When Should Bankruptcy Be an Option (for People, Places or Things)?

Abstract

When many people think about bankruptcy, they have a simple left-to-right spectrum of possibilities in mind. The spectrum starts with personal bankruptcy, moves next to corporations and other businesses, and then to municipalities, states, and finally countries. We assume that bankruptcy makes the most sense for individuals; that it makes a great deal of sense for corporations; that it is plausible but a little more suspect for cities; that it would be quite odd for states; and that bankruptcy is unimaginable for a country.

In this Article, I argue that the left-to-right spectrum is sensible but mistaken. After defining "bankruptcy," I outline a serious of puzzles for the standard intuitions, such as the absence of personal bankruptcy in many countries and the fact that state and bankruptcy is in some respects more defensible than municipal bankruptcy. I then develop and apply a five factor framework that considers 1) whether unsustainable debt is a potential problem; 2) the benefits of reshaping decision making incentives; 3) the risk of premature liquidation; 4) the dignity of the debtor; and 5) spillover effects.

Keywords: Bankruptcy, corporate reorganization, municipal, state, sovereign debt restructuring, financial distress, Detroit, four attributes of bankruptcy, when does bankruptcy work, Greece, European debt crisis

JEL Classification: F34, G33, H63, K35