... in this week's installment of the Becker-Posner blog. Posner starts with a brief description of what's at issue.
Congress is on the verge of passing and the President of signing a major overhaul of the Bankruptcy Code. (See Summary and Changes). The new bankruptcy law, popularly termed the “Bankruptcy Reform Act,” has engendered passionate debate inside and outside Congress. The criticisms of the Act bespeak a failure to analyze it in economic terms.
The Act is complex, but the thrust is to make it more difficult for individuals to declare bankruptcy under Chapter 7 of the Bankruptcy Code. Under Chapter 7, the bankrupt’s assets, minus exempt assets such as a home and work tools, are sold to repay creditors. When the bankrupt is an individual rather than a corporation, his assets often are too limited to enable the creditors to be paid in full what they are owed; often the creditors receive just a few cents on the dollar...
An alternative procedure that individuals (and their creditors) can avail themselves of is Chapter 13 bankruptcy: instead of surrendering his nonexempt assets, the debtor agrees to make periodic payments to his creditors for as long as five years after the bankruptcy.
Posner likes the new legislation, taking a general equilibrium view of its effects.
Critics have derided the Act as mean-spirited and hard on the poor, but they overlook the most important effect that the bill is likely to have, and that is to reduce interest rates... default is costly and this is bound to be reflected in interest rates...
I conclude that the new Act, by increasing the rights of creditors in bankruptcy (for remember that Chapter 13 enables a creditor to obtain repayment out of the debtor’s post-bankruptcy income, not just out of what may be his very limited nonexempt assets at the time of bankruptcy, as under Chapter 7), should reduce interest rates and thus make borrowers better off.
Becker agrees, but suggests pushing the envelope a bit further in collateralizing debt with future labor income.
One approach... is to make human capital loans not dischargeable through bankruptcy-except in extreme cases. I suggested in an earlier entry that loans to finance the purchase of the right to immigrate should also not be dischargeable. Creditors would have the right to garnish wages for a certain period of time, as under Chapter 13 of the Bankruptcy Code. The new reform of bankruptcy laws moves in this direction, the same direction already used for student and other loans when governments, not the private sector, are the creditors.
Another approach that helps provide insurance is to encourage “equity” loans when human capital is the main collateral available. By equity loans I mean a system where creditors share in both the higher and lower earnings of debtors. So when earnings of a debtor are higher, the amount he or she pays back is greater than when their earnings are lower. This system is quite common in financing agricultural loans in poorer countries, as demonstrated by the research on loans in developing nations by Robert Townsend and others.
As always, you should read the whole thing (including the lively discussions that follow).