It’s time to widen the floodgates

First published on the 5th of September in the blog A Burdz Eye View

Bankruptcy law is like criminal justice.  It’s a political football: no one wishes to be soft on crime and no one wishes to create a moral hazard by allowing a cheat’s charter.  However, Scotland, like the rest of the UK, is facing a huge personal debt problem and although austerity measures are being introduced to tackle soaring public debt, all evidence suggests that our personal debt levels will continue to rise over the next five years.

It is, therefore, correct that the Scottish Government brings forward a new bankruptcy bill in this parliament, which will launch a new Financial Health Service.

Personal debt in the UK currently stands at £1.45 trillion (that’s almost equal to the UK’s Gross National Product). The Scottish share of that is possibly as much as £145 billion. Of that, approximately £125 billion could be on mortgages and other secured debts with the remaining £20 billion being on credit cards, loans and other unsecured debts.

Of those that owe this £20 billion on unsecured debts, recent research by the University of Wales has found that possibly up to 200,000 Scottish consumers could be what they call iceberg bankruptcies: that is, debtors who are only making minimum payments to their debts and who could quickly slip below the water line if they were exposed to any type of income shock.

And this situation is unlikely to improve anytime soon. The UK Office of Budgetary Responsibility is anticipating that UK personal debt could increase to over £2 trillion by the first quarter of 2017 with incomes stagnating or falling in real terms and the cost of living increasing. Put simply more and more of us will need to continuing borrowing to maintain our lifestyles. And it’s not just a case of having to cut our cloth accordingly, either, as The Joseph Rowntree Foundation found out with their Minimum Income Survey: society appears to have changed. For example, many of us now live out of town and have to commute to work: so we need to own cars or pay excessive rail tickets; we have to pay the mortgages for the homes we bought but no longer can afford to live in or sell, with the housing market in the doldrums and negative equity being prevalent.  The most that is possible for many of us is cutting down on eating out and spending at Christmas.

It is, therefore, vital that the Scottish Government recognises the scale of the task ahead, although judging from the consultation document on bankruptcy reform, it is not clear it does.  The introductory text to the document states that the Scottish Government has a broad and ambitious agenda for reform and has looked at not just the processes but also the principles of bankruptcy and debt solution reform.  However, examining the questions asked, it is clear this is not the case. It is certainly true that what has been discussed is a modernisation of the laws and many of the suggested reforms are welcome, but it is unlikely these new reforms will be sufficient to deal with the challenges ahead.

The basic premise behind the reform proposals appears to be that bankruptcy is to be discouraged, suggesting a political fear of creating a moral hazard.  This is also the inference ­­­every time the quarterly insolvency figures are released by the Accountant in Bankruptcy and the Minister, Fergus Ewing, holds up the falling numbers as a success.

The question, however, that should be asked is whether those who need access to the remedy are getting access to it. A see no evil – hear no evil policy is never to be commended.  There is also evidence in relation to the lowest income debtors suggesting they are being excluded from obtaining access to bankruptcy due to the level of application fees.

The Scottish Government should note the recent observations of the International Monetary Fund in its 2012 World Outlook Report that schemes which write down and restructure personal debt can be desirable and can assist economies to recover more quickly from economic shocks like those experienced in the last few years.  This is particularly so, where there has been a rapid build up of personal debt and substantial levels of public funding to support financial institutions. It is one of the reasons the Republic of Ireland is currently being forced to liberalise their bankruptcy laws as part of the IMF recovery plan.

It is also not a new idea and is best illustrated with the comments of the Roman philosopher and lawyer, Cicero in the first century BC, who said when speaking about Nexum, a form of Roman debt bondage:

“ When the plebeians have been so weakened by the expenditures brought on by a public calamity that they give way under their burden, some relief or remedy has been sought for the difficulties of this class, for the sake of the safety of the whole body of citizens”

The Scottish economy and its consumers are that class and now need wider relief from their debts.

Which is not to criticise the proposals in the forthcoming bill, but simply to suggest that they do not go far enough. The Scottish Parliament has already done much in its short existence to assist debtors: arguably, we now have some of the most progressive debt laws in Europe.  But to face the tasks ahead, the Scottish Government needs to be bolder and recognise the full potential of using bankruptcy laws not only as a means of recovering debts, but also as an economic lever to assist in reviving our economy and encouraging growth.

Our current bankruptcy laws are dreadfully old century and were created for another era.  Despite being reformed in 1913, 1985, 1993, 2007 and 2010, they are essentially underpinned by the same principle which existed in 1856.  Our system was essentially created to allow creditors to recover debts but this is no longer an appropriate primary role in a credit based society.  The role of bankruptcy law today should be to provide debt relief, encourage entrepreneurship and act as a safety net for the poorest.

This was the case even before 1985, when less than 300 people were made bankrupt each year and over 86% of those bankruptcies were initiated by creditors.  These days, those figures have been almost reversed with over 90% of all Scotland’s 20,000 plus personal insolvencies each year being initiated by the debtors themselves, primarily to seek debt relief.

These levels of personal insolvency, however, still represent less than 0.38% of all those eligible to use the remedy, providing no evidence we are creating a can pay, won’t pay culture and by international standards well within the “safe limits”.

But the figures show that consumers are now burdened with unmanageable debts and their inability to resolve their situation will hamper the Scottish economic recovery and result in greater cost to the public purse and financial hardship amongst debtors.

While this bill will bring immediate improvements to the system, it is unlikely to stand the test of time and will require further, future reform.  Any hope that we are laying the foundations of a system which will serve a generation is overly optimistic.

By opening the gates to bankruptcy more widely for a short period of time and enabling greater protections for debtors, Scotland’s economy could benefit from the relief and begin the recovery that could prevent others from defaulting on their debts. We already have seen evidence of this potential with the financial stimulus the UK economy received by consumers reclaiming Payment Protection Insurance: some have even suggested it has done more to encourage growth than any UK Government initiative.

If we do not open these gates, we will need to return – at some point in the future -to, and address, the issue of personal debt. The UK economy is barely growing; 80% of the austerity measures and cuts have still to be made; personal debt is rising.  The Scottish Parliament does not require Westminster’s permission to legislate in this area, so the only question is: are we independently minded enough to follow our own path?  Ironically, for a pro-independence government, I have my doubts.