Creditors and consumer advocates traded barbs Wednesday over whether a proposed needs-based bankruptcy system would work.
Testifying before Senate Banking's financial institutions subcommittee, consumer advocates charged that requiring high-income borrowers to repay some of their debt would encourage reckless lending. Creditors countered that the proposed system would reduce filings and lead to lower borrowing costs.
The hearing was called by Sen. Lauch Faircloth, a supporter of needs- based bankruptcy. "We shouldn't make it easier to rid yourself of your debts," the North Carolina Republican said. "If you are employed and can pay some of what you owe, you should be required to do so. Otherwise, others are paying your bills."
But consumer advocates said needs-based bankruptcy would make lending less risky, which would encourage banks to make even more loans to consumers already deep in debt. They said that would lead to an even bigger increase in bankruptcy filings.
"The likely effect of limiting bankruptcy protection for unsecured debt is an increase in the outstanding balances of marginal consumers," said Lawrence M. Ausubel, a University of Maryland economics professor.
Gary Klein, a lawyer for the National Consumer Law Center, said a needs- based system would do nothing to control other factors that cause bankruptcy, such as high student loan burdens, medical costs, corporate downsizing, and high debt-to-income ratios.
Lenders also bear much of the burden for higher bankruptcy rates, he said. "Creditors are making bad loans that cannot be repaid," he said.
Creditors, however, said that needs-based bankruptcy is fairer than the current system because borrowers with significant incomes would be forced to repay debts.
"The fundamental flaw in the current bankruptcy code is that debtors are permitted complete discretion as to whether they will enter into a Chapter 7 liquidation plan or a Chapter 13 repayment plan," said James E. Smith, president of Union State Bank, Clinton, Mo.
Lenders also dismissed charges that they are a responsible for the record 1.3 million bankruptcy filings last year. Creditors said they carefully scrutinize borrowers before making loans, and they noted that there are often few warning signs before a consumer declares bankruptcy.
Bruce L. Hammonds, chief operating officer of MBNA Corp., said bankrutpcy affects all consumers because they must cover the debts of people who default. He estimated the cost at $400 per family last year.