Saturday, July 21, 2007

The Bankruptcy Study is Baaacccckkk!!!
Gail Heriot

Two years ago, a study claiming (falsely) that half of all bankruptices are caused by illness or injury received front-page treatment in newspapers all across the country.  Anyone reading the fine print, however, learned that, among numerous other tricks, the study included "uncontrolled gambling" as a medical cause.  The whole thing was timed to de-rail the 2005 bankruptcy reform legislation, but (fortunately for the cause of truth) it failed in that endeavor.

On Tuesday, the House Subcommittee on Commercial and Administrative Law held a hearing on "Working Families in Financial Crisis:  Medical Debt and Bankruptcy." And guess what?  It's baaaccckkk!  Two of the study's co-authors appeared as witnesses to present the study as if no one had ever offered the slightest criticism.

Fortunately, Todd Zywicki of George Mason University was there to rebut all this, which he did with great authority.  But through the use of a cheap trick, the majority staff members attempted prevent him from being as effective as he could have been in his oral testimony.  The agenda as originally prepared called for Donna Smith, who was featured in Michael Moore's Sicko, to testify first, followed by the experts witnesses on both sides, so that the witnesses invited by the minority would have a chance to respond to the study co-authors.  Minutes before the hearing began, the order of witnesses was re-arranged, so that Zywicki & and Clifford J. White III, Director of the Executive Office of United States Trustees, the other witness invited by the minority, would directly follow Ms. Smith’s emotional testimony.  The co-authors of the study, who were invited by the majority would both go later and thus be unrebutted. 

The legislative process in action is a beautiful thing to behold, isn't it?

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Gail Heriot


Gail, I'll take it as a given that the study is bogus, and that at the time, at least, the number of bankruptcies necessitated by medical expenses was much smaller than the study asserted. Still, the controversy about this study was part of the debate about the bankruptcy reform bill, which significantly tightened the criteria under which debtors could declare bankruptcy. Libertarians like Zywicki supported the bill because according to libertarian theory, the lax bankruptcy laws *must* be making it difficult for poor or marginal borrowers to get credit.

What opponents of the bill observed, however, was that risk-spreading financial instruments had revolutionized the lending industry, making it extraordinarily--even dangerously--*easy* for marginal borrowers to get credit. Any tightening of bankruptcy standards would thus not only hand a completely unnecessary windfall to lenders, but also risk exacerbating what was obviously to us--and is now obviously to everyone--a dangerous bubble in "subprime lending".

Now that the bubble has burst, with ripples that are threatening the health of the entire economy, isn't it a bad time to rush to the defense of such an obviously horribly-timed and fundamentally misconceived bill?

Posted by: Dan Simon | Jul 22, 2007 7:10:21 AM

From my limited experience in testifying before a Congressional subcommittee, I don’t understand why the speaking order matters. Why couldn’t a minority member use the questioning period to ask you and Zywicki whether you had any problems with the Warren study, and thus permit rebuttal then? Indeed, why can’t a minority member *now* pose additional questions to you in writing, and give you a chance to rebut the Warren claims in the record?

Separately, I don't see any connection between the bankruptcy bill and the subprime lending bubble.

Posted by: Ted Frank | Jul 27, 2007 10:24:26 AM

Ted, although it was sometimes claimed that the justification for bankruptcy reform was that bankruptcy was being "abused", that was never a serious argument. After all, lenders know exactly what borrowers' options are, and can adjust their lending decisions accordingly. The more serious implicit argument underlying the "abuse" claim is that the bankruptcy "abuse" made possible by lax bankruptcy laws had made lenders reluctant to lend to high bankruptcy risks, and thereby made it too difficult for those people to get credit at reasonable rates of interest.

As it turns out, at the time the reform was passed it was actually too *easy* for such people to get credit, in the sense that companies that were offering such credit are now finding themselves in dire straits after having lent money recklessly to bad credit risks. Hence bankruptcy reform was a bad idea based on its *own* justification.

Now, it may be that the negative effect of bankruptcy reform on subprime lending was actually minimal. In that case, the reform would simply have been pointlessly ineffective, rather than actually damaging. It's also possible that the recent subprime lending crisis has led to such a tightening of credit that high-risk borrowers now stand to gain from bankruptcy reform having already passed. In that case, the reform was merely ill-timed, rather than fundamentally ill-conceived. Either way, though, the passage of the bankruptcy reform bill was a terrible idea at the time--and some of us said so.

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