Debt's Dominion. . - Protection racket: how bankruptcy went from saving the average Joe to shielding the CEO - book review

Washington Monthly, March, 2002 by David Cay Johnston

DEBT'S DOMINION by David A Skeel, Jr. Princeton University Press, $35.00.

IMAGINE THE GOOD FORTUNE TO BE AN author whose history of bankruptcy in America is published just as Enron collapses, the credit card industry clamors to get tough on the customers it addicted to plastic money at 26 percent interest, and while the garbage that passed for accounting at Waste Management still fouls the air.

America could use a competent history of bankruptcy law right now because the excesses of the past two decades are about to bring us a new round of debtors seeking refuge from their creditors, some desperate and some manipulative. One bill favored by credit card banks would let them hound some debtors for life, adding late tees every month and denying the fresh start that bankruptcy has traditionally brought. This bill would make it much harder for the average uninsured Joe to get out from under crushing medical bills, while still leaving open the gaping loopholes in the law that helped facilitate some of the current disasters and serving as an easy out for large corporations whose filings, the result of gross mismanagement, protect fat executive salaries.

If ever there was a moment ripe for a serious examination of bankruptcy in America, this is it. The last history was published in 1935, making a solid history of how we got here most welcome just now. Author David A. Skeel Jr., a University of Pennsylvania law professor, promises readers the untold story of now bankruptcy evolved as a uniquely American way of dealing with debtors who cannot pay their bills, a story that he writes was shaped by political forces and an elite section of the bar.

At the founding of the Republic, Alexander Hamilton and the Federalists pressed for a new idea of bankruptcy as renewal, not a time for debtor's prison. Hamiltonians wanted to encourage credit to spur economic expansion, while the Jeffersonian Republicans wanted to protect farmers from foreclosure by bankers. This debate over how to deal with the insolvent and balance the interests of creditor and debtor, Skeel writes, has been waged for more than two centuries. A host of schemes have been tried, modified, and abandoned by Congress. Now, as we learn to live in a global economy, the American idea of bankruptcy as renewal rather than ruin is gaining currency in other developed countries, but the down side of that system is becoming all too apparent in the United States. A critical examination of the confluence of forces--asset inflation, accounting rules, and changing partnership laws--is desperately needed. Unfortunately, Skeel's book isn't it.

Limiting Liability

When the dot-com bubble burst, we came to what may be the end of two decades of asset inflation encouraged by government policy and financial engineering. Asset values are falling and bankruptcy filings are rising to record levels. Enron, Global Crossing, Kmart, Sunbeam, and more dot-corns than this article has periods have had to seek refuge from creditors in federal bankruptcy court.

Avoiding bankruptcy, because they had enough cash in hand to hold creditors at bay, were Cendant, Lucent, Mercury Finance, and a host of other companies that reported fattening bottom lines quarter after sizzling quarter until all that profit suddenly evaporated. The corporate books had been finely cooked until investors were served up a most unsavory net wealth reduction.

The executives who mismanaged their companies gorged themselves on greenback soup while serving up the mock kind to anyone not lucky enough, or informed from the inside, to sell their shares before the final course. And through all of this, the Big Five auditing firms put on the garnish of their opinion letters, helping lure more share buyers at ever-higher prices until the collapse.

The willingness of the Big Five accounting firms to sell their reputations was driven not by the lowest-bid work of auditing the books, which is supposed to give shareholders a reasonably reliable picture of a company's financial condition. What compromised their integrity was the big money they could get from these same companies selling "products" that make profits vanish from corporate income tax returns, as well as consulting. This is where the Big Five made their real profits. And then there was an obliging Congress, which, along with the 50 state legislatures, gutted partnership laws in ways that made corner cutting and outright fraud more palatable in the halls of accountancy and law. Until a decade or so ago, each partner was liable for the acts of every other partner, which served as a powerful self-policing mechanism within the corporate professions. Then came the savings and loan scandals of the 1980s, a rich treasure of bankruptcy lore, in which not a few accountant partners let their greed get the better of their professionalism. Soon partners in these global firms, who may never have set foot in an S & L, found themselves taking out second mortgages to pay the damages awarded against the entire partnership.