01 October 2014

Debt Forgiveness Pays

Some time ago I posted a series of comments about the twin virtues of promise-keeping and forgiveness. You can read them here, here, here, and here. While the virtue of promise-keeping regularly receives legal sanction through the the legal system (think contract law), the virtue of forgiveness features less prominently tucked away, as it is, in bankruptcy law. One supposes that the imbalance in the laws's pedagogy of virtue lies in the mundane: creditors have more political power than debtors.

Even though debt forgiveness is more limited than debt collection, it appears that a robust system of bankruptcy law like America's is good for more than the debts it discharges. Go here to read an insightful account of a research study that concludes that bankruptcy is an efficient policy of social insurance:
Getting approved for Chapter 13 bankruptcy protection "increases annual earnings by $5,562, decreases five-year mortality by 1.2 percentage points, and decreases five-year foreclosure rates by 19.1 percentage points."
While not part of the research study, I think it's also important to note is that these benefits accrue not only to the debtors but have positive effects on third parties and not only immediate family members. Reduction in foreclosure rates also benefits neighboring property owners.

The standard economic argument against liberal bankruptcy laws posits that the gains to debtors will be offset by the cost to other consumers of credit. In other words, the rest of us pay marginally more for credit because some don't pay at all. Such a result, even were it true, might nonetheless be warranted as a form of compulsory insurance. In other words, we all pay a small insurance premium in the form of higher interest rates to protect ourselves from the downside risk of the occurrence of certain financial contingencies.

But even the "common sense" observation that reducing access to bankruptcy would save the rest of us money isn't true.

Another study linked in the news account account concluded that the benefits from Congressional tightening of access to consumer bankruptcy in 2005 accrued to the financial services industry, not other consumers. Of course, that provides investors with interests in that industry with unbargained-for upside risk but, as I noted recently, that's simply another example of rent-seeking in the public square.

All in all, the virtue of forgiveness has tangible benefits, which shouldn't surprise anyone who has read the Gospel accounts.

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