Bankruptcy Phobia

Abstract:     
As the recent economic crisis has unfolded, bankruptcy has offered possible solutions at several key junctures. The first of these solutions, often referred to as mortgage modification, was geared toward homeowners who faced the loss of their homes in the months - now several years - since the start of the subprime crisis On the corporate side, Chapter 11 was an obvious alternative when large nonbank financial institutions like Bear Stearns and AIG stumbled in 2008. But regulators repeatedly balked, and the one exception to the avoidance of bankruptcy at all costs - Lehman Brothers - was anomalous. This aversion to bankruptcy, which seems to pervade all sides of the political spectrum, is the bankruptcy phobia that I explore in this Essay. I begin by speculating in more detail about the reasons for resisting bankruptcy-based solutions. The second and third parts of the Essay will then put the recent crisis in historical perspective. While the absence of bankruptcy solutions and new bankruptcy reforms at the outset of the crisis was puzzling, the historical analysis suggests that it is consistent with the pattern of previous crises. Using the late nineteenth century and the Great Depression as my principal examples, I will argue that significant bankruptcy reform, in striking contrast to major corporate reform, has often come well after a financial crisis was underway, and that the proliferation of dramatically different proposed bankruptcy and nonbankruptcy solutions that we see today is also consistent with historical patterns. I will conclude by speculating about some of the implications for bankruptcy reform.

Number of Pages in PDF File: 17

Keywords: Credit crunch of 2008, aversion to bankruptcy, corporate reorganization, insolvency laws, bankruptcy reform, bailouts, comparative historical analysis, Great Depression, financial crisis

JEL Classification: G33, K29, K39

Accepted Paper Series