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The American State of Bankruptcy, 2009

Not surprisingly, bankruptcy filings are on the rise and likely to increase. Is the 2005 bankruptcy reform act helping, hindering or neutral in this instance?

"People are hurting, and it is showing up in the bankruptcy courts."

This statement, profoundly simple then and depressingly obvious now, is from the March 2008 blog of University of Illinois law professor Robert Lawless. Two months later, Lawless, a national expert on bankruptcy trends, explained to Newsweek, "People borrow to stave off the day of reckoning, and then when credit tightens, the bankruptcy numbers go up." By the end of the year, Lawless got specific: "For 2009, I am expecting a little under 1,400,000 bankruptcy filings."

In early October 2009, Lawless's skill as a prognosticator was substantiated. Using data from the National Bankruptcy Research Center, the American Bankruptcy Institute, the research arm of the bankruptcy industry, reported "Consumer bankruptcies totaled 1,046,449 filings through the first nine months of 2009, the first time since the 2005 bankruptcy overhaul that filings have surged past the 1 million mark during the first three calendar quarters of a year. ... The filings for the first three-quarters of 2009 were the highest total since the 1,350,360 consumer filings through the first nine months of 2005."

The ABI says the jump of 35 percent over the same period last year was the first time the January-through-September total has exceeded 1 million since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 passed.

"Bankruptcy filings continue to climb as consumers look to shelter themselves from the effects of rising unemployment rates and housing debt," said ABI Executive Director Samuel J. Gerdano "The consumer filing total through the first nine months is consistent with our expectation that consumer bankruptcies will top 1.4 million in 2009."

ABI also reported that September 2009 filings by consumers reached 124,790, a 41 percent increase from the 88,663 consumer filings the September before and a 4 percent increase from the 119,874 filings in August 2009. Some 28 percent of the consumer filings in September were Chapter 13, the less punitive filing, which also sees debtors continue to repay at least a portion of their debts over time.

This wasn't what was supposed to happen under the new law, at least not according to its chief proponents: credit card companies, big banks, and the Bush Administration. (Lawless said simply, "That law was the poster child for campaign finance and special interest law reform.") They combined forces because they believed bankruptcy scofflaws were being allowed to file and skip out on their debts unfairly.

According to author and credit expert Gerri Detweiler, "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," she 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."

The American Bankers Association finds that an overstatement. "Bankruptcy reform was designed to eliminate abuse and ensure that the system is used fairly," the trade group wrote in July.

"Prior to bankruptcy reform, some higher-income filers had used bankruptcy under the old system as a financial planning tool, escaping from debts that they could afford to repay. Filers are now required to prove their income with a current tax return or pay stubs, helping to eliminate abusive filings where debtors did not accurately disclose their income. All debtors will be required to receive credit counseling before filing for bankruptcy."

As to the new law's efficacy, Peter Garuccio of the ABA told Miller-McCune, "If success is defined as fewer bankruptcies, then one could argue the reforms have not been successful. However, the intent of the bill was not to reduce total bankruptcy filings but to curb abusive filings — that is the more accurate measure."

Then there's the recession ...

"I'd be shocked," Washington attorney Philip S. Corwin, a partner at the law and lobbying firm of Butera & Andrews told Miller-McCune, "if the number of bankruptcy filings wasn't rising, given the unemployment rate and the general state of the economy. After all, we're in the worst economic downturn since the Great Depression. What the increase in flings does prove is that the critics of the 2005 changes who contended that it would impede access to bankruptcy were dead wrong. The people who need bankruptcy relief continue to get it, as they did before the 2005 act went into effect."

While with the American Bankers Association, Corwin directed the ABA's successful effort to see the 1994 Bankruptcy Reform Act pass. He continues to represent ABA on bankruptcy matters and was involved in the effort to enact the 2005 law.

But critics of the 2005 law don't buy the times-are-tough-all-over line. While the number of bankruptcy filings hit 2 million in 2005, a lot of those filings, Lawless explained, were the result of people hurrying to file before the changes took effect.

Today, he said, "You have to be careful not to read too much into the bankruptcy filings as a sign of what's going on in the economy. They are a weak, lagging indicator of what's happening in the economy. There are a lot of people in financial distress who don't file bankruptcy.

"So, the fact that bankruptcy filings have been going up probably has something to do with the economy, but probably also has something to do with some other things. And the biggest other thing is that after the 2005 changes to the bankruptcy law, bankruptcy filings were artificially depressed, but they have been returning to their, if you will, natural level of what they were before the 2005 law, which, frankly, was a disaster."

In June, USA Todayreported (in an article that quoted Lawless), "Bankruptcy filings took a dramatic nose dive after the 2005 bankruptcy reform measure was signed into law to curb bankruptcy abuse and make it harder to erase debts. But filings are surging back in part because of rising job losses. The unemployment rate has hit 10 percent. And tighter credit, dwindling 401(k) accounts, smaller paychecks and less savings have left unemployed workers and those who are working but struggling with fewer financial resources to keep creditors at bay."

Lawless pointed out that in the past, people could stave off bankruptcy by pushing their credit cards, both old and new, to their limits. "The fact that consumer credit has tightened and shrunk explains why bankruptcy filings have now gone up so dramatically."

Maureen Thompson, legislative director of the National Association of Consumer Bankruptcy Attorneys, agreed. "Credit card companies are reducing lines of credit and boosting interest rates, etc., so for people who have found themselves in financial difficulty, there is really nowhere for them to go to try to stay afloat while they either come up with the money to pay off their debts or somehow pay those debts down. They just don't really have anywhere to go right now."

Echoing Lawless's word choice, Thompson said, "Bankruptcies are a lagging indicator, meaning they take some time to catch up to the economy, and so with unemployment near historic highs and pretty much staying put — people talk about a 'jobless recovery' — we expect to see the numbers if not getting worse, then certainly hovering where they are now, over the 1 million mark.

"Why? Because you have people who were laid off six months ago and they kept getting deeper and deeper into debt and can't pay off those debts and find that they have to file for bankruptcy. I expect that we will see the kinds of numbers we are seeing now for some time into the foreseeable future, say 2011.

"Most people are saying that the economy's improving, but we aren't seeing that in the unemployment figures. We are expecting that the economy will be where it is for some time into the future."

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