Commentary: Personal Bankruptcy: How To Slow The StampedeToddi Gutner
Personal bankruptcies are piling up faster than credit-card offers. An astounding 1.1 million families--1% of all households--are expected to file for bankruptcy in 1996, a 26% increase over 1995. Figures released on Aug. 28 show that 1996's second quarter had the most bankruptcies of any quarter on record. Easier credit terms, which have propelled monthly consumer debt service to a near-record 17% of disposable income, combined with corporate layoffs and a rise in uninsured medical expenses are dealing a brutal blow to the financial health of many Americans.
It's a problem that hits every citizen in the wallet. Bank-card losses due to bankruptcy topped $10.4 billion in 1995, up from $7.2 billion in 1994. That cost trickles down to those who remain creditworthy in the form of higher interest rates and fees. The same applies in the medical field: Uncollected bills lead to higher insurance premiums for everyone. "Costs get passed on to consumers in the form of higher prices for goods and services and increased finance charges," says Robert Johnson of Purdue University's Credit Research Center.
IN TOO DEEP. Little is being done to remedy the situation. What's needed is congressional action. Legislators need to address the weaknesses in the U.S. Bankruptcy Code and to help alleviate the problem of rising consumer debt.
As things stand, consumers can choose to file for a Chapter 7 (liquidation of debts) or a Chapter 13 (repayment plan) bankruptcy. About 30% of debtors file Chapter 13; the remainder walk away from their debts. In part, that's because many are too deep in the hole to dig themselves out.
But there's another reason: While the Bankruptcy Code is a federal law, consumer rights vary from state to state. "The current system is too complex and diverse," says Elizabeth Warren, a Harvard Law School professor and consultant to the National Bankruptcy Review Commission, a government-appointed panel reviewing the code. "The more complex the system, the less certain we can be that it works well."
For example, several districts within states discourage Chapter 13 cases. Bankruptcy courts in Los Angeles, for instance, reject repayment plans unless the debtor can repay 70% or more. The same attitude prevails in New York. "If a debtor chooses a Chapter 13 and falls behind on payments, the courts don't modify plans so they can succeed," says David Doyaga, a New York bankruptcy lawyer. In part, that's because of overburdened courts, but it's also due to a bias against Chapter 13's hassles.
In Tennessee and Alabama, on the other hand, settling one's debts is encouraged. Courts may lower payments for a time to help debtors continue a plan. And the more debt repayment, the lower the costs that get passed along to all consumers.
INCENTIVES. Congress should consider a unified federal system with repayment as its cornerstone. Debtors who can pay at least 40% to 50% of their debts within five years should be required to do so; the balance would be discharged upon the plan's completion.
There must also be incentives to help debtors complete plans. Under the federal system, lawyers serving as Chapter 13 bankruptcy trustees are paid a maximum $127,000 annually. Trustees should be required to act as advocates for clients and to guide those having trouble keeping up with payments. Their compensation could be commission-based to reflect the progress of consumers who continue a plan.
Revamping the U.S. Bankruptcy Code is only part of the solution. Credit-card companies must take responsibility, too. Congress should require lenders to provide easy-to-understand disclosures about credit usage. Card companies know borrowers' salaries, so they could tailor bills to say: "If your gross income is $18,000, your total monthly credit-card debt should not exceed $450."
Finally, education can play a role. According to the Consumer Credit Counseling Service (CCCS), a nonprofit foundation, more than 60% of people who consulted its Austin (Tex.) office didn't know about such alternatives to bankruptcy as loan consolidation and creditor negotiations. Bankruptcy filers should be required to attend financial seminars that would be administered by the CCCS and funded by creditors.
Bankruptcy is an opportunity for a fresh financial start--but it should be the last resort, not the first option.