This month marks the 20th anniversary of passage of the Bankruptcy Reform Act of 1978, the last major reform of the bankruptcy system. Coincidentally, that landmark bill was also debated when the House Judiciary Committee was in the midst of impeachment proceedings. This month’s anniversary is an appropriate time to look back at the process and policy behind the Bankruptcy Reform Act of 1998, which died at the close of the 105th Congress under threat of a presidential veto.
The year of the 1978 act had fewer than 200,000 consumer bankruptcy filings — about one in every 400 households. The year of the failed 1998 act will have a record number of more than 1.4 million consumer bankruptcy filings — about one in every 70 households. Amazingly, more filings occurred during the last six months than during the entire decade of the Great Depression. Much of the debate surrounding the 1998 act centered on the blame for this dramatic rise. Those who stood against reform, primarily bankruptcy attorneys and self-appointed consumer advocates, blamed loose lending by credit card companies for the dramatic increase. Those urging reform, primarily credit card companies and free market advocates, blamed lax bankruptcy laws for the increase.
Bankruptcy attorneys and self-appointed consumer advocates have, to say the least, a credibility problem. For decades they argued for changes in the law that ratcheted up the attractiveness of filing for bankruptcy. In response, the Congress has repeatedly done just that, so those are the precise parties to blame for the record number of filings we now have in the midst of good economic times. Bankruptcy attorneys and consumer advocates have also greatly undermined their credibility in the current debate by spreading the lie, repeated by the First Lady in her weekly syndicated column, that credit card companies compete for payment priority in bankruptcy with child support payments. This is an especially hypocritical stance for bankruptcy attorneys who currently line up to be paid before both child support and creditors. Furthermore, bankruptcy attorneys are quick to point out that credit card companies have a financial interest in the reform process, but they ignore their own equally strong interest in a legal system that generates over a million filings and more than a billion dollars in legal fees per year.
Congress has improperly viewed bankruptcy as a creditor-funded social welfare program.
Consumers’ ability to pay tells a different story. The consumer credit debt service burden — nonmortgage principal and interest payments as a percentage of disposable income — is roughly what it was throughout much of the 1960s and 1970s when fewer than 200,000 consumers filed annually.
The attractiveness of filing Chapter 7 bankruptcy is unmistakable. Once every six years, the law allows a consumer to get an immediate discharge of unpaid debts without forgoing any future income, while retaining virtually all property, including real estate, cars and pensions. All this without any real means testing to determine if the debtor is capable of repaying any of those debts. One of seven households could benefit financially from filing, but filing rates are not higher because most debtors simply do not find out about the good deal available until they become distressed and either seek out an attorney or learn about the bankruptcy option from family and friends.
Congress has improperly viewed bankruptcy as a creditor-funded social welfare program. But, because creditors cannot cost effectively screen out high-risk borrowers, all debtors pay up front via higher interest rates and more stringent loan qualification requirements.
The Bankruptcy Reform Act of 1998 would have imposed a long overdue system of means testing on consumer filers by allowing judges to either dismiss a Chapter 7 case or convert it to a Chapter 13 repayment plan. That would have occurred if a review of the consumer’s finances, after accounting for living expenses, revealed an ability to pay back over a five-year period at least $5,000, or 25 percent of unsecured debts. That means test would not have applied to those with incomes below the national median. Further provisions would have curbed abusive repeat filings by extending the period between Chapter 7 discharges from six to eight years and making nondischargeable certain last minute-debts incurred within 90 days of filing.
The 106th Congress should put bankruptcy reform at the top of its agenda early next year. Overwhelming majorities passed consumer bankruptcy reform measures in both houses during 1998 on the basis of clear evidence of debtor abuse of the system. If the economy slips into recession, sentiment may change to sympathy for troubled debtors. The history of bankruptcy law in this country is replete with examples of Congress ratcheting up the attractiveness of filing during economic downturns. That prescription of debtor relief is the true cause of today’s record number of bankruptcies.