Incentives

I have been reading Richard Posner's book "A Failure of Capitalism". I will probably have more to say about this book but for now want to discuss a small point. On page 290 Posner includes in a list things that perhaps should be restricted:

... the right (which fosters overindebtedness) to eliminate debts by declaring bankruptcy. ...

This is a very simpleminded way of looking at things. It is true that the ability to discharge debt in bankruptcy does to some extent encourage reckless borrowing. However it also discourages reckless lending. So it is unclear whether it fosters overindebtedness on balance. Furthermore the ability to discharge debt also encourages prudent borrowing. Which means restrictions on bankruptcy might primarily deter prudent borrowers (who are more likely to worry about such things). So determining socially optimal bankruptcy regulation is considerably more complicated than Posner indicates here.

In general I think efforts to discourage inappropriate loans should concentrate on the lenders. After all we generally expect that people who have money are smarter and more prudent than people who don't have money and thus are easier to deter with evidence that a loan is likely to go bad.