I’ve been sitting on this great post about reforms to US bankruptcy laws and how they fit into the general pattern of risk being shifted from business to workers and to ordinary people in general. But I waited too long and Paul Krugman’s already written it. So go and read his piece, and then, if you want, you can look at the things I was going to write that Krugman hasn’t said already.
First, if you’re looking for reading on this general topic, let me recommend “When All Else Fails : Government as the Ultimate Risk Manager, ” (David A. Moss), which I reviewed here Moss shows how both bankruptcy and limited liability were (correctly) viewed as significant departures from laissez-faire when they were introduced in the 19th century. Of course, there’s no hint that the sacred status of limited liability is going to be challenged any time soon.
Second, given the rising trend in bankruptcy, this is going to affect a lot of people, quite possibly most people, at some time. Currently, more people go bankrupt than get divorced every year and, although the number has declined marginally with the economic recovery, the underlying trend is clearly upward. The proposed reforms are unlikely to change this. Although the bill will make bankruptcy a less attractive option for people who are already in difficulty, this demand side effect will be more than offset by the increased willingness of credit card companies and other lenders to lend to people with precarious repayment capacity.
Finally, while Krugman is probably right in describing the target of the reformers as a system of debt peonage, my long exposure to Dickens (and more recently to Patrick O’Brien) leads me to think that the large and powerful incarceration lobby might get in on the act here – anyone for debtors’ prison ?
John Quiggin 
Matthew Rabin in tonight’s Downing Lecture, in Melbourne, claimed that 8.5% of US households had taken out ‘payday loans’ — the sort of loan where you borrow $300 and then repay $354 in two week. He also commented on the massive growth in pawn shops and fringe finance institutions such as rent-to-buy furniture.
He saw the origins of this not in irrational myopia but in a demand for immediate gratification boosted by need. Its an interesting idea — people have long-term and short-term objectives but the short-term desires can dominate, particularly if, as Krugman argues, families face a crisis.
Rabin presented empirical arguments for taking the new behavioural economics based on psychology seriously. One of the more interesting presentations I have been to lately.
By the way I also saw your statistic in the recent “Two-Income Trap” literature. US children now face a higher chance of being in a family that bankrupts than divorces. Most of the bankruptcies are among single parent (mother) families with a double-income package of debt.They take on debt based on a dual income and then divorce, or a spouse dies or becomes invalid –common enough events, and the family goes bust.
“and the family goes bust”
Soon, they won’t be going bust. They’ll become indentured labour, it would appear.
God bless America.
“Rabin presented empirical arguments for taking the new behavioural economics based on psychology seriously.”
I am surprised that psychology is not a much more serious part of economics already. The assumption that markets involve perfect information seems to be undergoing a fairly intelligent re-thinking in recent times. Joseph Stiglitz alludes to this in some of his writing.
However the other assumption of perfectly rational participants trying to maximise marginal utility has always struck me as the weaker of the two pillars underlying the efficient market hypothesis. It faces questions like the ability of suppliers to influence what buyers perceive as maximum utility (ie marketing) and the conflict you mention above between long term and short term desires of consumers. These are just two quite obvious questions. I am sure there are many more. There seems to be basic research being carried out in this area from the psychology side like studies to see what people actually choose in controlled experiments. But are any economic modeler’s including these results into their economic model’s? What are the results of incorporating this on this new information on the economists side?
Here’s some heartening news about the progress of the US bankruptcy law and the nature of US political culture in general:
“The Senate defeated 53-46 an amendment that would have prevented anti-abortion protesters from using bankruptcy to avoid paying fines or civil judgments for violent demonstrations at abortion clinics.”
http://www.bloomberg.com/apps/news?pid=10000103&sid=aSBBZ1ksZcvo&refer=us
Just imagine, only 46 senators could be scrounged up to undermine the radical principle of equal application of the law.
More evidence that the US is in the midst of a collective nervous breadown.
JQ, the debt peonage system in the post-bellum South was enforced by privatized, vigilante justice meted out by the Ku Klux Klan and other similar organisations. These activities, while formally illegal, occurred with the tacit consent of local and state justice systems.
The landlords wanted repayment of debts, but they also wanted a cashflow from their lands and they wanted consumers who would purchase overpriced goods from their stores.
In other words, landlords had an interest in keeping the shotgun shacks full of people.
Credit card companies, on the other hand, have no interest beyond liquidating the assets of debtors, leaving debtors with no place to live and no stake in maintaining connections with community.
In other words, the result of these new laws is likely to be something that hasnot been heard of for a long time — vagabondage.
SWIO,
The two assumptions you talk about were dropped for mainstream economics decades ago. Yes, they are still incorporated in first year economics courses, but only as simplifying assumptions, to allow the economically illiterate to see the underlying mechanisms.
The price mechanism, thanks to the work of Hayek and many others, has been shown not to rely on perfect information or even perfectly rational participants. I suggest you read some of his work before commenting further.
Thanx Andrew. I’ll do that.