‘Consumer bankruptcy is insurance for which the insured need not save or pay’

G. Marcus Cole

8 Few empiricists in the legal academy have made as large a contribution to the understanding of the law of consumer finance as that made by Professor Elizabeth Warren. Warren and her daughter, Amelia Warren Tyagi, here present statistics intended to move readers with the plight of the “fragile middle class.” But their case rests upon three unspoken and generally unshared beliefs: first, that the middle class is entitled to the lifestyle to which they have become accustomed; second, that the middle class is entitled to this lifestyle regardless of the costs and of who must bear these costs; and third, that since such redistribution to the middle class is, and has always been, politically unpalatable, it must be accomplished surreptitiously through legal mechanisms that most lawyers do not understand, let alone the voting public. In short, Warren and Tyagi want to use bankruptcy to insure a lifestyle for the middle class that their own productivity cannot provide, and the authors want the rest of us to pay for it. While they do not defend these beliefs explicitly, the claims they do make can only be fully appreciated with these beliefs in mind.

The first belief is revealed by Warren and Tyagi’s choice of numbers. They lament the skyrocketing costs of home ownership, education, automobiles, and medical care. They never ask about the costs of less-expensive alternatives (renting and public transportation, for example). Perhaps someone who has experienced a life of lesser means can appreciate that, by failing to consider the alternatives, Warren and Tyagi are implicitly claiming that the middle class is entitled to these increasingly expensive consumer goods, which the less well-off often do without.

As anecdotal proof of the middle class’s plight, Warren and Tyagi note how today’s parents must spend hundreds of dollars on an infant car seat for each child, and, with several children, a large and expensive car to accommodate them. While government regulators may require parents to purchase car seats, they do not require them to purchase cars, especially cars with leather interiors. To those of us who grew up in housing projects or as working-class renters—whose parents did not have a car, or a safe place to park it—Warren and Tyagi’s complaints are more likely to inspire resentment than sympathy.

Their second hidden belief, that the middle class is entitled to its lifestyle regardless of cost, is not as easily exposed. But consider the concept of risk. One irrefutable fact of life is that life is full of risks, and there are different ways to approach these risks. One can take risk “head on,” without any help from anyone else. When risks are particularly large, this “self-insurance” may require that one “saves up” to face the risk. A second way to address a risk is to pay someone else to bear it. A third-party insurer will require a premium equivalent to the probability that the feared event will occur, plus an additional amount for administrative expenses and profit. For many large risks, the premium is preferable to the large savings required to self-insure. A third way to confront risk is to take steps to minimize or eliminate it. A healthy diet and exercise, for example, can reduce many health risks, as can stopping at red traffic lights.

Yet a fourth way to approach risk is to engage in risky behavior and impose the consequences on others. The success of this approach requires a society unwilling to permit people to suffer the consequences of their failure to confront risk responsibly. Any society that has consumer bankruptcy laws is such a society. The United States is one of the few developed countries that fall into this category, and it has only been such a society for a relatively short portion of its history. Only recently have a few European countries begun to experiment with such regimes.

To put the matter plainly, Warren and Tyagi call for a generous consumer bankruptcy system that will obviate the need for members of the middle class to set aside savings to protect against job loss or to pay premiums for medical emergencies. In other words, consumer bankruptcy is insurance, and it is insurance for which the insured need not save or pay.

A society that employs bankruptcy as its primary substitute for savings and health insurance is fraught with inefficiencies that impose costs on everyone; if the “insured” do not pay the costs, then someone else must. All too often, this “someone else” turns out to be more responsible members of the middle class who must pay more for cars and health care to subsidize others’ tastes for granite kitchen countertops and leather car interiors.

If we take seriously the reality of “bankruptcy as insurance,” then we ought to ask ourselves two questions. First, what risks should we, as a society, insure against, either because we actually benefit from insuring against them or because we are in a better position to minimize them? Second, once we have decided that social insurance is beneficial, what form should it take? The answer to the first question will rarely lead us to the second, since there are few circumstances in which society or the government knows more about the risks to any given person, or is in a better position to assess or reduce them, than that person herself. Even where we encounter such risks, we would rarely choose the blunt instrument of bankruptcy as a protection against them. Health risks, for example, are more effectively addressed through health insurance, not bankruptcy.

This last observation uncloaks the third underlying belief held by Warren and Tyagi—that the only way to accomplish the desired redistribution to the middle class is through surreptitious means. If the voting public were asked to make payments directly to members of the middle class in order to preserve a lifestyle that, as Warren and Tyagi have effectively demonstrated, they can no longer afford, such a transfer-payment plan would be resoundingly defeated. If the voting public understood that they were paying more for goods and services to subsidize the Warren and Tyagi conception of the middle-class lifestyle, they would be outraged. But since the voting public is unlikely to discover that higher prices and fewer jobs are a result of a complex and esoteric legal regime called “consumer bankruptcy,” Warren and Tyagi can achieve the middle-class entitlement that they desire by simply persuading enough legislators.

The argument that “the middle class is not over-consuming because the things they consume cost more” has yet to persuade enough legislators to become embodied in law. The best antidote to the potential adoption of such a consumer-bankruptcy system is to fully appreciate the underlying belifs motvating its advocates. <

G. Marcus Cole is a professor of law at Stanford Law School, where he is also the Helen L. Crocker Faculty Scholar and an associate dean.

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Originally published in the September/October 2005 issue of Boston Review