Dark Bilious Vapors

be careful what you wish for, because you just might get it.

In last Friday's "Moneybox" column in Slate, Daniel Gross points us to an interesting study (.pdf file, Adobe Reader or other PDF viewer required) by law professors Robert Lawless (University of Nevada-Las Vegas) and Elizabeth Warren (Harvard) (and sponsored by the Ewing Marion Kauffman Foundation) and published in the Califormia Law Review, which suggests that in working so hard to pass the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the financial services industry may have cut off its nose to spite its face. From the Kaufmann Foundation's abstract of the study:

New bankruptcy legislation failed to account for hundreds of thousands of entrepreneurs, independent contractors and self employed individuals who traditionally have turned to bankruptcy relief as an important safety net in their effort to recover from a failed undertaking, according to a new research study.

In fact, large numbers of entrepreneurs use the bankruptcy system, despite official government statistics that say their presence in bankruptcy has declined sharply. A result of the faulty data is a skewed picture of the measurement and strength of the nation's small business economy. The new legislation, according to some experts on entrepreneurship, could also serve to deter would-be entrepreneurs from embarking on risky new business formation.

...

According to the research, which appears in the most recent issue of California Law Review, owners of small businesses annually file an estimated 260,000 to 315,000 bankruptcies. Those numbers are about nine times higher than the government's official data, which lists only about 37,000 business cases.

Official government statistics report that business bankruptcies began a steady decline in the mid-1980s, when businesses comprised about 18 percent of all bankruptcy filings to their present-day total of only 2 percent of all filings (see Figure 1). Today, corporations and other legal entities comprise almost all of the business filings counted by the government. Entrepreneurs who take on the risk of a new business undertaking have essentially disappeared from the official business bankruptcy statistics.

The authors trace the problem of the faulty reporting to efforts in the mid-1980s to simplify the official bankruptcy reporting process and the advent of new computer software that changed the way attorneys completed forms used to compile the government statistics. This technological change has created a systematic bias in which entrepreneurs were reclassified as consumer cases rather than business cases.

So, the recently enacted bankruptcy reform may seem like a classic case of ensnaring dolphins in an effort to catch tuna. America's economic system is exceptional in part because it encourages, pardons, and excuses failure. Nobody starts a business intending to go bankrupt, but it happens. And when it does, the nation's bankruptcy system—and its general tolerance of failure—has enabled people to pick up, move on, and try again with relative ease. In today's economy, which affords people unprecedented opportunities to start their own businesses, credit cards are frequently the preferred method of financing. So, while the new bankruptcy law might deter some people from overborrowing, it might also deter some people from leaving their dreary jobs and opening a store, or selling on eBay, or importing T-shirts. At the margins, lots of mundane businesses, and perhaps even a few great ones, may never get off the ground.

The financial services sector plainly got what it wanted in the bankruptcy reform bill. But as Warren and Lawless note, the provisions that prevent discharge from bankruptcy unless the debtor completes a course in personal financial management, that set up means-testing for payment, and that prohibit repeat filings within eight years, "needlessly penalize entrepreneurs who are in bankruptcy court not because [of] overconsumption but because [of] a failed business." In their desire to crack down on consumers, Congress and the financial services companies may be cracking down on the sort of people who, when they succeed, create jobs, pay taxes—and become excellent customers for financial services companies.

Len on 07.04.05 @ 07:17 AM CST