Bankrupt Nation

Memphis, Tennessee, is famous for blue suede shoes, barbecues and bankruptcies. If you want to understand how today's bankers - the successors to the Medici - deal with the problem of credit risk created by unreliable borrowers, Memphis surely is the place to be.
On average, there are between one and two million bankruptcy cases every year in the United States, nearly all of them involving individuals who elect to go bust rather than meet unmanageable
obligations. A strikingly large proportion of them happen in Tennessee. The remarkable thing is how relatively painless this process seems to be - compared, that is, with what went on in sixteenth-century Venice or, for that matter, some parts of present-day Glasgow. Most borrowers who run into difficulties
in Memphis can escape or at least reduce their debts, stigma-free and physically unharmed. One of the great puzzles is that the world's most successful capitalist economy seems to be built on a foundation of easy economic failure.
Yet the consequences of default in Memphis are far less grave than the risk of death Antonio ran in Venice. After the Plasma Center, my next stop was the office of George Stevenson, one of the lawyers who make a living by advising bankrupts at the United States Bankruptcy Court Western District of Tennessee. At the time of my trip to Tennessee, the annual number of bank­ ruptcy filings in the Memphis area alone was around 10,000, so I wasn't surprised to find the Bankruptcy Court crowded with people. The system certainly appears to work very smoothly. One by one, the individuals and couples who have fallen into insolvency sit down with a lawyer who negotiates on their behalf

with their creditors. There is even a fast-track lane for speedy bankruptcies - though on average only three out of five bankrupts are discharged (meaning that an agreement is reached with their creditors).

The ability to walk away from unsustainable debts and start all over again is one of the distinctive quirks of American capitalism. There were no debtors' prisons in the United States in the early 1800s, at a time when English debtors could end up languishing in jail for years. Since 1 8 9 8 , it has been every American's right to file for Chapter VII (liquidation) or XIII (voluntary personal reorganization). Rich and poor alike, people in the United States appear to regard bankruptcy as an 'unalienable right' almost on a par with 'life, liberty and the pursuit of happiness'. The theory is that American law exists to encourage entrepreneurship - to facilitate the creation of new businesses. And that means giving

people a break when their plans go wrong, even for the second time, thereby allowing the natural-born

 risk-takers to learn through trial and error until they finally figure out how to make that million. After all, today's bankrupt might well be tomorrow's successful entrepreneur.

At first sight, the theory certainly seems to work. Many of America's most successful businessmen failed in their early endeavours, including the ketchup king John Henry Heinz, the circus supremo Phineas Barnum and the automobile magnate Henry Ford. All of these men eventually became immensely rich, not least because they were given a chance to try, to fail and to start over. Yet on closer inspection what happens in Tennessee is rather different. The people in the Memphis Bankruptcy Court

are not businessmen going bust. They are just ordinary indi­viduals who cannot pay their bills - often the large medical bills that Americans can suddenly face if they are not covered by private health insurance. Bankruptcy may have been designed to help entrepreneurs and their businesses, but nowadays 98 per cent of filings are classified as non-business. The principal driver of bankruptcy turns out to be not entrepreneurship but indebted­ ness. In 2007 US consumer debt hit a record $ 2 . 5 trillion. Back in 1959, consumer debt was equivalent to 16 per cent of disposable personal income. N o w it is 24 per cent. One of the challenges for any financial historian today is to understand the causes of this explosion of household indebtedness and to estimate what the likely consequences will be if, as seems inevitable, there is an increase in the bankruptcy rate in states like Tennessee.

Before we can answer these questions properly, we need to introduce the other key components of the financial system: the bond market, the stock market, the insurance market, the real estate market and the extraordinary globalization of all these markets that has taken place over the past twenty years. The root

cause, however, must lie in the evolution of money and the banks whose liabilities are its key component. The inescapable reality seems to be that breaking the link between money creation and

a metallic anchor has led to an unprecedented monetary expan­sion - and with it a credit boom the like of which the world has never seen. Measuring liquidity as the ratio of broad money to output over the past hundred years, it is very clear that the trend since the 1970s has been for that ratio to rise - in the case of broad money in the major developed economies from around 70 per cent before the closing of the gold window to more than 100 per cent by 2005.  In the eurozone, the increase has been

especially steep, from just over 60 per cent as recently as 1990 to just under 90 per cent today. At the same time, the capital adequacy of banks in the developed world has been slowly but steadily declining. In Europe bank capital is now equivalent to less than 10 per cent of assets, compared with around 25 per cent at the beginning of the twentieth century. In other words, banks are not only taking in more deposits; they are lending out a greater proportion of them, and minimizing their capital base.

Today, banking assets (that is, loans) in the world's major econo­mies are equivalent to around 1 5 0 per cent of those countries' combined G D P .

 According to the Bank for International Settle­ments, total international banking assets in December 2006 were equivalent to around $ 2 9 trillion, roughly 63 per cent of world G D P .

Is it any wonder, then, that money has ceased to hold its value in the way that it did in the era of the gold standard? The modern-day dollar bill acquired its current design in 1957. Since then its purchasing power, relative to the consumer price index, has declined by a staggering 87 per cent. Average annual inflation in that period has been over 4 per cent, twice the rate Europe experienced during the so-called price revolution unleashed by the silver of Potosi. A man who had exchanged his $ 1 , 0 0 0 of savings for gold in 1 9 7 0 , while the gold window was still ajar, would have received just over 26.6 ounces of the precious metal. At the time of writing, with gold trading at close to $1,000 an ounce, he could have sold his gold for $26,596.

A world without money would be worse, much worse, than our present world. It is wrong to think (as Shakespeare's Antonio did) of all lenders of money as mere leeches, sucking the life's blood out of unfortunate debtors. Loan sharks may behave that way, but banks have evolved since the days of the Medici precisely in order (as the 3rd Lord Rothschild succinctly put it), to 'facilitate the movement of money from point A, where it is, to point B, where it is needed'. Credit and debt, in short, are among the essential building blocks of economic development, as vital to creating the wealth of nations as mining, manufacturing or mobile telephony. Poverty, by contrast, is seldom directly attribu­table to the antics of rapacious financiers. It often has more to do with the lack of financial institutions, with the absence of banks, not their presence. It is only when borrowers in places like the East End of Glasgow have access to efficient credit networks that they can escape from the clutches of the loan sharks; only

when savers can put their money in reliable banks that it can be channelled from the idle to the industrious.

The evolution of banking was thus the essential first step in the ascent of money. The financial crisis that began in August 2007 had relatively little to do with traditional bank lending or, indeed, with bankruptcies, which (because of a legal change) actually declined in 2007. Its prime cause was the rise and fall of 'securitized lending', which allowed banks to originate loans but then repackage and sell them on. And that was only possible because the rise of banks was followed by the ascent of the second great pillar of the modern financial system: the bond market.