Bankruptcy Reform: Try, Try Again

  Supporters of bankruptcy reform just can't seem to catch a break. In December 2000, a bill that had been in the works since 1997 died when then-President Clinton refused to sign it.
  In 2001, the Sept. 11 terrorist attacks on the World Trade Center and the Pentagon pushed bankruptcy reform to the back burner. The first formal meeting between the House and Senate conferees to work out differences in the legislation had been scheduled for Sept. 12.
  And in 2002, a compromise bill hammered out after lengthy negotiations between Republican and Democratic lawmakers also failed. The hang-up: a controversial amendment that would have prohibited individuals convicted of attacking legal businesses, such as abortion clinics, from discharging their debts by filing for bankruptcy.
  That's not to say that bankruptcy reform is dead. The Judiciary Committee of the House of Representatives will "be looking to take up bankruptcy in the next couple of months," a spokesperson says.
  And lawmakers won't be starting from scratch. Rep. F. James Sensenbrenner (R-Wis.), the committee chairman, will use as the basis for the legislation the bill approved by the Senate/House conference committee, minus the abortion-clinic amendment.
  Nonetheless, it appears a bankruptcy-reform bill may face roadblocks again this year, even though Republicans control both the House and the Senate as well as the White House. For one thing, a Congress preoccupied with possible war with Iraq, terrorism, a struggling economy and the Feb. 1 Columbia space shuttle disaster may have little time or inclination to deal with bankruptcy reform. "Clearly, the nation is in a crisis mode," says Stuart Feldstein, president of Hackettstown, N.J. SMR Research Corp. "There's an awful lot on the plate of Congress that comes before (bankruptcy reform)."
  Adds David Wyss, chief economist for rating agency Standard & Poor's Structured Finance Group: "My guess is that Congress has other fish to fry. You're not going to get much headway on this. The odds are still against getting it through."
  Another reason the reform law may stall is that lawmakers may be reluctant to pass a bill making it harder for debtors to file for bankruptcy when the country is mired in the economic doldrums.
  Times Change
  "Congress is now legislating against a backdrop of a sluggish economy with growing numbers of unemployed, which may make it harder to pass a more muscular law affecting consumer bankruptcies," says Samuel J. Gerdano, executive director of the American Bankruptcy Institute, an association of bankruptcy professionals.
  The push for bankruptcy reform first came in the late 1990s, when bankruptcies soared to record highs despite a robust economy. "The argument had been made that in that environment, consumer bankruptcies should not have been going up at the rate they were going up," Gerdano says. "It was a matter of people simply taking advantage of a very easy bankruptcy process."
  That's not the case now. "The argument today would be that people are losing their jobs, unemployment is higher than it was before, and others who are not losing their jobs are being downsized or otherwise losing benefits, which put a crimp in their household balance sheets," Gerdano says.
  Nevertheless, lenders claim the need for bankruptcy reform remains. For the 12 months ending Sept. 30, 2002, personal filings hit a record 1.5 million, up 7.8% from the same period in 2001, according to the Administrative Office of the U.S. Courts (chart, page 36). "Most people believe 2003 will be an even bigger year, perhaps close to 1.6 million," Gerdano says.
  Not everyone agrees with Gerdano's forecast. "Overall, we're looking for bankruptcies to be down by about 5% this year," Wyss says. "Basically, it will be matching last year's rise, which still leaves them at a pretty darn high level."
  But that scenario assumes that an economic stimulus package is approved by Congress, Wyss says.
  When or if the economy improves this year also depends on whether the U.S. goes to war with Iraq, says Allen Grommet, senior economist with Cambridge Consumer Index. "We can't estimate whether the economy will come back until after this Iraqi war thing is over," he says.
  What's more, the number of filings could rise if bankruptcy reform makes headway. Some observers say that much of the increase in bankruptcies last year could be traced to debtors filing when it seemed the tighter restrictions of the reform bill were imminent. "You could see lawyers advertising again, 'Go bankrupt, avoid the rush,'" Wyss says.
  Also troubling is a "bit of a spike" in credit card chargeoffs to 7.5% of receivables in December, second-highest loss rate since March 2002, when chargeoffs on securities backed by credit cards stood at 7.6%, Wyss says. Bankruptcies account for 40% or more of card chargeoffs. S&P tracks $420 billion in card bonds.
  The reform bill that went down to defeat last year was designed to make it more difficult for consumers to discharge debt, moving them into a Chapter 13 reorganization rather than a Chapter 7 liquidation in which their card balances and other unsecured debt are erased. Under that bill's so-called means test, if a debtor is found to have sufficient income to repay at least 25% of the debt over a five-year period, or has at least the median income for his or her state, a reorganization likely would be required.
  The Homestead Exemption
  The bill also imposed a $125,000 homestead cap if the debtor moved into the state within 40 months of filing for bankruptcy. And the bill would have limited the homestead exemption to $125,000 for anyone who owes a debt in violation of federal or state securities laws, including violations of the Racketeer Influenced and Corrupt Organizations Act (RICO).
  Observers say they expect any bill introduced this year to include most of the same provisions.
  There's no doubt that a Chapter 13 filing increases an issuer's chance of recovering at least some of the payment due. Cases overseen by 200 Chapter 13 trustees ended with repayment of about $4 billion to credit granters last year, says Henry E. Hildebrand III, a Chapter 13 trustee in Nashville, Tenn. Hildebrand is chairman of the legal and legislative rules committee of the National Association of Chapter 13 Trustees.
  In the Nashville area, about $10 million a month is being disbursed to creditors, Hildebrand says
  Over the past 20 years, the number of debtors overall filing for Chapter 7 as opposed to Chapter 13 "has remained relatively static," with about two-thirds filing for Chapter 7, Hildebrand says. He adds that those ratios vary greatly by state.
  That's the case in Tennessee, where 70% of cases are filed under Chapter 13, William Houston Brown, U.S. Bankruptcy Judge for the Western District of Tennessee, said at a recent ABI press briefing.
  In Nashville, consumers are using Chapter 13 not as an alternative to Chapter 7 but as an alternative to repayment plans arranged by credit-counseling agencies, Hildebrand says. "These people will walk in with the idea that 'I want to pay this debt but I can't do it on their terms,'" he says.
  Hildebrand notes that credit counselors "can't help you with your mortgage default, they can't help you with your car repo, and in many cases, they cannot get an understanding or agreement from the retail cards."
  Hildebrand questions whether the proposed legislation would be successful in forcing more people into Chapter 13. "From what I can tell, most debtors that are targeted by the bankruptcy-reform bill would not get caught by the bankruptcy-reform bill," Hildebrand says.
  Eighty-four percent of existing filers fall below the median income, according to Hildebrand. Of the remaining 16% of filers, anywhere from 3% to 8% would be subject to the means test, he says.
  There are a large number of consumers who file for Chapter 13 because they have a mortgage default, "and Chapter 7 doesn't help you stay in your house," Hildebrand says. "That universe will still be there" under bankruptcy reform.
  However, people seeking to rewrite their auto loans would not be able to do so because the reform bill takes that option away from Chapter 13, he says.
  Cars Win, Cards Lose
  Under current bankruptcy laws, if a debtor has a $10,000 note on an $8,000 car, he would have $8,000 in secured debt, leaving $2,000 be divvied up among the unsecured creditors, Hildebrand says. "The reform bill would say 'no, it's a $10,000 secured debt that has to be paid in full.' That money comes away from the credit cards and the medical bills and goes to the auto finance companies. The incentive is gone."
  In the past, debtors would file for Chapter 13 to save their house, auto, and furniture. "If they're not able under a new bill to make some of the adjustments in ongoing car payments or the value of their car, things of that nature, they may not have the same incentive or ability to file for Chapter 13 as they currently do," Brown says.
  In addition, there seem to be more elderly and young debtors filing for bankruptcy, Hildebrand says. "Young debtors are being saddled with both student loans and credit card debt and the credit card balances you never would have seen 20 years ago."
  "Older people are coming into bankruptcy with limited or fixed incomes but have second or third mortgages on the only asset they have, which is their house," he adds. That makes it more difficult for them to pay their debts.
  Many debtors are several months delinquent on their mortgages and car payments and on extremely tight budgets when they file for bankruptcy, with little money to pay other creditors, Judge Brown says. "Any legislative effort to push more people in to Chapter 13 will encounter the same reality," he says. "Filing Chapter 13 only works if you have the income to fund a realistic plan of repayment."
  One emerging issue is that of repeat filings, H. Jason Gold, a bankruptcy trustee in Virginia, said during the ABI press briefing. "We have a great deal many repeat filings," Gold says. "Roughly speaking, a debtor can ... get a bankruptcy discharge every six years. We see many, many debtors taking advantage of that."
  'Extraordinary' Debt Loads
  The law addressed serial filing by extending the filing period to every eight years, Gold says. "From the consumer credit industry point of view, that's an improvement," he says. "From the debtor's point of view it's quite the opposite."
  Gold says, however, that he doesn't believe the provision will have a major impact on serial filers.
  The reasons debtors are filing for bankruptcy also have changed over the years, Hildebrand says. Initially, most bankruptcies could be attributed to factors such as divorce or catastrophic medical expenses. Now more bankruptcies are filed by consumers who took on "extraordinary" debt loads because of the easy availability of credit, he says.
  "When I started this work 20 years ago, most of the consumer debt was not anonymous, nor was it unsecured," he says. "It was based upon asset-financing-buying a car, or a refrigerator."
  For now, it's unclear whether reform would succeed in reining in bankruptcies. Beyond tightening of bankruptcy standards, issuers need to answer a single question: What is the root cause?
  "Is it the issue of too easy credit or is it consumer irresponsibility, or is it both," Gold says. "That's probably an issue that will never get resolved."