Why Bankruptcy is Good - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 20 July 2013
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- By Asad Dossani, Author, The Lucrative Derivative Report


Asad Dossani
Earlier this week, the city of Detroit became the largest US city to file for bankruptcy protection. This made headlines largely because Detroit was once a thriving city, and was the birthplace of the American auto industry. Years of industrial decline, rising pension costs, high debt levels and falling tax revenues mean that Detroit can no longer pay its bills.

The common connotation attached to bankruptcy is highly negative. It implies that things are so bad, and only getting worse. However, this is a misperception. For the city of Detroit, bankruptcy is a good decision, and the city will come out stronger in the long run.

Why is this the case? Bankruptcy means that the city can renegotiate its debts so that creditors receive less. This will bring the city's financial obligations to a level that is sustainable in the long run. Bankruptcy is like wiping clean one's past, and starting fresh for the future.

There are two alternatives to bankruptcy. The first is default, whereby the city does not meet its financial obligations, are there is no agreement reached with creditors. The second is a bailout by the federal or state government. Default is highly disorderly, while bailouts tend to just delay the inevitable future bankruptcy or default.

Many Eurozone countries would benefit heavily from bankruptcy. Countries like Greece that are highly indebted and have received bailouts would be allowed to start fresh if they could file for bankruptcy protection. Many of the indebted Eurozone countries are going through severe recessions due to the austerity measures imposed as conditions of the bailout.

Bankruptcy may sound like a bad word, but it is much better than default and much better than a bailout. Bankruptcy protection exists so that when debt levels become unsustainable, cities, companies, or countries are allowed to start again without getting weighed down by the past.

Another benefit of bankruptcy is that it forces bondholders to take losses. The threat of bankruptcy means that bondholders will properly take default risk into account when making loans, rather than relying on bailouts to ensure they get repaid. Though Detroit filing for bankruptcy means that things are tough, it is a good decision and will pay off in the long run.

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is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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2 Responses to "Why Bankruptcy is Good"

KSRao

Jul 21, 2013

After all, somebody is losing somewhere, here it is bondholders, and it does not seem to be fair in anyway! Most of these holders could be bodies investing funds of the working class. Companies and cities must learn methods to live frugally! India and Indian states are also heading for similar disaster if we do not mend our ways! We would do well to repay our foreign loans first than dole out benefits to countrymen as otherwise they will balloon up converted to Indian currency and the Indian rupee will lose whatever little credibility it has now.

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Krishna

Jul 21, 2013

Why does declaring bankruptcy force lenders to let go of their claim? is it beacause they now have to compete with others for their debts? Did they not know it before to negotiate their debt?

What is the impact of declaring bankruptcy for the borrowers future (as it is claimed that you are wiping off your past)

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