Magazine article The American Prospect

Debtors' Prison

Magazine article The American Prospect

Debtors' Prison

Article excerpt

Economic history is filled with bouts of financial euphoria followed by painful mornings after. When nations awake saddled with debts incurred to finance wars, episodes of failed speculation, or grand projects that haven't paid off, they have two choices. Either the creditor class prevails at the expense of everyone else, or governments find ways to reduce the debt burden so that the productive power of the economy can recover.

Creditors--the rentier class in classic usage--are usually the wealthy and the powerful. Debtors, almost by definition, have scant resources or power. The "money issue" of 19th-century America, about whether credit would be cheap or dear, was also a battle between growth and austerity.

The creditor class views anything less than full debt repayment as the collapse of economic civilization. In fact, however, debts are often not paid in full. In the 20th century, speculators lost fortunes as dozens of nations defaulted on debts. Several 19th-century U.S. states and municipalities defaulted. Losers in wars and revolutions seldom pay debts. (Those czarist bonds have no value except on eBay.) The Brady Plan of the late 1980s paid bondholders of defaulting Third World debtors at about 70 cents on the dollar so that economic growth could resume.

Sometimes, debts simply cannot be paid. That's why debtors' prison was a ruinous idea (except as a deterrent). The real issue is how to restructure debt when it becomes impossible to repay. This is not just a struggle between haves and have-nots but between the claims of the past and the potential of the future.

Debt can be reduced or renounced in ways that are constructive or that add to the chaos. Inflation, for instance, is one way of eroding debt, and a risky one. There can be a calamitously abrupt default (Lehman Brothers) or a careful and beneficial restructuring (General Motors).

Bankruptcy ingeniously provides orderly relief from past debt so that the productive enterprise is not needlessly destroyed. A judge evaluates the assets, liabilities, and viability of an insolvent business. If it is deemed viable, creditors are not permitted to sell off the machinery, but they get paid off at so many cents on the dollar, and the enterprise is restored to constructive use.

American business values the bankruptcy system for its own purposes, even though investors occasionally take a bath. But the same business elite looks askance when others--homeowners, small nations, the entire economic system--seek relief from punishing and economically perverse debt. …

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