The Anti-Economist — From the July 2013 issue

The Scarlet Debtor

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Debt forgiveness is one of the most important innovations of modern capitalism, but it is a fairly recent one. Though the Constitution gives Congress explicit authority to enact “uniform Laws on the subject of Bankruptcies throughout the United States,” early U.S. bankruptcy laws were short-lived and provided mostly for involuntary proceedings initiated by creditors. Before the elimination of federal debtors’ prisons in 1833, jail was a common consequence of failure to pay. Not until the Nelson Act of 1898 did the country have a lasting bankruptcy code and thus a framework for debt protection.

Despite their obvious practical advantages, voluntary bankruptcy and procedures like it have always drawn objections, often with a moral edge. In his insightful book Debt: The First 5,000 Years, the anthropologist David Graeber notes that in many languages the word debt is a synonym for “fault,” “sin,” or “guilt.” Such associations are of obvious rhetorical benefit to the lender who refuses to forgive debts; more important, Graeber notes, they leave borrowers believing they have an obligation to pay what they owe. But Graeber argues persuasively that the strict enforcement of debt contracts is in fact a kind of class warfare.

Who is actually responsible for excessive debt? In a financial world shaped, as ours is, by bankers’ desire for performance bonuses, borrowers are often coaxed into taking out unnecessary loans. In times of crisis, the lender who overextends the loans made during periods of financial speculation bears as much responsibility as the borrower whose terms were made so enticing. Yet it is inevitably the borrower who is deemed profligate, and who is expected to pay the price when the system collapses. But this attitude defies economic logic. “The remarkable thing about the statement ‘one has to pay one’s debt,’ ” writes Graeber, “is that even according to standard economic theory, it isn’t true. A lender is supposed to accept a certain degree of risk.”

The debt boom-and-bust cycle has repeated itself regularly throughout modern history. In the United States such cycles have happened almost routinely ever since a frenzy of land speculation fueled by cotton wealth culminated in the Panic of 1819. Historians have shown that reckless lending by under-regulated “wildcat” banks was a key cause of the crisis. Lenders bore similar responsibility in the savings-and-loan debacle of the 1980s and the 2008 housing-market collapse. But even though bankruptcy law in the United States and other developed nations has matured enough to recognize that lenders have obligations, too, cultural disapproval of indebtedness continues to be widespread. When CNBC’s Rick Santelli proclaimed, on February 19, 2009, that we should not bail out a bunch of “losers” — that is, mortgage holders — he was expressing just the sort of class entitlement that Graeber describes.

Santelli’s rhetoric may have helped spark the birth of the Tea Party, but he got the picture exactly wrong. Though the federal government bailed out banks and business, far too few individual borrowers were relieved of their debt. Allowing more homeowners to keep their homes would not only have been just — it would have been good economics. Iceland’s recovery from its own 2008 financial crisis shows why. The country’s parliament nationalized failing banks, then forced them — along with other lenders — to reduce excessive mortgage debt, making shareholders take the losses; the United States and much of Europe did the opposite. Icelandic officials did not worry about how international credit markets would greet their stubbornness. “Why are the banks considered to be the holy churches of the modern economy?” asked President Ólafur Ragnar Grímsson. “Why are private banks not like airlines and telecommunication companies and allowed to go bankrupt if they have been run in an irresponsible way?” Having radically cut its debt load, Iceland is well on the way to economic recovery.

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