Congress having just lurched to an agreement on the thorny question of what to do when institutions go belly up, it's a good time to look at how things have worked out for individuals under the terms of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which celebrates its third birthday Oct. 17. To almost quote Ronald Reagan, are we better off now than we were three years ago?
In July, Michael Simkovic, a former fellow at Harvard's John M. Olin Center for Law and Economics, wrote that "the data suggests that although bankruptcies and credit card company losses decreased, and credit card companies achieved record profits, the cost to consumers of credit card debt actually increased. In other words, the 2005 bankruptcy reforms profited credit card companies at consumers' expense."
In his study, "The Effect of 2005 Bankruptcy Reforms on Credit Card Industry Profits and Practices," published online by the Social Science Research Network, Simkovic focused on one industry — credit cards — since those unsecured creditors were the main evangelists behind the act.
But as the credit crisis unspools, the damage may go much further.
BusinessWeek reporter Christopher Farrell wrote a year ago — well before the credit crisis exploded — "a law intended to help the financial industry may be damaging the housing sector, creditors and borrowers alike."
"It doesn't matter what you think of the purpose of the new bankruptcy law. The timing is bad," he quoted Susan M. Wachter, professor of real estate at the Wharton School of Business.
At the current election's sole vice presidential debate, moderator Gwen Ifill confronted Sen. Joe Biden, who voted for the bill, directly: "Some people have said that mortgage-holders really paid the price."
Biden, for his part, said the damage wasn't that bad, answering, "Well, mortgage-holders didn't pay the price. Only 10 percent of the people who are — have been affected by this whole switch from Chapter 7 to Chapter 13 — it gets complicated."
What Were They Thinking?
On one hand, there's the view of the people who pushed for the act, chiefly the credit card companies, big banks and the Bush administration. Last year, Steve Bartlett, president and CFO of Financial Services Roundtable, told the House Subcommittee on Commercial and Administrative Law that as far as both American consumers and the economy are concerned, the revised law is "working quite well."
Not so fast, said Henry J. Sommer, president of the National Association of Consumer Bankruptcy Attorneys. He told the same panel that the 2005 amendments were not protecting consumers and that the new law's biggest impact is the "enormous increase in the (filing) costs and burdens ...
"I doubt that it was the intention of even those who voted for the bill to increase documentation requirements, bureaucratic paper work and other costs so much that honest low-income and working families, not the 'high rollers' at whom the amendments were supposedly aimed, are deterred or prevented from obtaining the bankruptcy relief they need. But that is what has happened," Sommer said.
Author and credit expert Gerri Detweiler, writing at CreditBloggers.com, called the law a disaster.
"The idea of the 2005 bankruptcy 'reform' law was that it would stop abusive filings and as a result everyone would be better off, except the shameless few who were abusing the system," Detweiler wrote. "We were sold this bill of goods so effectively that many of us who are usually quite compassionate felt the reforms probably made sense. After all, shouldn't it be difficult to file for bankruptcy? The resulting mess was legislation that bankruptcy judges are calling a colossal failure."
After quoting three bankruptcy judges, including Keith M. Lundin of Tennessee ("Unquestionably, this is the most poorly written piece of legislation that I or anyone else has ever seen."), she concluded that the act is crushing "consumers suffering from the perfect storm of bad mortgages, credit card debt, stagnant wages or unemployment and rising food and fuel prices."
A New Chapter in Relief
Some history may be helpful. Traditionally in this country, bankruptcy, especially personal bankruptcy, had left a stigma. But that began to change in the "greed-is-good" 1980s, and within a decade bankruptcy had evolved into a more acceptable way of shedding onerous debt and starting over. Some critics went so far as to say the Bankruptcy Code was being used for fraudulent purposes.
Beginning in the mid-1990s, bills were introduced in Congress to tighten the code. Epitomizing that stance was the explanation of Rep. James Sensenbrenner, R-Wis., one in sponsoring the 2005 act: "This bill will help restore responsibility and integrity to the bankruptcy system by cracking down on fraudulent, abusive and opportunistic bankruptcy claims."
The sponsors' charge that the majority of those filing for bankruptcy were cheaters was met with strong and vocal objection, with many opponents counter-claiming that the credit card companies' aggressive marketing tactics and their near-usurious interest rates were at least equally to blame. Stalemate ensued, and prevailed, until the new century.
Enter George W. Bush in 2000 and greater Republican control of Congress in 2004, and the stage was set for a new bill, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This time it passed both bodies with ease, Bush signed it in May and it went into effect Oct. 17, 2005.
The main change from the law for most busted consumers was in shutting the door to the more generous Chapter 7 bankruptcy, in which, as CNN Money put it, "your assets (minus those exempted by your state) are liquidated and given to creditors, and many of your remaining debts are cancelled, giving you what's known as a 'fresh start.'" And if you don't have any assets to liquidate — the case for the vast majority of filers — then your creditors get nothing.
The law instituted a means test for those seeking Chapter 7, and if the test — and not a judge, as had been the case before — determined you had some "disposable monthly income" to apply to your debts, you faced the more challenging Chapter 13. Chapter 13 requires a repayment plan for those debts the court decides must be repaid over the next three to five years — in other words, a not-so-fresh start.
In the 180 days between the law's passage and its taking effect, there was, to no one's surprise, a huge jump in the number of filings, bringing the total number of consumer bankruptcies for 2005 to more than 2 million, up 31 percent from 2004. Chapter 7 is much more attractive for a debtor than Chapter 13, and there was a rush to file when it helped debtors.
The law's backers said this demonstrated that the changes they had pushed for were in fact needed. The act's detractors said it was only a temporary jump and that the wise thing to do would be to wait and see.
The wait-and-seers turned out to be right. Consumer bankruptcies in 2006 fell more than 70 percent from 2005's spike. In 2007, the number rose by 35 percent but was still well below 2005 levels, according to the American Bankruptcy Institute. The rise is generally considered to be a sign of the hard economic times.
Still, last October, Farrell pointed out that the total is about half that of 2001-2003. Wasn't that the plan?
Well, as Farrell wrote, "Score one for the law of unintended consequences.
"The reason: A new bankruptcy law ... makes it much harder for households to get out from under consumer debt. The result: More people being forced to walk away from their homes, leaving lenders holding the bag. ... Perversely, a law intended to help the financial industry may be damaging the housing sector, creditors and borrowers alike."
Even lawyers who represent creditors see little actual benefit to their clients or to debtors. As longtime Northern Virginia lawyer Herbert L. Karp puts it, "Like so many other aspects of the new law, the requirement that debtors go through credit counseling before they can file has turned out to be a sham.
"Today, in most cases it means paying $50 for 20 minutes of 'counseling' by phone and listening to someone tell you to make a budget and stick to it. People in debt already know that; they just can't do it. That's why they're filing for bankruptcy, and it's not because they were living high on the hog. In the great majority of cases, they're in financial trouble because of medical bills, divorce or job loss.
"They need to be helped, not punished."
The current bailout has drawn calls for reform of the reform. On Sept. 23, for example, a coalition of consumer groups such as the Center for Responsible Lending and the AARP, as well as more activist entities like the Association of Community Organizations for Reform Now and the Leadership Conference on Civil Rights, held a "telephone press call" to demand that if Congress rescues Wall Street, it had better rescue Main Street as well — in particular homeowners — by allowing them to rewrite their mortgages under the supervision of bankruptcy courts.
At that event, AARP President William D. Novelli called on Congress to give bankruptcy judges the discretion to restructure primary mortgage debt, changing loan terms as was acceptable before the 2005 act, as "an effective way of providing relief to homeowners at no cost to taxpayers." That provision is not in the bailout, but calls for it have not abated.
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