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. Last Updated: 07/27/2016

The Advantages of Bankruptcy

In capitalist Russia, the words "redistribution of property" have always meant something negative. In the early 1990s, it was about large-scale looting from the government's privatization programs. In the late 1990s, it was a catchphrase for battles among oligarchs. In the Putin years, it involved state-controlled companies raiding private companies.

Nonetheless, the successful development of a capitalist economy is impossible without redistributing property in one form or another. This is particularly true during a crisis.

The Russian government needs to adopt a new form of property redistribution -- one that differs fundamentally from the corrupt schemes of the 1990s. Within the boundaries of transparent bankruptcy laws, it needs to take back ownership from those companies that have failed and put them in the hands of new owners who have a chance of making a profit.

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What is the ideal mechanism for handling bankruptcies? The government identifies a company that cannot pay off its debts, puts in under bankruptcy protection, and then sells it to the highest bidder, using the funds to pay off the company's creditors.

In reality, the bankruptcy process is very complex, which explains why bankruptcy laws vary widely from country to country. Moreover, the government, which has the ultimate responsibility for regulating bankruptcy proceedings, faces numerous hurdles. For example, government officials must ensure that the owners and managers of the firm applying for bankruptcy do not sell off their shares. But all too often, corrupt officials are looking for ways to profit from bankruptcy proceedings rather than protecting the public interest. The other important interest for the government in regulating bankruptcies is to avoid massive layoffs in cities in which the financially troubled firm is the main employer.

There are many companies that have borrowed enormous sums of money against their shares and are now left unable to pay them off. The best government policy in such cases would be to subject these companies to bankruptcy proceedings with a strong government role in administering and regulating the process. For example, if a real estate developer cannot honor its debts, the government should take ownership of the buildings it has already built, sell them at open auctions and give the money to its creditors. Since real estate prices are falling, the creditors might earn only a percentage of the amount of the original loan, but is that really so bad? The alternative is to use taxpayer money to settle those debts.

There is also another, even less desirable option. This is when the government bails out a failing enterprise in return for a specified number of the company's shares at pre-crisis prices -- for example, when the government paid off Alfa Group's debts to Deutsche Bank. But in this operation, the government ends up with nearly worthless shares.

Even when the situation concerns an industrial giant, there should be no confusion between the interests of its owners and those of the workers. If a company eliminates its debts through bankruptcy proceedings and remains profitable, it won't lay off its workers.

Bankruptcy implies the removal of both the company's owners and its creditors. At the same time, it is no easy task to find a new owner for a company during a crisis -- even if the firm is debt-free. This is why the question of nationalization has become so urgent. Even with all of the costs and drawbacks involved in such a policy, it is better than simply throwing money at a company that will never be able to pay off its debts. After all, if a businessperson were to lose a lot of money at the gambling table, no one on the side would even think of stepping in and covering the losses.

Konstantin Sonin, a professor at the New Economic School/CEFIR, is a columnist for Vedomosti.