The One Minute Case for Bankruptcy

What is bankruptcy?

Bankruptcy is a financial state that occurs when a person or business can no longer repay its debts. In the legal sense, bankruptcy begins when a court recognizes that the financial state of bankruptcy exists. The bankruptcy court takes charge of the bankrupt entity and disposes of its assets or reorganizes it to pay off as much of the debts as possible.

A bankruptcy proceeding recovers money for the creditor, but both parties benefit.

The purpose of a bankruptcy proceeding is to facilitate the maximum recovery of the money owed to the creditor. But it also benefits the debtor. After the debtor pays off what he can, his remaining debt is extinguished. This is not a “get of jail free” card; the debtor, whether a person or business, must face the damage to its reputation and a greater difficulty in obtaining credit for a long time into the future. Rather, it is an acknowledgement that the debtor simply cannot repay his debt. For both parties, bankruptcy offers timely resolution to an otherwise unsolvable dilemma. The creditor regains a portion of the money owed, and the debtor, relieved from the burden of a debt he cannot pay, can move on with his life.

Bankruptcy is economically valuable.

In economic terms, a speedy and fair process of bankruptcy allows both assets and people to resume being productive as quickly as possible. The creditor regains cash that it can redeploy as it sees fit. If it is a bank, it has regained funds that it can loan out again to more productive businesses or creditworthy individuals. The creditor can also redeploy the assets of the bankrupt entity into the hands of a more capable manager.

Take the financial malaise of General Motors as an example. Although effectively bankrupt, there has been no legal recognition of this fact (as of this writing in March 2009). As a result, its factories and workers continue to be tied up inefficiently making mediocre cars. General Motors is a drag on the American economy.

Bankruptcy would free General Motors’ factories and employees to be more productive. Once a court legally acknowledges General Motors’ bankruptcy, it could allow General Motors’ new owners, its creditors, to appoint a more competent manager. Or the creditors could sell the plants to a superior car manufacturer, such as Toyota. Either way, after reorganization under bankruptcy, the plants would be used to make cheaper, more attractive cars that customers want to buy.

The creditors may also choose to shut down some or all of the plants and sell them for scrap. But recycling the old plants into new steel that becomes the girders of modern, efficient factories is a better use for those plants if they are obsolete. No party is in a better position to make these judgments than General Motors’ creditors, who have their financial self-interest at stake.

While General Motors is just a single, albeit enormous, example, speedy and fair bankruptcies end the bleeding of money-losing operations across the economy, and re-direct inefficiently utilized assets and capital to more productive activities. In sum, bankruptcy facilitates economic recovery. A failure to permit bankruptcy prolongs stagnation.

Some fallacies about bankruptcy

Bankruptcy always means shutting down a business. This is not true. Creditors, in consultation with the bankruptcy court, decide whether to shut down and liquidate, or to operate under new management. Creditors have every incentive to make the decision that maximizes their pay-out over time, not just the amount of cash that can be had right now.

Bankruptcy is bad for employees. Considered in full context, bankruptcy is good for employees. An economy with speedy and fair bankruptcy procedures is one where healthy, growing companies predominate. Healthy companies can pay employees more because their labor is worth more to them. Therefore, employees benefit from bankruptcy, even if someone occasionally faces dislocation or the uncertainty of working for new management. But, even if employees dislike such occasional dislocation, there is no alternative to bankruptcy if their employer is not financially viable.

Bankruptcy allows deadbeats to avoid meeting honest obligations. When bankruptcy laws are properly drafted and applied, this is the exception rather than the rule. Bankruptcy laws are designed to protect the rights of all parties, not to unfairly favor debtor or creditor. Bankruptcy acknowledges a fact, that the debtor cannot repay all his debts, and it facilitates the repayment of all debts that can be repaid.

Government should stop bankruptcies. During financial panics, governments sometimes try to prevent bankruptcies by putting moratoriums on them, subsidizing bankrupt entities, or changing the laws governing bankruptcy to favor debtors. Such interventions are both unjust and impractical. They are unjust because they deny the legitimate right of the creditors to collect what they are owed. The money they are owed is their property, and they have the right to collect it, to the extent it is reasonably possible. Such interventions are unjust and impractical because they attempt to deny reality. “Stiffing” the creditors or forcing innocent third parties to bail out the bankrupt entity through subsidies does not change the fact that the bankrupt entity cannot repay its debts.

Bankruptcy is moral.

Bankruptcy is just, if resolved through a fair and speedy judicial process. A bankruptcy proceeding acknowledges the actual state of affairs that exists, that the bankrupt entity cannot repay its debts. It resolves this dilemma for the maximum benefit of the creditor, but in so doing allows both parties – debtors and creditors – to resolve this matter with finality, and move on with their lives. Bankruptcy only involves the parties to the debt obligation. It does not require that innocent, third parties be forced to subsidize or bail out creditors or debtors. In doing so, it respects the rights of all concerned.

A just process of bankruptcy is also economically practical. Bankruptcy removes assets from those who have mismanaged them, and puts them into the hands of those who are most capable of putting them to productive and financially responsible use.  The institution of bankruptcy is an essential part of a prosperous and just capitalist society.

The One Minute Case Against Wage and Price Controls

What is a job?
A job is a contract between two parties, in which one party agrees to provide certain services on a certain schedule in exchange for payment from the other party. By definition, an employee agrees to do job for a particular wage by his own voluntary consent. This is opposed to slavery, in which a slave is forced to work without his consent or compensation.

What determines wages? Can employers pay workers whatever they want?

A wage is the price an employer pays for the services his employee. While the two may negotiate any wage they come to mutual agreement on, the mutual self-interest of both and market forces intersect at a market-set price that represents the intersection of their interests. Disregarding non-economic factors, an employer wishes to pay his employee as little as possible. The maximum amount he will pay however is the value of the marginal productivity a given worker provides. (The marginal productivity is the value per unit of time the worker provides to the employer.) If the worker refuses to work at or below his marginal productivity, then the employer will not hire him, since doing so will incur a loss. Conversely, disregarding non-economic factors, the employee wishes to be paid an infinite amount. The minimum wage he will actually accept is the marginal value of his labor. This can be measured in terms of the next-most useful value-producing activity the workers may engage in.

For example, suppose that my marginal productivity as a programmer is $30 per hour. I will accept any job paying above $30 an hour, but no job below it, since I can find an employer paying that much in another computer or tech-related industry. A fast-food worker might have a marginal productivity of say, $6 an hour – the value per hour that his labor creates for the business. From the employer’s perspective, I create $40/hour of value, and the fast food workers creates $7 of value, so he will be willing to hire us. (Assuming that no one is willing to provide the same value for a lower wage.) However, if I only provide $20 of value, the employer will not hire me, because he would incur an hourly loss of $10 in doing so. Similarly, if the fast food worker only provides $5 of value, he would not be hired either because he would cause a loss of $1 for each hour he works.

Can the government increase wages when employers don’t pay enough?

Suppose that the government imposed a minimum wage of $8. Would the fast food worker who provides a value of $7 per hour now be paid $8? No, he would lose his job – because keeping him would mean a $1 loss for each hour he works to his employer. All minimum wage laws have a similar effect – they cause everyone with a marginal productivity below the minimum wage to lose their jobs – most often teenagers and the very poor. Wage caps (including progressive income taxes) have a similar effect – they lead the most productive individuals of our society to retire early or forgo new opportunities — resulting in a lost opportunity for them, and for everyone who might have benefited from their ideas.

What if the government creates a job by paying an unemployed worker to do make-work such as digging holes in the ground?

Where would the money to pay for his wage come from? It would have to be taken by force from the remaining employed fast food workers and computer programmers. Everyone will be paid less to pay for the government workers, but has a job been created? No – now the fast-food employer has $1 less to pay to his other $8 employees, so he must fire some of them or go out of business. Each new $7 government worker costs at least one $7 privately employed worker. This is always a social loss because by definition, the government worker is less productive. If he were not, then the private business would voluntarily employ workers to perform his job.  While a minimum wage causes everyone who produces less than the marginal productivity of the minimum to lose his job, each new government job causes at least one more productive worker to lose his job.

If the government cannot raise wages, can it lower prices?

Prices are determined by the marginal value of a given good, just as a wage is determined by the marginal productivity of an employee. Attempts to regulate the cost of goods have the same effect as wage controls: if the price is set below the cost of a good, producers will be unable to make any.   Since different producers have different costs, lowering the prices of a good will decrease the percentage of producers able to supply them, until they can make none at all.

So how can prices be lowered?

The only way for prices to go down is to increase the productivity of workers.  Productivity in the production of a good comes from the application of mental effort to the production of values. A profit (the difference between the value of a good to a consumer and the cost to produce it) is the reward of an entrepreneur for bringing about the new wealth he’s created. In the absence of government coercion, profits can exist only as long as men continue to create new values ,or improving on existing ones.  The only to make goods cheaper is to allow entrepreneurs the freedom to invest in improvements in the capital and labor methods used in production

Doesn’t a more efficient product result in lost jobs for those who were replaced by automation or better processes?

When oil lamps replaced candles, the cost of producing affordable lighting greatly decreased. In the absence of a government monopoly, competing lamp-makers quickly started making their own lamps, which brought the price decrease to the consumer. In the process of transitioning from candles to laps, many thousands of candle-makers lost their jobs.  However, oil lamps did created a new industry of their own and increased the prosperity of society as a whole, just as electric lighting did in the 20th century.  Since consumers could buy cheaper lamps, they now had more money to spend on other things, ,creating new industries, and raising their overall standard of living.

Technological progress and capital accumulation has both created new careers made us enormously more productive – we not only have a wider range of vocations to choose from but work far fewer hours.

Can government “soften the blow” when all these candle-makers lose their jobs?

In today’s world, the government would probably try to subsidize the candle or lamp-makers when their chief product became outdated. What would that subsidy accomplish? It would save the candle-makers jobs – but it would cost the jobs of everyone who stood to benefit from the increase wealth that came from cheaper lights. In the short term, the candle-makers might benefit – but in the long term, they would lose too, since they would lose the new, higher paying jobs the could have making electric lights and the new products the cheaper lights would allow consumers to afford. Meanwhile, the Thomas Edison’s, Graham Bells, Thomas Moore’s, and Bill Gates’ would be too busy working to pay off taxes to have the time or money for research.

Of course, we know that these inventors and entrepreneurs succeeded. But how many didn’t because they never got their first break in the field because of a minimum wage, or gave up before they tried because the red tape was too much, or the taxes too high, or they knew that the old, outdated industries would use the government to tax and regulate them out of existence? The real tragedy is that we will never know.

The One Minute Case For Capitalism

Capitalism a social system based on the principle of individual rights.

A capitalist society is based on the recognition of individual rights, including property rights. Under capitalism, all property is privately owned, and the state is separated from economics just as it is from religion. Economically, capitalism is a system of laissez-faire, or free markets, where the government plays no part whatsoever in economic decisions.

Capitalism is the only social system compatible with the requirements of man’s life

To pursue the values necessary for his life a society, man requires only one thing from others: freedom of action. Freedom means the ability to act however one pleases as long as one does not infringe on the same and equal freedom of others.   In a political context, freedom means solely the freedom from the initiation of force by other men. Only by the initiation of force can man’s rights be violated. Whether it is by a theft, force, fraud, or government censorship, man’s rights can be violated only by the initiation of force. Because man’s life depends on the use of reason to achieve the values necessary for his life, the initiation of force renders his mind useless as a means of survival. To live, man must achieve the values necessary to sustain his live. To achieve values, man must be free to think and to act on his judgment. To live, man must be free to think. To be free to think, man must be free to act. In the words of Ayn Rand, “Intellectual freedom cannot exist without political freedom; political freedom cannot exist without economic freedom; a free mind and a free market are corollaries.”

Capitalism recognizes the inherent worth of the individual

In a human society – one that recognizes the independence of each man’s mind – each individual is an end in himself.  He owns his life, and no one else’s.  Other men are not his slaves, and he is not theirs.  They have no claim on his life or on the values he creates to maintain his life, and he has no claim on theirs.  In a free society, men can gain immense values from each other by voluntarily trading the values they create to mutual gain.  However, they can only create values if they are free to use their minds to exercise their creativity.  A man is better living off on his own than as a slave to his brothers.  Capitalism recognizes each man as an independent, thinking being.

The individual is an end in himself

Just as no individual has the right to initiate force against anyone, neither does any group of men, in any private or public capacity. It is immoral to initiate force against any individual for any reason. This includes the initiation of force for “the public good.” The “public” is merely a collection of individuals, each possessing the same rights, and each being an end in himself. Any attempt to benefit the “public good” is an immoral attempt to provide a benefit to one group of individuals at the expense of another. In a free society, no individual benefits at the expense of another: men exchange the values they create in voluntary trade to mutual gain. The rule of law in a free society has just one purpose: to protect the rights of the individual.

Capitalism leads to freedom and prosperity

A free, capitalist economy has never existed anywhere in the world. The closest the world came to a free market was during the Industrial Revolution in Great Britain and during the late 19th century in the United States. The Industrial Revolution was a period of unprecedented economic growth and unimaginable improvements in quality of life. In less than two hundred years, the life of most people in the Western world changed from a a short life filled with poverty, plague, and near-constant war to a modern, comfortable existence that  even the kings of medieval Europe couldn’t have imagined.  Since 1820, the leading capitalist nations have increased their wealth sixteen fold, their populations more than four-fold, their productivity twenty-fold.  Annual working hours went from 3,000 to less than 1,700 and life expectancy doubled from thirty to over seventy years. 1

Yet despite the undeniable material superiority of capitalist societies, its critics continue to attack it as inhuman and selfish.  What the world lacks is not evidence of capitalism’s practical superiority, but a moral defense of a man’s right to his own life.

Reference

  1. Angus Maddison. Phases of Capitalist Development, p4 (1982)

Further Reading

The One Minute Case Against Interventionism

Free markets created the modern world

A free, capitalist economy has never existed anywhere in the world. The closest the world came to a free market was during the Industrial Revolution in Great Britain and during the late 19th century in the United States. The Industrial Revolution was a period of unprecedented economic growth and unimaginable improvements in quality of life. In less than two hundred years, the life of most people in the Western world changed from a a short life filled with poverty, plague, and near-constant war to a modern life that even the kings of medieval Europe couldn’t have imagined.1 This miracle was made possible by the philosophical and political ideals formed during the Enlightenment, and the freedoms demanded and fought by the philosophers, statesmen, and entrepreneurs of Western civilization. Yet the Enlightenment also laid the sees for the collectivist and materialist ideology behind socialism, which struck the first major blow against capitalism with the Sherman Antitrust Act of 1890.

Capitalism declined with the rise of collectivism in the 20th century

The assault on free markets was intensified by Herbert Hoover, who imposed unprecendented regulations of Wall Street to eliminate “vicious speculation”, regulated labor markets, and created government works programs.2 FDR inherited these programs and created numerous government agencies which made the financial industry is the single most regulated industry in the economy and turned an economic recession into the Great Depression.3 The Federal Reserve was supposed to stabilize the currency, The FDIC was supposed to prevent bank runs, the SEC was supposed to be stop shady investments, Fannie May and Freddie Mac were supposed to make homes affordable to everyone. Yet also these restrictions on capitalism had the opposite effect of their intended purpose: the dollar has lost 95% of it’s value, the SEC is the main cause of corruption in Wall Street4 5, and housing prices are unstable and highly inflated.

Interventionism is a vicious cycle of wealth destruction

Economic interventionism, also known as statism, exists in every mixed economy – a society in which the government interferes with market economy. In a interventionist economy, the state takes wealth away from from some enterprises and transfers it to other organizations or individuals. Whether it does so through taxation, corporate welfare and bailouts, monopoly privileges, wage and price controls, trade restrictions and tariffs, currency inflation, antitrust regulations, state-ownership of businesses, or “make work” programs, the effect is the same: to punish virtue and competence and reward vice and waste.

All the values created by a business are possible only because its customers value them sufficiently to pay for them. To the extent that any individuals voluntarily exchange value for value without harming anyone else, their actions benefit themselves and harm no one. However, in an interventionist state, the product of those individuals is seized and transferred to those who did not earn it. This is a vicious cycle, because it rewards those in the public and private sector who manipulate the state to seize unearned benefits and punishes the productive individuals who focus on creating values and create products and services that consumers want.

The more the looters seize, the fewer wealth is available to producers. The more productive businesses fail or move elsewhere, the heaver the burden is on those who remain. The more money is taken from the producers, the greater the incentive for the lazy to skim from their labor. When the burden of stealing sufficient wealth outright becomes too unpopular, politicians resort to stealing it by printing money, until the currency of the country becomes worthless, trade becomes impossible, and productive activity grounds to a halt. Inevitably, it is the executives of the productive businesses who politicians blame for the crisis their own policies created.

Entrepreneurs and CEO’s are the unrecognized heroes of the modern world

Capitalism cannot guarantee that all our needs will be provided for – no system can turn mere wishes into reality. But it does give entrepreneurs the incentive to compete to provide the best possible service they can. The brief flowering of freedom during the 19th century created the wealthy, industrial society in which we now live in – but it is being destroyed from within by the collectivist ideology of interventionism. When political connections rather than consumers decide who is allowed what values should be created, entrepreneurs have no incentive to improve their products or to try bold new techniques, and instead spend their resources trying to bribe politicians.  Politicians can force prices to be artificially low, but they cannot lower costs or substitute for the creative risk taking that drives the economy – they can only drive the remaining wealth creators out of existence.

References

  1. The Capitalist Manifesto, The Industrial Revolution Brings Advance by Andrew Bernstein, 2005
  2. Hoover’s Attack on Laissez-Faire by Murray Rothbard, 1963
  3. Robert Higgs: How FDR Made the Depression Worse
  4. Robert P. Murphy: The SEC Makes Wall Street More Fraudulent
  5. See the The One Minute Case against the SEC

Further Reading

The One Minute Case against the SEC

Markets regulate themselves

Long before the existence of the Securities and Exchange Commission, medieval guilds and trading houses established common standards, accreditation agencies, and accounting rules that have evolved to the present day. The system of English common law has been evolving since the 12th century 1, and the accounting system used today was codified in 1495.2.

Numerous non-governmental bodies have continued to develop accounting rules and set auditing standards for public organizations.3 It is the American Institute of Certified Public Accountants, not the government, which sets ethical standards for the profession and U.S. auditing standards for audits of private companies; federal, state and local governments; and non-profit organizations.

Voluntary oversight organizations are embraced by their participants because they provide executives with a value – they allow them to discover waste and fraud and advertise honesty to partners and customers. Unlike government regulatory bodies, they are flexible, efficient, and competitive. When the compliance costs of accounting rules exceed their value, or when lax controls lead to unethical or risky behavior, the markets embrace new standards. The Securities Act of 1933 and the Securities Exchange Act of 1934 did not begin the process of regulating markets, but nationalized much of the auditing market and turned it over to politicians and bureaucrats.

Regulations hinder competition and raise costs for investors

The SEC subsidizes politically connected corporations at the expense of smaller firms, hindering innovation and encouraging corruption. Established corporations lobby the government to create burdensome regulations that smaller investment funds and markets cannot afford, thus creating coercive monopolies that raise profits a few firms at the expense of investors.4 Government bodies like the SEC, the MSRB, the FTC, the USITC, the Fed, the Treasury, the IRS, the OTS, the MSRB, and the state attorney’s offices issue hundreds of thousands of laws, rules, opinions, bulletins, comment letters and threats and require numerous reports, statements, forms, notices, and approvals that investment firms and public companies must obey. 5 This creates an artificial scarcity of investment products that benefits large corporations and discourages savings and investment. Smaller companies cannot afford to raise money by issuing stock, and investors are forced to choose between public but expensive mutual funds and secretive and risky hedge funds with entry fees that only the rich can afford.

The SEC creates corruption

Rather than making Wall Street honest, regulatory agencies are the primary instruments of fraud and corruption on Wall Street. Politicians who control regulatory agencies have an incentive to use their power to extract benefits for themselves and their constituencies, rather than to keep markets honest and efficient. Power hungry politicians like Eliot Spitzer use the power of the SEC to go on crusades again innocent businessmen 6, and thus force regulatory bodies to hide the evidence of real corruption.7 By blocking outsiders from seeing its records, the agency is makes it harder for investors to discover real fraud.8

The case of Bernie Madoff is a typical case study in how the SEC encourages fraud. Investors figured out that Madoff couldn’t possibly make the profits he claimed, and have been writing the SEC since 1999, urging them to put a stop to Madoff’s Ponzi scheme. However, Madoff used his close family ties to the SEC, and was instrumental in founding key regulatory bodies – and then nominated his family members to serve on their boards. When skeptical investors inquired about the irregularities in his fund, Madoff told them that the SEC had already investigated and cleared him over a period of three years.

While Madoff stole $50 billion dollars under their noses, the SEC’s budget surpassed $900 million dollars, and grew at record rates during the two Bush administrations. In response to this outrageous case of nepotism and corruption, the government will likely increase its budget and staff once again.9

The SEC makes markets more volatile and risky

By banning crucial market functions like short selling10 and “insider trading” 11 the SEC hinders the market’s ability to react to new information, and makes markets more unpredictable and expensive.

The SEC cannot even oversee itself

While the SEC is charged with enforcing regulations like Sarbanes-Oxley, it consistently fails to control and report on its own processes and receives failing grades from the government’s own auditing body.12 This is not surprising – like any socialist organization, it has no incentive to be efficient or responsible to stockholders.

The chief source of fraud and corruption in the United States is not Wall Street, but Washington D.C.

Notes

  1. Medieval English common law: foundations for 21st century legal systems
  2. Wikipedia: The history of accountancy
  3. Self-Regulation in Today’s Securities Markets: Outdated System or Work in Progress?
    CFA Institute Centre Publications (September 2007)
  4. See How the SEC Subsidizes Stocks by Jeff Scott and SEC: Protecting Investors Or Uncompetitive Companies?
  5. (There are so many regulations that the department charged with publishing them can only report that “The Office of the Federal Register Library now contains more than 550 cubic feet .. which has the force and effect of law.” – History of the Federal Register
  6. The Cost of the “Ethical” Assault on Honest Businessmen by Alex Epstein and Yaron Brook (Silicon Valley Biz Ink, July 8, 2003)
  7. Deafened by the S.E.C.’s Silence, He Sued
  8. The S.E.C. Prevents Investors From Discovering Accounting Fraud
  9. The SEC Makes Wall Street More Fraudulent by Robert Murphy
  10. See the One Minute Case for Stock Shorting
  11. See Inside Insider Trading and Should Insider Trading Be Legal? by Yaron Brook
  12. GAO Finds Material Weakness in SEC’s Controls