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Combatting Fear of Abuse--A Sisyphean Task?

posted by Jason Kilborn

Over the past few weeks, at conferences with judges and policymakers in Varna (Bulgaria), Seoul, and Beijing, I've been confronted with a surprising degree of skepticism about personal insolvency systems and fear of opportunistic individuals abusing the ability to evade their debts (especially while hiding assets). I've pointed out the interesting progression identifiable in Europe in recent years of a marked relaxation of such fear of abuse, especially in places like France and most recently Slovakia, which have gone all the way to adopting a very US-like open-access system to immediate discharge. For the real skeptics--and they are numerous in Bulgaria and China, both of whom are considering adopting their first personal insolvency laws--these arguments seem to fall on more or less deaf ears. Detractors put me in a no-win situation by offering one of two rejoinders: (1) the incidence of discovered abuse is low in these systems because debtors are crafty or anti-abuse institutions are weak, or (2) anti-abuse institutions like the means test and restrictive access hurdles are successfully dissuading abusers from seeking access, so we need more--not less--of this kind of effort (which I've criticized as wasteful, unnecessary, and counterproductive). A common third response is the classic "we're different" position--that is, any comparative empirical evidence from elsewhere is irrelevant to the new, entirely unique context of [insert skeptical country's name here].

I've considered launching into some kind of research project to address this skepticism, but I don't think it will help. The situation reminds me of the two most common resistant reactions to empirical research: (1) we already knew that, or (2) that can't be true. The haters are gonna hate, it seems to me. So if the lighthouse is no good, we need to come up with a different approach to assuaging the concerns of policymakers, especially in China, that rampant abuse will not infect a new personal insolvency system and undermine public confidence and payment morality.

I've come to believe institutions are our best strategy. An Insolvency Service or other administrative organ dedicated to rooting out fraud and processing these (mostly) low-value cases in a quick, efficient, low-cost, and minimally formal way seems to be a win-win. It reassures the skeptics that a cop is on the beat, and it avoids allowing formalities, especially court formalities, to bog down these cases. Obviously an agency can get caught up in its own procedures, too (and substance matters, as well, as evidenced by the extremely inefficient German procedure and the hunt for the slightest hint of abuse in the UK's DRO procedure), but it seems to me that diverting personal bankruptcy cases away from the courts somehow is key (including by getting a private trustee to do all the work and engaging the courts only when (rarely) necessary, as in the US and UK). 

But an entirely new agency structure is also expensive, in terms of both monetary expenditure (both initial and ongoing) and personnel development (both recruitment and training). I wonder whether this cure is worse than the disease, and it offers another powerful lever of resistance by abuse-fearing policymakers.

I would greatly welcome any thoughts that others have about the proper way to achieve the closely related goals of (1) assuring skeptics that abuse can and will be laid bare (to the extent reasonably possible) and (2) moving personal insolvency cases through processing quickly and efficiently to a reinvigorating discharge. Many places are struggling with this issue, so I hope a crowdfunding strategy might produce some innovative ideas.


My advice would actually be for you to step back a second and consider how bankruptcy should be designed in an environment where petty graft is considered normal, and being caught lying in one's own interest is not embarrassing. My read of this post is that you don't understand that 'truth' and 'honesty' mean something different in different cultures.

It is probably the case that somewhat different bankruptcy institutions need to be set up in different cultures to tackle different concepts of what is 'honest' behavior. So I think you're on the right track with an institutional approach tailored to the environment in question. And I think you should worry less about the expense of doing things differently than what you see in the US and focus more on what can work in a different cultural environment.

Similar to parole systems that release people from the prison, there are two types of errors in releasing debtors from the sweatbox:

1. Undeserving debts are discharged
2. Deserving debtors cannot obtain discharges.

There are costs associated with each of these errors along with the costs of the system itself. Presumably, as the costs of the system are increased, the total costs of the Type 1 and 2 errors will be decreased. An efficient insolvency system would minimize the sum of these three costs. This can only happen if additional costs of the system are offset by reducing the costs of Type 2 errors and Type 1 errors.

If you start without a system, then the cost of such a system (and Type 1 errors it introduces) must offset by reducing the costs of Type 2 errors. If such a system cannot be devised, then either having no system (Type 1 costs > Type 2 costs) or debt jubilees (Type 2 costs > Type 1 costs) would be most efficient.

Skeptics of personal insolvency systems essentially believe that the costs of the system plus the Type 1 undeserving debt discharges will exceed the Type 2 non-dischargeable debt costs.

Type 2 costs are hard to measure so it's difficult for skeptics to believe that building easily quantified costly systems to reduce them will be efficient, especially when additional Type 1 costs will be incurred.

I'd focus on getting policy makers to understand the Type 2 costs of non-dischargeable debt on a personal and societal level. As societies with effective parole systems have found, keeping folks in the sweatbox too long can be very costly.

Thanks, Greg! I've generally taken the approach you suggest in trying to make more vivid the costs of Type 2 under-treatment, or at least point out that other legislators (particularly in Europe) have concentrated on the many negative consequences to creditors, debtors, and society of such under-treatment. This discussion appears in a long introductory section of the World Bank's Report on the Treatment of the Insolvency of Natural Persons, which I urged attendees at a conference in Beijing this past Friday to read with care--even if quantification is elusive, as you say, I hope it helps policymakers to feel the costs of doing nothing (or at least not enough) in an increasingly competitive global marketplace.

Your comment dovetails nicely with anon's, as I fully well appreciate that honesty is measured and valued differently in different cultures and regions. If Type 2 under-treatment is hard to quantify, so too is Type 1 over-treatment; that is, giving relief to scoundrels. How much "dishonesty" is a real problem, beyond a societal tolerance level? In the parole context, violent crime is a real, palpable cost of Type 1 errors; in the personal insolvency context, a few creditors losing the right to pursue their likely practically uncollectible claims ... not so much, it seems to me. But I admit that it seems to ME that way, and I am sensitive to the fact that some people are very bothered by ill-gotten gains. Even more than parole, I think tax evasion is a useful parallel context. How much are we willing to spend to collect all the tax that's due--and how much cheating are we willing to accept (implicitly) by not funding an IRS to the hilt? It's all about trade-offs, and I will continue to struggle to express the costs of doing nothing and allowing Type 2 under-inclusion to be the status quo (as compared with allowing Type 1 errors of cheaters keeping their tax money to be the status quo in the tax system!).

People innately measure their well-being by reference to others. Right now, eTrade has a series of ads exploiting exactly this sentiment -- invest with us to be richer than your friends and neighbors. I would hypothesize this heuristic or a related heuristic spills over into debt relief. We have an innate need to make sure someone is not getting something they don't deserve, not getting ahead of us. In country after country, the story of the undeserving debtor always resonates when it comes to debates about bankruptcy reform. And, to pick up Anon's point, the intensity of the heuristic almost certainly varies across cultures.

If my hypothesis is correct, the Type I/Type II error debate and similar debates do not engage the heuristic. These points tell people how they should intellectualize the issue, but they don't address how people actually internalize issues like debt relief. Not surprisingly, my advice is to do the empirical project. What are attitudes about debt relief? How do these attitudes relate to well-known heuristics on wealth and social status? How do these attitudes vary across cultures?

Points well taken, Bob, but the crazy thing is that this is both a moving and a scattershot target. Asking about how "Chinese people" feel about debt relief (or petty graft, or honesty, ...) is like asking what the Congressional intent behind a statute was--it was the lowest common denominator among a huge cacophony of competing feelings. Even in the US the feelings you've mentioned are clearly present among both members of the public and Congress--recall the rant on the Chicago Board of Trade floor by the commentator angry about writing down mortgage balances a few years back.

I've focused on the moving target part, since these attitudes have changed dramatically over time in such varying places as Denmark, France and the Netherlands on the one hand, to places like Russia, Slovakia, Poland, etc., etc., on the other. In Russia, a country that epitomizes anon's petty-graft-is-the-norm attitude, legislators finally swept aside both fear of abuse and petty jealousies to enact a relief statute that rivals the US in terms of openness, but it took until 2015 to get past the "this could never work in our corruption-infested country" sentiment. Legislators did this based in large part on a cold intellectualization of the issue--is this better for us in the long run than not having it, as Greg suggests. Where personal insolvency has succeeded, cold reasoning seems to have won the day; where it has not, irrational emotional resistance has been to blame.

I'm left struggling to either formulate compelling intellectual arguments or to structure an empirical study that can actually demonstrate something robust and useful. I think I just have to accept Joseph Spooner's conclusion that we just have to wait until the golden moment when the political stars align with a sensitive policymaker taking the reigns. Keeping up the drumbeat of counter-commentary is useful, though, especially marshaling evidence that "everybody's doing it"--another powerful heuristic.

At the substantial risk of over-simplifying, a policymaker in a place like China might think about the trade-offs between a credit system that encourages responsible, productive business risk-taking and debt-driven personal financial distress as a two-dimensional grid. Any society at any point in time could be plotted as a point on this grid. Policies for a particular country could be analyzed by movements on the grid over time.

Presumably, policy-makers would like to use their powers to move into the high-functioning credit / low financial distress quadrant. They could use the grid to determine policies that helped other societies get into this quadrant, and policies that were counterproductive.

Potential policies might include various personal insolvency systems but would also include many intended to prevent financial distress. Manufacturers find that constantly improving systems to prevent scrap/rework is typically less costly than relying on quality inspections. Analogously, credit-system policy makers might wonder:

1. Are preventative measures more important than insolvency systems in reducing personal debt-related distress? Is this approach taken by good-credit / low-distress societies?

2. Does the existence of insolvency systems make it more difficult politically to implement preventative measures? Is this why after 80 years of tweaking personal insolvency systems, the US is in the good- credit / high-distress quadrant?

3. Are countries with insolvency systems more likely to be in the good-credit / low-distress quadrant? If so, why? If not, why not? Have there ever been examples of good-credit / low-distress societies that do not rely on insolvency systems?

Note that preventative measures might include socialized health care, usury laws, predatory lending prohibitions, stabilized housing costs, and restrictions on consumer lending / revolving unsecured credit. Also, it might be useful to model the credit systems in two dimensions (availability and quality) rather than simply good/bad as I have above.

As a side note, my thinking on insolvency systems has been broadened by Michael Hudson’s work on debt jubilees used in Ancient Egypt, Sumer, etc. A new book on the topic is supposed to be forthcoming. Imagining the ancient societies on the grid described above might help build a better framework for analyzing credit-system policies.

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