Consumer Bankruptcy in the Balance: Providing an Effective Safety Net For Overwhelmed Families

Footnotes

1 The National Consumer Law Center is a nonprofit organization specializing in consumer credit issues on behalf of low-income people. We work with thousands of legal services, government and private attorneys around the country, representing low-income and elderly individuals, who request our assistance with the analysis of credit transactions. The National Consumer Law Center also serves as an advocate for low-income consumers on consumer lending and bankruptcy. NCLC publishes materials for lawyers and consumers, including the nationally acclaimed book Surviving Debt: A Guide for Consumers. NCLC has trained lawyers and counselors nationwide on consumer protection issues relevant to low-income consumers.

My own experience includes 12 years as an attorney representing clients in bankruptcy, as an advocate for consumers on bankruptcy issues, as a teacher and trainer of other lawyers, and as an author of books on bankruptcy and consumer debt. My work also focuses on helping homeowners with financial problems avoid foreclosure. The bankruptcy system has always provided an important means to that end.
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2 Foreclosures have more than tripled since 1980. There were approximately half a million foreclosures in 1996.
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3 See National Consumer Law Center, "The Energy Affordability Crisis of Older Americans" p. 23 (August, 1995).
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4 Ausubel, "Credit Card Defaults, Credit Card Profits and Bankruptcy", 71 Am. Bankr. L.J. 250 (1997).
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5 The number of consumers who have visited consumer credit counseling for help in the last 20 years has increased at a faster rate than bankruptcy filings. More than two million families sought such help in 1997.
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6 Commercial banks earned 14.8 billion in the third quarter of 1997, the third consecutive quarter of record profits and the 19th consecutive quarter involving profits of more than 10 billion. See Ausubel, Credit Card Defaults, Credit Card Profits and Bankruptcy, 71 Am. Bankr. L.J. 250 (1997) for a discussion of the role of credit card profits in the current boom in banking.
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7 Even Mastercard recognizes this trend. In its recent report on debt and bankruptcy, its economist states: "Stagnation in real wages during the last 20 years and the growing disparity in income and wealth, ... have almost certainly contributed to the rise in personal bankruptcies. Declines in income caused by job loss make it more difficult for those affected to service previously accumulated debt." Chimerine, "Americans in Debt: The Reality", p.24 (MasterCard International 1997).
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8 Sullivan, Warren, and Westbrook, As We Forgive Our Debtors, pp. 91-102 (Oxford University Press, 1989). See generally Medoff and Harless, The Indebted Society pp. 103-119 (Little Brown & Co. 1996) (in the last two decades real wages of the newly hired have fallen faster than those of longer tenured employees).
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9 More than two billion credit card solicitations were sent out in 1997. See Hays, "Banks Marketing Blitz Yields Rash of Defaults" Wall Street Journal, p. B1 (September 25, 1996). MBNA, one of the largest issuers, claims 30 million credit card solicitations each month in 1997 together with 6 million phone solicitations. Hansell, "A Banking Powerhouse of Cards", N.Y. Times, p. C1 (October 22, 1997).
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10 See Chacon, "Debt Burden Soaring for U.S. Students" Boston Globe, p. 1 (October 23, 1997). According to the Nellie Mae study on which the article is based, an average student's debt increased from $8,200 in 1991 to $18,800 in 1997.
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11 "Family Finances in the United States: Recent Evidence from the Survey of Consumer Finances" Federal Reserve Bulletin, p. 1, 21 at Table 14 (January, 1997). Overall, the rate is one family in nine.
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12 See Sullivan, Warren, and Westbrook, As We Forgive Our Debtors, pp. 147-165 (Oxford University Press, 1989).
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13 See Hildebrandt and Thomas, "The Rising Cost of Medical Care and Its Effect on Inflation", Federal Reserve Bank of Kansas City, Econ. Rev. p. 47 (Sept./Oct. 1991).
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14 Domowitz & Sartrain, Determinants of the Consumer Bankruptcy Decision, p. 25 (1997).
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15 See Dugas, "Special Report: Going Broke, Wage Garnishments a Key Factor" USA Today, p. 1A (June 10, 1997); Hansell, "We Like You. We Care About You. Now Pay Up. Debt Collecting Gets a Perky Face and Longer Arms", NY Times, F.1 (Jan. 26, 1997).
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16 Sterling & Shrag, Default Judgments Against Consumers: Has the System Failed?" 67 Denv. U. L. R. 357, 384 (1990).
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17 See, e.g, Adding Insult to Injury: Credit on the Fringe, Hearing before the Subcommittee on Consumer Credit and Insurance of the House Committee on Banking, 103rd Cong., 1st Sess. (1993). Rehm, In a First, FDIC Warns Banks About Dangers of Sub-Prime Lending, 162 Am. Banker 2 (May 13, 1997).
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18 See Forrester, "Mortgaging the American Dream: A Critical Evaluation of the Federal Government's Promotion of Home Equity Financing" 69 Tul. L. Rev. 373 (1994).
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19 Three neutral academic studies show this remarkable correlation. Ausubel, Credit Card Defaults, Credit Card Profits and Bankruptcy, 71 Am. Bankr. L.J. 250 (1997); Bhandari & Weiss, The Increasing Bankruptcy Filing Rate: An Historical Analysis, 67 Am. Bankr. L.J. 1 (1993); Statement of Kim Kowalewski, Chief, Financial and General Macroeconomic Analysis Unit, Congressional Budget Office, before the Subcommittee on Administrative Oversight and the Courts, Committee on the Judiciary, United States Courts, (April 11, 1997). See Commission Report at pp. 84-86. These studies stand is sharp contrast to credit industry funded studies which purport to show otherwise.
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20 Borrowers who maintain balances pay interest at rates which typically range from 14.5 to 19.8%.
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21 Minimum payments on many credit cards will not amortize the loan, thus sucking people in over their heads. If minimum payment terms are offered which won't amortize the debt in two years, consumers should be told, in clear and conspicuous language, what they need to pay, if they make no further charges, in order to pay off the loan over a two year period.
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22 Low initial rates are designed to encourage consumers to use credit in the first months after credit is granted. Many consumers do not understand what the permanent rate will be or the impact of the rate change on a large unpaid balance.
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23 Some lenders raise rates arbitrarily after consumer balances reach a certain level. Interest rate changes should be tied to an actual change in the interest rate environment so that consumers are not caught unawares.
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24 When a lender extends a consumer's credit limit unilaterally, in some cases after a consumer is already struggling with the existing balance, the message is that the lender believes that the consumer can afford to take on more credit. Consumers would not be hurt by having to ask for more credit, rather than having it offered unilaterally. Such a request should trigger at least minimal underwriting requirements.
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25 These hidden security interests in items of property which have no resale value to the creditor provide inappropriate leverage to lenders in the collection process even though there is no potential that the lender could make money in the event of repossession.
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26 Consumers receive checks from several major lenders in the mail for as much as $5,000. Not everyone understands that cashing these checks can lead to acceptance of high rate credit terms. In addition, providing preapproved credit through cashed checks eliminates the cooling off period which more common credit application processes provide.
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27 With credit card cash advance machines prevalent in casinos, is it surprising that some gamblers get overextended on credit and file bankruptcy based on those credit card debts?
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28 Offering credit aggressively to college students who cannot afford to pay off their debts until they join the work force some years later is prevalent because interest mounts until the debt is paid. By lending aggressively to college students, at a time in life when money is scarce, our society runs the risk of saddling people early in life with an unmanageable problem which will later preclude more important uses of credit such as purchase of a home and car.
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29 Competition in the market has not worked to keep rates at reasonable levels. On a procedural level, the Supreme Court has held that credit card lenders can rely on the law in the state where they are incorporated in setting the interest rate and many of the other terms of credit for consumers nationwide. This has led to a "race to the bottom". States deregulate in order to create the best possible environment to encourage a credit card company to locate there in order to export terms of credit across the country. This helps certain states create jobs. However, it means that those other states that do want to regulate for the benefit of their citizens can no longer do so. Either states should be freed to create and enforce meaningful regulations or the federal government should step in with consumer protections.
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30 H.R. 1975, 105th Cong., 1st Sess. (1997) "Credit Card Consumer Protection Act of 1997". See also H.R. 3146, 105th Cong., 2d Sess. (February 3, 1998) "Consumers and Lenders Bankruptcy Accountability Act of 1997" for an approach to addressing these problems by changes to the bankruptcy system.
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31 Deuteronomy 15:1-2 ("At the end of every seven years thou shalt make a release. And this is the manner of the release: every creditor shall release that which he has lent unto his neighbor and his brother, because the Lord's release hath been proclaimed".)
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32 Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934). See Gross, Failure and Forgiveness, ch. 6 (Yale University Press 1997).
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33 Sullivan, Warren and Westbrook, "Consumer Debtors Ten Years Later: A Financial Comparison of Consumer Bankrupts 1981-1991", 68 Am Bankr. L. J. p. 121, 128 (1994).
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34 Proposed legislation favored by the credit industry includes: S. 1301, 105th Cong., 1st Sess. § 102 (1997); H.R. 2500, 105th Cong., 1st Sess. §§ 101, 102 (1997); H.R. 3150, 105th Cong., 2d Sess. § 101 (1998). Consumer groups including the National Consumer Law Center, the Consumer Federation of America, the National Association of Consumer Bankruptcy Attorneys and the United Auto Workers are opposed.
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35 See Report of the Commission on the Bankruptcy Laws of the United States, Part I at 159 (1973); H.R. Rep. No. 595, 95th Cong., 1st. Sess. 120-121 (1977); Report of the National Bankruptcy Review Commission, Vol. 1, at pp. 89-91 (October 20, 1997) [hereinafter "Commission Report"].
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36 Teresa A. Sullivan, Elizabeth Warren, and Jay Lawrence Westbrook, As We Forgive Our Debtors, pp. 205-206 (Oxford University Press, 1989). This seminal book and the empirical work which underlies it remains the single most authoritative published source for studying bankruptcy demographics. It has been updated more recently in an article by the same authors which concludes that debtors are now even poorer and less able to pay their debts than they were when the initial study was done. "Consumer Debtors Ten Years Later: A Financial Comparison of Consumer Bankrupts 1981-1991", 68 Am Bankr. L. J. 121 (1994).
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37 Barron and Staten, "Personal Bankruptcy: A Report on Petitioners' Ability to Pay", Monograph 33, Georgetown U. Credit Research Center (1997). This report is reprinted as Appendix G-2.b to the National Bankruptcy Review Commission Report.
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38 GAO Draft Report at p. 8. The final report is due out on February 8, 1997 (requested by Senators Charles E. Grassley and Richard J. Durbin). The GAO concluded that the study's "fundamental assumptions were not validated". In addition, the GAO review concluded that the credit industry's study: failed to assess the accuracy of the data collected; failed to account for major expenses which bankruptcy debtors have after filing including payments on non-housing secured debt and reaffirmed or non-discharged non-priority debts; failed to evaluate potential differences among the sites chosen for the study; and failed to use statistically valid research techniques.
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39 Without allowing for the GAO's criticisms, the creditor's study concludes that debtors could pay 13.7% of their debts over five years. The GAO report points out that this conclusion must be modified because the creditors did not account for 1.) repayment plan failures (approximately 67% under current law), 2.) debts which must be paid back despite bankruptcy including car loans, student loans, reaffirmed debts and interest on those debts (payment obligations on these debts represent approximately 46% of total debts and thereby reduce a family's ability to pay other debts) and administrative costs of payment plans (10% of plan payments under current law). When these deductions from payment capacity are taken into account, what is left is the ability to pay about 5% of total debts over a five year period.
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40 67% of repayment plan cases fail under current law. There is every reason to think that if economically marginal debtors are forced into involuntary repayment plans, the failure rate would be higher.
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41 See D. Caplovitz, Consumers In Trouble: A Story of Debtors in Default pp. 280-285 (Free Press, 1974).
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42 Medoff and Harless, The Indebted Society, at pp. 12-13 (Little, Brown & Co. 1996).
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43 Report of the National Bankruptcy Review Commission, Vol. 1, at p. ix (October 20, 1997) [hereinafter "Commission Report"].
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44 Fed. R. Bankr. P. 9011.
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45 See 11 U.S.C. § 727.
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46 See 11 U.S.C. § 523(a).
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47 See, e.g., In re Barrett, 964 F.2d 588 (6th Cir. 1992) (finding that debtor's second chapter 13 filing, when he had insufficient income to support plan, was in bad faith but that third chapter 13 case, after circumstances had changed was not in bad faith); In re Love, 957 F.2d 1350 (7th Cir. 1992).
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48 Fed. R. Bankr. P. 2004. It is hard to see why creditors concerned about abuses can't utilize the examination process to uncover them. If it is not financially feasible for a creditor to pursue an examination, why should taxpayers instead bear that burden for the creditor's benefit.
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49 11 U.S.C. § 341. Fed. R. Bankr. P. 2003.
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50 11 U.S.C. § 707(b).
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51 18 U.S.C. §§ 151-157. Bankruptcy fraud is punishable by fine and imprisonment for up to five years. 18 U.S.C. § 157.
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52 That is the provision which Congress added to the Code in 1984 and which has functioned to root out debtors who can afford to pay their creditors. See, e.g., In re Kelly, 841 B.R. 908 (9th Cir. 1988); In re Krohn, 886 F.3rd 123 (6th Cir. 1989) (substantial abuse found where debtors could pay back their debts with "good, old fashioned belt tightening").
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53 See, e.g., H.R. 3146, 105th Cong., 2d Sess. § 8 (February 3, 1998). Creditors should not be allowed to obtain leverage by forcing new litigation on consumers who cannot afford to pay.
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54 For example, efforts should be made to provide improved credit reporting for people who complete chapter 13 payment plans. In addition, the discharge available in chapter 13 should be as broad as possible in order to serve as incentive to choose that chapter. Costs can be lowered by encouraging secured lenders to accept modifications to their mortgages in exchange for more favorable treatment.
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