December 20, 2009
What are we going to do with small businesses that are flirting with bankruptcy? This week, I have had numerous ‘end-of-season’ conversations with businesspeople about the state of the nation. One of the recurring subjects was what are we going to do with the thousands of businesses that are close to going bust.
More significantly, because of the banking practice of getting personal guarantees from small business people for basic working capital, many good individuals face personal bankruptcy because they were caught on the wrong side of the cycle.
Without credit to keep the businesses going, many will have to decide to shut up shop in the new year.
I am not just talking about property people here, the troubles are across the board. The business model of our country is broken. Costs, rates, rents and taxes are too high, and debts are crippling businesses, with the real rates of interest above 11 per cent for many. In normal times with a properly functioning credit system, businesses would be able to survive through the recession, staying open and waiting for the cycle to turn – but not this time.
Thousands are now technically bankrupt and people are thinking of moving abroad to avoid the stigma of bankruptcy here. In Ireland, we treat our bankrupts with particular vindictiveness.
A bankrupt person in Ireland has to wait 12 years before the stain of bankruptcy is lifted, and they can borrow again to create a business. In Britain it is one year.
Equally, bankruptcy proceedings have to be heard in the High Court, with all the expenses that incurs.
In other countries, people who take risks, build things and employ others are supported by the law so that if they fail, they will start again. Not so in Ireland. Here, if you fail, you fail spectacularly and everything is structured to make sure that, if you fall, you don’t get back up again.
How does that facilitate a recovery?
Societies are made up of all sorts, as different as the average school classroom in terms of abilities and personalities. While entrepreneurship is not for everyone, the people who get up in the morning and take risks, creating things and expanding businesses, are crucial to the welfare of others. If they make mistakes, they shouldn’t be hammered for it.
In Ireland, if we examine our bankruptcy laws, what we see is that the weight of the law is there to protect the creditor, not the borrower. But the creditor creates nothing. The creditor, normally a bank, simply acts as a middleman, passing on other people’s savings to those who would use the savings to create things.
Why should the creditor be so protected in a crisis? Surely the balance of risk in the deal should be more evenly distributed. In the crisis, if our law hammers the risk-takers and protects the creditors, the entrepreneurs will just leave and the lawyers, civil servants and banks will win.
Without entrepreneurs, the society doesn’t create wealth, and we end up being a large debt-servicing agency dancing to the bankers’ tune rather than a vibrant, competitive economy where businesses are started and people are encouraged to go and do things for themselves.
One of the reasons the US is such a dynamic capitalist society is because, as one of its core values, it allows people to make mistakes. People aren’t regarded as a success until they have failed. Failure is not a stigma; it is a war wound, a battle story to be remembered fondly in better times.
In the US and Britain, bankruptcy is part and parcel of business; here, in contrast, it is a stick with which to bash people.
More worryingly, by treating unlucky risk-takers as outcasts, we reinforce the conservatism which characterises our country and reinforces the bias towards the professions, which afflicts so much of Irish society.
The day the Irish mammy tells her clever child to start a business rather than become a lawyer is the day we start turning the corner. However, that day will only come when we change the way we treat people who are bankrupt.
The more the law upholds the age-old social stigma of bankruptcy, the more the mammies will funnel their smart kids into medicine, law or some other profession, and the fewer wealth creators we will have.
The best way to gauge this deep and unproductive bias at the heart of our society is to look at the number of people who entered formal bankruptcy proceedings here.
In Britain in 2008, 67,000 people entered formal bankruptcy, with another 39,000 entering an individual voluntary arrangement (an IVA is a legal alternative to bankruptcy in Britain that does not exist in Ireland). In an IVA case, a third party negotiates with creditors and, if those holding more than 75 per cent of a debt agree, a binding scheme of arrangement is entered into. This is a sensible arrangement, as it gives people a chance.
In Ireland, this kind of scheme doesn’t exist and, in 2008, fewer than 100 people entered bankruptcy. Put another way, in Britain 1 in 580 people entered bankruptcy/IVA in 2008; in Ireland, the number was less than 1 in 45,000.
Now look at the figures for the US. In the US, there were 1,074,225 bankruptcy filings by individuals in 2008.That is one in 283 of the population. Many of these are personal bankruptcies rather than business-related.
Bankruptcies happen, and to deny them simply clogs up the system and punishes the entrepreneurs who get into trouble. But fluidity in business where people can deal with creditors rationally is a sign of health not weakness. Easier bankruptcy laws are not a delinquents’ charter, but a logical reaction to the fact that risk exists.
Some argue that the easier it is to declare yourself bankrupt, the higher the risk of ‘moral hazard’.
Moral hazard is the risk that a bankrupt will just go bankrupt again and again and that in a sense you risk accommodating ‘bad behaviour’.
But forget moral hazard for a minute and think about real hazard. Real hazard is when you drive away your creative and entrepreneurial class by attaching a stigma of failure to them too easily. Real hazard is when you make it so difficult for them to recover that you freeze them out after one mistake.
Real hazard is when you uphold the age-old Irish bias against risk-takers and turn large parts of the society into employees waiting for someone else to take the lead. These are the actual rather than the moral hazards which can ruin a society and eliminate the chance that the economy can recover. In short, by hounding bankrupts, we weaken ourselves.
So are we going to give ourselves a chance? Are we going to condemn businesses that are in trouble to years in the wilderness? Are we going to let people who have made mistakes, recover and start again? Or are we going to be vindictive?
The choice is ours. If we change our bankruptcy laws, we can give people a second chance, make creditors know that the risk of investing in businesses is shared and, more to the point, allow the brains and initiative of the Irish people to flourish without the stain of failure being permanent.
The recession gives us a chance to change our mindsets. We could begin with banishing the stigma of a listing in Stubbs Gazette and realising that, in every venture, there is risk. The country that takes no risks goes backward.