National Bankruptcy

The word “bankruptcy” is often misused. It is not uncommon to hear someone say, “So-and-So is bankrupt” when what they really mean is that “So-and-So cannot pay his bills.” In this latter situation, if So-and-So cannot pay his bills, then he or she is technically “insolvent.” Insolvency means that you cannot pay your bills as they fall due in the ordinary course of business. Insolvency can also reflect a situation in which someone’s total assets, if made immediately available, would not serve to pay off all of the liabilities. It is an important distinction.

The United Bankrupt States of America?

What prompts me to write about bankruptcy is a recent report by economist Laurence J. Kotlikoff, professor of economics at Boston University. Kotliloff wrote of his conclusion that the U.S. government is “bankrupt” insofar as it will be unable to pay its creditors, who, in his use of the term, “are current and future generations to whom [the U.S. government] has explicitly or implicitly promised future net payments of various kinds.” Later, Kotlikoff notes that “Unless the United States moves quickly to fundamentally change and restrain its fiscal behavior, its bankruptcy will become a foregone conclusion”: 

“The proper way to consider a country’s solvency is to examine the lifetime fiscal burdens facing current and future generations. If these burdens exceed the resources of those generations, get close to doing so, or simply get so high as to preclude their full collection, the country’s policy will be unsustainable and can constitute or lead to national bankruptcy.

“Does the United States fit this bill? No one knows for sure, but there are strong reasons to believe the United States may be going broke.”

Kotlikoff takes note of what he calls a total net “fiscal gap” that looms in the future of the nation. This fiscal gap is the present value of the difference between the federal government’s future income and expenses, as calculated using relatively optimistic assumptions, not including any contingent liabilities such as natural disasters or wars. 

The basic numbers in Kotlikoff’s thesis are just a summing up of accounts that are standard in the life of the nation: interest payments, government operations, social security, national defense and other elements of the federal budget that will persist for as long as there is a U.S. government. Kotlikoff adds up the national liabilities to the astounding sum of $65.9 trillion, or about 500% of the nation’s gross domestic product.

I happen to agree with the criticism of U.S. fiscal policy that is embodied in Kotlikoff’s report. By shining a spotlight on the long-term indebtedness of the U.S. government, Kotlikoff is doing a good service. He is highlighting the immense level of federal liability. But I have to take issue with Kotlikoff’s use of the term “bankrupt” in this context. Can the United States government really be financially “bankrupt”? There are implications of sovereign debt and potential future government default that go far beyond the government simply not being able to pay its bills on time. I want to take the opportunity to explore some terms and revisit some history.

What Is Bankruptcy?

The U.S. Constitution specifically requires that Congress enact a bankruptcy law (Article I, Section 8, Clause 4). Thus, in the United States today, bankruptcy is a creature of a federal statute known as the U.S. Bankruptcy Code, with associated rules of procedure. Because bankruptcy in the U.S. is a legal process governed by law and procedure, no one can be “bankrupt” until a certain set of things happens in a U.S. bankruptcy court. 

But what we see today in the U.S. bankruptcy system is the modern evolution of a long and ancient process. Since at least Roman times, and maybe before, a bankruptcy process has been the means by which a society could balance the need to eliminate or moderate a debtor’s debt with the protection of the creditors to whom the debt was owed. In other words, bankruptcy is and always has been a form of legally sanctioned “workout” between debtors and creditors. 

There is a common perception that bankruptcy is a means by which debtors can avoid repaying debts to creditors. But bankruptcy is also intended to be a means by which creditors can recover from debtors as much as possible of what they are owed. It is not too much to say that an orderly process of bankruptcy is necessary (and certainly intended) to foster the growth of commerce, despite its association with personal and business financial failure. 

Ideally, by means of bankruptcy proceedings, debtors can be made to stop piling up debt for unproductive purposes, and creditors can be made to stop extending credit to bad risks. The nation’s (if not the world’s) economic resources can go elsewhere besides into more bad debt, and in a rational economic system, the resource inputs will be put to higher and better uses.

The bankruptcy process is also often referred to as providing a means for debtors to obtain a “fresh start.” This is because, in many instances, bankruptcy proceedings can eliminate most, if not all, of the debt that a debtor owes. But credits and debits must balance, and the debtor’s gain is a creditor’s loss. It is not always pretty, but this is the idea that we have to work with. 

Bankruptcy’s Ancient Roman Roots

The concept of bankruptcy is quite old. The word itself comes from two Latin words, bancus and ruptus. In ancient Rome, the bancus was a tradesman’s counter, across which almost all transactions were conducted and money was exchanged, not unlike the merchant’s counter today (except without the cash register). You can see old banci in, for example, the ruins of Pompeii, preserved for almost two millennia beneath the ash of the Vesuvius eruption of A.D. 79. And the word ruptus means “broken.” So literally, bancus ruptus translates as the breaking of a tradesman’s counter. 

Under the debt-payment laws of ancient Rome, when a merchant was in financial distress, his creditors could go to the local authorities and swear that they were owed unpaid debts. After an investigation, the judicial authority would make a determination as to whether or not a merchant’s business was able to pay the debts. If the determination was that a merchant could not pay, then a third party was appointed by the creditors, or by a Roman magistrate if creditors could not agree on whom to appoint. This third party acted similar to the role of a trustee, and was called the curator bonorum, meaning “protector” or “caretaker.”

The trustee had the legal power to take over the day-to-day running of the merchant’s business. If there was no hope of returning the business to solvency, the trustee could literally smash a merchant’s marketplace bench or openly carry off the bancus as a declaration to the public of a merchant’s financial distress. Thus the merchant’s place of business was broken or gone, hence the term bancus ruptus. 

After smashing or carrying off the merchant’s bancus, the trustee then was charged with holding and disposing of the merchant’s property for the benefit of the creditors. The trustee auctioned off the property of the bankrupt merchant to the bidder who would pay the most to creditors. The merchant was usually left with nothing and could find himself and his family sold off into slavery.

The ancient roots of both the concept and the term for bankruptcy deal exclusively with personal and commercial financial failures. There are no real historical roots for sovereign financial failure. When Alaric and successive groups sacked Rome, for example, they did more than just smash the banci of the merchants; they tore the nation to ribbons. Thus, the use of the word “bankruptcy” in connection with unpayable U.S. federal financial obligations may be inapt. It would probably be better to label the U.S. situation as one of “insolvency,” but let’s look at some more history. 

Bankruptcy in Anglo-Saxon Law

Rome conquered the British island as far north as Scotland, and Roman law governed parts of Britain even after the Roman Empire fell. The historical records are sketchy, but point to the existence of some form of bankruptcy procedure in medieval Britain. We do know that for over 450 years there have been codified bankruptcy laws in Anglo-Saxon jurisprudence. However, what we assume to be bankruptcy today, the elimination of debts, is not what bankruptcy started out as in English law, or what it became. 

In England in 1542, creditors passed the first modern statute that one could view as bankruptcy related. The law had to do with the concept of perjury, or lying to the authorities. This statute was designed to prevent fraud by debtors upon creditors. Under the 1542 statute, the debtor was summoned to appear before a chancellor upon the demand of the creditors. The debtor was examined under oath. If the chancellor determined that the debtor owed a valid debt and the debtor failed to surrender his possessions to pay his debt, the debtor was sent off to prison. 

In 1570, England passed its first full bankruptcy law, during the reign of Henry VIII. This law is the foundation of the early American bankruptcy laws. The practical reason for passing the law was because the debtors’ prisons were at capacity and the incarceration of large numbers of people was creating a national problem in England. While debtors’ prisons remained, under the law of 1570, creditors gained additional remedies to enforce the collection of debts. As the law was implemented, early bankruptcy procedures and remedies had some provisions that would be considered unusual under today’s law. For example: 

Bankruptcy was not a legal proceeding that a debtor initiated as a matter of self-protection (as is often the case today), but rather something that was commenced against a debtor

Thus, individuals could not file for bankruptcy, and only creditors could commence a bankruptcy case against the debtor. The usual situation came about when the debtor was avoiding repayment to the creditor 

People were commonly imprisoned for unpaid debts. Simply the act of filing a bankruptcy action brought a severe stigma upon the debtor and the debtor’s family.

Bankruptcy commissioners (eventually called trustees) could break into a debtor’s home and seize assets, which could then be sold to satisfy the debt. But even the sale of all of a debtor’s assets did not stop the collection of remaining debts owed. That is, there was no discharge of obligation for the remaining unpaid debts 

Collection efforts could continue even after the sale of all of the debtor’s property. It was not uncommon that a highly indebted individual could have his ear cut off or have his ear nailed (while still attached to his head) to a pillory in a public place. Ouch!

Under the English Statute of Anne, a revision to the earlier bankruptcy act passed in 1705, uncooperative debtors could be executed. According to historical records, five people were executed under this law.

Bankruptcy, Demographics, and North American History

Early American law closely followed English law. Hence, the legal process of bankruptcy was available during the first days of American colonization. Bankruptcy proceedings and remedies followed the English template and occurred from the British Maritime provinces of Canada to the Massachusetts Bay Colony to the Virginia settlements. English bankruptcy procedure spread wherever English colonization carved a trail. The State of Georgia was founded as a “debtors’ colony,” to which English debtors were sent in lieu of debtors’ prison in England. 

The concept of “indentured servitude” became established in the Colonies, as both a means of emptying the English jails and of populating the New World with a labor force. The religious nature of many early American settlements provided an overt intellectual foundation, if not also a moral justification and a stern warning, for what followed. One verse that was oft cited was Proverbs 22:7. “The rich rule over the poor and the borrower is slave to the lender.”

Indentured servitude was a means by which debtors could work off their debt through physical labor to benefit the creditor. Many individuals in England, looking for a way out of a system stratified by class and rigid economic limits, booked passage to the New World by signing up as indentured servants to pay the fare. The indentured servitude concept evolved to where creditors bought and sold indentured servants in a manner that paralleled slave ownership. Instead of being based on race, however, indentured servitude was based on economic condition and debt. The worth of any given indentured servant could actually be reduced to a net value. 

In pre-Revolutionary America, indentured servitude became an established legal remedy. There was a well-defined system of chasing down, apprehending and returning indentured servants who had “escaped” from their situation, which formed the model for later fugitive slave laws. One of the most famous indentured servants in American history was a young man named Benjamin Franklin, whose later views on avoiding and staying out of debt were very much formed and informed by his early indentured experiences. 

France, Debt, and Debtors

It is interesting to speculate what would have happened in the early exploration and development of North America had France followed a similar path in its bankruptcy laws and procedure. France, too, had many poor people and not a few debtors who owed quite a bit of money to creditors. But instead of adopting a national policy to send its poor and indebted to the New World, France sent Jesuit priests (and some explorers and traders) to its territories in Canada. 

Apparently lacking an understanding of the use to be made of indentured servants in overseas colonies, France kept much of its debtor class at home. French society and legal process was content merely to throw the debtors into a French version of debtors’ prison. In many instances, French authorities took these “sweepings of the jail,” as they were called, and put them to work serving in the army and fighting wars with France’s neighbors. 

So in the 17th and 18th centuries, Britain sent debtors to the New World. France sent priests and a few trappers and traders, and remarkably few women. After a century of such divergent immigration patterns, France was confronted with a populous group of English-speaking, British-controlled colonies to the south of its own holdings in Quebec, Ontario, and beyond Michigan and Wisconsin to as far west as the Rocky Mountains. And by the 1750s, the English-speakers south of the Great Lakes were expanding west into the French territories of the Ohio River Valley. 

Thus, there came a time when French interests came into direct conflict with the expanding colonial and demographic interests of Britain. Open warfare between Britain and France erupted in western Pennsylvania (involving, by the way, a young Virginian named George Washington). The French enlisted Indian allies and waged the Seven Years’ War (1756-1763). This war expanded from its roots around the Great Lakes region to oceans and colonies throughout the world. 

At one stage of the fighting in North America, the French and their Indian allies pushed English settlement back east of the Appalachian Mountains and into present day York County, Pa. (For the next 200 years, the collective memory of Indian atrocities toward white settlers during this war would carry great weight in the thinking processes of both colonial, and later U.S., policies toward the otherwise native Americans. This is another discussion for another time.) But eventually, the manpower and resources of the British territories prevailed against the French. Not a few formerly indentured servants in Colonial America “bought” their freedom with service to the English king during the Seven Years’ War.

The Seven Years’ War put an end to French territorial expansion in Canada and severely curtailed what the French were able to do in their lands west of the Mississippi. At war’s end, Canada became a British territory. In the late 1770s and early 1780s, the French monarchy attempted to regain some advantage in North America by supporting the U.S. Revolutionaries who were fighting against the British. Famous names such as Marquis de Lafayette and Comte de Rochambeau assisted the Americans ashore. And it was a French fleet under Comte de Grasse that sealed the fate of the British under Gen. Charles Cornwallis by trapping the British Army at Yorktown in 1781. 

But fighting a battle for empire is expensive, even for a French king. By the late 1780s, the French leadership had to summon together a legislature for the purpose of raising revenue to meet the otherwise unpayable debts of the French nation. Once convened, the legislature had a few ideas of its own. And the French monarchy, having no emigration outlet for its vast debtor class, ultimately faced many of its impoverished citizens in the streets of Paris during the French Revolution in 1789.

National Debt and the Consequences to France

The French Revolution was an outgrowth of the need for the French government to confront its national debt. This revolution was truly an example, writ large, of the ancient Roman concept of bancus ruptus, except that in this case, the French people smashed the entire national system of governance and a whole lot more. The national debt of France was a result of a long series of efforts by the monarchical government to gain and hold empire. Yet the French effort to gain and hold empire did not include a national policy of “exporting” large numbers of the nation’s poor people to distant lands where they could find some hope, if not make trouble for others. 

The French Revolution gave rise to Napoleon. And in 1803, Napoleon found himself badly in need of funds and facing an indefensible situation in North America. So Napoleon sold France’s Louisiana Territories to a young and rising United States of America and its ambitious and prescient President Jefferson. The price for the Louisiana Territories was all of 3 cents per acre. For France, this was truly a national bankruptcy sale.

Until we meet again…
Byron W. King
July 26, 2006