The Rule of ... ?

The 1787 Constitutional Convention convened just weeks after Shay’s Rebellion had been put down in Massachusetts. This was not the first debtor rebellion in the states since the end of war, but it was the largest and it pointed up the inadequacy of the weak central government authorized by the Articles of Confederation to deal with certain internal problems, let alone foreign policy.

Significant conflict between “monied interests” and ordinary farmers developed in the years following the end of the American Revolution. The vast majority of the American economy was agricultural. Almost everyone was involved in agriculture at some level. The only way most farmers could get a start or deal with seasonal cash flow issues was to incur debt. Those that had money to lend could turn a profitable business, providing they could be repaid. That was becoming increasingly problematic.

The American states owed considerable war debts to foreign interests. The states could only raise funds through taxation, mostly in the forms of property, trade, and import/export taxes (including imports from and exports to other states). This inhibited interstate trade and pushed farmers at the margins into poverty. Taxation with representation was becoming as noxious as taxation without representation had been.

To make matters worse, since no reliable form of specie existed in the American states, America’s creditors demanded repayment in gold or silver, commodities that were extremely scarce in the states. This effectively established a precious metal standard for both government and private debts. When farmers could not produce precious metals to pay their debts and their mounting taxes (of ever increasing variety), courts issued judgments against them. To satisfy the judgments, properties were foreclosed and even meager personal possessions were confiscated. Many basically honest people found themselves in debtor’s prison.

Americans had been used to a certain level of democratic governance for well over a century. But representative and executive positions had mostly been reserved for the upper class. However, the wave of populism fostered by the revolution was changing things. Debtors had gained the upper hand in some state legislatures and had passed laws that were overly favorable to debtors and disrespectful property rights. Although well meant, these laws caused a credit contraction as those with resources quit lending. This harmed the very people the laws intended to help, causing yet more conflict between the ‘haves’ and the ‘have-nots.’

America was in crisis as the Philadelphia convention convened in May 1787. The Founders’ response to the credit-debt crisis was multi-pronged. Article I Section 10 of the Constitution prohibited states from enacting any “Law impairing the Obligation of Contracts.” It also prohibited states from taxing (or regulating — Article I Section 8) interstate or international commerce, reserving this right to Congress. The federal government assumed the states’ war debts under Article VI, rendering some of the state level taxation unnecessary. (This was a sticky issue because some states had been more responsible in paying down their debts than other states.) Article I Section 8 also reserved to Congress the sole authority of establishing “uniform Laws on the subject of Bankruptcies throughout the United States,” ensuring that there would be some kind of standardized relief available to debtors.

These provisions taken together helped ensure the sanctity of the contract and of private properties, while also providing a pathway to relief for debtors. That pathway was only defined when Congress passed bankruptcy laws beginning in 1801. The laws regarding contracts apply to everyone at all levels. This rule of law is a significant stabilizing element that helps form the basis of our economy and of our system of government.

GMU economist Todd Zywicki argues in this WSJ op-ed that the Obama administration has violated this basic rule of law in its exuberance to save union jobs at Chrysler.

“The Obama administration's behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors -- entitled to first priority payment under the "absolute priority rule" [of U.S. bankruptcy law] -- have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar. …

“Violating absolute priority undermines this commitment by introducing questions of redistribution into the process. It enables the rights of senior creditors to be plundered in order to benefit the rights of junior creditors.”

Moreover, Zywicki argues that “in a Chapter 11 reorganization, creditors have the right to vote to approve or reject the plan. The Obama administration's asset-sale plan implements a de facto reorganization but denies to creditors the opportunity to vote on it.” This is the essence of the Chrysler “speedy bankruptcy” that has been mentioned in news sound bites. The rule of law is being violated to pay off political cronies; in this case, “union workers whose dues, in part, engineered [Pres. Obama’s] election.”

“The value of the rule of law,” writes Zywicki “is not merely a matter of economic efficiency. It also provides a bulwark against arbitrary governmental action taken at the behest of politically influential interests at the expense of the politically unpopular.” This is one of the basic tenets of our system of government. Government is to be of, by, and for all of the people, not just the politically powerful or favored.

Moving away from the rule of law to the arbitrary rule of men on contract issues will dismantle the creditor-debtor balance the Founders and their successors so carefully crafted. As occurred when state legislatures began disrespecting contract law and property rights in the 1780s, this path will also lead to a credit crunch as those with resources to lend factor in political risk factors.

Zywicki says, “we need to ask how eager lenders will be to offer new credit to General Motors knowing that the value of their investment could be diminished or destroyed by government to enrich a politically favored union. We also need to ask how eager hedge funds will be to participate in the government's Public-Private Investment Program to purchase banks' troubled assets.”

Many of the President’s fans seem to assume that their political opponents have been rendered permanently politically impotent. But history shows that they will come to power again. How will the President’s current supporters feel in some future day when their political opponents wield the method the President is pioneering to the benefit of their own politically favored groups?

The sanctity of the contract is not a partisan issue; it is an American issue. Majorities from all sides of the political spectrum (perhaps excepting Communists) should stand up against this abuse of power before it becomes another standard tool in the American political arsenal. It really doesn’t matter who is being paid off in this current instance. The danger posed by this action is enough to warrant opposing it.