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I spoke recently, at a banking-ethics conference at Bar Ilan, in favor of introducing a workable personal bankruptcy system in Israel.
Right now it's virtually impossible to declare personal bankruptcy in Israel. Even if the court declares you "without means" and arranges a merely nominal monthly payback to your creditors, you can't make a fresh start. You are basically condemned to a lifetime of poverty, because all your earnings will be eaten up by your creditors - who don't get any benefit from the arrangement, since the court has already approved a laughably inadequate payback scheme. The only people who benefit from the system are swindlers, who have no problem making a fresh start on the black market.
Only a tiny number of people actually declare bankruptcy and, of these, most are not actually granted a discharge, which in the US is virtually automatic. Furthermore, even these select few (no more than a few hundred individuals a year) do not enjoy a true "fresh start," because bankruptcy in Israel is considered a disgrace and legally disqualifies the bankrupt from many activities, including being a lawyer or managing a business.
Many attendees approached me afterwards to talk about my proposal. I was surprised that virtually all were vehemently opposed. If I had suggested a legislative initiative that was truly innovative I could have understood the opposition, but a realistic personal bankruptcy option exists in virtually all the advanced English-speaking countries, and the sky has not fallen in England, New Zealand, Australia, or even Canada (where some people speak French). The truth is that Israel's current bankruptcy legislation, at the beginning of the 21st century, is far behind the bankruptcy reform instituted in the US in 1898, at the end of the 19th century.
I was also a bit amused at the nature of some of the objections. One banker was concerned that the credit market would bust, since banks would not want to give loans to consumers who could so easily evade their debts. A prominent credit analyst was equally concerned - that the credit market would boom, since customers would enter an immoderate spending glut knowing they were shielded from losing all!
Obviously both of these doomsday scenarios cannot be fulfilled. Both critics correctly saw one side of the coin: Bankruptcy protection will reduce the supply of credit because it increases the exposure of the lender, and increase the demand for credit because it limits the exposure of the borrower. When supply retreats and demand goes up, the price will certainly rise, but the quantity can either rise or fall, and so can profits. So bankruptcy legislation will raise the interest on consumer loans, but it may be worth it. In return for the extra few points they pay, consumers get a valuable service: insolvency insurance.
Bankruptcy, after all, is no more than another kind of social insurance to protect households and provide a safety net against misfortune. Unemployment benefits protect against job loss, welfare protects against falling into poverty, and bankruptcy laws protect people who had an expectation of being able to pay back their loans, but due to unexpected turns of fortune are unable.
Of course all three kinds are susceptible to exploitation by swindlers, but that's no reason to throw out the baby with the bathwater. In fact, bankruptcy legislation is the least vulnerable of the three, since swindlers are already able to obtain the protection it provides by having themselves declared "without means" and continuing business as usual underground. The additional fresh-start protection is of value primarily to the honest.
For the record, based on the research I have seen, the credit analyst was closer to the mark: A more liberal bankruptcy system is correlated with higher levels of consumer credit. So lenders don't have much to fear from a fairly implemented system, and may even have much to gain.
More even-handed bankruptcy would also be good for the economy. A research study by Wei Fan and Michelle White found that locations with more lenient bankruptcy rules have higher levels of self-employed individuals, meaning that these regimes encourage enterprise. This should hardly come as a surprise - America's liberal business bankruptcy laws are repeatedly cited as a factor in the US' prodigious advantage over Europe in entrepreneurship.
A European Union commission recently reported that "Many in the EU feel that there is a stigma on failure, which works as deterrent to entrepreneurial initiative. This climate is contrasted with the climate in the US where business failure is in certain business communities considered as a learning experience."
Indeed, a leading venture capitalist told me that his fund actually prefers to lend to someone who previously had a business that went belly up, because these people have a better awareness of the risk environment and yet have shown that they are not afraid.
The bankruptcy literature is filled with parallels to the Biblical laws of erasure of debts in the seventh year and restoration of homesteads in the Jubilee year. Debt relief bills are sometimes referred to as "jubilee acts." It is ironic and a bit of a shame that Israel, which gave the world this inspiring vision for a society with a built-in mechanism for a fresh start, has such a primitive system for realizing this vision.
The writer is research director at the Business Ethics of Jerusalem (www.besr.org), an independent institute in The Jerusalem College of Technology. He is also a rabbi.
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