Donald Trump, Harry Truman and how bankruptcy changed

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Donald Trump has bankrupted businesses. And he’s damn proud of it.

After being criticized for his past bankruptcies during a recent presidential debate, he rebutted:

First of all, like many other very big businessmen…almost all of them, they all used chapter laws, bankruptcy laws, to their own advantage…

Now hundreds of businesses I’ve opened. I used [bankruptcy] three times, maybe four times. That’s great…I’m glad I did.

Four times I took advantage of the laws. And frankly, everyone in my place too.

I used the laws of the land to my advantage, I’m sorry.

He is right to say that bankruptcy is common. More than fifty thousand companies filed for bankruptcy in 2013. About the same number of people filed for personal bankruptcy in 2010 as there were bachelor’s degrees (1.6 million). We really like our second chances.

But we haven’t always been as indifferent to bankruptcy as Trump portrays. Ironically, a former president spent a quarter of his life in financial ruin because he refused to use the bankruptcy code.

Twenty years before he was president, Harry Truman owned a men’s clothing store. It flourished for a time, but a recession in 1921 caused sales to plummet.

Truman tried deep discounts to save the store. “Buy your men’s furniture from us at new prices,” read a sign near the register. “YOU will smile at big discounts. WE will smile at increased business.”

It did not work. The company went bankrupt in 1922, deeply in debt.

But Truman and his partners did not file for bankruptcy. As David McCullough wrote in his biography of Truman, they voluntarily continued to pay their debts decades after the store closed:

After long discussions, the partners decided not to file for bankruptcy – and thus to erase their debts – but to try to repay their creditors as best as possible, as time passed… Fifteen years later the bankruptcy of the store, Harry would still be paying on the haberdashery, and as a result would be short of money for twenty years.

Truman and his partners found it immoral to leave creditors with losses. The store’s failure was the fault of the owners, not the lenders. The debt had to be repaid, no matter how long it took. In 2012, the Truman Library paid seven dollars debt that the former president would have owed to a newspaper delivery man from 1947.

How common was this practice? It’s hard to say. But we know for sure: bankruptcy filings were much rarer in Truman’s day than they are today.

The number of personal bankruptcies per capita is more than 80 times higher today than 100 years ago.

From 1960 to 2004, the US economy grew by an average of 3.4% per year, while bankruptcy filings increased by more than 8% per year.

There are several reasons for this.

Bankruptcy today is a fairly orderly process. In most cases, you file, your credit score is ruined, you move on.

In the past, this left people devastated, with bankruptcy judges seizing assets with so little sympathy that people almost starved. In his book about life in the 1930s, Frederick Lewis Allen wrote of communities so destitute because of bankruptcy that “a mob dragged a judge out of his courtroom, beat him, hung him by the neck until he passed out – all because he was carrying out the law.”

In his biography of the Great Depression, attorney Benjamin Roth describes neighbors showing up at liquidation auctions to buy seized assets at low prices to be returned to their former owners. “Crowds of angry farmers gathered at bankruptcy proceedings and farm auctions, carrying clubs and swinging a noose around a nearby tree to deter outside bidding,” he wrote. “A New York Life Insurance agent was attacked by a mob when he quoted a price for a farmhouse that was less than the value of the mortgage.”

Laws have changed over the years to make bankruptcy friendlier to borrowers. The Chandler Act of 1938 introduced debt reorganization, creating a smoother way to start over. The Bankruptcy Reform Act of 1978 gave borrowers more rights and simplified the filing process.

The social stigma of bankruptcy has also changed. Rafael Efrat of California State University Northridge, found “a noticeable shift, beginning in the 1960s, in public attitudes toward people filing for personal bankruptcy.”

He explained: “People began to attribute more sympathetic feelings towards the bankrupt. This sympathetic mood was largely due to a shift in societal attribution of blame for financial failure.” Banks started looking like the bad guys who got borrowers in trouble. Borrowers with gainful employment bragged about forgoing their mortgages during the housing crash as if it were an honorable thing to do.

Trump echoed that view. “Let me tell you about the lenders,” he said during the debate. “These lenders aren’t babies. They’re absolute killers. They’re not the nice, nice little people, okay?”

OK.

What I want to know is which system was the best? Truman’s day to pay off your debts, or Trump’s day to walk away with pride?

Those who lived through the Great Depression had a lifelong aversion to borrowing. Inasmuch as that’s a good thing – banking and credit crises were rare in the decades that followed – tough bankruptcy laws kept people out of trouble. Truman never returned to a life fueled by debt. Trump has.

And no one should want borrowers who can pay their debts to walk away because it’s convenient, as we saw in the housing crash. Companies owned by private equity firms do this, too. Lenders can assess a business’s chances of failure. It is much more difficult to assess the chances of greed exploiting a loophole. And the cost is ultimately paid by more reputable borrowers. Strict laws here make a lot of sense.

But every intelligent invention is the result of an experiment, which is not always crowned with success. For capitalism to work, the whole system – entrepreneurs, investors, bankers, consumers – must accept that failure is not just optional, but desirable. We are doing something terribly wrong if lots of businesses don’t collapse every year, and something much worse if we don’t give their old owners a second chance. A lenient bankruptcy code facilitates this process. There is a positive correlation between flexible bankruptcy and entrepreneurship laws. A big part of the reason America innovates better than other countries is because we accept that a failed business doesn’t mean a failed person, or even an idea that fails. Everyone gets a second hit. And it’s a good thing.

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