Now pay it back

Now pay it back

Mar 10th 2005 WASHINGTON, DC
From The Economist print edition

At last, Congress gets tough on debtors

LAST year, nearly 1.6m Americans filed for relief from their creditors. That number has almost doubled in the past decade. Under current law, people get their debts wiped away by the mere act of filing under Chapter 7 of the bankruptcy code. But a new law, the Bankruptcy Abuse Prevention and Consumer Protection Act, makes that much harder. It imposes a means test that would force people who earn more than their state's median income into Chapter 13 of the code, which requires debtors to submit to a repayment plan. It would also make poorer debtors jump through many more hoops to get relief.

As The Economist went to press, the bill looked likely to pass the Senate. The Republicans had fended off nearly every Democratic bid to soften it. They also voted down an attempt by Chuck Schumer, the senior senator from New York, to tack on a provision blocking violent protesters, including those protesting outside abortion clinics, from filing for bankruptcy in order to avoid fines. (This amendment had sunk the bill in previous years, when pro-life House Republicans revolted.) Now the bill is in a shape both the House leadership and George Bush say they will accept. But is it a sensible reform?

America's 30-year-old bankruptcy law—as Democrats and consumers' groups point out—is rooted in the idea of a “fresh start” for honest debtors who have had a spot of bad luck—illness, divorce, a lost job. But credit-card issuers and banks have long been pushing for a change. The stigma of bankruptcy, they argue, has eroded, and Chapter 7 is too often used as a financial planning tool. Meanwhile, honest borrowers are forced to pay a “bankruptcy tax” in the form of higher interest rates and credit-card penalties.

Is the system really abused? In fact, evidence suggests that the boom in personal bankruptcies has more to do with the piling on of consumer debt than with debtors playing the system. In the 1990s, revolving debt (mostly credit-card debt), grew by as much as 12% a year; from 1980 to 2004, it increased nearly 15 times. And the non-partisan American Bankruptcy Institute puts the number of bankruptcy filers who could afford to pay a good chunk of their debts at 3.6%: still a big number, but not nearly as much as the 10% or more claimed by creditor groups.

In any case, the bill's means test (an average of the debtor's past six months of income) should catch those who can clearly pay up. But opponents fear that the test, which they think too harsh and arbitrary, will drag those who rightly belong in Chapter 7 unfairly into court.

More troubling is the part of the legislation that makes it harder for poorer debtors, not likely to be the abusers of the system, to file for bankruptcy. Some 84% of all filers are too poor to qualify for the new law's means test. But they will still be put through a great deal of rigmarole to get relief. For example, all debtors will have to get credit counselling before they file—a costly process, and one which does little to steer people out of bankruptcy. The bill also requires people to produce all sorts of paperwork, from payroll stubs to tax returns. Those who have not kept strict records will have to give up or pay for a lawyer to plead their case in court.

Other quirks of the legislation make one wonder why credit-industry groups are so keen on it. One loophole allows rich debtors to go on shielding assets in special trust accounts that are legal in a few states. And debtors' fancy homes in Texas and Florida will still be off-limits to creditors. The bill's backers say that fear of trampling on states' rights stopped them closing such loopholes. But it smells rather pervasively like special treatment for the rich.

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