Bankruptcy Bill

The Senate is moving toward passing the bankruptcy reform bill. This bill is a bad idea for one simple reason: it's motivation is founded on erroneous assumptions. AP writes

Backers have been pushing the legislation for eight years, arguing that bankruptcy frequently is the last refuge of gamblers, impulsive shoppers, divorced or separated fathers avoiding child support, and multimillionaires — often celebrities — who buy mansions in states with liberal homestead exemptions to shelter assets from creditors.

In other words, those filing for bankruptcy are portrayed as either deadbeats running up debts of their own free will and then trying to get out of them, or the wealthy trying to protect their mansions and fortunes. This is inaccurate and misleading in several ways.

First off, as the TPM Bankruptcy blog notes, the bill does nothing to address the homestead exemptions. "The ultimate irony is that this bill, which purports to close loopholes and hold debtors accountable, opens the door to manifest manipulation by a small but wealthy group of bankruptcy filers." So those multi-millionaires will still be able to protect their $10 million mansions.

More importantly, those resorting to bankruptcy are often there through little if any fault of their own. As previously noted on this blog, over 50% of bankruptcies are caused by medical bills. One can run up huge medical bills very quickly in today's hospitals, even with health insurance. One serious illness can lead to financial ruin. When my daughter was born in 2000, she was very ill and had to be in neo-natal intensive care for two weeks. The bills came to over $25,000. Thankfully that was covered by insurance. But many Americans do not have health insurance and would therefore be stuck with that bill if they were in the same boat. Tightening the bankruptcy rules would ruin many of the families stuck in this nightmare.

When it does come to credit card debt, it is awfully hard to find sympathy for the industry. The Washington Post recently published an article detailing the business practices of the credit card industry. Reading through the article, one realizes just how important card holders at risk of bankruptcy are to the industry's business model, and consequently why the industry is so desirous of keeping these people trapped. The credit card companies, generally speaking, are extremely predatory. When card holders start getting in trouble, they pounce and try to grab as much as they can. Make your payments a few days late? Welcome to 30% interest on your account, plus monthly late fees which add to the balance. Those late fees and interest charges push your balance over the credit limit of your account? Here's some more fees to compound the problem. Once caught in their traps, it becomes very difficult for a card holder to escape. The consumer will make financially crippling payments to the creditor only to see their balance grow each month because of fees and usurious interest. This is called negative amortization, and at that point, there is no escape for the debtor because they cannot make the balance go down.

Here's a good analogy, from John Cole, to how the process works:

I give you a blogad for $1 a month. I then find out you were late paying your car insurance, so I jack the price of the blogad up to $100.00. You don't have the $100.00 to pay when due, so I charge you another $35.00 for being late, $50.00 for being over your limit, and then I charge you interest at 30%. Then, I ruin your credit rating, making it impossible to buy other blogads elsewhere. Then, when you owe about $1500 because of interest, late fees, overbalance fees, and whatever else I can cook up, you apply for bankruptcy. Even though I have received several hundred times what you initially owed me, I want Congress to re-write the bankruptcy laws that have stood for DECADES [centuries, actually] so that I can continue to get obscene profits by syphoning off some of your future earnings.

The fees alone accounted for nearly $15 billion in revenue for the credit card industry in 2004, nearly 11% of the total. The companies want card holders to get caught in this pit because they get to milk their victims dry, often getting back much more than they paid out on behalf of the debtor, taking advantage of the good faith efforts these debtors make in trying to pay what they owe. This is why the creditors are so free about offering credit to anyone and everyone. They want victims caught in their traps. The card holder who uses his or her responsibly does not do much for the company's bottom line. So, the companies find those most likely to get trapped, suck their victims dry while they struggle in vain to escape the trap, and now are working to cut off the one means of getting away. As I said, it is difficult to feel sympathy for the poor credit card companies.

Now the bill's supporters will say that these people should have been more responsible to begin with, and they just put themselves in this position. Generalizations are dangerous. Those deep in debt because of medical bills have not been irresponsible. Those who must feed their families on credit cards because they've lost their jobs, divorce, or because of a death in the family have not been irresponsible. The fact is, "90% of bankruptcies are filed following divorce, job loss, death in the family, and illness" according to the bankruptcy blog.

For the remaining 10%, those who presumably were irresponsible, how many of them end up paying back far more than their actual debt during those cycles of negative amortization? For example, the credit card company pays out $5000 on behalf of a customer. The negative amortization cycles begin and the balance grows each month. How many such customers end up paying more than $5000 before giving up and filing bankruptcy? The Post article notes,

Bankruptcy experts say that too often, by the time an individual has filed for bankruptcy or is hauled into court by creditors, he or she has repaid an amount equal to their original credit card debt plus double-digit interest, but still owes hundreds or thousands of dollars because of penalties.

So, while these people may indeed have been irresponsible to get so far in debt to begin with, they certainly have made a good faith effort to pay off their debts, and do not deserve to be punished further.

Finally, the bankruptcy bill is misleading for another very simple reason. The system already has ample means of addressing bankruptcy claims and weeding out those who really are trying to abuse the system. I have met with lawyers to go over the process of filing for bankruptcy. Means testing is already present. The court will estimate a filer's monthly cost of living and compare that with monthly income. If what is left over is sufficient to pay off the debt in a reasonable time frame, say 4-5 years, the filer has to pay it, though the creditor is prevented from charging additional interest. If what is left over is not enough to pay the whole debt off, but perhaps only half, then the court will order that what can be paid off be paid off. This is called a chapter 13 bankruptcy, and is the most common form. Yes, in the most common form of bankruptcy, the creditor is still getting paid most or all of what is owed. The bankruptcy basically removes the fees and interest that the credit card companies love so, which is why they want it to be harder to file chapter 13.

Only if the filer's income is comparable to or less than their monthly cost of living expenses, i.e. little is left over to pay their debts, can one completely write off the debt, which is a chapter 7 bankruptcy.

The existing system already provides sufficient protection for the creditor to recover debts and to minimize abuse of the chapter 7 bankruptcy. Therefore there is no need to tighten the rules. This bill, if enacted (and the president has indicated he will sign it), will tighten the screws on working families already struggling to get by while padding the profits of predatory creditors. It is an unconscionable attack on the middle and working classes.