|
 Editor's
note: On the afternoon of April 14, 2005, the House passed the bankruptcy
bill, clearing the way for President Bush to sign it into law.
The bankruptcy bill that the Senate passed earlier
this month is a good news/bad news bill. It's good news for big
business, and mostly bad news for financially troubled consumers.
In the not-too-distant future, consumers will
have a harder time erasing their debts by filing for bankruptcy.
The sweeping new provisions to the bankruptcy code will prevent
many Americans from qualifying for a "fresh start" Chapter
7-style bankruptcy, in which debts are discharged. Many instead
will be forced to file Chapter 13, which requires payment toward
debt under a court-ordered payment schedule over three to five years.
The legislation is expected to
sail through the House of Representatives in early April, land on
President Bush's desk, and promptly get signed into law.
Not surprisingly, banks, credit card companies and
retailers have lobbied for its passage for eight years, in an attempt
to stem "abuses" from consumers who fall deeply into debt
and then look for an easy way out. Their argument: The number of
bankruptcy filings has skyrocketed in recent years. Roughly 70 percent
of bankruptcy filers go for Chapter 7 because it effectively wipes
the slate clean for debtors, though it stays on their credit records
for 10 years from the date filed.
Last year, more than 1.1 million consumers filed under
Chapter 7, while only half that number did in 1994, according to
the American Bankruptcy Institute, a research group.
This is not a clear-cut story of right vs. wrong,
where protagonists and antagonists can be clearly identified. Surely
some consumers use credit cards to spend, spend, spend without any
intention of repaying their debts. But I don't believe this is usually
the case, and I'm not inclined to see this as the story of greedy,
deadbeat consumers who have been abusing the hapless credit card
industry. In fact, I would tend to cast the credit card industry
in the role of evil villain, mainly because of its widely adopted
universal
default policy that jacks up interest rates to 25 percent and
higher if consumers make one billing misstep with an unrelated creditor.
But credit cards are a necessary evil these days,
one that we should do everything in our power to control. We should
all deal with debt responsibly -- by not taking too much on and
by paying it off promptly.
However, sometimes life throws unexpected financial
hardship our way, whether it's in the form of high medical bills,
job loss or divorce. Critics of the legislation say that it will
remove a safety net for Americans who suffer from such calamities,
and will keep them mired in debt for life.
Provisions of the new bill
Right now, bankruptcy judges decide which form of bankruptcy is
most appropriate for the consumer who seeks debt relief. The new
bill calls for financially troubled Americans to be subjected to
a "means test" to determine their eligibility for a Chapter
7 filing. Generally, consumers whose incomes are higher than the
median income level in their state, and who have disposable income
of $100 a month that can be used to repay $6,000 over five years,
would be pushed into a repayment plan under Chapter 13.
The means test has been characterized as "over-inclusive"
and "painfully inflexible." It follows guidelines set
up by the IRS for tax evaders, and imposes severe limits for allowable
expenses: about $200 a month for food and less than $800 for housing
and utilities, for example. In addition, the means test will subject
consumers to lengthy and expensive hearings in the courts.
Some assets spared
Some assets will be protected from creditors. Here's a good provision
of the bill: Any contributions made to a 529 college savings plan
more than two years prior to filing for bankruptcy would be exempt
from assets available to creditors, says Joseph Hurley, a 529 plan
expert who operates the Web site savingforcollege.com. A $5,000
limit applies to contributions made more than one year but less
than two years prior to filing for bankruptcy.
While homes are exempt in certain states, the new
provisions require homeownership for a minimum of 40 months. In
other words, if you file for bankruptcy within 3.3 years of purchasing
a home, it would no longer be off limits to creditors, even if the
home is situated in a state that offers the homestead exemption.
But a lot of money can be overlooked, too. Up to $1
million in retirement benefits can be shielded from creditors. And
an unlimited amount of money can be stashed away in state-sponsored
asset-protection trusts (available in five states) without interference
from creditors. Interesting, don't you think?
Flaws of the bill
A group of 92 professors at prestigious universities across the
country found many problems with the bill and tried unsuccessfully
to urge lawmakers to vote against its passage. Their area of expertise
is bankruptcy and commercial law.
"The bill is deeply flawed, and will harm small
businesses, the elderly and families with children," they warned
in a letter
directed to lawmakers. "In our view, the fundamental change
over the last ten years has been the way that credit is marketed
to consumers."
Credit has been offered increasingly to riskier borrowers
in the subprime market, they argued, so the higher default rate
is to be expected. "Nonetheless, consumer lending remains highly
profitable, even under current law," they said.
The professors made a strong case against the bill,
tearing away at numerous provisions that are unfair, particularly
to certain segments of the population, most notably the elderly
and families with children. But the most compelling argument they
make rips apart the very foundation upon which the new bill is laid.
Proponents of the bill, including its sponsor, have
argued that it will relieve honest Americans from having to pay
the "bankruptcy tax."
"In their view, the cost of credit card defaults
is passed along to the rest of those who use credit cards, in the
form of higher interest rates," the professors explain. But
this so-called tax just does not exist, say the educators: "The
average interest rate charged on consumer credit cards has declined
considerably over the last dozen years," they point out. "More
importantly, between 1992 and 1995, the spread between the credit
card interest rate and the risk-free six-month Treasury bill declined
significantly and remained basically constant through 2001. At the
same time, the profitability of credit-card-issuing banks remains
at near-record levels."
Poof. There goes the whole rationale for passing the
bill in the first place, and with it the illusion that credit card
companies suffer losses when consumers with financial hardships
file for bankruptcy under Chapter 7. The credit card companies aren't
really losing money; they're just not making as much as they could
if everybody had the wherewithal to pay their bills.
Credit card issuers are also not making as much money
because of the growing identity theft problem, which forces them
to pick up the tab when credit cards are used fraudulently. Why
don't they direct their energies to curbing that problem? It would
be a win-win situation for business and consumers alike.
Another thing they can do to save a bunch of
money: Cut their marketing departments in half and stop sending
so many solicitations to prospective customers -- particularly high-risk
borrowers. This only tempts Americans to dig themselves deeper into
debt.
Longtime financial journalist
Barbara Mlotek Whelehan earned a certificate of specialization in
financial planning.
If you have a comment or suggestion, write to
Boomer Bucks. If you
have a particular financial problem that you would like addressed,
please send your queries to Dr.
Don, Tax Talk,
the Real Estate
Adviser or the Debt
Adviser.
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