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03/27/2005

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logicnazi

So as I understand it basically you are suggesting that people should have the right to take loans against say 15% of their future income for the next 10 years (or a fixed amount and indefinite years) and these loans would be immune from bancruptcy except in extreme circumstances.

While I think there are advantages to allowing this in limited circumstances, like student loans and the immigration case I think there are very real benefits to restricting this in general.

First of all there is the purely economic argument. Presumably these human capital loans will have significantly lower interest rates since they are less likely to be discharged in bancruptcy. Those individuals who are very confident they won't go bancrupt or have strong cultural aversion to bancruptcy will of course take the lower interest rate loans when given the chance. This will shift the population taking non human capital loans toward a much riskier mixture as the people who are least likely to default move to human capital loans.

As a result the interest rates on non-human capital loans will skyrocket forcing more people to move to human capital loans and ultimately I would expect human capital loans to push out the less secured type of loan. In essence this amounts to just making bancruptcy much harder. Yes, we would have lower interest rates but they would only be availible through loans which couldn't be discharged through bancruptcy. If this is the goal why not just come out and do it directly?

Perhaps you mean to restrict somehow the type of loans that can be taken with human capital. Maybe you mean to let mortgages be so secured but not credit card debt. I am somewhat skeptical about the efficency of such a scheme, since it is fairly easy to convert home equity into cash and so forth, but once again if the goal is to create a two tiered debt system why not just do it directly? If the benefits (and harms) are just to be gotten by making a distinction between credit card debt and other types of loans why bother with the human capital bit at all?

This brings me to my other objection. While this scheme might be a good idea if people really were rational they are not. Part of the benefit of bancruptcy is that it effectively caps the amount of debt someone can accrue. If one allows human capital loans a young harvard buisness grad would probably be able to bury himself in debt against future expected earnings to a much greater degree than is even possible today.

Quite simply it seems like a bad idea to make it really easy for youthful exuberance, or a drug habit to sink someone in debt for their entire life. In fact I would not dismiss the growth of a live fast die young culture of people who build up the much easy to aquire debt and then expect to die before they pay it back (even killing themselves to do so).

brian

I disagree with both Posner and you Becker especially in establishing a regime whereby laws makes it harder for people to make a "fresh start" through bankruptcy. I dislike your idea of securing loans to human capital because I think that will harm greatly entrepreneurial activity within America. It will make it riskier for people with new ideas and inventions to start small businesses and compete against large corporations.

Why is this so? As most small business owners know when starting up they often use any available resource including their credit cards and home equity loans to finance the business. Most small business owners must secure their loans with personal guarantees which pierce the shield afforded to large corporations that separate the individual from the corporate entity. When large companies like Worldcom and Enron went bankrupt the shareholders may have lost the equity in their stock holdings, but they are shielded from creditors personally going after them as the corporation is deemed a separate entity, a "person" if you will.

When small businesses go bankrupt, and the failure rate can be quite high, if the owners are saddle with the costs of repaying the loans above and beyond the equity lost in the business already (which may have been their life's savings) then they are at an additional disadvantage against their larger, more protected competitors. Thus fewer people will decide to become entrepreneurs.

You may think this is a good thing that more people should stick to being employees all their lives, but for someone who views that small business drive economic growth then if such "reforms" are passed to make it harder for people to come out of bankruptcy with a clean slate then I fear the country will be a lot duller, anemic place.

John Smith

Posner seems to posit that if the total/overall amount of credit offered were lower, then interest rates would be lower. I guess if no credit were extended, then the interest rate one received would be perfectly proportionate to one's foreseeable ability to repay over the term of the loan (assets and income).

But this is not a defense of prohibiting bankrupts from squirming out of repayment, it is an argument in favor of limiting the total amount of credit extended and encouraging personal savings.

The same gains could be realized by taxing credit card companies that exceed a certain level of credit-lending, much like we "tax by regulation" energy companies that exceed a certain level of pollutant emissions. In fact, we could make entry into the credit-card industry more difficult, by drastically increasing licensing costs. This would jack-up the cost of using a credit-card, which would discourage credit-card use.

Posner could argue that without plugging up the back-end, people would just escape paying their debts, but perhaps we should make it easier to escape paying credit-card debt. It would increase the tax on the credit-card companies so much that their continual losses in bankruptcy court would encourage them to stop over-lending credit to those who cannot foreseeably repay.

If the problem is that credit-card companies are lending too much credit, there is no reason why we must plug up the back-end and side with the credit-card companies, other than pro-business libertarian ideology.

Paul Gowder

Hey, Dr. Becker: Why not go all the way? I think this is a brilliant idea, but it could be expanded.

I have a modest proposal for you: Why not simply have lenders foreclose on human equity like on any other asset?

So when the borrower defaults on their credit cards/student loans, the lender can just foreclose directly on them, and take title to their person. Then the lender can put them to work -- either in the lender's own business, or leased to a third party -- to pay off the debt.

The minimum wage could be credited against the debtor's back debt (at least until it's repealed as a violation of freedom of contract), and -- barring negative amortization -- a debtor with 20k or so of high interest debt could be freed in 20, 30 years.

It might require a change in some nasty laws -- I think there's a constitutional amendment to be repealed. The thirteenth, or some silly thing like that. But that's hardly a big deal, in the face of promoting the free ailenability of human equity

Kevin

These human equity loans might not work out so great because of the large monitoring expenses involved in getting the debtors to honestly report their income, which they must share a portion of with the lender. If a human equity "debtor" is deciding whether to take a second job, there's a new incentive to make sure that the job is off the books. If these loans become more common, we can expect workers to move into the grey- and blackmarket, with all the negative consequences that entails.

Of course, if, as Professor Becker says, these loans work successfully in undeveloped countries, then my horror story is probably unfounded. What piece of the puzzle am I missing?

Michael Martin

An interesting idea. But having seen how over the course of history lawyers have found new ways to follow the money, I'm skeptical as to whether the system would really save any administrative costs. Aren't borrowers who end up making more than they expect just going to go out and hire lawyers to try and avoid payments under the "equity" loan in the same way they now hire lawyers to avoid paying regular loans? Yet it's probably a step in the right direction to the extent that it privatizes more of the process and shift some of it from contentious failures to success stories where parties might be more likely to agree on how the pie should be split up.

A question for Prof. Becker: could equity loans coexist with the current bankruptcy system in any regime, or would they require a completely new system?

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