Three years after the advent of sweeping U.S. bankruptcy law changes designed to limit bankruptcy cases, the number of people filing for protection from creditors has risen sharply over the past several months. More troubling: The faltering economy, credit crunch and housing bust are likely to push even higher numbers of families into bankruptcy come 2009, predict consumer advocates, economists and bankruptcy experts.
|Ballooning bankruptcies: Filings creeping upward in bad economy|
What’s new: Three years after dramatic changes in bankruptcy laws made it more difficult to file for protection from creditors, bankruptcy cases are on the rise. Bankruptcy experts expect the numbers to rise even more in 2009 as the economy continues to worsen.
“Most consumers never want to file for bankruptcy,” says John Rao, a bankruptcy attorney at the National Consumer Law Center, a Boston-based consumer advocacy group. He is among those predicting a sharp increase in bankruptcies in 2009. (SeeTips for those considering bankruptcy)
Economy ‘driving’ bankruptcies upward
“It’s driven by things like layoffs and health care and divorce. We’re going to see a lot of it over the next couple of years. Unemployment is going up. We still haven’t fixed the health care problem in the country and credit card companies are going to be stricter with credit.”
The revised bankruptcy law took effect three years ago — on Oct. 17, 2005 — and preceded a spike in bankruptcy filings, as people tried to beat the deadline before stricter requirements took effect, followed by a dramatic decline in cases. Now, things are heating up again in bankruptcy courts across the country.
As the law moves into its fourth year of implementation, critics are clamoring louder than ever for a do-over on bankruptcy laws — or at least a patch to fix problems that have come to light in the three years since its inception.
“There’s a fair amount of pent up anger over the impact of the bankruptcy law on consumer debtors,” says Sam Gerdano, executive director of the American Bankruptcy Institute, a nonpartisan bankruptcy information and education group.
“Three years later, the law did nothing to fix the underlying problem. There’s still the same amount of distress in the American middle class,” says Bob Lawless, a bankruptcy expert and University of Illinois law professor. Lawless has analyzed bankruptcy filing data and predicts, at the current pace of nearly 4,500 filings per business day in September 2008, the total number of filings will reach 1.2 million in 2009. “That doesn’t account for the economic conditions we’re having and we all know we’re in bad shape.”
He adds: “Bankruptcies aren’t going to go down in the long run unless people stop borrowing.”
Bankruptcy is a complex legal proceeding that allows a person or corporation to eliminate debt they cannot repay by dissolving their assets, working out future payment plans and dismissing some types of debt altogether. This fresh start levies a heavy price: Bankruptcies remain on credit reports for seven to 10 years and leave filers with bad credit records. As a result, they have lower credit scores, pay higher interest rates on credit cards or other loans — if they can get them at all — and may be rejected for job opportunities, auto insurance or apartment rentals.
The federal law — the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 — ushered in stricter requirements for debtors to file for bankruptcy. A means test to determine financial eligibility to file, higher filing fees, an eight-year moratorium on filing for bankruptcy a second time, debtor audits and mandatory credit counseling and debt management sessions were among the new provisions.
Proponents of the law argued that setting the bar higher for those who could file would weed out those who were abusing and gaming the system by deliberately running up debt and safely walking away from obligations through the bankruptcy process. They pointed to the 1.5 million bankruptcy petitions filed on average each year between 2001 and 2004 as the reason to reform the filing process.
Those who can pay
Supporters of the law included the banking and credit card industry and car and mortgage lenders. A spokesman for the American Bankers Association, a leading banking industry trade group, points to bankruptcy data on the percentage of nonbusiness Chapter 7 filings versus Chapter 13 nonbusiness filings. Chapter 7 allows some people to walk away from debts without paying anything while Chapter 13 requires at least partial repayment of debts.
2007 consumer bankruptcy fact box
- There were 822,590 nonbusiness related bankruptcy petitions filed in 2007; 61 percent were Chapter 7; 39 percent were Chapter 13 and less than 1 percent were Chapter 11.
- Average bankruptcy case processing time from filing to disposition: 129 days for chapters 7, 11 and 13; an average of 124 days for Chapter 7 consumer cases; 150 days for Chapter 11 cases; and 155 days for Chapter 13 cases.
- The maximum period that a bankruptcy case can be open is 440 days.
- Median monthly income reported by filers: $2,491 for Chapter 7, $5,951 for Chapter 11 and $3,307 for Chapter 13.
Source: Administrative Office of the U.S. Courts.
The proportion of people filing for Chapter 7 has decreased — from more than 71 percent in 2003 down to 60 percent in 2007. Chapter 13 filings have gone from 29 percent in 2003 to 39 percent in 2007.
“Some folks who do in fact have the means to repay a portion of their debt and are doing so under Chapter 13,” says Peter Garuccio, ABA spokesman. He says it’s too early to say whether the reform measures have been successful “because of what’s going on in the economy right now.”
Supporters also point out that bankruptcies drive up the cost of doing business and lead to higher costs for all consumers.
“Somebody will eventually pay for those debts; it’s not just the person who originally incurred them,” says Valerie Hayes, vice president of legal, compliance and governmental affairs for ACA International, the debt collection industry trade group.
Consumer groups opposed the law, arguing that the vast majority of people filing for protection were not abusers, but families in serious financial trouble. Amending the bankruptcy code to make it more difficult to file would mean more families stressed out and suffering longer without relief, they argued. Bankruptcies were the byproduct of a larger American problem: too much debt, too little savings, easy credit and families living beyond their means.
“Part of the reason people are struggling so long before they come into bankruptcy is the easy availability of credit lets them do that,” says Katie Porter, a University of Iowa College of Law professor and consumer bankruptcy researcher.
Alarming credit trends
Key reasons for concern about rising bankruptcy trends include:
- The economy. Rising job loss as the economy spirals into what economists currently call a “mild recession” will almost certainly nudge bankruptcies upward.
- Declining home values. For many years, consumers relied on home equity lines of credit (or HELOCs) to pay down credit card debt. But declining home values have nearly wiped out equity in millions of homes and closed the door on a key alternative to bankruptcy.
- The credit crunch. Wall Street’s financial woes and bank failures have already started to trickle down to Main Street as bankers have tightened credit standards for all forms of borrowing, including credit cards. Banks typically charge off unpaid credit card debts after 180 days of nonpayment. However, they must write off the debts much sooner (after only 60 days) when borrowers file for bankruptcy. Because bankruptcies are trending upward, Innovest, a New York-based investment research firm, is projecting higher than normal charge-off rates (as much as 10 percent compared to 5 percent or 6 percent) come the first quarter of 2009. In addition, the banking industry has saidcredit card regulationexpected by year’s end from the Federal Reserve may lead to higher interest rates and less credit available for credit card users.
- Credit cards as family lifeline. Higher food, gas, health care and utility costs have forced many families and people on fixed incomes to put basic living expenses on credit cards that they aren’t paying off each month. This trend, say financial planners and credit counselors, is a train wreck waiting to happen with bankruptcy as the most likely conclusion.
“A ‘perfect storm’ has occurred,” notes Todd Ossenfort, chief operating officer for Pioneer Credit Counseling, a national credit counseling service based in Rapid City, S.D. “Now the house of cards is coming tumbling down.”
Filings creeping upward
After several failed attempts over a nearly seven-year period, bankruptcy reforms finally passed through Congress and were signed by President Bush in April 2005. That year saw a surge in filings — up to 2 million — as debtors raced the deadline to file before tougher measures took effect. According to filing data compiled by the Administrative Office of the U.S. Courts, bankruptcies dipped to just 617,000 cases in 2006, the first full year of the new law. However, the numbers soon began to ratchet upward. There were more than 850,000 total filings in 2007.
Despite the fact that the bankruptcy law was promoted as a way to reduce cases, the number of filings have ballooned in 2008 and may surpass pre-2005 levels. Total bankruptcy filings rose 38 percent from 2006 to 2007. By the end of 2008, they are projected to jump by perhaps 30 percent over 2007 levels — to just over 1 million cases.
One sector that has felt the impact of rising bankruptcy filings: the debt collection industry. Filing for bankruptcy triggers a cease-fire from debt collection calls because the law requires an automatic stay or end of collection efforts once a bankruptcy petition is filed in court.
“Our members are hearing a lot more from consumers that they are in the process of filing for bankruptcy,” says Hayes of the debt collection trade group. “Once a collector hears that, they have to cease collection on that account.”
Some can’t afford to go bankrupt
One clear impact of the law: You need more money to file for bankruptcy.
“Some people are unable to get through the system because of the cost,” says Rao, from the consumer law center. “That’s actually one of the saddest impacts.”
A Government Accountability Office (GAO) report released in June 2008 on the dollar costs associated with the 2005 law revealed costs have gone up for filers. Administrative and bankruptcy court fees rose from $209 to $299 for Chapter 7 filers and from $194 to $274 for Chapter 13 filers. The fees may be waived for filers who qualify.
Those seeking bankruptcy protection must also pay about $100 for mandatory credit counseling sessions (required before filing) and debt reduction seminars (taken before debts are discharged). The fees for the courses are about $50 each and filers can get online, telephone or walk-in instruction.
Attorneys fees also have increased since the bankruptcy law took effect, mainly because cases now require much more paperwork, accounting and certification of accuracy of filings than previous years. According to a GAO survey, attorneys fees for Chapter 13 cases rose 55 percent or more in the majority of districts reviewed. The fees ranged from as low as $1,500 to above $4,000, according to the GAO survey.
In February and March 2007, lawyers charged an average of $1,078 for Chapter 7 filings — up from $712 during the same period two years earlier.
Leesa Kumley, a certified credit counselor with the Pioneer counseling agency, says one of her recent clients, an elderly woman living on a $600-a-month Social Security check, had $20,000 in credit card debt — amassed as she put medical co-pay costs, prescription medication and heating bills on credit cards.
“Bankruptcy may have been an option for her to get out of the credit card debt,” Kumley says, “But she couldn’t afford to pay an attorney.”
Bankruptcy attorney Claire Ann Resop says people who can’t afford attorneys fees often don’t have enough assets to make it worthwhile for creditors to go after debts.
“If they are really so poor that they cannot afford the money to pay for the bankruptcy, nobody can collect from them anyway,” says Resop, who is also serves as a trustee who oversees Chapter 7 liquidation cases in Madison, Wis. “They’re below the poverty line. They usually don’t need to file.”
Resop and others note the emotional and physical toll that battling debt places on families. Increased stress, sleeplessness, depression and other medical complications are common in people going through bankruptcy. Resop compares the driver’s license photos of bankruptcy petitioners (presented to verify identification) with the people sitting before her at court hearings. “They are stressed and miserable and it ages them,” she says.
“Garnishment is a credible threat to people,” says Porter, the Iowa law professor. “They are being called, their friends and neighbors are being called, they are being called at work, they are getting lawsuits filed against them. There is a feeling of helplessness. It’s this thing looming over you, it’s the constant fear that next week your paycheck could be gone with garnishment. You do not see a way out of it.”
Going it alone
Consumers who’ve tried to file for bankruptcy without an attorney (called pro se filings) have faced difficulty navigating the complex set of rules before them. The GAO notes that Chapter 7 pro se filings decreased from about 11 percent of filings in February-March 2005 to just 5.9 percent in all of 2007.
Kumley relates the mistake of another client, a woman who filed for bankruptcy with no legal advice. She neglected to get a free copy of her credit report before filing. The report would have shown her all potential creditors — information she needed to include on bankruptcy papers to discharge all debts. At the end of the bankruptcy, the woman still had a $9,000 unpaid debt on her record and could not file for bankruptcy again for eight years.
Says Kumley: “It gets pretty scary when they don’t know and are trying to do it themselves.”
At the same time, free legal services for bankruptcy filers — pro bono services — are more difficult to obtain. “Fewer attorneys have been willing to volunteer their services to assist bankruptcy filers since the act went into effect, largely due to the increased time and responsibilities required to handle a bankruptcy case,” the GAO wrote in the review.
Another snag for pro bono legal help: Wording in the 2005 law makes it unclear if attorneys providing free legal assistance to debtors would be considered “debt relief agencies” and subject to limits on the types of advice they can give. “Some unfortunate and needy debtors may not be able to obtain pro bono counsel in their hour of desperate need,” according to a July 2008 bankruptcy institute news release announcing a grant awarded to Harvard Law School to study the problem.
Several observers have noted a distinct lack of enthusiasm in Congress for revisiting bankruptcy laws after the seven-year battle preceding the 2005 legislation.
“Bankruptcy reform seems to be the third rail of American politics,” notes Lawless. “There’s huge resistance to opening up any part of that law.”
Last month, bankruptcy reform was thrust into the center of debate over the $700 billion Wall Street rescue package. Consumer groups tried but failed to add a provision to the bailout plan that would have helped homeowners filing for Chapter 13 bankruptcy, a proceeding that allows filers to keep their homes.
Under current law, bankruptcy judges cannot adjust the terms of mortgages to give relief to bankrupt homeowners trapped in adjustable rate mortgages. Loans on cars, vacation homes and other assets can be written down to reflect market value, but not loans on principal residences. Without adjusting the mortgage terms down to affordable amounts for future payments, homeowners could still lose their homes through foreclosure even though they seek protection in bankruptcy court. The measure failed to make the final bailout plan, but supporters vowed to keep pushing for reforms.
Gerdano, who heads the bankruptcy institute, is setting his sights higher than Congress. He cited Democratic presidential candidate Barack Obama’s pledge to resurrect homeowner bankruptcy relief if he’s elected president. Obama voted against the bill; his Republican opponent John McCain voted for it. Gerdano says consumer groups won’t be satisfied with bankruptcy relief alone and are looking to the White House for substantial change.
“The current conditions are such that people are thinking of bigger remedies beyond tweaks of the bankruptcy code,” he says, adding, “There’s a lot percolating.”
For more information on bankruptcy, go to:
The American Bankruptcy Institute’s Consumer Bankruptcy Center.
The National Association of Consumer Bankruptcy Attorneys offers tips for consumers with debt problems.
See related: Consider all options before filing for bankruptcy