The Bankruptcy Trap
Bloomberg Businessweek|April 13, 2020
For the economy to escape the crisis and grow again, people and companies will need help with their debts
Pat Regnier and Molly Schuetz

Bankruptcy laws were written to help individual companies. They don’t work so well when many get into trouble at once. The companies’ balance sheets are interdependent: Reducing what one owes will weaken its creditors, making it impossible for them to pay their creditors, and so on. Businesses that could have bounced back are forced to liquidate as their court cases drag on.

This is called systemic bankruptcy, and it’s the Bankruptcy laws were written to help individual companies. They don’t work so well when many get into trouble at once. The companies’ balance sheets are interdependent: Reducing what one owes will weaken its creditors, making it impossible for them to pay their creditors, and so on. Businesses that could have bounced back are forced to liquidate as their court cases drag on.

This is called systemic bankruptcy, and it’s the nightmare scenario for the financial impact of the Covid-19 pandemic. Steps can be taken to avoid it, but it’s not clear whether governments and central banks in the U.S. and around the world will take them in time.

The best way to avoid debt gridlock is to use government support to keep the number of bankruptcies below the tipping point at which they become systemic, says Joseph Stiglitz, a Nobel laureate economist at Columbia University. He co-wrote a paper with Tarik Roukny and Stefano Battison about interconnectedness and systemic risk that was published in 2018 by the Journal of Financial Stability. “Somewhere between the case of an isolated bankruptcy (American Airlines) and mass default (Indonesia, with 70% of businesses in arrears) is the borderline between individual and systemic bankruptcy. There’s no bright line,” Stiglitz wrote in an email on April 6. (His example of an isolated bankruptcy, American Airlines, was under protection from creditors from 2011 to 2013.)

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