Bankrupcy
One of the great puzzles about American finance system is that the world’s most successful capitalist economy seems to be built on a foundation of easy economic failure - bankrupcy.
The ability to walk away from unsustainable debts and start all over again is one of the distinctive quirks of American capitalism. There were no debtor’s prisons in the US in the early 1800s, at a time when English debtors could end up languishing in jail for years. Since 1898, it has been every American’s righ to file for Chapter VII (liquidation) or XIII (voluntary personal reorganization). Rich and poor alike, people in the US appear to regard bankrupcy as an ‘unalienable right’ almost on a par with ’life, liberty and the pursuit of happiness’. The theory is that American law exists to encourage entrepreneurship - to facilitate the creation of new business. And that means giving people a break when their plans go wrong, even for the second time, thereby allowing the natural-born risk-takers to learn through trial and error until they finally figure out how to make that million. After all, today’s bankrupt might well be tomorrow’s successful entrepreneur.
Bankrupcy may have been designed to help entrepreneurs and their businesses, but now-a-days 98% of filings are classified as non-business. The principal driver of bankrupcy turns out to be not entrepreneurship but indebtedness. In 2007, US consumer debt hit a record $2.5 trillion. Back in 1959, consumer debt was equivalent to 16% of disposable personal income. Around 2008, it is 24%. In the same period, mortgage debt has risen from 54% of disposable personal income to 140%. One of the challenges for any financial historian today is to understand the causes of this explosion of household indebtedness and to estimate what the likely consequences will be if, as seems inevitable, there is an increase in the bankrupcy rate.
What is the answer to this question?
The root cause must lie in the evolution of money and the banks whose liabilities are its key component. The inescapable reality seems to be that breaking the link between money creation and a metallic anchor has led to an unprecedented monetary expansion - and with it, a credit boom the like of which the world has never seen.
Marshallian k ratio (after the economist Alfred Marshall) is the ratio of the monetary base to nominal GDP. Measuring liquidity as the ratio of broad money to output over the past hundred years, it is very clear that the trend since the 1970s has been for that ratio to rise - in the case of broad money in the major developed economies from around 70% before the closing of the gold window to more than 100% by 2005. In the eurozone, the increase has been especially steep, from just over 60% as recently as 1990 to just under 90% in 2008. At the same time, the capital adequacy of banks in the developed world has been slowly but steadily declining. In Europe, bank capital is now equivalent to less than 10% of assets, compared with around 25% at the beginning of the twentieth century. In other words, banks are not only taking in more deposits; they are lending out a greater proportion of them, and minimizing their capital base. Today, banking assets (that is, loans) in the world’s major economies are equivalent to around 150% of those countries’ combined GDP. According to Bank for International Settlements, total international banking assets in December 2006 were equivalent to around $29 trillion, roughly 63% of world GDP.