A couple of years ago I was speaking at a Credit Today Scotland conference in Edinburgh. The room was filled with creditors, debt collectors, debt management companies and insolvency practitioners. As the token money adviser I was just a tat out of my comfort zone.
I told the story of Donald Trump walking by Tiffany’s one day. He turned to a colleague as they passed a beggar and asked him if he knew the difference between himself and the beggar. The Colleague didn’t know, so Trump gave him the answer: about 900 million dollars. The irony was that whereas the beggar was probably solvent, trump wasn’t with his assets hugely outweighed by his liabilities. I was making the point to them they should be careful as many of their clients were effectively bankrupt.
It’s a sobering thought that if someone like Donald Trump could be effectively bankrupt, how many more of us could be as well. Last year in Scotland there was nearly 23,000 personal insolvencies in total, that’s approximately 0.5% of Scotland population over the age of 18.That means in the next two year, one in one hundred people in Scotland will be declared insolvent.
At another conference I was at last week, Citizen Advice Scotland, the Accountant in Bankruptcy office was there and said the figure was only about 0.3% of the population per year, which was an acceptable figure. However, the Accountant in Bankruptcy were not counting those who went into protected trust deeds, another type of personal insolvency in Scotland. Total personal insolvencies are 0.5% of the population. But should the laws be changed to allow that number to be doubled? Could it be in Scotland’s best economic interests if the number was double that?
The problem with bankruptcy is the University of Wales carried out research and believes there are over 2 million iceberg bankruptcies in the UK. That is people who are paying only the minimum each month to their debts and cannot reduce their overall indebtness. People, that is, who could become bankrupt if they were to lose their jobs and if they don’t, will never repay all their liabilities. With some experts believing up to 30,000 jobs could be at risk in Scottish local authorities alone in the next couple of years, and assuming of those 2 million iceberg bankruptcies, up to 200,000 could be in Scotland, it’s not difficult to see we could see the numbers of personal insolvencies increase quickly over the next couple of years.
This is likely to be aided with new bankruptcy laws due to be implemented in November 2010 as part of the Home Owner and Debtor Protection (Scotland) Act 2010. Certificated sequestrations (the formal name for what most people consider to be bankruptcy in Scotland) will allow anyone who can show they can’t pay their debts as they fall due to apply for sequestration. That of course doesn’t mean everyone who meets that criteria will, as sequestration can result in people losing their homes and other assets, but where people have negative equity and cars worth under £1,000 (soon to be £3,000) bankruptcy may become an option.
But the question needs to be asked is this a bad thing? Of those 200,000 iceberg bankruptcies in Scotland, the reality is many of these people cannot reduce their indebtness. That is their situation is unlikely to improve and in most cases, will only get worse. That is people who are being left without any disposable income to spend on consumer goods in their local economies for prolonged periods of time, can’t take their children even modest holidays and are so dependent on credit that their debts only get worse. This is also people who are constantly juggling their credit cards and loans, suffering from stress and the frustration of not being able to address their problems. The links between debt and mental health are clear and well established.
So could we help more people to go bankrupt? It may even help the Scottish economy, breathing life back into consumers who are effectively dead financially – up to 200,000. Could we increase the rules in bankruptcy to protect people who have modest amounts of equity in their homes, so they don’t need to sell their home if they go bankrupt, but get to keep it? Such ideas aren’t that fantastic. In the United States, federal homestead protection laws protect the first $15,000 of equity in the home in bankruptcy. Some states have their own laws, which allow higher amounts and in states like Florida, there is no cap on the amount of equity someone can have.
In the United States, there is credit rationing between states, unlike in the UK, which means is it is easier to obtain credit in some states as opposed to others. This is often used as a reason for Scotland not going radically on its own, even though under devolution it could, but, then why not? The availability of credit throughout the EU varies as does the cost, which is part and parcel of having your own legal system. Why should the Scottish Government not use a economic lever like bankruptcy laws to control the availability of credit and indebtedness in Scotland, considering the wider social problems it can have. In the United States the rate of self–employment and business start up is higher than it is here and one of the reasons for that is commonly believed to be the bankruptcy laws, which make people less risk averse. With thousands of jobs cut due in Scotland and a need to increase growth in the private sector, including business start ups, why should the Scottish Government not consider reforming our bankruptcy laws to encourage this?
But there lies a problem. Politically, even 30,000 insolvencies a year in Scotland is likely to be unacceptable, although very possible, soon. There could be repercussions if bankruptcy numbers begin increasing, like credit rationing and increased homelessness (especially under the current laws). We could, therefore, see obstacles being reintroduced into Scottish bankruptcy laws to artificially keep the numbers low. Artificially low that is because the number of people who will be able to go insolvent each year won't really reflect the numbers that are really bankrupt. So we end up with a bottle kneck, where we only allow so many through, not for economic reasons, but for political ones. This has happened before. Prior to 1985 in Scotland the number of bankruptcies in Scotland were less than 300, by 1993 after changes in the law, the numbers increased to over 11,000 and bankruptcy became a consumer remedy, instead of just a remedy for business people. This caused controversy as it saw huge costs for the public purse. The current situation, however, is completely different with the Accountant in Bankruptcy office soon to be full cost recovery – that is costing the public purse nothing. When the laws were changed again in 1993 the numbers went back down to 4,300 – but that didn’t mean the number of people needing to go bankrupt had fallen, just that there were thousands who were trapped in debt traps and weren’t being allowed to escape. Even by 2007/8 (14 years later) the number of insolvencies had only increased to 13,600. In 2008 the lid was again lifted with changes in the law and the numbers increased to approximately 22,000 in the space of a year.
Now many may complain that with bankruptcy increasing their will be more small businesses not getting paid and ending up bankrupt themselves, laying off employees and creating a death spiral. The truth, however is the, the top ten creditors in bankruptcies are huge high street or multinational creditors, not small local businesses – although many of these suffer when local consumers spend years with no disposable income because of debt repayments and cannot be fully economically active in their local communities. The reality is, many of these big international firms still make profits even with thousands of bankruptcies each year and there is other multi national finance companies that specialise in buying up and speculating in their bankruptcy debts to make profits.
We need to change the way we see bankruptcy. Traditionally, in Scotland and the UK we have seen it as a method of debt recovery (which it isn’t – less than 13% of all personal insolvencies are initiated by creditors), but as part of the social safety net we have in society that allows people debt relief and the ability to rehabilitate themselves, not because of recklessness or fecklessness, but usually because of bad luck and misfortune. We need also to see bankruptcy laws as economic levers in society that can be used to reduce indebtedness for future generations by forcing creditors to ration the availability of credit and also as tools that can help encourage people to start up their own businesses by sending out the message, just because you go broke, doesn’t mean you lose everything.
If other countries can use their bankruptcy laws intelligently like this, there is no reason we can’t in Scotland. One percent of the Scottish population going bankrupt in the coming years is not a scandal, but a necessity for our future economic health. 0.3-0.5% is not enough with up to 200,000 iceberg bankruptcies out there.