What we have here is a failure to adjudicate

RMA Journal, The, May, 2004 by Dev Strischek

ISBN 0674009029; [c] 2002 Harvard University Press., 320 pages, $29.00.

Ask any banker for nominations to a top 10 list of the most irrational, illogical fields of knowledge in our industry, and the chances are good that bankruptcy law will get a nod, if not a winking or blinking. The sorry spectacle of our government taking 200 years to get it right goes right back to our colonial roots, when moral rectitude clashed with amoral profiteering, according to University of Pennsylvania law professor Bruce H. Mann.

Combing through the letters, records, and account books of 18th century merchants, lawyers, collectors, creditors, and debtors, Mann offers a refreshing historical perspective on the struggle between a simpler world's word of honor and the inexorably expanding new economic order's impersonal bonds of contracts and laws. Frankly, the view of debt incurrence as a cost of business and the extension of credit as a calculated risk requires less reliance on personal honor than on quantitative assessment of the success of the venture. Still, while we bankers pontificate about risk management today, we condemn failed debtors as damaged goods and bankruptcy fliers as lacking the moral stuff to dig themselves out from tinder their liabilities. Mann says it well: "Today when individuals fail--although not when corporations do--the ethic of personal responsibility remains powerful enough that we may wonder about the social consequences of their failure, but we rarely question the economic and political structures that undermined their independence by creating a world in which mere subsistence often requires husbands and wives to work, leaving families vulnerable when they lose a wage earner to death, illness, injury, divorce, or unemployment."

Mann shows bankers how long and why we have been so schizophrenic about business and personal failure. His central theme is the gradual shift from the belief that failure to pay one's obligations is a personal moral weakness to a more tolerant acceptance that individual insolvency is more likely to result from forces beyond the individual's control. The moral-weakness argument assumes that the individual is self-sufficient and able to control the environment. Jefferson's republic of gentlemen farmers made the same assumption and were equally unrealistic. Not even the log-cabin survivalist farmer was immune from the inevitable environmental and economic catastrophes of his times.

Now let's extend the time horizon forward to today's world of wage earners and salaried workers living tinder the constant threat of recession and acquisition, market slumps and a month's severance, and the nonstop hire of easy credit to finance mass consumption. Add to this an inexorable rise in the cost of our standard of living that outpaces our ability to pay for it all. It's no wonder that our personal balance sheets are fat with debt and thin in liquidity. A jerk on the reins of our economic horses and we stumble over the first of our growth hurdles. Thrown from our saddles, we're now trampled by a posse of collectors with dunning notices and a cavalry of lawyers with writs dispatched by the same people who staked us on this risky race to riches in the first place.

Early 17th century American religious leader Cotton Mather preached that too many persons brought "debts upon themselves, in such a manner, and in such measure, that a folly nothing short of criminal is to be charged upon them." Of course, this strict interpretation didn't apply to the better sort. Mann describes in great detail how elite businessmen were largely exempted from crimes of moral deficit. Until 1800, large-scale debtors engaged in high-risk enterprises were tolerated as victims of forces beyond their control. Lee Iacocca ripped this too-big-to-fail page out of our history books when he begged Uncle Sam to bail out Chrysler 20 years ago. In contrast, insolvent small farmers and other economically impoverished debtors were held morally culpable for welshing on their debts.

Despite the moral dichotomy, as the colonial economy expanded, entrepreneurs searched farther and farther beyond their local communities for credit. As debtors connected with creditors, word of honor was supplanted by legal contracts. Thus, as the economy increased in scale, the personal relationship gave way to more formal acknowledgments of debt. Of course, the larger scale introduced more volatility and greater risk, and the trade-off between the potential for profit and the risk of loss forced investors and creditors to accept that the social benefits of a wealthier society necessitated acceptance of failure from time to time. For example, there seemed little point to imprisoning a skilled entrepreneur for failure to pay his debts when he was more likely to pay them if kept out of jail.

In fact, during the 1750s to 1770s, the more commercial colonies of New York, Rhode Island, Massachusetts, and Connecticut experimented with bankruptcy statutes that discharged debtors from all liability after distributing their assets among creditors. Unfortunately, these laws had short shelf lives because of continuing moral indignation over the criminality of failure to repay debts as well as their favoritism toward the wealthier merchant classes of the day.