Bankruptcy Bill Might Not Have Desired Effect
The credit industry--banks, credit card issuers, auto dealers and other lenders--is hoping the bankruptcy reform bill working its way through Congress will reduce consumer bankruptcy filings and force people to pay more of their debts.
Whether the reforms will do either is still an open question.
The Senate approved a bankruptcy bill Thursday and sent it to a conference committee to be reconciled with a similar bill passed by the House. President Bush has promised to sign the bill, which caps a three-year campaign by banks and credit card companies to make it harder for consumers to walk away from their debts.
All sides agree that the measure, slated to take effect six months after Bush signs it, would make bankruptcy more time-consuming, complicated and expensive. Consumers would have to fill out more paperwork and, if their incomes are high enough, might be pressed to repay some of their debts.
Those deemed able to pay--under a formula outlined in the measure--would be shunted from Chapter 7 bankruptcy, which liquidates many debts, to Chapter 13, which requires a repayment plan. Under the proposed rules, protecting certain assets, such as a car, a large retirement account or equity in a home, may also be more difficult for some filers.
Instead of reducing the number of bankruptcy filings, however, the reforms’ immediate effect may be to increase them. The changes are onerous enough that bankruptcy attorneys and consumer advocates predict a small wave of consumers trying to beat the deadline.
“People have been calling already and saying, ‘If the bankruptcy law is going to change, I’d better file,’ ” said J. Scott Bovitz, a Los Angeles attorney and vice chairman of the State Bar of California’s personal and small-business bankruptcy committee.
Creditors’ groups say the ease of filing for bankruptcy under the current law and the lack of stigma attached to going broke helped lead to a fivefold increase in the number of consumer bankruptcy filings from 1980 to 1998, when filings peaked at 1.4 million. Since then, the number of filings has declined 13%.
Creditors hope the reforms will keep that downward trend on track. In particular, supporters hope the extra paperwork will put a crimp on “bankruptcy mills”--law firms that advertise “quick and easy” filings. Creditors blame increased advertising by these firms for the surge in bankruptcy filings in the 1990s and increased acceptance of bankruptcy “as a financial planning tool,” said American Bankers Assn. spokeswoman Catherine Pulley.
Pulley contends such law firms take advantage of naive consumers “who don’t understand the consequences” of a bankruptcy filing.
Consumer advocates also worry about naive debtors--but for different reasons.
Though some wealthy, sophisticated people may take advantage of the six-month window to file, most of those who go bankrupt don’t realize they’re going broke until the last minute, said Henry Sommer, a Philadelphia bankruptcy attorney. Under the proposed reforms, these people could wind up with a more expensive bankruptcy, even though they don’t have the ability to repay creditors.
And how many bankruptcies ultimately are filed in coming years may have more to do with the economy than with any new bankruptcy restrictions.
If layoffs and corporate cutbacks continue, the number of bankruptcy filings will probably increase regardless of the rules, said Sam Gerdano, executive director of the nonpartisan American Bankruptcy Institute, which includes creditors, credit counselors and bankruptcy attorneys among its members. Hard economic times and resulting layoffs typically push more debt-laden consumers over the edge, Gerdano said.
Creditors themselves could be contributing to a trend toward more bankruptcies, critics charge. Creditors are stepping up their marketing efforts to get credit into the hands of consumers--whether they need it or not.
Total credit extended to consumers increased 13% during the first nine months of 2000, when banks and credit card companies mailed 14% more solicitations, according to BAI Global, a credit research firm. Consumer groups, which fought unsuccessfully to get restrictions on creditors included in the reforms, say the push to get consumers deeper into debt could result in more Americans going broke.
Another subject of much debate is how much more money creditors can expect to get from consumers who file for bankruptcy.
Creditor and consumer groups agree that the vast majority of those who file for Chapter 7 bankruptcy are unable to pay any of their debt. Most have few assets and little income for creditors to take. One study by federal bankruptcy judges found that the median income of people filing for bankruptcy in 1999 was $22,000.
“I don’t think anybody is under any great illusions” about creditors receiving any payment from most bankruptcies, Gerdano said. “The income is not there.”
Still, some who file for Chapter 7 liquidation do have the ability to pay. The proposed law would attempt to sniff them out, first by determining whether they earn more than most people in their areas. If they do, a formula would be applied to see whether they might have enough money left over--after certain allowed living expenses--to pay some of their debts.
The bankers association said that as many as 10% of those who erase their debts in Chapter 7 would be prevented from doing so under these new rules and estimated that creditors could recoup $4 billion a year from that group.
Groups such as the Consumer Federation of America and many academics who study bankruptcy dismiss those figures. Travis Plunkett, the federation’s legislative director, said less than 3% of those who file Chapter 7 could repay anything. The bankruptcy institute puts the figure at 4%.
Just because someone is deemed able to pay doesn’t mean he or she will pay, however. Two-thirds of the people who file for Chapter 13 fail to make all their promised payments, Gerdano said. Some end up filing for Chapter 7, whereas others simply walk away from their debts and the courts altogether.
Some consumer advocates fear stricter rules would force more consumers underground. Instead of getting a fresh start in bankruptcy, these debt-laden people might attempt to evade their mainstream creditors by moving out of their homes, working off the books and turning to loan sharks for credit, Sommer said.
Pulley of the bankers association acknowledged that could happen.
“There are always a certain number of people who don’t want to pay their bills,” she said.
Meanwhile, the creditors’ best hope of getting paid also would be outside the system--at least the system of official bankruptcy repayment plans.
The reforms would give credit card issuers and other consumer lenders greater latitude to strike deals directly with debtors who file for bankruptcy. The creditors typically would promise to continue extending credit to those who agreed to make paying the debt a priority.
These side deals, known as “debt reaffirmation,” are usually not allowed under current bankruptcy laws because they can interfere with a court-approved repayment plan. In fact, Sears, Roebuck & Co. was convicted of fraud in 1999 and fined $60 million for its high-pressure debt reaffirmation techniques. The retailer paid $498 million in settlements to bankrupt credit card holders who had agreed under duress to repay their debts.
The reforms, however, would give creditors greater power to use such side deals to jockey for position with the debtors’ other creditors, which could increase the amount recouped by some at the expense of others, attorneys said.
“That’s where the action’s going to be--out in the hallways,” Sommer said.
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Going for Broke
A measure passed Thursday by the Senate to make it harder for Americans to file for bankruptcy comes at a time when bankruptcy filings have fallen from their highs in California and nationwide.
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National
Consumer bankruptcies have declined 13% since peaking at 1.4 million in 1998. Business bankruptcies have fallen 50% since peaking in 1991.
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Total consumer bankruptcies (in millions)
2000: 1,217,972
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Total business bankruptcies (in thousands)
2000: 35,472
Source: American Bankruptcy Institute
