FOOL ON THE HILL
More than two-thirds of all personal bankruptcy filings are for Chapter 7, even though Chapter 13 allows those with some income to repay some debts in the future. Congress had significant bipartisan support for bills to tighten up the standards for Chapter 7 eligibility, only to have them vetoed by President Clinton last year. They're back this year.
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Even those of us who have never faced the prospect of personal bankruptcy are clear on the fact that it is a horribly demeaning process. Bankruptcy requires appearing before a court, having our financial woes laid open as public record, and being assigned a trustee whose job it is to determine how any of our attachable assets should be used to recover our debts. Bankruptcy probably rates right down there with a visit to the proctologist or 36 hours in Newark International Airport as the least fun experiences that people endure and live to tell about. And yet there are efforts in Congress to tighten the laws on bankruptcy and make it easier for debtors to collect assets from certain individuals. Yesterday the House Judiciary Committee passed HR 333, which would make it harder for certain categories of people to erase credit card and other unsecured debt by declaring bankruptcy. The bill will now be sent to the full House of Representatives, while a similar bill works its way through the Senate. President Bush has signaled that he would support any such legislation, differing from former President Clinton, who vetoed it last year, stating it would overburden struggling debtors. Nearly every press release I read made the same statement that Clinton wanted further protection for "struggling debtors." What other kinds of bankrupt debtors are there? Ah, demagoguery. Really, there is no doubt that the majority of people who file for bankruptcy are struggling. The question is, and the focus of this bill is, how much are they able to pay, and should debtors with steady income be able to walk away from their debts? For individuals there are two primary statutes under which they can claim bankruptcy protection: Chapter 7, which, just as in commercial cases, provides for total eradication of debts, and Chapter 13, which requires consumers with the ability to repay some of their debts do so under the auspices of a trustee. (There are other chapters, such as 12, which allows farmers to continue operating their farms under protection.) For a debtor's creditworthiness, one would think that Chapter 13 would be a better option, allowing the person to repay some of his or her debts. However, the effects of a Chapter 7 bankruptcy are so minimally harsher that most individuals opt to go that route and wipe the slate clean. Current statistics support this claim: Of the 1.2 million personal bankruptcies filed in the last 12 months, less than one-third were under Chapter 13. The changing standard would make it much more difficult for certain consumers to declare Chapter 7, setting tougher standards for those who have income sufficient to repay some of their debts under Chapter 13. The new mathematical formula would include current income, consideration of recent "luxury purchases" and cash withdrawals, but also gives credits for certain necessary expenses. Opponents to the bill point out that it is too harsh for those who have sudden setbacks such as divorce or job loss. The bill that Clinton vetoed, which is markedly similar to the one that just passed the House committee, allowed debtors to shield their residences, which he believed was an unfair advantage to the wealthy, who are more likely to own their homes rather than rent. I see the first one -- people do some really crappy things to each other in the course of a divorce -- but those who are filing due to lost jobs probably do not have the income needed to force them into Chapter 13 anyway. Still, let's stipulate that there are exceptions that can be added. I also understand Clinton's point about any law's shielding of the value of a residence. My interest in this is that any existing law that aids in consumer irresponsibility should be looked at askance. It's not the slightest bit controversial to call the last decade one of prosperity for the U.S., as unemployment rates fell to record lows and average wages increased in almost every job sector. So how can it be that the number of annual consumer bankruptcies increased by more than 80% between 1990 and 1999? One culprit is the surge in the amount of unsecured credit being carried by consumers, the debt payments of which have grown to be more than 16% of disposable income, as compiled by the American Bankruptcy Institute. There is an enormous social cost here. It is estimated that personal bankruptcies removed more than $40 billion from the U.S. economy in 1999, or the equivalent of every vehicle sold worldwide by General Motors (NYSE: GM) in the first quarter of 2000. Every person who holds a mortgage, or pays a credit card, or has any form of debt shares an ongoing burden for this cost in the form of higher credit expenses. Those who are rated the worst credit risks by credit agencies bear an even larger portion of this burden in the form of even higher rates. Although bankruptcy is not something that all of us will face in our lives, it is something that we each pay for every day, even in the embedded costs of such things as electricity rates and consumer goods, as companies are forced to maintain a cash reserve for their "doubtful accounts." These are receivables that the company does not expect to collect. Bankruptcy is a powerful tool, something that many people will legitimately need in their lifetimes. I may need it in my lifetime. What it should NOT be is a convenient dodge for people who have simply overspent, who have lived far beyond their means. Under the bill, particularly those expenses considered luxury goods and services will not be assumed as dischargeable, meaning that someone who has failed the new test for Chapter 7 would also potentially be on the hook for any luxury charge made in the 90 days before filing. In the current treatment of bankruptcy laws, a consumer could live irresponsibly, living a champagne life on a beer budget, and then walk away from his or her obligation to pay. While this will certainly continue to exist, a more strict test for those who truly qualify for total protection from debts will give a judge leeway to force those who lived irresponsibly to repay a portion of those debts out of future earnings. This, in principle, I am all for, particularly if the law includes provisions to force creditors to a higher standard of truth-in-lending, which this bill does. It is quite staggering that the number of bankruptcies has surged over the last decade as so much wealth was being created. Certainly there are hundreds of thousands of people with real stories of woe, real need for protection, even if their own actions created their debts. These are the people that the Chapter 7 code was written for: It is a good law that protects the less fortunate of our society. But new standards will prevent those for whom total debt forgiveness was not intended, those using bankruptcy as a shelter of convenience. This shelter will be there still, but it should be applied in a way that forces those who have the means to pay for that which they bought. Fool on! Bill Mann, TMFOtter on the Fool Discussion Boards Bill Mann's golf game was once described as "a malicious affront to the sport." To view Bill's stock holdings, visit his profile. The Motley Fool is investors writing for investors.
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