29 June 2015

The benefits of bankruptcy……….

I'm not a financial expert but I have always understood that declaring 'bankruptcy' was a mechanism which allowed a failed mercantile entity (let's call it Widgets Plc) to negotiate its way out of insurmountable debt. I believe that it works something like this: Widgets Plc trades in its marketplace and either takes on too much borrowing or trading conditions change - either way, Widgets finds itself unable to pay its bills. At that point one, some or all of the creditors (people or businesses who have traded with or lent money to Widgets Plc) move in and force Widgets into bankruptcy in order to realise  some asset value in order to settle debt. Alternatively, the bankruptcy process can force Widgets into a restructuring which usually involves cost cutting, redundancies and refocussing of business activity. This second route is intended to allow some part of the reconstructed Widgets to continue to trade, but profitably, in order to pay off some or all of the debt at some future point.

But key to forcing bankruptcy is timing - lenders or trading partners need to act responsibly and before debt has reached a point where Widgets is guaranteed to collapse completely. In many cases, this doesn't happen and, when bankruptcy is declared, the assets realise far less than the debt meaning that, in the most extreme cases, creditors get only a fraction of what they are owed. Seen this way, bankruptcy can be seen either as a punishment for poor business methods or, on the other hand, as punishment for poor or inappropriate lending.

So, why does this subject interest me right now? The simple answer is 'Greece'.

From where I sit, Greece is a victim of both excessive lending and borrowing. Everything was fine until the global financial crisis of 2007/8 which was caused, not by the Labour Party (as David Cameron and the Tories would have you believe) but by the irresponsible lending practices of banks and banking institutions around the world. When the party stopped, everyone had a hangover and recovery has been both painful and slow. For those economies with something to sell or trade, recovery has been possible. Not so for those weaker economies, like Greece, who were lent money without thought or consideration of their ability to repay.

And now Greece wants to declare bankruptcy which, in advanced economies is a way of restructuring debt but, in this situation, bankruptcy will crystallise the level of debt and it may be that some of the lenders will not be able to survive the losses.

I don't know enough to predict an outcome but, if the Greek people are forced to endure more 'austerity' I can easily see a rise in Greek nationalism where wider European institutions and countries are blamed for the pain. And the Islamic State will look to exploit such an opportunity.

All because the banks can never be blamed for their own mistakes.