Commentary: Bankruptcy Reform: Everybody's Mad And That's Fine

After two years of research, thousands of interviews, and hundreds of witnesses testifying at 21 hearings, the National Bankruptcy Review Commission on Oct. 20 unveiled a 1,300-page report to Congress on how to fix the nation's bankruptcy laws. And its 172 proposals managed to please...almost nobody. The recommendations "would shift the delicate balance between debtor and creditor interest clearly in favor of creditors," protested the National Association of Consumer Bankruptcy Attorneys. "Seriously flawed and too one-sided" for debtors, fumed Paul A. Schosberg, president of America's Community Bankers, representing more than 2,000 savings and loans and banks. "The recommendations would lead to an increase in the already record-high number of bankruptcy filings."

Even within the commission, deep divisions led four of the nine members--mostly private lawyers and federal judges--to issue a scathing dissent. Edith H. Jones, a conservative federal judge from Houston, blasted the majority for advocating proposals "that are not only unrealistic, [but] are simply deaf to the public debate over frustration with the nation's bankruptcy system."

MIDDLE GROUND. Does this brawl suggest that the commission was a dud? Hardly. Given the heated emotions swirling around the bankruptcy debate, howls of protest were inevitable. Still, the panel's suggestions would fix a system that is clearly broken. Despite the current economic boom, bankruptcy filings by individuals have soared by roughly half (table). The commission found a reasonable middle ground that cracks down on abuses by the wealthy while protecting financially distressed borrowers from the clutches of lenders who have tried unfairly to portray all delinquents as the new welfare queens.

Admittedly, bankruptcy once carried more of a social stigma. But since the 1970s, when Congress made it easier to declare insolvency, it has become fashionable for millions of individuals--from the working poor to the super-rich--to duck their financial obligations. "The word has gotten around that bankruptcy provides a very attractive financial planning tool for individuals tired of paying their bills," says Philip S. Corwin, an outside lobbyist for the American Bankers Assn. There's a cost: Retailers and other creditors claim they will lose $40 billion this year.

Consumer advocates are upset because the commission, to its credit, proposed reining in some of the most abusive practices that helped consumers but were also widely abused by the rich. But the commission also infuriated lenders by preserving the right of individuals to pursue a Chapter 7 liquidation--which often leaves little for creditors, because courts will wipe a debtor's slate clean. Banks had wanted the commission to press for more "means testing," which would force many delinquents to continue paying off their old obligations. The truth is that for all the publicity surrounding spurious bankruptcy filings of the rich and famous, most filers are working stiffs victimized by a corporate downsizing, divorce, or other calamity--folks who need a clean break from the past. "A very tiny percentage [of filers] are wise guys trying to take advantage of the system," says Albert Togut, a New York bankruptcy attorney.


If bankers and retailers really want to reverse the bankruptcy spiral, they should spend less time lobbying Congress and more time reforming their promiscuous marketing practices. Despite their repeated vows to tighten lending standards, creditors will likely mail out as many as 3 billion credit-card solicitations this year--some, ironically, to individuals who used bankruptcy to clear old credit-card debts.

The commission is trying to encourage greater responsibility by borrowers so they can't simply walk away from their debts. But lenders have to be responsible, too, by keeping credit cards out of the hands of known deadbeats. The commission's proposals would help foster accountability on both sides, which is what's necessary to cure the bankruptcy epidemic.

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