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What Bankruptcy Reform Means to You

Tom Taulli
October 17, 2005

Americans have had a nice safety net in the personal-bankruptcy laws, which allowed debtors to wipe away much or even all of their outstanding obligations. What's more, the process is fairly easy and inexpensive. More than a million people pursue this option every year in the United States. And it's even losing its stigma. After all, many celebrities -- Burt Reynolds, Wayne Newton, Kim Basinger, MC Hammer -- have filed for bankruptcy, as have a lot of well-known companies. For several decades, in fact, bankruptcy appeared to be the standard operating practice among U.S. steel companies.

Of course, this is all bad news for lenders -- especially credit card companies, which have to write off much, if not all, of their bankrupt customers' debt. As a result, the financial industry has lobbied hard over the past seven years to make the bankruptcy process more onerous.

It worked. Effective today, there will be a new federal bankruptcy law, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This law is a clear signal that the pendulum has swung toward the interests of lenders. And it marks the most momentous change in U.S. bankruptcy laws since Jimmy Carter was president.

Traditionally, when a person filed for personal bankruptcy, Chapter 7 was the preferred method. Since the purpose of bankruptcy was not to punish but to provide a "fresh start," debtors would have certain types of assets that were exempt from liquidation (in some cases, no assets would be liquidated) and could cancel all debts remaining after liquidation. True, this is harmful to a person's credit rating. But over time, credit can be re-established.

Under the new law, Chapter 7 will be much harder for people to elect. Debtors will be subject to a means test and will not qualify if they exceed the median income for the state they live in and have the ability to pay $6,000 of unsecured debt over five years. The most common form of unsecured debt is cr