A Wish List for Bankruptcy Reform
One of my first forays onto the Not News soapbox was a look at the culture of debt in this country. In that piece, I briefly mentioned the movement (or lack thereof) of bankruptcy legislation in Washington. In the past three years, many Americans have ridden a roller coaster of financial disasters including corporate scandals, fallout from 9/11 and general economic slowdowns. In that time, the proposed legislation to revamp the many Americans deal with their debt has changed very little — and it has made very little progress.
Many in Congress are quick to lay blame at the other party for the eleventh hour demise of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2002, but a closer examination of the bill’s provisions tells a different tale. For reasons that few in Congress ever mention, this bill had it coming. And, from a “consumer protection� standpoint, its 2003 cousin is asking for it, too. But, since we at Not News prefer to dispense constructive criticism, I am not going to spend any more time simply trashing what’s wrong with bankruptcy reform. I’m going to present my own personal bankruptcy reform wish list.
A Brief Digression: Chapter 7 vs. Chapter 13
Before we can discuss the proposed changes in the bankruptcy reform bill, we need to understand how current consumer bankruptcies work. While the term “Chapter 11� is tossed about for corporations in financial distress, consumers are generally limited to one of two chapters of the bankruptcy code, Chapter 7 and Chapter 13.
In Chapter 7, the debtor is allowed to keep some secured assets — such as a house and a vehicle. The rest of the debtor’s property is sold by a trustee. The proceeds from the sale are distributed to the creditors and the unsecured debt, typically credit card debt, is discharged. Debtors emerging from Chapter 7 have a “clean slateâ€? (though their credit ratings are severely damaged). In Chapter 13, the debtor must repay creditors in full or in part over a specified time period, usually three to five years. This repayment period is usually designed and supervised by a bankruptcy court.
Given those differences, it’s easy to see why almost 70% of bankruptcies are currently filed under Chapter 7. Most of the remainder are Chapter 13. Credit card companies, banks and other lenders, who take the hit when a person’s debts are discharged, would like to see more people file under Chapter 13. That way, they could recoup some of their losses. They argue that many people who currently file under Chapter 7 have the ability to repay some of their debts but are simply abusing the system.
The current reform proposal would require that anyone wishing to file for personal bankruptcy attend credit counseling first. This is an effort to filter out those who simply have sloppy financial management skills from those truly in financial distress. After financial counseling comes the means test. Those wishing to file for Chapter 7 would have to prove that they cannot afford to repay a portion of their debts along with their basic living expenses. The ability to pay, however, is not determined by actual living expenses, but by the IRS’s idea of what living expenses should be for a family of similar size. If, after applying the means test, the court believes the debtor would have even a small amount of money available for creditors, the debtor is placed in Chapter 13.
Item 1: Eradicate Random Riders
First, let’s address the situation widely blamed for killing the 2002 version of the Senate Bankruptcy Bill. Sen. Charles Schumer (D-NY) introduced a provision to the bill which would prevent anti-abortion protestors from discharging court fines in bankruptcy proceedings. As one might expect, the provision launched a long, heated debate about everything Republicans and Democrats usually debate about except the actual issue at hand – bankruptcy. While I typically support Sen Schumer’s efforts for consumer protection (he’s tireless in fighting predatory lending and ambiguous credit solicitations), he really disappointed me on this one. Adding the anti-abortion provision only served to inflame the bill’s supporters, making them less likely to compromise on the real flaws of the bill when it comes up for vote in this session. I hope Sen. Schumer sees the light and simply introduces a provision that prevents anyone from discharging any type of court fine in bankruptcy. There, done. Moving on . . .
Item 2: Be Supportive
Child support is one of the few debts that cannot be discharged in bankruptcy. (Student loans are another, by the way). Under current bankruptcy laws, child support and alimony rank below legal fees in debts to be repaid after a Chapter 13 filing. The current reform bill would attempt to rank them higher. I applaud that and hope the ranking change actually pans out in practice.
Item 3: Snip the Loophole
Think back to the media coverage of the collapse of Enron, World Com, et. al. Often there were sidebar stores about the multi-million dollar estates owned by the companies’ executives. Very often, these homes were located in one of five states — Texas, Florida, Iowa, Kansas or South Dakota — all of which have generous homestead laws Under these laws, debtors in these states could keep their homes and the entire equity they’ve built – even if that equity is several million dollars. This “millionaires’ loophole� has been a bone of contention for bankruptcy reformers for many years. For example, in Texas, the “residence� protected after bankruptcy can be up to 10 acres in size and can include commercial property. It seems fundamentally unfair to submit working class families to an inflexible “means test� in one section of the law and yet shield millions of dollars of home equity in another.
Closing this loophole, however, has proven problematic. For one thing, the loophole exists in the laws of only five states. Enacting federal legislation to limit it means effectively expanding some kind of home value limit across all 50 states. Determining exactly what that limit should be is difficult given the wide disparity in home values.
Looks like it’s time for those IRS tables again. If they are needed anywhere, it’s here.
I will say that legislators were on the right track when they tried to include a length of residence limitation on the homestead laws. This was an attempt at preventing those wealthy individuals who have recently been sued from buying a home in a homestead state and attempting to stash assets in a hurry.
Item 4: Can’t Justify the Means
That main problem with the Chapter 7 means test is its lack of flexibility. Many consumer groups opposed to bankruptcy reform argue that it does not allow bankruptcy courts to use their own judgements when working with debtors saddled with medical expenses or other unique hardships. Many bankruptcy judges actually prefer increased enforcement of an existing initiative as a way of curbing bankruptcy abuse. In December of 2001, the Justice Department’s Executive Office for U.S. Trustees, the division which administers the nations bankruptcy cases, issued what it calls a “civil enforcement initiative.� This initiative submits bankruptcy cases to more rigid scrutiny within existing bankruptcy laws — and no means test. The initiative is two-fold, targeting both unscrupulous bankruptcy attorneys and debtors intending to abuse the system.
The result, say bankruptcy judges, is a reduction in abuse, while still allowing bankruptcy judges room to consider the “totality of the circumstances.� The office says that even limited enforcement of the initiative during 2002 prevented 5,800 unnecessary Chapter 7 filings.
Supporters of proposed bankruptcy legislation say the civil initiative doesn’t weed out enough abusers and that the means test provision is the best solution. I say that a year is not enough time to test a system that uses existing laws and could potentially be far less costly and easier to administer than the complicated and inflexible means test.
I say, drop the means test, press on with the initiative and provide funding for a study into how much of a difference the 2001 initiative makes on bankruptcy filings. Congress is so very fond of these studies.
One exemption: repeat offenders. People who have filed for bankruptcy before should be submitted to a means test or at the very least, some form of counseling. They should have to prove that they are not using bankruptcy as a financial planning tool.
Item 5: What about the Education?
While many applauded the idea of requiring debtors to go through debt counseling, the fact is, there are simply no resources to enact a large scale federally-run debt counseling program. Therefore the debt counseling required by the current reform proposal would need to be outsourced to independent agencies. A report by the Consumer Federation of America says that a lack of regulation has made the credit counseling arena “a minefield� for debt-ridden consumers. Before we push people into mandatory debt counseling, we should get a better handle on just who is policing these agencies. Right now, it appears that no one is.
Finally, let me say this, I may not be a bankruptcy expert but I’m not sure you need to be an expert to see that various incarnations of this bill have been kicking around Washington for some time now. They all have had one thing in common: they were heavily backed by the credit card and banking industries. An examination of the bill’s provisions proves that they stand to gain the most if the legislation passes. Given my distrust of any company that sends me more than three “exclusive offers� in a given week, I admit a bit of a bias against the bill at the onset. But even with that bias, I have yet to be convinced that the “rampant abuse� of the bankruptcy system is as severe as the industry claims. Bankruptcy filings were up in 2002, but there were also increases in layoffs, unemployment, credit card solicitations, and credit card industry profits (ahem). I agree that there are likely abusers, but there are also people who legitimately need the relief that bankruptcy offers. The system needs to be flexible enough to tell the difference. I am not convinced that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2003 is the answer.
