When personal bankruptcies hit
1.5 million in 2002, and went to
1.6 million in 2003, one of the goals of bankruptcy “reform” in 2005 was to reduce the number of bankruptcy filings. After climbing to
2 million in 2005 (the surge was caused, in part, by those attempting to preempt new and stricter filing laws), filings dropped to 600,000 in 2006. Problem solved, right? Wrong.
Bankruptcy filings are
on the rise as we start
the new year, and are
slated to hit 1 million by the end of December. How do we explain the surge in bankruptcy filings today? Several developments are at work here.
TREATING THE SYMPTOM, NOT THE DISEASE
According to noted bankruptcy attorney
Leon D. Bayer, in addition to making it more difficult to file for personal bankruptcy, the principle reasons that people file for bankruptcy were not addressed in the 2005 legislation. How could they be? Consider this. Over 90% of all personal bankruptcies are
filed for three reasons: Job loss, divorce, or catastrophic illness. There is no legislation on earth that our credit industry-pandering Congress can pass that can do anything about these life events.
Because no provisions were made to work with people hit by these real life incidents in the 2005 bankruptcy bill debtors soon found that “broke and in debt” was no longer good enough. The newly divorced, the medically recovering, and unemployed would have to wait until they hit “distressed debtor” status to qualify for bankruptcy. Debtors, after all, had to be taught a lesson. This explains why military personnel in the National Guard were not given special consideration either. A deadbeat is a deadbeat according to the industry – no exceptions.
So, rather than solving the bankruptcy challenges in America, the new legislation simply deferred and, more realistically, compounded the situation for those confronting uninvited real financial problems.
“VIVA LAS VEGAS”
Now, you’re probably scratching your head and asking, Why didn’t our guys in Congress anticipate this? Couldn’t they see that disqualifying people who needed bankruptcy for a fresh start only put off the inevitable? Good question. To start, we need to acknowledge that the credit companies aren’t run by dummies. They may be greedy, which compels them to make dumb decisions as a group over time. But they’re not run by inherently dumb people.
The credit card industry saw that bankruptcy filings were going through the roof in 2005. They also understood there was a bubble waiting to burst around the corner (hey, if I saw it they darn well should have too). As well, they realized they needed to protect themselves and their “fees and penalties” gold mine (average household credit card debt earned the industry $1,700 a year in finance charges and other fees in 2002).
To be sure, the industry also knew that the vast majority of debtors filing for bankruptcy were placed in that situation by uninvited life circumstances – job loss, divorce, or illness. But the details of the debtors’ lives were viewed by disengaged industry lobbyists as “unfortunate” as they were unimportant. Like on the Vegas strip, the goal of The House (i.e. the credit industry) is to get people in the door, at the table, and to keep them there. If they’re not "at the table" you can’t get debtors – no matter what their circumstances – in the fee and penalty cycle. And like Vegas in the early days, the industry went to their muscle (i.e. Congress) to make it more difficult for debtors to qualify and pay for bankruptcy. And they got their wish.
This is where the hypocrisy of the credit industry, and the shortsightedness of Congress, may have made things even worse.
THE CREDIT CARD GUYS GET GREEDY(ER)
By helping the industry reduce filings after 2005, Congress helped insure that the credit card companies would have more money on the books for 2006 (I’m not sure I would label this additional money as “earnings”; does favorable legislation that effectively puts more money in your pocket count as something you earned in your book?). The industry was emboldened. You would think that the industry would have learned a lesson from being just one year removed from record bankruptcies (and the fact that Americans have a savings rate that is effectively zero). Think again.
In 2007, according to
Laurent Belsie at the National Bureau of Economic Research, the credit card companies then …
“… started lending more, even to consumers with bad credit. Credit card debt increased more quickly during the past two years than at any time during the previous five years."
Put another way, comfortable in the knowledge that it was more difficult for borrowers to enter into bankruptcy proceedings the credit industry determined it was in their financial interest to lend more. Teaser rates, cashable checks, and other industry gimmicks filled our mailboxes. And why not? By raising the bar necessary to file for bankruptcy the industry knew that fees, penalties, and other charges would add significantly to their client’s debt load.
According to Robert D. Manning, author of
The Credit Card Nation, all of this is a good thing for the industry because ...
[i]n the old days, the best customer was someone who could pay off their loan. Today the best client of the banking industry is someone who will never pay off their loan.
Indeed, why settle for half on a $8,000 account this year when you can settle for half on a fee and penalty bloated $12,000 debt two or three years later? Distressed debtors, who can be kept in the game longer, can do more for the bottom line than a debtor in bankruptcy proceedings.
WHAT WOULD ADAM SMITH DO?
By keeping borrowers on the hook the industry is able to keep America’s working class toiling away, paying off debt for longer periods of time. While some market analysts might argue “No one told them to take out these cards … they knew what they were getting into …” the posture is full of hubris and ignorance.
Again, the vast majority of bankruptcies occur because of unexpected and uninvited life circumstances. To create a piece of legislation that punishes misfortune because of idealized notions of accountability (which Corporate
America’s CEOs increasingly do
not share), or because of the 10% of filers who are actually bad apples, is not commensurate with what Adam Smith envisioned when he wrote about market capitalism. More specifically, the 2005 legislation does not fit with the “laws of justice” that Adam Smith believed should govern markets (and for the Conservative Christians who supported this bill, don’t get me going about what Jesus would have done in 2005).
In fact, when any industry moves to take advantage of situations like this Adam Smith was very clear on what the state needed to do – intervene on behalf of those who have had misfortune visited upon their house. How many Americans do you believe actually look to “take advantage” of catastrophic illness, divorce, or a forced layoff? In my world, at least, none of these qualify as shrewd life opportunities or good business strategies.
Forcing those who have just lost a job, separated from a spouse, or suffered catastrophic illness into the same category as legitimate deadbeat debtors does little to enhance the integrity of the market Adam Smith spoke about. Not to mention what it does to our sense of community. It’s also not very Christian. At its worst, some might even argue that the 2005 bankruptcy reform bill has served to create a new form of indentured servitude ... and just in time for the looming mortgage meltdown.
¡Viva! Las Vegas.
- Mark
P.S. For those interested in more, here's an
excellent article from the FDIC on the relationship between deregulation, credit card debt, and personal bankruptcy filings. It's long, but worth the read.
And helping to put lipstick on this financial pig are the Federal Reserve and government regulators who Roubini believes should be investigating themselves for their irresponsible actions. 
