Even the most financially responsible people have probably had a daydream about letting loose and going on the spending spree of a lifetime. You can do everything you can to maintain your savings discipline, but that doesn't mean the temptation won't sometimes be there to go crazy. Let's face it: It's the rare person who can claim never to have given in to the occasional extravagant purchase.
Sometimes, you probably wish that you could just forget about saving for your future and live for the moment. If your personality includes a bit of cynicism, you might even have contemplated the thought that you could not only run through your entire savings but also max out all your credit cards, refinance your mortgage, take out a home equity loan, and stop paying your bills. Then, just as your financial house of cards is about to come crashing down on you, you magically pull a rabbit out of your hat and make everything better -- in other words, you declare bankruptcy and get all that debt wiped out.
Yesterday marked the one-year anniversary of new laws reforming the bankruptcy process. After a year of working under this new law, it's appropriate to take a step back and ask whether the changes have achieved the goals that bankruptcy reform set out to accomplish.
The purpose of the Bankruptcy Reform Act of 2005 was to make the bankruptcy laws less prone to abuse by debtors looking for an easy escape from their debt. To serve this purpose, the new law added a number of provisions that made it more difficult for debtors to qualify for bankruptcy relief. Before a debtor would be allowed to file a bankruptcy petition in the first place, the debtor would need to visit an approved credit counseling service. The debtor would then have to work out a plan to resolve the outstanding debt. If the debtor still wanted to file bankruptcy, a copy of this plan would have to be submitted to the court along with a certificate from the credit counseling service showing what services the debtor used.
In addition, the Act significantly limited access to one type of bankruptcy, called Chapter 7, which provides for a complete and immediate liquidation of assets and retirement of debt. For those debtors with income above the median income for their state of residence and with more than a minimal amount of disposable income, the new law made it impossible to file under Chapter 7 and forced those debtors to use another type of bankruptcy, Chapter 13. This second type of bankruptcy, also known as reorganization, requires the debtor to come up with a plan to pay creditors over time. Unlike Chapter 7, it does not offer immediate relief; reorganization plans under Chapter 13 can take years to reach their conclusion.
Also, the Act added several rules that debtors have to follow. In addition to the credit counseling requirement, the new law requires several pieces of documentation related to the debtor's current and future income, including pay stubs, an itemized monthly income statement, the debtor's most recent income tax return, a statement of any anticipated future earnings or changes in salary, and a disclosure of certain tax-favored accounts such as 529 plans or education savings accounts.
One way to measure whether the Bankruptcy Reform Act succeeded or failed is to look at the number of bankruptcy filings. One could argue that since the purpose of the Act was to eliminate abusive bankruptcy filings, the new law should have caused the total number of filings to fall. Furthermore, if the law made it tougher to file under Chapter 7, then one would expect to see fewer Chapter 7 filings and more Chapter 13 filings.
It is clear that the number of total filings has dropped significantly. Statistics released by the American Bankruptcy Institute indicate that the number of filings fell from more than 650,000 in the fourth quarter of 2005 to just 113,000 in the first quarter of 2006. However, since then, filings have steadily risen. Another factor to consider is that the number of filings in 2005 was far higher than previous levels, as debtors rushed to take advantage of old laws before the new law became effective last October. Over the past several years, quarterly filings averaged about 400,000. Yet last year, the quarterly average was more than 500,000. Some commentators predict that bankruptcy filing levels will return to pre-reform levels as early as next year.
A similar pattern emerges in looking at the percentage of cases filed under Chapter 7. Before reform, about 70% of all cases were filed under Chapter 7. Immediately before the new law took effect, this percentage rose to 85%. With the new law in place, it has now fallen to 55%-60%. It's unclear whether the law had any permanent effect or simply caused a temporary acceleration of bankruptcy filings.
Understanding the impact of these laws depends greatly on your source of information. The American Bankers Association, which includes among its membership bankers from large creditor banks like Wells Fargo
It's likely too soon to be certain about the effects of bankruptcy reform. What is clear, however, is that many honest people are suffering for the bad actions of a few abusive debtors. The best way to deal with the new law is to do everything you can to avoid getting into financial straits in the first place, but unfortunately, circumstances sometimes make that impossible.
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