Down and Out
By: Frances Cerra Whittelsey; Source: AARP Bulletin Date Posted: 2006-11-01 12:46:00-05:00
Since a tough new federal bankruptcy law went into effect a year ago, the number of Americans going to court to wipe out debt has plummeted.
"It's hard to make long-term predictions, but it looks like the law is working as intended, cutting out abusive filings and filings of convenience," says Laura Fisher of the American Bankers Association in Washington.
"That's patently ridiculous," counters Brad Botes, a member of the National Association of Consumer Bankruptcy Attorneys (NACBA). He thinks it's only a matter of time before the number of personal bankruptcies is back up to pre-2005 levels. "The problem is still there: too much easy credit," he says. Companies "continue to send credit cards to anyone who has a pulse—and to some who don't."
Congress enacted the controversial law to fix a system denounced by banks, retailers and others for letting "deadbeats" off the hook when they in fact could afford to pay their bills. About 1.6 million people a year were declaring bankruptcy before the reforms were passed, costing the economy $82 billion in losses in 2005, according to Senate Finance Chairman Chuck Grassley, R-Iowa.
Consumer advocates argued that job loss, catastrophic medical problems or losing a spouse—not profligate spending by deadbeats—cause most personal bankruptcies and that the legislation would only aggravate the financial troubles of these debtors.
Since the law went into effect Oct. 17, 2005, fewer people have indeed declared bankruptcy—the law's provisions have proved to be costly and confusing for those seeking relief, leading a judge in Texas to declare one provision unconstitutional.
The law raised the bar for anyone hoping to wipe out debt, especially for those with income above the median in their state. It also imposed new rules: a "means" test to determine if a debtor can repay some or all of his bills and—at the debtor's expense—credit counseling and financial management classes.
In addition, fewer people are eligible to file for Chapter 7 bankruptcy, which eliminates most debt through the sale of assets, and more are declaring under Chapter 13, which requires a debt repayment plan. Chapter 13 cases made up 41 percent of all filings in the first half of 2006, up from 24 percent in 2005, reports the American Bankruptcy Institute (ABI).
In a virtual stampede to avoid the hassles and expense of filing under the new law, more than 2 million Americans—an all-time high—petitioned for bankruptcy in 2005, with 619,588 filings in October alone. The ABI reports that filings fell to about 263,660 in the first half of 2006, the lowest number for the January-through-June period in 20 years and about 69 percent lower than in 2005. Preliminary estimates by the NACBA show that third-quarter filings were still well below 2005.
Travis Plunkett, legislative director of the Consumer Federation of America, worries that the law so far doesn't seem to be "snaring" abusers of the system. Rather, it's extracting more money from "desperate debtors," he says, noting that "estimated costs for a typical Chapter 7 bankruptcy have roughly doubled," thanks to higher legal and filing fees.
One "desperate debtor" who petitioned for bankruptcy under the new law is Christine, 57, a waitress in the Bronx, N.Y. Christine, who requested that her last name be withheld, had no health benefits to pay for diabetes medication. With just $14,000 in income last year, she fell behind on her credit card bills when she was out of work for a few months.
"I'm an older person doing everything by the book," Christine says, "but I can't get [a break]." Before she filed for bankruptcy, she says, a credit counseling agency told her she didn't make enough money to even consolidate her debts.
Mildred Johnson, 88, a former federal worker who lives in Queens, N.Y., also had accrued a credit card balance—more than $25,000—that overwhelmed her. With consolidation, her payments dropped to $614 from $982 a month, but that was still much more than she could handle on $16,000 a year in income from Social Security and a pension.
"I was about to blow my brains out," Johnson says. "The bills weren't going down—the money was just going to the finance charges." Paying $400 a month to rent her subsidized cooperative apartment, she "had no money at all for even personal things." She concluded that bankruptcy was the only answer.
Johnson, like Christine, ultimately had her debts forgiven because of her low income, but both women have struggled to pay the costs of bankruptcy. Johnson, for instance, says she paid about $50 each for a counseling session certifying that she couldn't repay her debts and for a financial management course. Filing fees cost her $299, up from $209 under the old law. Her lawyer gave her a break on her legal fees, which typically begin at around $1,500.
Fisher of the bankers' association acknowledges that the bankruptcy process is more complicated and costly, but of necessity. "In the past, people didn't have to prove their income, and there was a lot of opportunity for abuse," she says. "Now they have to show tax returns, pay stubs, so that if they have income, they can repay at least some of their debts."
Mallory Duncan, senior vice president of the National Retail Federation, says he's "skeptical of the need for the fees" lawyers are charging, pointing out that lawyers are unsure how to interpret the new law and have hiked fees to cover "their uncertainty."
But some bankruptcy lawyers—and judges—say the law is so complex and poorly written that they must hash out what it means. In July U.S. District Court Judge David C. Godbey of Dallas ruled as unconstitutional a provision that forbids lawyers from advising clients to take on more debt before filing for bankruptcy. Additional debt, Godbey said, could be a prudent option—a loan for a car, for example, that's needed to get to a job, or refinancing a home for a better interest rate. While the court awaits Godbey's final ruling, the association of bankruptcy attorneys and the Connecticut Bar Association have filed a lawsuit challenging the same provision.
In another Texas case in December 2005, U.S. Bankruptcy Judge Frank R. Monroe of Austin was forced to dismiss the case of a man who hadn't been aware of the counseling requirement before he filed for bankruptcy to save his mobile home from foreclosure. "Can any rational human being make a cogent argument that this makes any sense at all?" a frustrated Monroe wrote in his decision.
It's the "greatest of misnomers," Monroe says, to call the law, as Congress did, a "consumer protection act."
Frances Cerra Whittelsey is a freelance writer in New York.
Additional Related Links
Mired in Debt? Here's What to Do (November 2006)
Throw Me a Lifeline (May 2005)
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