Off with debtors’ heads?

THE much-hyped federal bankruptcy reform legislation goes into effect Monday, and Congress is already debating whether to suspend or modify the draconian law so that people battered into hopelessness by the Gulf Coast hurricanes don’t receive another economic beating.

Other desperate Americans cannot count on such mercy. As the new law smashes into the nation’s vulnerable economy, no one will escape suffering.

Breaking with 225 years of precedent, Congress passed the law in March, apparently encouraged that it will make bankruptcy even more onerous and humiliating -- and oblivious to the fact that it will discourage the risk-taking necessary for innovation in an entrepreneurial economy. Among other changes, the act requires debtors to pass a means test before they are eligible for relief under Chapter 7 of the U.S. Bankruptcy Code. The most common personal bankruptcy filing, Chapter 7 lets filers receive forgiveness for most of their unsecured debt in just 90 days. Most people prefer this avenue.

But rather than permitting the financially overburdened to break free of their debts in Chapter 7, the new law will require that those who earn more than the median annual family income for their state (in California, $42,012 for an individual and $68,310 for a family of four) to proceed under Chapter 13. Under the new law, Chapter 13 will compel the repayment of debts over a period of five years, unless the bankrupt person can show that “special circumstances,” such as “a serious medical condition or a call or order to active duty in the armed forces,” apply to his or her case.

People who earn more than the median statewide income will be presumed to be “abusive filers” under the new law, and the Office of the U.S. Trustee, the agency of the Justice Department charged with administering the Bankruptcy Court, is empowered to seek dismissal or conversion of such cases. Unforeseen disasters of the type that typically overwhelm the middle class, such as family medical emergencies, job layoffs and natural disasters, may or may not count as “special circumstances” for people who file under Chapter 7 but make more than the median income.

After the mandatory meeting of creditors, the court-appointed Chapter 7 trustee, who administers the meeting, will need to decide whether the debtor has shown sufficient “special circumstances” to overcome the presumption of “abuse.” There is little in the new law to give the trustee, or the Bankruptcy Court, any guidance in making the decision, and it is certain that more and more people who would have paid their debts under Chapter 7 will now be forced into the more onerous Chapter 13 filing.

People have filed a historic surge of personal bankruptcies since the law’s passage, triggering what local bankruptcy lawyers call the “YBK Scenario”: a wave of panic filings designed to beat the clock. In the week ending Oct. 7, bankruptcy filings soared to more than 20,000 per day, almost triple the number of filings per day in March.

The effect of the new law will be even more devastating as residential foreclosures continue to rise and adjustable-rate loans become increasingly more difficult to pay. Gasoline prices and the decision by credit card companies to raise monthly minimum fees already mean that consumers have significantly less money in their wallets to pay their debts.

Congress should ensure that the victims of hurricanes Katrina and Rita do not have their hardship compounded. It should immediately pass legislation exempting them from the severity of the new law.

This month’s announcement by the U.S. Trustee that it will view the hurricanes as a “special circumstance” that would overcome the presumption of abuse is a positive first step. But Congress must also use this opportunity to reexamine the basic premises of the new law. People who face financial ruin should not have to rely on the goodwill of the Justice Department. When a family has been so hammered by economic circumstance that it feels the need to hold up bankruptcy’s figurative sign -- “We need help!” -- it’s downright un-American for the government to come in and start bullying.