To read the elite media, you’d think that when the Senate voted 74-25 last week to reform the federal bankruptcy laws, it was voting to bring back debtors’ prison. For weeks before the vote, newspapers had been running tear-jerking tales of average folks taken to the cleaners by wicked credit-card companies–and if bankruptcy reform went through, they’d never be able to wipe those debts away. Here’s a sample from the Washington Post:
“For more than two years, special-education teacher Fatemeh Hosseini worked a second job to keep up with the $2,000 in monthly payments she collectively sent to five banks to try to pay $25,000 in credit card debt.
“Even though she had not used the cards to buy anything more, her debt had nearly doubled to $49,574 by the time the Sunnyvale, Calif., resident filed for bankruptcy last June.”
Now, that sounds sad–until you read the next sentence:
“That is because Hosseini’s payments sometimes were tardy, triggering late fees ranging from $25 to $50 and doubling interest rates to nearly 30 percent. When the additional costs pushed her balance over her credit limit, the credit card companies added more penalties.”
Earth to Fatemeh: Try making those payments on time. That’s why there’s this item called “Due Date” printed on your bill. Doesn’t your special-ed job pay you a regular salary?
And I won’t even get into wondering why it was that someone making a salary of–what, $50,000?–would get $25,000 into consumer debt in the first place. Had Hosseini incurred, say, huge medical expenses or unexpected liability for an ex-husband’s debts that she never even knew about, we sure as heck would have heard about it from the Washington Post. (Yes, her husband left her and the kids a good six or seven or eight years ago, but there’s no indication that he’s reneged on child support–which, again, we would have heard about.). And then there’s Hosseini’s place of residence–in Sunnyvale, the very epicenter of the Silicon Valley, some of the most expensive real estate on earth. Kind of glitzy for a mere special-ed teacher, no? Sorry, but I suspect that Hosseini, with her five (!) credit cards, got carried away by the area’s glittering lifestyle and then in over her head. And, under the current bankruptcy laws, she can kiss all that old debt good-bye–but she’ll never have to do something sensible, such as sell her house for its giant equity and move to someplace she and the kids could better afford.
Stories like Fatemeh Hosseini’s might go over big at the Washington Post, but they’re undoubtedly exactly why the Senate’s Republicans and Democrats united in order to pass the reform bill 3-1. It’s not a perfect bill (there are still a couple of loopholes that let some people who shouldn’t erase their debts). But it does establish a means test that would forbid people who earn more than the median income in their states from completely wiping out their debts under Chapter 7 of the Bankruptcy Code. If a judge reviewed their reasonable expenses and determined that they could pay back, say $6,000–$100 a month over five years–they’d have to file under the code’s Chapter 13 and at least repay something. The Chicago Tribune, in an editorial supporting the reforms, said the reforms would apply only to those earning over $45,000 a year, that state’s median income–and exempt about 80 percent of the people who currently file.
As a newspaper and magazine reporter, I used to write regular stories about bankruptcy court. The scenes there were amazing: middle-income people who’d run up tens of thousands of dollars in credit-card debt to buy…stuff. Leather sofas, wide-screen television sets, waterbeds, diamond earrings, vacations in Mazatlan, cars for both the kids. Their expenses? They “needed” cable TV. That fur coat they hadn’t paid for kept them warm (honest–that’s what one gal told a bankruptcy judge in Los Angeles!). Representatives for department stores, a pathetic lot, would plead for them to “reaffirm” (keep making the payments on) about-to-be-repossessed washing machines that the stores sure didn’t want back. Yes, most of the debtors had acted foolishly, but a little $100-a-month ding for five years might be a good lesson in money management learned the hard way.
Up until 1978, the federal bankruptcy laws were a lot stricter. Even under Chapter 7, the judge could look at a debtor’s future income stream as well as his or her assets to determine whether it was really impossible for him or her to repay at least part of the debt. Tough federal exemption laws limited the amount of property that did not have to be liquidated–sold by the court trustee–to pay creditors. As a result, there were relatively few personal bankruptcies: just 172,000 in 1978, the year Congress made a major overhaul of the laws. Compare that to last year’s 1.6 million filings–nine times as many. But as we did with so many other unpleasant things during the 1970s, we decided to remove the stigma from bankruptcy. Congress even erased the word “bankrupt” from the new code–too mean-sounding. And it got rid of the federal exemption laws, allowing state laws to govern what property a debtor could keep. Florida, for example, has a “homestead” law that allows debtors to keep even multimillion-dollar mansions–which seems to be why O.J. Simpson moved there after getting hit with a huge judgment over Nicole’s death. (The reform bill the Senate passed would limit such exemptions to $125,000 in equity.)
For the past eight years members of Congress have been trying to do something about what is essentially a scandal. Reform passed one year, but Bill Clinton refused to sign the bill into law. Another year, Democrats decided that they were in favor of bankruptcy reform–but only for people who picket abortion clinics, who would not be able to use bankruptcy to avoid any fines they might incur. Now, it looks as though bankruptcy reform may finally have a serious chance. I’ll let the Cato Institute have the last word on why that’s a good thing–because the rest of us lose when people who can pay their debts get to choose not to:
“Bankruptcy has evolved into a government sponsored social welfare program administered by the courts. One difference is that it is seemingly funded by expropriating tens of billions of dollars from creditors instead of through tax revenues. Another difference is that the relief offered debtors is not means tested. Many debtors could pay their debts but simply choose not to. But lenders understand and consider the risk of nonpayment. Thus debtors as a group pay up-front for the potential benefits of the discharge through higher interest rates and morestringent loan qualification requirements. Ironically, bankruptcy ‘protection’ can hurt the group it is intended to protect.”