Britain’s bankruptcy rules have exacerbated the effect of the credit crunch across the country, the UK’s leading economics institute said today.

Bankruptcy reforms introduced in 2004 under the Enterprise Act allowed bankrupts to be discharged after one year instead of three to help to reduce the stigma of “honest failure”. However, the National Institute of Economic and Social Research said that this had fostered an environment in which people were happy to take on debt that they could not repay, inflating the losses of banks and other lenders.

The institute has called for international cooperation to make bankruptcy laws more stringent, especially in the United States, where lenient bankruptcy and mortgage rules allow borrowers to wipe out their debts without penalty. American borrowers who default on their mortgage can leave the property and write off any unpaid mortgage bills. This, the institute said, amplified the scale of the global credit crisis.

Patricia Hewitt, who was Trade and Industry Secretary when the Enterprise Act was introduced, said at the time: “It will open up markets, increasing competitive pressures. It will improve consumer protection. It will give those entrepreneurs who have failed honestly a second chance and help ensure that companies in difficulty do not go under unnecessarily. Together, these measures will help promote an enterprise culture and drive up productivity.”

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However, Martin Weale, director of the institute, said: “This Government has done its best to make things worse. The Enterprise Act had a disastrous impact on people’s attitude to excessive risk-taking. There should be international cooperation on bankruptcy laws, as those investing in US banks may not realise how lax the US bankruptcy laws are.”

The institute is giving warning today that the economy faces its riskiest run for more than a decade. It predicts that a consumer crunch will cause household spending growth to grind to a halt in the autumn, undercutting the Chancellor’s predictions for the economy to rebound strongly next year.

Experts forecast that record numbers of consumers will become insolvent by the end of this year. KPMG, the accountant, said that it expected 130,000 people to declare themselves bankrupt or enter into an individual voluntary arrangement.

IVAs allow consumers to repay only a portion of their debts, and there were 106,000 last year. However, insolvency figures for the first three months, to be released today, are tipped to show only a slight rise. Experts say that IVA figures are still low after a spat between the companies setting up IVAs and lenders. Lenders refused to accept many IVA schemes, arguing that IVA firms were taking too big a slice of borrowers’ repayments for themselves.

The institute also said that the Government should limit the amount of money that homebuyers can borrow. It said that they should be allowed a mortgage to cover a maximum of only 90 per cent or 95 per cent of the value of the property. Last year borrowers could choose from a range of loans offering up to 130 per cent of the value of a property. All lenders have stopped offering such mortgages.

Road to ruin

— Reforms to the Enterprise Act made in 2004 allow bankrupts to be discharged after just one year

— Restrictions faced by bankrupts, such as denial of credit of more than £250 and freedom to become a company director, are also cleared after 12 months

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