Gauging the Bottom-Line Effects of the Bankruptcy Bill
Sought by creditors since the late 1980s, debated by Congress since 1997, and derided by consumer advocates since its inception, bankruptcy reform legislation cleared its final congressional hurdle Thursday when the House voted 302 to 126 to send it to President Bush, who plans to sign it shortly.
The core of the bill, which the Senate approved last month, is meant to direct higher-income debtors into repayment plans. Doing so could add $3 billion a year to the bottom lines of credit card companies and unsecured consumer lenders, according to some projections. Other provisions should boost the bottom lines of companies such as investment banks, secured creditors, and commercial lenders.
"By targeting high-income ... [debtors] with substantial repayment capacity, it is estimated that means-testing will recover roughly $3 billion of the $40 billion discharged in bankruptcy every year," Todd J. Zywicki, a visiting professor at Georgetown University Law Center, told a Senate committee in February.
The bill would establish a means test, or formula, to determine if a debtor earns more than the median income of the debtor's state and has the funds to repay at least a portion of the debts. The test would subtract living expenses, secured debt payments, and certain other expenses from the debtor's income. If the debtor has enough remaining income to repay at least $6,000 over five years, the test would require filing for protection under Chapter 13 of the Bankruptcy Code and developing a plan to repay creditors.
Individuals who do not meet the means requirements would be able to discharge their debts by filing under Chapter 7, the section of the code that forgives debt. However, to reduce repeat filings, the bill would require such debtors to attend financial management training.
Prof. Zywicki predicted the changes would steer 7% to 10% of all filers into repayment plans.
Last year 1.6 million people filed for protection from creditors under the Bankruptcy Code.
"Focusing scrutiny on those high-income debtors who can repay a substantial portion of their debts without significant hardship ... makes possible the recovery of substantial losses with minimal administrative cost," Prof. Zywicki said.
Industry officials say that while the number of debtors who would be steered into Chapter 13 is small, they hold a disproportionately large size of debt that is discharged each year.
"The top 10% of Chapter 7 filers is probably responsible for far more than 10% of that total debt," said Phil Corwin, a partner in the Washington law firm Butera & Andrews and a nearly 20-year veteran of the industry's bankruptcy reform effort.
In fact, the bill zeroes in on the biggest debtors by requiring people who have more than $1.1 million of debt - and the means to repay it - to file under Chapter 11, which would be changed to make income earned after filing available to creditors. Some debtors had tried to exploit the current Chapter 11 protections for businesses.
The change "should be a check on high-end abuse" of the bankruptcy system, said John McMickle, a partner in the Washington office of the law firm Winston & Strawn LLP, who helped draft the first bankruptcy reform bill in 1997, when he was a Senate aide.
House Judiciary Committee Chairman James F. Sensenbrenner Jr., R-Wis., said during debate Thursday that the bill "will improve bankruptcy law and practice by restoring personal responsibility and integrity" to the system. "It will also ensure that the system is fair to both debtors and creditors."
Despite such assurances, consumer advocates charge that wealthy individuals still would be able to escape debt by hiding their assets, while middle- and low-income people hit by medical bills, divorce, or other life-changing circumstances would be forced into burdensome repayment plans.
Critics also say credit card marketing, interest rate, and penalty policies prey on consumers and drive many of them into bankruptcy.
The bill "imposes no responsibility whatsoever on the credit card industry," Rep. William Delahunt, D-Mass., said during House debate Thursday. "We talk about personal responsibility. What about corporate responsibility? The credit card industry bought and paid for this legislation. Somewhere north of $40 million was part of that effort. This bill was written for and by the credit card industry. It's got nothing to do with the consumer."
In addition to steering more debtors into repayment plans, the bill would raise the bar on how much debtors have to repay if they buy so-called luxury goods and services or get cash advances shortly before filing for bankruptcy.
Currently, charges or cash advances of over $1,000 made 60 days before a filing are not dischargeable. The bill would change the limits to $500 and 90 days for charges and $750 and 70 days for cash advances - for each line of credit. The change, aimed at stopping people from loading up on debt before filing, would not apply to charges for necessary goods and services, like groceries or rent.
Additionally, the bill would cap at $125,000 the assets a debtor could shelter from creditors by buying real estate, within 40 months of filing, in one of the five states that prohibit creditors from seizing debtors' homes. Additionally, people who courts say tried to evade creditors by moving to one of these states within 10 years of filing for bankruptcy would not be allowed to use the so-called homestead exemption. Filers who committed securities fraud would not be allowed to exempt their homes from the pool of assets distributed to creditors.
Unsecured creditors also would benefit from a provision that would increase the length of Chapter 13 repayment plans from three years to five years. The change is expected to increase the likelihood, and the total amount, of repayment.
Additionally, the bill takes aim at repeat bankruptcy filings by extending the period between Chapter 7 filings to eight years and Chapter 13 filings to five years.
Still, some analysts say it would take a long time for the changes to significantly reduce chargeoff rates, if it even happens at all.
"It will be beneficial to creditors in general, but not as beneficial as some might think," said Robert Hammer, the chairman of R.K. Hammer Investment Bankers of Thousand Oaks, Calif. "I don't see loan losses benefiting from improved recovery, because not all loan losses are due to bankruptcy. Bankruptcy only accounts for half of loan losses. There are people who progress through the delinquency process and never file for bankruptcy."
Skeptics predict a wave of filings before the legislation takes effect in six months, and they offer pessimistic long-term projections on how much lenders would recoup from court-mandated repayment plans.
The research firm Global Insight Inc. projects that personal bankruptcy rates will rise 11.3% between 2004 and 2007, because of worsening economic conditions and higher levels of consumer debt.
"The long-term thrust of the bill has been oversold in terms of how much of a difference it is going to make to creditors," said Bert Ely, an independent consultant in Alexandria, Va. "How much more are you going to be able to squeeze out of folks who are not very good at managing their finances in the first place?"
Others say the bill would deter filings.
"The real value of the bill is that it is going to make it much, much less attractive for people to file who have a meaningful capacity to repay and are using the system as a low-risk way to avoid significant amount of debts," said Jeff Tassey, the managing partner of the lobbying firm Tassey & Associates, who has been representing financial services companies in bankruptcy efforts since the early 1990s.
Mr. McMickle pointed to three changes in the law that he expects to discourage people who can repay their debts from entering bankruptcy in the first place: the means test, requiring filers to make their tax and other financial statements available to court, and letting creditors file motions to dismiss a Chapter 7 case if they believe the debtor can repay.
"When you go to a system that has a means test, systemically looks at all the records of where their income comes from, and permits creditors to appear in court - that level of change is bound to deter some people," he said. "A certain number of people will be deterred from filing at all. That is very difficult to quantify, but is probably the most meaningful thing about this bill."
Some analysts say the cultural change that the industry expects the new law to institute could hurt the industry's bottom line.
"A greater proportion of the population will be reluctant to run up debt and get more conservative in their spending and use more debit cards, which banks make less money from," Mr. Ely said.
Also, some analysts say the changes would pit secured and unsecured creditors against each other. By putting more people into plans to repay unsecured loans, the bill could make them fall behind on payments to their secured creditors, the analysts argue.
To get the bill passed, the financial services industry has had to make some concessions. The biggest was diluting the means test. Early versions of the bill would have tested the means of all bankruptcy filers, while the current version applies the test only to filers who earn less than the median in their state. Additionally, the threshold was reduced for discharging credit card charges and cash advances for big-ticket purchases.
To offset new burdens on debtors, lawmakers added some consumer protections, none of which industry officials say are onerous.
Creditors would have to maintain a toll-free number where consumers could get an estimate of how long it would take to pay off the principal making only minimum payments.
Early versions of the bill would have let customers enter their account balance and interest and find out exactly how much it would cost and how long it would take to pay off the debt. The requirement was scaled back significantly when card companies complained that it would be prohibitively expensive.
Card companies would have to print a warning, in a "clear and conspicuous" manner, on the front of billing statements about the financial hazards of making minimum payments.
Additionally, statements would have to clearly state the date a payment is due, what penalties will be charged for late payments, and when they will be charged.
By Michele Heller, American Banker
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