtors would otherwise have reached and so changes who gets credit and on what conditions.[3]
How the law arrived here
English bankruptcy began as a creditors' remedy rather than a debtor's relief. The Statute of Bankrupts of 1542 applied only to traders and was initiated by creditors against a debtor presumed to have absconded, and default carried a stigma of dishonesty that the vocabulary still has. Debtors' prison persisted until the Debtors Act of 1869.
The modern direction is the opposite one. Discharge was extended from traders to everyone, then supplemented with reorganisation, so that the dominant purpose became keeping the enterprise running rather than liquidating it. In the United States the Bankruptcy Act of 1898 established a general discharge and the Bankruptcy Reform Act of 1978 created the Chapter 11 reorganisation.
Reorganisation is where the two Austrian arguments meet and pull in opposite directions. Keeping a going concern together can preserve genuine value that a piecemeal sale would break up, and this is a real gain. But it is decided by a court rather than by bidders, which means the question of whether these assets are worth more together than apart gets answered without the prices that would have answered it.
See also
- Insolvency
- Debt
- Contract
- Malinvestment
- Moral hazard
- Austrian Business Cycle Theory
- Profit
- Entrepreneur
References
- ↑ Murray N. Rothbard. America's Great Depression, 1963, Part I, ch. 1 and Part III.
- ↑ Murray N. Rothbard. The Ethics of Liberty, 1982, ch. 19, "Property Rights and the Theory of Contracts".
- ↑ Lawrence H. White. "Bankruptcy as an Economic Intervention" (pdf), Journal of Libertarian Studies 1:4.
Links
- Bankruptcy as an Economic Intervention (pdf) by Lawrence H. White
- In Praise of Bankruptcy by Henry Thornton, October 2008
- Yet Another GM Bailout by Briggs Armstrong, November 2008
- Bankruptcy at Wikipedia