The Right to Default
Cottle, Michael
The Right to Default When did bankruptcy become an accepted fixture of everyday life? BY MICHELLE COTTLE My friend "Tom" is your typical yuppie. He has the pretty wife, the cute kid, the...
...Hundreds of thousands of Americans are treating debt discharge as an entitlement, wiping their financial slates clean regardless of their income or assets...
...Let’s be clear...
...All debtors should initially be required to file a Chapter 13, after which, each case would be reviewed to determine what percentage of an individual’s debts he was equipped to repay over time, or if the case merited a Chapter 7. This would protect those who need a full discharge, but prevent people with significant assets or earning potential from using bankruptcy as an easy out...
...There is nothing inherently immoral about financial problems-or about a system that helps people deal with such problems...
...The government has done its share of spreading the message that debt is good for you, particularly in recent years...
...In an ideal world, bankruptcy would protect a debtor from creditor harassment while he worked out a repayment plan...
...So I threw in a few little things just to see what the system will do with me...
...One December f h g was by a single mother of two, who less than a year earlier had gotten off state assistance and to his parents...
...Yet credit counselors and attorneys report that clients frequently come to them with debts on 8 or 10 or 20 cards...
...In areas where filing rates are high, “bankruptcy mills” have sprung up, legal firms comprising only one or two lawyers, and a team of paralegals to handle the actual filings...
...A 1996 survey by Visa found that 14 percent of filers had declared bankruptcy at least once before...
...Let’s be clear...
...The commission is scheduled to present its findings in October...
...The ultimate result: bankruptcy...
...But regardless of the experts quoted and the individuals profiled, at some point in every article, someone would note that Americans are operating so close to the fmancial edge that one unexpected expense pushes them over...
...But in addition to rendering pending legal claims pointless, Tom’s Chapter 7 wiped away everything from his credit card bills to penalties he owed on back taxes...
...Creditors say they’d be happy with this arrangement, and in fact, are proposing such a measure to the National Bankruptcy Review Commission, the panel set up in 1994 as part of a package of minor reforms to analyze the system...
...The concept of bankruptcy providing a fresh start is understandably appealing, but it shouldn’t wipe away the concept of personal responsibility (which the country seems so eager to throw in the faces of welfare recipients...
...The FDIC reports that, since 1990, the average return on assets of “credit card banks” (those with more than SO percent of their assets in card loans) has ranged from two to four times that of other insured institutions...
...These varying standards are what allow for abuses like the Florida mansions and Virginia racehorses...
...Yet, a 1996 study by Purdue University’s Credit Research Center found that 45 percent of people in Chapter 7 had the ability to repay a third or more of their unsecured debt over a three-year period...
...No one is sent a credit card against their wishes,” says Philip Corwin, a Washington lobbyist for the American Bankers Association...
...And continuing to accept misuse of the system perpetuates the notion that the government should clean up our messes for us, because we are either too dumb or too self-indulgent to help ourselves...
...The reality is that Americans aren’t as financially sophisticated as we like to think...
...But he did not hesitate to stick his creditors with several thousand dollars worth of uncollectable debt, while simultaneously flirting with bankruptcy fraud...
...The bank can then figure out what its break-even point is, that point at which the bank has collected payments from you totaling more than your credit limit...
...Far more popular is Chapter 7 liquidation, which accounted for 70 percent of 1996 consumer filings...
...But Hollywood and Madison Avenue can’t take all the blame for this one...
...Nineteen seventy-eight was a red-letter year for bankruptcy law...
...Only individuals for whom repayment was an unreasonable burden would receive a total discharge of debt...
...As undemocratic as it may seem, a form of means testing should be implemented...
...and everyone blames society for being morally bankrupt, thus removing the stigma from financial bankruptcy...
...Of course, the ideal solution would be to help people avoid falling into a position where they feel they need to file bankruptcy...
...Right after that, I quit paying on my condo...
...More to the point: While extending a $1,000 credit line to a family with a $10,000 annual income may be good democratic capitalism, extending the family multiple cards or $25,000 in credit borders on the criminal...
...But he did not hesitate to stick his creditors with several thousand dollars worth of uncollectable debt, while simultaneously flirting with bankruptcy fraud...
...The Debt Peddlers The most vocal critics of bankruptcy being treated as a quick-fur are the creditors associations, including Visa U.S.A...
...No one at the lender level seems to care about overextension of debt, and human nature being what it is, most people believe they can afford more debt, when many simply cannot...
...While this is in part the result of millionaires, celebrities, and major corporations joining in the debt-discharge orgy, it is also an outgrowth of our society’s increasing reliance on debt spending...
...Take the case of former corporate raider Paul Bilzerian...
...They know that the average customer will charge a certain percentage of his income every month, then pay off a certain percentage of that balance at month‘s end...
...Banks insist that this “democratization” of credit helps feed the economy and enables low-income families to participate in the marketplace...
...I’m not saying that everyone who files for bankruptcy is a cheat, a deadbeat, or a self-indulgent yuppie...
...Although a small percentage of people fmd themselves with debts that are more than they could ever repay, more often than not the problem is that people are unable to meet creditors’ demands for payment right now...
...While this is in part the result of millionaires, celebrities, and major corporations joining in the debt-discharge orgy, it is also an outgrowth of our society’s increasing reliance on debt spending...
...When a bank extends you a line of credit, he explains, they are working with a formula...
...While regular deficit spending has been part of the U.S...
...By now you’ve all heard the disturbing news: Despite a thriving economy, and the decline in corporate bankruptcies, Americans are declaring personal bankruptcy in record numbers...
...Each creditor, in turn, would receive his fair share of the debtor’s budgeted payments...
...The system makes it too easy just to walk away from debt,” he says...
...But reversing this trend will involve more than tweaking the existing bankruptcy code, because the rise in filings-estimated to have begun around 1981-cannot be traced to any single change in law or economic policy...
...As a first step, banks need to provide customers with the basic information necessary to help them manage their debt...
...With his massive tax cuts and foreign borrowing, the Gipper showed the entire nation what kind of party could be financed with debt...
...Rather than squirrel away the money (which would have been illegal), Tom had it diverted directly into the account of another friend whose larger boat he had been planning to purchase (a move both illegal and frivolous...
...He has the pretty wife, the cute kid, the well paying job in high-tech, the two cars (one a Mercedes 300), the sailboat (a 35footer rigged for racing)- and the obligatory Chapter 7 bankruptcy on his credit report...
...I doubt they’ll even notice...
...fiscal agenda since the late 1940s, Ronald Reagan elevated the practice to high art...
...As a result, Americans have developed a sense of entitlement to a certain lifestyle, a belief that a downturn in one’s financial situation doesn’t have to mean tough spending choices...
...The current system, however, is far from that ideal...
...He probably spent an hour total on mine...
...fiscal agenda since the late 1940s, Ronald Reagan elevated the practice to high art...
...This kmd of profit potential leads to fierce competition: There are currently an estimated 7,000 institutions issuing Visas and Mastercards...
...His decision to file bankruptcy stemmed from a five-car pile-up his vehicle was involved in three years ago...
...Currently, the court does allow debtors to “reaffirm” individual debts (;.e., reach a repayment agreement with specific creditors), but there is little incentive to do so...
...The injustice comes when debtors receive more relief than they need...
...Under the Bankruptcy Act of 1898, debt forgiveness was an ill-defined, cumbersome process...
...Clearly, this is a person for whom the bankruptcy system was intended...
...Ifsomeone has the ability to repay a portion of their debts, they should file a Chapter 13,” says Philip Corwin, adding, “Of course, if someone is either unemployed or income insufficient, our position is that’s a mistake we made as lenders, and we’ll have to eat it.,’ Certainly, no fair reform is possible until the issue of lending practices is addressed...
...Overhead is low, and the firm can churn out dozens of Chapter 7 cases per month...
...But the trustee has 500 cases sitting on his desk,” notes Tom...
...Volumes have been written about what turned us from a nation of savers into one of feckless spenders...
...The Federal Reserve reports that consumer debt, having more than doubled in the past decade, has reached $1.19 trillion...
...We want it all, we want it now, and we don’t want to worry about paying for it until next month...
...Or, “If you pay x amount each month on a balance of x dollars, it will take you x years to pay off your debt...
...Although it may sound criminal, such asset juggling is perfectly legal, and is recommended by some attorneys and accountants as smart financial planning...
...In this rush to grab new business, banks have replaced careful debt underwriting with hard-sell marketing-loosening lending criteria, extending excessive credit to lower-income households, and tempting existing card holders with higher limits and low introductory interest rates...
...In addition to ushering in the Reform Act, which made the filing process infinitely quicker and easier-and thereby more lucrative-for attorneys, this was the year the Supreme Court overturned a ban on attorney advertising...
...He’s good to his parents...
...Having read that the sale of assets up to six months prior to filing must be reported, Tom took care not to leave a paper trail: “I signed the boat over to a friend who wanted to buy it, then filed a pre-dated transfer-of-liability notice...
...Such practices have removed a once major deterrent to filing...
...As former Secretary of Commerce Peter Peterson writes in his book Will America Grow Up Before it Grows Old?: “Reagan gave us a spectacular consumption boom...
...Volumes have been written about what turned us from a nation of savers into one of feckless spenders...
...The favorite culprit is mass advertising and television, which drive consumerism with their message of instant gratification...
...After that point, even if you charge up to your limit and default, the bank has turned a profit...
...George Salem, a securities analyst with New York‘s Gerard Klauer Mattison & Co., issued an investment report on the banking industry last June and later presented his findings at the House Banking Committee hearings on consumer debt: “[Personal] bankruptcies are up sharply because of the proliferation and looseness of credit card debt...
...Now, with the filing rate eight times that of the Depression era, most people agree that something needs to change...
...Neither illness nor job loss is a recent invention...
...To make the system function more fairly and eficiently, a uniform national exemption policy needs to be set up...
...People like me shouldn’t get away with this,” he admits...
...The reason: profit...
...An upstanding citizen in other respects, Tom’s willingness to walk away from his financial obligations reflects another key to the rise in filings: this culture’s growing acceptance of bankruptcy...
...And no one is sent a card without applying for it...
...Yes, this December Tom joined actress &m Basinger and former baseball commissioner Bowie Kuhn among the swelling ranks of Americans taking advantage of Uncle Sam’s debt forgiveness program...
...Even attorney Harvey Miller, a senior partner with New York‘s Weil Gotshal and Manges and a 25year practitioner of bankruptcy law, admits the legal community has gone overboard: “Flipping through the TV channels at night, you see all these ads with lawyers saying, ‘Don’t be burdened with debt...
...Some banks even target Chapter 7 filers because the customer can be charged steep interest rates and cannot declare bankruptcy again for six years...
...One Miami legal firm actually markets itself as The Bankruptcy Clinic...
...Several years ago, when, due to legal troubles, he was preparing to file bankruptcy, Bilzerian sunk $6 million into a mansion in Florida, where state law allows filers to exempt an unlimited dollar amount in home equity...
...a borrow-andspend administration, a feel-good decade in which we could have it all-without the bother of actually producing it...
...Say you have a $5,000 credit limit...
...Remaining assets are collected and sold off by a trustee, who distributes the proceeds to the various creditors...
...No longer is filing bankruptcy tantamount to sewing a scarlet “B’ on all your clothing...
...One December f h g was by a single mother of two, who less than a year earlier had gotten off state assistance and taken a clerk‘s job paying just under $10,000 a year...
...Included among her reported debts were medical bills totaling more than $5,000...
...Fair Play Whatever their sins, however, creditors are dead-on in their criticisms of the current one-size-fits-all Chapter 7 bankruptcy...
...To this end, credit card statements would include information such as, “If your income is x amount, you should not be carrying a balance of over x amount...
...Rather, four key developments began taking shape around that time whose combined influence created a debt-default juggernaut that shows no signs of slowing...
...With profit margins at risk, creditors are looking to overhaul a system they believe makes default too attractive for consumers...
...But while the creditors blame the lawyers, the law, and society for the crisis, practically everyone else blames the banks for dispensing credit unwisely...
...Regardless of how smoothly the system runs, however, the additional steps involved with filing and evaluating each Chapter 13 would lengthen the process...
...Without question, Americans are drowning in credit card offers...
...Radio and television ads, billboards, and flyers tout bankruptcy as the quick, simple way to solve your financial problems...
...But financial hardship has always been a part of life...
...The government has done its share of spreading the message that debt is good for you, particularly in recent years...
...He would do anything in the world for his friends...
...The only assets I turned over were one of our cars and a camera...
...There are legal means available...
...My friend Tom, however, clearly is not-a fact he is unabashedly honest about...
...There are guidelines about what you can and can’t discharge, but there’s no structure in place to check that...
...The money from the sale of my boat will never cross my hands...
...As a result, Americans have developed a sense of entitlement to a certain lifestyle, a belief that a downturn in one’s financial situation doesn’t have to mean tough spending choices...
...Maybe...
...BY MICHELLE COTTLE My friend "Tom" is your typical yuppie...
...He would do anything in the world for his friends...
...Now seems like a good time to point out that Tom is not a bad guy...
...Anyone is eligible for Chapter 7; petitions are almost never denied, except in cases where there’s proof of “substantial abuse” (the definition of which remains vague...
...Extending the six-year wait now required before a Chapter 7 filer can declare bankruptcy again could also give repeat offenders pause for thought...
...At the creditors meeting in January, he asked me exactly one question about my finances: Which Mercedes did I intend to keep...
...And although economic disasters cannot be controlled, consumers can be educated as to the dangers of excess debt...
...most people don’t know what their credit card interest rates mean in terms of real dollarsor even what rates they’re paying...
...Such data would help consumers understand the price involved with carrying a debt and enable them to make better-informed financial decisions...
...Certain types of debt are considered nondischargeable, including child support, recent IRS debt, and student loans...
...He loves his new baby...
...Chapter 13 is known as a wage-earner plan...
...That’s it...
...Why should the majority of Americans struggle to meet their daily expenses when their neighbors have decided simply to tear up the bills and start from scratch...
...Now, because you are such a good customer and are making regular payments, by the time you reach your credit limit, the bank will most likely have upped it to $7,500 or $10,0001’ As a result of a creeping balance, often accompanied by multiple cards, Dubow says, “It’s not unusual for people to come in with $20,000 worth of card debt...
...As former Secretary of Commerce Peter Peterson writes in his book Will America Grow Up Before it Grows Old?: “Reagan gave us a spectacular consumption boom...
...I went and saw an attorney back in March...
...Nice n’ Easy To my friend Tom, the impetus behind the rise in filings is clear...
...As a result, he notes, people are much more aware of the bankruptcy option...
...The result can be seen in the phenomenon of “creeping debt,” says Alan Dubow, president of the Debt Relief Center, a national non-profit chain of financial counseling centers...
...But since I was about to trash my credit history, I discharged some legitimate debts as well...
...Repayment plans typically last three to five years, at the end of which the remainder of the debt is discharged...
...As a result, it has become increasingly difficult to tell the lawyers from the used-car salesmen...
...To this end, Tom began planning for his filing months in advance...
...Their concerns are clear: The bankcard industry estimates it lost $4.7 billion to bankruptcies in 1995 alone, up 45 percent from 1994...
...Last year, General Electric went so far as to impose a $25 annual fee on “convenience users,” customers who selfishly pay off their balance every month without allowing interest to accrue...
...Of course, Tom also did some “asset readjustment” that wasn’t kosher...
...And with consumer spending making up 68 percent of the nation’s GDP, we have become a society in which living beyond your means is considered, not only acceptable, but downright patriotic...
...It gets better...
...While we’re on the subject of exploiting the system, now seems the time to introduce the third major contributor to the bankruptcy crisis: the lawyers...
...Unfortunately, many lawyers are all too happy to file a no-fuss Chapter 7 for a client who might benefit just as well from some other option, such as debt consolidation or a repayment plan with an individual creditor...
...One of the little things he failed to mention on his Chapter 7 petition was that, up until the day before filing, he owned a sailboat...
...Many people also assume that banks-which, after all, are in the business to make money-wouldn’t extend a line of credit to a person who wasn’t financially qualified for it...
...But for the most part, Chapter 7 gives people a fresh start...
...According to Behavioral Analysis Inc., more than 2.7 billion solicitations were mailed in 1995 alone...
...A debtor’s first step is to determine which of the two main consumer filing options he needs, Chapter 7 or Chapter 13...
...A provision should also exist to allow someone like Tom, faced with one overwhelming expense, to discharge a specific debt without tossing out all his others...
...Similarly, a Virginia millionaire preparing to file took advantage of his state’s exemption allowance for one horse and invested close to $650,000 in a racing thoroughbred...
...It allows debtors to shelter their assets from repossession while working with a court-appointed trustee to draw up a repayment schedule...
...Even though Tom was not at fault, he was facing a $250,000 lawsuit...
...And with consumer spending making up 68 percent of the nation’s GDP, we have become a society in which living beyond your means is considered, not only acceptable, but downright patriotic...
...Considering the overall litigation-fest of recent years, it may also be time to retighten legaladvertising standards so that attorneys don’t stray from the marketing of services into the promotion of specific ways for clients to milk the system...
...To compound the problem, creditors encourage borrowers to carry large balances-and rack up interest payments-by liberally expanding the credit lines of customers who carry a heavy debt load, and by setting minimum monthly payments as low as 2 percent of the principal...
...There is no minimum amount of debt or specific income-to-debt ratio required, and no distinction is made between the portions of a person’s debt that they can and cannot repay...
...Bankruptcy, he determined, was his best option...
...The trustee receives a commission based on the amount recovered...
...In other words, the rise in bankruptcies is an unfortunate-but unavoidable-fact of modern life...
...After all, consumers who don’t default on their debts wind up paying the price of bankruptcy in the form of higher bank fees and interest rates...
...As Salem notes:”[C]ard issuance has taken on the character of mass-mailed advertising or promotion rather than a loan...
...In reference to a former client who was the proud holder of 63 major cards, one Florida bankruptcy attorney asks: “Now if you’re a bank and you pull this woman’s credit report and see that she’s got 58 cards, is it responsible to send her another one...
...Taking Corwin at his word-that is, holding banks accountable for their actions-might put a measure of prudence back into credit issuance...
...But the debtor would still be protected from creditors from the moment he filed, and the additional work involved might slow attorneys’ filing frenzy just enough to make them consider what other options might better benefit a client...
...The Federal Reserve reports that consumer debt, having more than doubled in the past decade, has reached $1.19 trillion...
...Tom knows that his shell-game could mean big trouble if for some reason his bankruptcy trustee decides to launch a post-filing investigation...
...On the heels of these personal narratives came laundry lists of the common causes of consumer bankruptcy -job loss, divorce, high medical bills, car accidents, credit card debts-along with the requisite finger pointing: The lawyers blame the banks for making excess credit too obtainable...
...Currently, while quick to condemn debt default, lenders are even quicker to help filers re-establish credit-at the highest interest rate allowed...
...I used that money to pay off debts that I wouldn’t be able to discharge, like new taxes...
...If you charge $200 every month and pay off only $50 dollars of that, your debt will increase monthly by $150 plus interest...
...The favorite culprit is mass advertising and television, which drive consumerism with their message of instant gratification...
...Let’s ignore for a moment that debt isn’t so much the problem as is excessive debt, and that people’s credit limits are frequently upped without their consent...
...Under Chapter 7, debtors are allowed a certain number of property exemptions, broken down by category: $15,000 in home equity, $1,000 in jewelry, $8,000 in furnishings, and so on...
...But Hollywood and Madison Avenue can’t take all the blame for this one...
...It’s a pathetic law...
...While regular deficit spending has been part of the U.S...
...Currently, 35 states preempt federal exemption allowances with state ones, some dating back to the 1800s...
...Today’s filing process is relatively quick, easy, and cheap, with court filing fees running well under $200...
...The Bankruptcy Reform Act of 1978 changed all that...
...I’m paying a big price for being bankrupt, so I might as well take advantage of it...
...An upstanding citizen in other respects, Tom’s willingness to walk away from his financial obligations reflects another key to the rise in filings: this culture’s growing acceptance of bankruptcy...
...When the American Bankruptcy Institute reported last summer that 1996 petitions were on track to hit a record 1.1 million, every newspaper in the country ran an article on our nation’s consumer bankruptcy crisis...
...We want it all, we want it now, and we don’t want to worry about paying for it until next month...
...Tom, for example, makes over $75,000 a year...
...Specifically, a measure of justice needs to be injected into the system...
...No longer is filing bankruptcy tantamount to sewing a scarlet “B’ on all your clothing...
...Leading off each piece was a disheartening tale about how some naive young couple (or single mom or grandmother) had either: a) been struck a devastating financial blow such as an unexpected illness or layoff or b) allowed themselves to sink slowly into a morass of unrecoverable credit card debt...
...The lawsuit was a debt that I could never have paid back,” he says...
...Flipping through the filings at the District of Columbia bankruptcy clerk‘s office, you find numerous cases of people who fell on hard times...
...He isn’t far off base...
...and the American Bankers Association...
...The guy I’m buying from has agreed to keep the boat in his name for a few months and just add me to his insurance...
...But this measure would need to be combined with tougher standards for reacquiring credit after bankruptcy...
...Tom admits he’s abusing the system, but rationalizes: “I’m not an idiot...
...Banks expecting to collect on a debt would need to show that they’d been reasonable in issuing credit to the filer, and upfront in keeping him donned of his debt load...
...Yet the number of personal bankruptcy filings has tripled since 1981...
...But, Dubow notes, just because someone eventually defaults on a card balance doesn’t mean that the bank didn’t make a profit...
...With his massive tax cuts and foreign borrowing, the Gipper showed the entire nation what kind of party could be financed with debt...
...Most Chapter 7s, however, are ruled no-asset cases, which means unsecured creditors (those to whom significant collateral, such as a car or home, has not been pledged in case of default) rarely see any of their money...
...Of course, the actual dollar amounts might shock customers, but if lenders are genuinely interested in helping people use credit wisely, they need to be upfront about what those little interest payments can add up to...
...Flipping through the filings at the District of Columbia bankruptcy clerk‘s office, you find numerous cases of people who fell on hard times...
...But, as is often the case, what is positive in moderation can be lethal in the extreme...
...The entire concept of debt-forgiveness is based on overwhelming need, and the process should reflect as much...
...To encourage banks to provide such data, court judgments about whether a particular credit issuer should be included in a debtor’s repayment plan could be contingent upon whether that creditor had acted responsibly in its dealings with a debtor...
...a borrow-andspend administration, a feel-good decade in which we could have it all-without the bother of actually producing it...
...Be honest, how many of you know the exact rate you’re paying on your cards...
...I’m not saying that everyone who files for bankruptcy is a cheat, a deadbeat, or a self-indulgent yuppie...
...the banks blame the government for making filing too easy and the lawyers for being too quick to recommend bankruptcy...
Vol. 29 • March 1997 • No. 3
