"But, Yossarian, suppose everyone felt that way."
"Then," said Yossarian, "I'd certainly be a damned fool to feel any other way, wouldn't I?" --Joseph Heller, Catch-22
Last November 29, American Airlines declared bankruptcy under Chapter 11, the provision of the bankruptcy code that allows a corporation to stiff its creditors, break contracts, and keep operating under the supervision of a judge. This maneuver, politely termed a "reorganization," ends with the corporation exiting bankruptcy cleansed of old debts. In opting for Chapter 11, American joined every other major airline, including Delta, Northwest, United, and US Airways, which has been in and out of Chapter 11 twice since 2002. No fewer than 189 airlines have declared bankruptcy since 1990. As the sole large carrier that had not gone bankrupt, American missed out on savings available to its rivals and thus was increasingly uncompetitive.
Bankruptcy is intended to give a fresh start to persons and enterprises overwhelmed by creditors. In the case of American (like other airlines before it), the main "creditors" are its employees. The costs of American's bankruptcy will be borne mainly by its workers and secondarily by taxpayers. The contracts being broken are union contracts and legal promises to honor pension obligations. American is laying off 13,000 workers, slashing wages, and reducing its annual pension contribution from $97 million to $6.5 million. The airline hopes to stick the federal Pension Benefit Guaranty Corporation with liability for much of the $6.5 billion that it owes its workers and retirees.
This national indulgence for corporate bankruptcy has a certain logic. The Wall Street Journal editorial page recently termed bankruptcy "one of the better ways in which American capitalism encourages risk-taking," and that is the prevailing view. Thanks to Chapter 11, a potentially viable insolvent enterprise is given a fresh start as a going concern, rather than being cannibalized for the benefit of its creditors.
However, what's good for corporate capitalism is evidently too good for the rest of us. Suppose everyone felt that way?
Wall Street has convinced lawmakers that relief for the masses, even in a deflationary economic emergency, would not only inflict unacceptable costs to bank balance sheets; it would also promote "moral hazard"--the economist's term for rewarding and thereby inviting improvident behavior. Thanks to a revision in the bankruptcy law passed in 2005 and signed by President George W. Bush after nearly a decade of furious lobbying by the credit-card industry and the banks, consumers generally face far more onerous bankruptcy terms than do corporations.
The housing collapse, depressing trillions of dollars of consumer assets, is the single biggest drag on the recovery. But underwater mortgage holders, unlike submerged corporations, have never been eligible for bankruptcy relief. Homeowners are explicitly prohibited from using the bankruptcy code to reduce the amount of the mortgage to the present value of the house or to a monthly payment that could enable them to keep their home.
The selective privileges of bankruptcy display yet another facet of the convenient concept of corporate personhood. Some persons are evidently more equal than others. The gross disparity in the way that bankruptcy law treats corporate persons and actual people is only one of multiple double standards that increasingly define our age.
Petty felons and 200,000 small-time drug users do prison time, while corporate criminals whose frauds cost the rest of the economy trillions of dollars are permitted to settle civil suits for small fines, with shareholders bearing the expenses. Ordinary families pay tax at a higher rate than billionaires. When fracking contaminates a property and makes a home uninhabitable, the homeowner rather than the natural-gas company suffers the loss. The mother of all double standards is taxpayer aid and Federal Reserve advances--running into the trillions of dollars--that went to the banks that caused the collapse, while the bankers avoided prosecution, and the rest of the society got to eat austerity.
Linking all of these disparities between citizens and corporations is the political power of a new American plutocracy. Until our politics connects these dots and citizens start resisting, the financial elite will rule. Despite the Occupy movement, most regular people have yet to experience the sudden enlightenment of Captain Yossarian, who decided, unpatriotically, that he didn't want to die. In the face of economic pillaging, we are behaving like damned fools.
Bankruptcy privileges for the elite have been with us for centuries. On October 29, 1692, Daniel Defoe, merchant, pamphleteer, and the future best-selling author of Robinson Crusoe, was committed to London's King's Bench Prison because he could not pay debts that totaled some 17,000 pounds. Before Defoe was declared bankrupt, his far-flung ventures had included underwriting marine insurance, importing wine from Portugal, buying a diving bell to search for buried treasure, and investing in 70 civet cats whose musk secretions were prized for the manufacture of perfume.
In that era, there was no Chapter 11. Bankrupts like Defoe ended up in debtors prison, an institution that would persist well into the 19th century. Typically, creditors could obtain a writ of seizure of the debtor's assets (historians record that Defoe's civet cats were taken by the sheriff's men); if the assets were insufficient to settle the debt, another writ would send the bankrupt to prison, from which he could win release only by negotiating a deal with his creditors. Defoe had no fewer than 140 creditors. However, he managed to negotiate his freedom by February 1693, though he dodged debt collectors for the next decade. His misadventures later informed Robinson Crusoe, whose fictional protagonist faces financial ruin as "an overseas trader" and lands bankrupt in prison four times, deeply in "remorse at having ruined his loyal and loving wife."
It gradually dawned on enlightened opinion that putting debtors in prison might be economically irrational. Once behind bars, a debtor stripped of his remaining assets had no means of resuming productive economic life, much less satisfying his debts. In this insight was the germ of Chapter 11.
With the accession of President George W. Bush and Republican control of Congress in 2001, the banking industry increased its efforts to tilt the bankruptcy code against consumers, spending about $100 million in lobbying over eight years. In 2005, Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act. Its key provisions made it more difficult for consumers to file under Chapter 7, under which most debts are paid out of only existing assets and then forgiven, and compelled more people to file under Chapter 13, which requires a partial repayment plan over three to five years. The act introduced for the first time a means test, in which only debtors with income below the state's median are exempt from the more onerous provisions of the law. If a citizen has above-median income, there is a "presumption" of abuse, and future income is partly attached in order to satisfy past creditor claims, no matter what the circumstances. Many states have a "homestead exemption" protecting an owner-occupied home, up to a dollar limit, from creditor claims. This, too, is overridden by the 2005 federal act.
In promoting the law, financial executives testified that if losses could be reduced, savings would be passed along to the public in the form of lower interest rates. But after the law passed, the credit-card industry increased its efforts to market high-interest-rate credit cards to consumers, including those with poor credit ratings. Adding insult to injury, the industry invented new fees. Thanks to the "reform," when overburdened consumers did go broke, credit-card companies now had far more latitude to squeeze them for repayment.
Testifying against the bill, Elizabeth Warren warned:
Women trying to collect alimony or child support will more often be forced to compete with credit-card companies that can have more of their debts declared non--dischargeable. All these provisions apply whether a person earns $20,000 a year or $200,000 a year.
But the means test as written has another, more basic problem: It treats all families alike. It assumes that everyone is in bankruptcy for the same reason--too much unnecessary spending. A family driven to bankruptcy by the increased costs of caring for an elderly parent with Alzheimer's disease is treated the same as someone who maxed out his credit cards at a casino. A person who had a heart attack is treated the same as someone who had a spending spree at the shopping mall. A mother who works two jobs and who cannot manage the prescription drugs needed for a child with diabetes is treated the same as someone who charged a bunch of credit cards with only a vague intent to repay. A person cheated by a subprime mortgage lender and lied to by a credit-counseling agency is treated the same as a person who gamed the system in every possible way.
At bottom, this trend was a rendezvous between flat or falling wages and banks making it ever easier for consumers to go more deeply into debt. Inflated assets--which turned out to be a bubble--were advertised as a substitute for income. Are your earnings down? Just borrow against your home. Between 1989 and 2004, credit-card debt tripled, to $800 billion, while earnings stagnated. Homeowners borrowed trillions more against the supposed value of their home. The moral vocabulary of debt is filled with denunciations about improvident borrowers, but who ever heard of an improvident lender? Yet it was the recklessness of banks that caused the financial collapse.
The financial crash that began rumbling in 2007 had numerous consequences, but in many ways the most durable and destructive one is the continuing undertow of the housing collapse. The collapse began with a housing bubble pumped up by subprime mortgages. It is being prolonged by the loss of several trillion dollars in household assets representing the collapse of housing prices. With about one homeowner in five holding a mortgage that exceeds the value of the house, and more than a million homeowners defaulting every year, the result is forced sales into a depressed housing market. This puts further downward pressure on prices, prolonging and deepening a classic deflationary spiral.
The housing deflation is such a widely recognized cause of the persistent economic slump that even the Federal Reserve has publicly criticized the Obama administration for its feeble response to the housing/mortgage crisis. Bill Dudley, president of the New York Federal Reserve, recently told a bankers' convention, "The ongoing weakness in housing has made it more difficult to achieve a vigorous economic recovery. With additional housing-policy interventions, we could achieve a better set of economic outcomes."
The administration's housing policy has been built on two programs of shallow relief, both intended to avoid direct reduction in principal owed and both widely dismissed as failures. The first, the Home Affordable Modification Program (HAMP), gives mortgage servicers bonus payments for voluntarily reducing monthly payments. It has helped fewer than one underwater homeowner in ten, and as many as half of those who get HAMP relief go right back into default. The program is a well-documented bureaucratic nightmare for the homeowner. The second, more recent program, known as HARP, for Home Affordable Refinance Program, allows moderately underwater homeowners to refinance mortgages held by Fannie Mae and Freddie Mac, as long as the debt is not more than 125 percent of the value of the home. But HARP does not reduce the principal owed, and its terms exclude those most in need of relief. The much-touted legal deal announced February 1, supposedly worth $26 billion, would actually give homeowners about $3 billion in mortgage write-downs (the rest is accounting changes and counseling outlays), compared to a $700 billion gap between the market value of homes and the mortgages against them.
The more straightforward solution, analogous to a corporate Chapter 11, would be to give a bankruptcy judge the power to adjust the outstanding mortgage debt. When congressional progressives proposed this as part of the legislation creating HAMP, Wall Street fiercely resisted. Several Democrats as well as nearly all Republicans ended up voting against it. Direct relief, from the perspective of the financial industry and its allies in the Treasury, is odious because it would require banks to acknowledge the actual, as opposed to nominal, condition of their balance sheets.
So while corporations continue to get a fresh start under Chapter 11, the aftermath of the financial crisis continues to sandbag millions of homeowners and the economy as a whole. This double standard is not just a question of fairness. The selective relief for corporations and banks, but not for the 99 percent, is killing the recovery. None of this will change until the citizenry builds a politics that demands a single standard.
This piece draws on the themes of a book that Robert Kuttner is completing for Knopf, titled Debtors Prison.
© 2023 The American Prospect
"But, Yossarian, suppose everyone felt that way."
"Then," said Yossarian, "I'd certainly be a damned fool to feel any other way, wouldn't I?" --Joseph Heller, Catch-22
Last November 29, American Airlines declared bankruptcy under Chapter 11, the provision of the bankruptcy code that allows a corporation to stiff its creditors, break contracts, and keep operating under the supervision of a judge. This maneuver, politely termed a "reorganization," ends with the corporation exiting bankruptcy cleansed of old debts. In opting for Chapter 11, American joined every other major airline, including Delta, Northwest, United, and US Airways, which has been in and out of Chapter 11 twice since 2002. No fewer than 189 airlines have declared bankruptcy since 1990. As the sole large carrier that had not gone bankrupt, American missed out on savings available to its rivals and thus was increasingly uncompetitive.
Bankruptcy is intended to give a fresh start to persons and enterprises overwhelmed by creditors. In the case of American (like other airlines before it), the main "creditors" are its employees. The costs of American's bankruptcy will be borne mainly by its workers and secondarily by taxpayers. The contracts being broken are union contracts and legal promises to honor pension obligations. American is laying off 13,000 workers, slashing wages, and reducing its annual pension contribution from $97 million to $6.5 million. The airline hopes to stick the federal Pension Benefit Guaranty Corporation with liability for much of the $6.5 billion that it owes its workers and retirees.
This national indulgence for corporate bankruptcy has a certain logic. The Wall Street Journal editorial page recently termed bankruptcy "one of the better ways in which American capitalism encourages risk-taking," and that is the prevailing view. Thanks to Chapter 11, a potentially viable insolvent enterprise is given a fresh start as a going concern, rather than being cannibalized for the benefit of its creditors.
However, what's good for corporate capitalism is evidently too good for the rest of us. Suppose everyone felt that way?
Wall Street has convinced lawmakers that relief for the masses, even in a deflationary economic emergency, would not only inflict unacceptable costs to bank balance sheets; it would also promote "moral hazard"--the economist's term for rewarding and thereby inviting improvident behavior. Thanks to a revision in the bankruptcy law passed in 2005 and signed by President George W. Bush after nearly a decade of furious lobbying by the credit-card industry and the banks, consumers generally face far more onerous bankruptcy terms than do corporations.
The housing collapse, depressing trillions of dollars of consumer assets, is the single biggest drag on the recovery. But underwater mortgage holders, unlike submerged corporations, have never been eligible for bankruptcy relief. Homeowners are explicitly prohibited from using the bankruptcy code to reduce the amount of the mortgage to the present value of the house or to a monthly payment that could enable them to keep their home.
The selective privileges of bankruptcy display yet another facet of the convenient concept of corporate personhood. Some persons are evidently more equal than others. The gross disparity in the way that bankruptcy law treats corporate persons and actual people is only one of multiple double standards that increasingly define our age.
Petty felons and 200,000 small-time drug users do prison time, while corporate criminals whose frauds cost the rest of the economy trillions of dollars are permitted to settle civil suits for small fines, with shareholders bearing the expenses. Ordinary families pay tax at a higher rate than billionaires. When fracking contaminates a property and makes a home uninhabitable, the homeowner rather than the natural-gas company suffers the loss. The mother of all double standards is taxpayer aid and Federal Reserve advances--running into the trillions of dollars--that went to the banks that caused the collapse, while the bankers avoided prosecution, and the rest of the society got to eat austerity.
Linking all of these disparities between citizens and corporations is the political power of a new American plutocracy. Until our politics connects these dots and citizens start resisting, the financial elite will rule. Despite the Occupy movement, most regular people have yet to experience the sudden enlightenment of Captain Yossarian, who decided, unpatriotically, that he didn't want to die. In the face of economic pillaging, we are behaving like damned fools.
Bankruptcy privileges for the elite have been with us for centuries. On October 29, 1692, Daniel Defoe, merchant, pamphleteer, and the future best-selling author of Robinson Crusoe, was committed to London's King's Bench Prison because he could not pay debts that totaled some 17,000 pounds. Before Defoe was declared bankrupt, his far-flung ventures had included underwriting marine insurance, importing wine from Portugal, buying a diving bell to search for buried treasure, and investing in 70 civet cats whose musk secretions were prized for the manufacture of perfume.
In that era, there was no Chapter 11. Bankrupts like Defoe ended up in debtors prison, an institution that would persist well into the 19th century. Typically, creditors could obtain a writ of seizure of the debtor's assets (historians record that Defoe's civet cats were taken by the sheriff's men); if the assets were insufficient to settle the debt, another writ would send the bankrupt to prison, from which he could win release only by negotiating a deal with his creditors. Defoe had no fewer than 140 creditors. However, he managed to negotiate his freedom by February 1693, though he dodged debt collectors for the next decade. His misadventures later informed Robinson Crusoe, whose fictional protagonist faces financial ruin as "an overseas trader" and lands bankrupt in prison four times, deeply in "remorse at having ruined his loyal and loving wife."
It gradually dawned on enlightened opinion that putting debtors in prison might be economically irrational. Once behind bars, a debtor stripped of his remaining assets had no means of resuming productive economic life, much less satisfying his debts. In this insight was the germ of Chapter 11.
With the accession of President George W. Bush and Republican control of Congress in 2001, the banking industry increased its efforts to tilt the bankruptcy code against consumers, spending about $100 million in lobbying over eight years. In 2005, Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act. Its key provisions made it more difficult for consumers to file under Chapter 7, under which most debts are paid out of only existing assets and then forgiven, and compelled more people to file under Chapter 13, which requires a partial repayment plan over three to five years. The act introduced for the first time a means test, in which only debtors with income below the state's median are exempt from the more onerous provisions of the law. If a citizen has above-median income, there is a "presumption" of abuse, and future income is partly attached in order to satisfy past creditor claims, no matter what the circumstances. Many states have a "homestead exemption" protecting an owner-occupied home, up to a dollar limit, from creditor claims. This, too, is overridden by the 2005 federal act.
In promoting the law, financial executives testified that if losses could be reduced, savings would be passed along to the public in the form of lower interest rates. But after the law passed, the credit-card industry increased its efforts to market high-interest-rate credit cards to consumers, including those with poor credit ratings. Adding insult to injury, the industry invented new fees. Thanks to the "reform," when overburdened consumers did go broke, credit-card companies now had far more latitude to squeeze them for repayment.
Testifying against the bill, Elizabeth Warren warned:
Women trying to collect alimony or child support will more often be forced to compete with credit-card companies that can have more of their debts declared non--dischargeable. All these provisions apply whether a person earns $20,000 a year or $200,000 a year.
But the means test as written has another, more basic problem: It treats all families alike. It assumes that everyone is in bankruptcy for the same reason--too much unnecessary spending. A family driven to bankruptcy by the increased costs of caring for an elderly parent with Alzheimer's disease is treated the same as someone who maxed out his credit cards at a casino. A person who had a heart attack is treated the same as someone who had a spending spree at the shopping mall. A mother who works two jobs and who cannot manage the prescription drugs needed for a child with diabetes is treated the same as someone who charged a bunch of credit cards with only a vague intent to repay. A person cheated by a subprime mortgage lender and lied to by a credit-counseling agency is treated the same as a person who gamed the system in every possible way.
At bottom, this trend was a rendezvous between flat or falling wages and banks making it ever easier for consumers to go more deeply into debt. Inflated assets--which turned out to be a bubble--were advertised as a substitute for income. Are your earnings down? Just borrow against your home. Between 1989 and 2004, credit-card debt tripled, to $800 billion, while earnings stagnated. Homeowners borrowed trillions more against the supposed value of their home. The moral vocabulary of debt is filled with denunciations about improvident borrowers, but who ever heard of an improvident lender? Yet it was the recklessness of banks that caused the financial collapse.
The financial crash that began rumbling in 2007 had numerous consequences, but in many ways the most durable and destructive one is the continuing undertow of the housing collapse. The collapse began with a housing bubble pumped up by subprime mortgages. It is being prolonged by the loss of several trillion dollars in household assets representing the collapse of housing prices. With about one homeowner in five holding a mortgage that exceeds the value of the house, and more than a million homeowners defaulting every year, the result is forced sales into a depressed housing market. This puts further downward pressure on prices, prolonging and deepening a classic deflationary spiral.
The housing deflation is such a widely recognized cause of the persistent economic slump that even the Federal Reserve has publicly criticized the Obama administration for its feeble response to the housing/mortgage crisis. Bill Dudley, president of the New York Federal Reserve, recently told a bankers' convention, "The ongoing weakness in housing has made it more difficult to achieve a vigorous economic recovery. With additional housing-policy interventions, we could achieve a better set of economic outcomes."
The administration's housing policy has been built on two programs of shallow relief, both intended to avoid direct reduction in principal owed and both widely dismissed as failures. The first, the Home Affordable Modification Program (HAMP), gives mortgage servicers bonus payments for voluntarily reducing monthly payments. It has helped fewer than one underwater homeowner in ten, and as many as half of those who get HAMP relief go right back into default. The program is a well-documented bureaucratic nightmare for the homeowner. The second, more recent program, known as HARP, for Home Affordable Refinance Program, allows moderately underwater homeowners to refinance mortgages held by Fannie Mae and Freddie Mac, as long as the debt is not more than 125 percent of the value of the home. But HARP does not reduce the principal owed, and its terms exclude those most in need of relief. The much-touted legal deal announced February 1, supposedly worth $26 billion, would actually give homeowners about $3 billion in mortgage write-downs (the rest is accounting changes and counseling outlays), compared to a $700 billion gap between the market value of homes and the mortgages against them.
The more straightforward solution, analogous to a corporate Chapter 11, would be to give a bankruptcy judge the power to adjust the outstanding mortgage debt. When congressional progressives proposed this as part of the legislation creating HAMP, Wall Street fiercely resisted. Several Democrats as well as nearly all Republicans ended up voting against it. Direct relief, from the perspective of the financial industry and its allies in the Treasury, is odious because it would require banks to acknowledge the actual, as opposed to nominal, condition of their balance sheets.
So while corporations continue to get a fresh start under Chapter 11, the aftermath of the financial crisis continues to sandbag millions of homeowners and the economy as a whole. This double standard is not just a question of fairness. The selective relief for corporations and banks, but not for the 99 percent, is killing the recovery. None of this will change until the citizenry builds a politics that demands a single standard.
This piece draws on the themes of a book that Robert Kuttner is completing for Knopf, titled Debtors Prison.
"But, Yossarian, suppose everyone felt that way."
"Then," said Yossarian, "I'd certainly be a damned fool to feel any other way, wouldn't I?" --Joseph Heller, Catch-22
Last November 29, American Airlines declared bankruptcy under Chapter 11, the provision of the bankruptcy code that allows a corporation to stiff its creditors, break contracts, and keep operating under the supervision of a judge. This maneuver, politely termed a "reorganization," ends with the corporation exiting bankruptcy cleansed of old debts. In opting for Chapter 11, American joined every other major airline, including Delta, Northwest, United, and US Airways, which has been in and out of Chapter 11 twice since 2002. No fewer than 189 airlines have declared bankruptcy since 1990. As the sole large carrier that had not gone bankrupt, American missed out on savings available to its rivals and thus was increasingly uncompetitive.
Bankruptcy is intended to give a fresh start to persons and enterprises overwhelmed by creditors. In the case of American (like other airlines before it), the main "creditors" are its employees. The costs of American's bankruptcy will be borne mainly by its workers and secondarily by taxpayers. The contracts being broken are union contracts and legal promises to honor pension obligations. American is laying off 13,000 workers, slashing wages, and reducing its annual pension contribution from $97 million to $6.5 million. The airline hopes to stick the federal Pension Benefit Guaranty Corporation with liability for much of the $6.5 billion that it owes its workers and retirees.
This national indulgence for corporate bankruptcy has a certain logic. The Wall Street Journal editorial page recently termed bankruptcy "one of the better ways in which American capitalism encourages risk-taking," and that is the prevailing view. Thanks to Chapter 11, a potentially viable insolvent enterprise is given a fresh start as a going concern, rather than being cannibalized for the benefit of its creditors.
However, what's good for corporate capitalism is evidently too good for the rest of us. Suppose everyone felt that way?
Wall Street has convinced lawmakers that relief for the masses, even in a deflationary economic emergency, would not only inflict unacceptable costs to bank balance sheets; it would also promote "moral hazard"--the economist's term for rewarding and thereby inviting improvident behavior. Thanks to a revision in the bankruptcy law passed in 2005 and signed by President George W. Bush after nearly a decade of furious lobbying by the credit-card industry and the banks, consumers generally face far more onerous bankruptcy terms than do corporations.
The housing collapse, depressing trillions of dollars of consumer assets, is the single biggest drag on the recovery. But underwater mortgage holders, unlike submerged corporations, have never been eligible for bankruptcy relief. Homeowners are explicitly prohibited from using the bankruptcy code to reduce the amount of the mortgage to the present value of the house or to a monthly payment that could enable them to keep their home.
The selective privileges of bankruptcy display yet another facet of the convenient concept of corporate personhood. Some persons are evidently more equal than others. The gross disparity in the way that bankruptcy law treats corporate persons and actual people is only one of multiple double standards that increasingly define our age.
Petty felons and 200,000 small-time drug users do prison time, while corporate criminals whose frauds cost the rest of the economy trillions of dollars are permitted to settle civil suits for small fines, with shareholders bearing the expenses. Ordinary families pay tax at a higher rate than billionaires. When fracking contaminates a property and makes a home uninhabitable, the homeowner rather than the natural-gas company suffers the loss. The mother of all double standards is taxpayer aid and Federal Reserve advances--running into the trillions of dollars--that went to the banks that caused the collapse, while the bankers avoided prosecution, and the rest of the society got to eat austerity.
Linking all of these disparities between citizens and corporations is the political power of a new American plutocracy. Until our politics connects these dots and citizens start resisting, the financial elite will rule. Despite the Occupy movement, most regular people have yet to experience the sudden enlightenment of Captain Yossarian, who decided, unpatriotically, that he didn't want to die. In the face of economic pillaging, we are behaving like damned fools.
Bankruptcy privileges for the elite have been with us for centuries. On October 29, 1692, Daniel Defoe, merchant, pamphleteer, and the future best-selling author of Robinson Crusoe, was committed to London's King's Bench Prison because he could not pay debts that totaled some 17,000 pounds. Before Defoe was declared bankrupt, his far-flung ventures had included underwriting marine insurance, importing wine from Portugal, buying a diving bell to search for buried treasure, and investing in 70 civet cats whose musk secretions were prized for the manufacture of perfume.
In that era, there was no Chapter 11. Bankrupts like Defoe ended up in debtors prison, an institution that would persist well into the 19th century. Typically, creditors could obtain a writ of seizure of the debtor's assets (historians record that Defoe's civet cats were taken by the sheriff's men); if the assets were insufficient to settle the debt, another writ would send the bankrupt to prison, from which he could win release only by negotiating a deal with his creditors. Defoe had no fewer than 140 creditors. However, he managed to negotiate his freedom by February 1693, though he dodged debt collectors for the next decade. His misadventures later informed Robinson Crusoe, whose fictional protagonist faces financial ruin as "an overseas trader" and lands bankrupt in prison four times, deeply in "remorse at having ruined his loyal and loving wife."
It gradually dawned on enlightened opinion that putting debtors in prison might be economically irrational. Once behind bars, a debtor stripped of his remaining assets had no means of resuming productive economic life, much less satisfying his debts. In this insight was the germ of Chapter 11.
With the accession of President George W. Bush and Republican control of Congress in 2001, the banking industry increased its efforts to tilt the bankruptcy code against consumers, spending about $100 million in lobbying over eight years. In 2005, Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act. Its key provisions made it more difficult for consumers to file under Chapter 7, under which most debts are paid out of only existing assets and then forgiven, and compelled more people to file under Chapter 13, which requires a partial repayment plan over three to five years. The act introduced for the first time a means test, in which only debtors with income below the state's median are exempt from the more onerous provisions of the law. If a citizen has above-median income, there is a "presumption" of abuse, and future income is partly attached in order to satisfy past creditor claims, no matter what the circumstances. Many states have a "homestead exemption" protecting an owner-occupied home, up to a dollar limit, from creditor claims. This, too, is overridden by the 2005 federal act.
In promoting the law, financial executives testified that if losses could be reduced, savings would be passed along to the public in the form of lower interest rates. But after the law passed, the credit-card industry increased its efforts to market high-interest-rate credit cards to consumers, including those with poor credit ratings. Adding insult to injury, the industry invented new fees. Thanks to the "reform," when overburdened consumers did go broke, credit-card companies now had far more latitude to squeeze them for repayment.
Testifying against the bill, Elizabeth Warren warned:
Women trying to collect alimony or child support will more often be forced to compete with credit-card companies that can have more of their debts declared non--dischargeable. All these provisions apply whether a person earns $20,000 a year or $200,000 a year.
But the means test as written has another, more basic problem: It treats all families alike. It assumes that everyone is in bankruptcy for the same reason--too much unnecessary spending. A family driven to bankruptcy by the increased costs of caring for an elderly parent with Alzheimer's disease is treated the same as someone who maxed out his credit cards at a casino. A person who had a heart attack is treated the same as someone who had a spending spree at the shopping mall. A mother who works two jobs and who cannot manage the prescription drugs needed for a child with diabetes is treated the same as someone who charged a bunch of credit cards with only a vague intent to repay. A person cheated by a subprime mortgage lender and lied to by a credit-counseling agency is treated the same as a person who gamed the system in every possible way.
At bottom, this trend was a rendezvous between flat or falling wages and banks making it ever easier for consumers to go more deeply into debt. Inflated assets--which turned out to be a bubble--were advertised as a substitute for income. Are your earnings down? Just borrow against your home. Between 1989 and 2004, credit-card debt tripled, to $800 billion, while earnings stagnated. Homeowners borrowed trillions more against the supposed value of their home. The moral vocabulary of debt is filled with denunciations about improvident borrowers, but who ever heard of an improvident lender? Yet it was the recklessness of banks that caused the financial collapse.
The financial crash that began rumbling in 2007 had numerous consequences, but in many ways the most durable and destructive one is the continuing undertow of the housing collapse. The collapse began with a housing bubble pumped up by subprime mortgages. It is being prolonged by the loss of several trillion dollars in household assets representing the collapse of housing prices. With about one homeowner in five holding a mortgage that exceeds the value of the house, and more than a million homeowners defaulting every year, the result is forced sales into a depressed housing market. This puts further downward pressure on prices, prolonging and deepening a classic deflationary spiral.
The housing deflation is such a widely recognized cause of the persistent economic slump that even the Federal Reserve has publicly criticized the Obama administration for its feeble response to the housing/mortgage crisis. Bill Dudley, president of the New York Federal Reserve, recently told a bankers' convention, "The ongoing weakness in housing has made it more difficult to achieve a vigorous economic recovery. With additional housing-policy interventions, we could achieve a better set of economic outcomes."
The administration's housing policy has been built on two programs of shallow relief, both intended to avoid direct reduction in principal owed and both widely dismissed as failures. The first, the Home Affordable Modification Program (HAMP), gives mortgage servicers bonus payments for voluntarily reducing monthly payments. It has helped fewer than one underwater homeowner in ten, and as many as half of those who get HAMP relief go right back into default. The program is a well-documented bureaucratic nightmare for the homeowner. The second, more recent program, known as HARP, for Home Affordable Refinance Program, allows moderately underwater homeowners to refinance mortgages held by Fannie Mae and Freddie Mac, as long as the debt is not more than 125 percent of the value of the home. But HARP does not reduce the principal owed, and its terms exclude those most in need of relief. The much-touted legal deal announced February 1, supposedly worth $26 billion, would actually give homeowners about $3 billion in mortgage write-downs (the rest is accounting changes and counseling outlays), compared to a $700 billion gap between the market value of homes and the mortgages against them.
The more straightforward solution, analogous to a corporate Chapter 11, would be to give a bankruptcy judge the power to adjust the outstanding mortgage debt. When congressional progressives proposed this as part of the legislation creating HAMP, Wall Street fiercely resisted. Several Democrats as well as nearly all Republicans ended up voting against it. Direct relief, from the perspective of the financial industry and its allies in the Treasury, is odious because it would require banks to acknowledge the actual, as opposed to nominal, condition of their balance sheets.
So while corporations continue to get a fresh start under Chapter 11, the aftermath of the financial crisis continues to sandbag millions of homeowners and the economy as a whole. This double standard is not just a question of fairness. The selective relief for corporations and banks, but not for the 99 percent, is killing the recovery. None of this will change until the citizenry builds a politics that demands a single standard.
This piece draws on the themes of a book that Robert Kuttner is completing for Knopf, titled Debtors Prison.