Wednesday, October 25, 2006

Bankruptcy Reform - One year later...

There have been many stories in the press about the anniversary of the bankruptcy reform act and it's impact. In general, the reports are holding to party line. I say that because one of the goals of the reform was to reduce bankruptcy filings and filings are down significantly. Although some are calling the current level "historically low", you need only to go back 7 or 8 years to reach monthly filing levels comparable to the previous quarter.

Let me take some of the talking points and address them specifically.

Significantly lower filing rates. The first goal of the legislation was to reduce the number of bankruptcy filings. I want to offer an analogy: a medical clinic is seeing 1000 patients a month with minor to major wounds. The clinic supporters, faced with increasing costs to serve patients, decide to charge everyone coming in according to their income. Activists complain that will cause some patients to not come to the clinic but supporters claim those that can afford to pay, will pay
their fair share and those that do not will continue to get free or close to free care. After instituting the plan, admissions drop to 600 a month.

Now the question is, did the number of people that got injured drop? Did fewer people get hurt because of the possibility they would have to pay for medical care?

The number of bankruptcy filings in 2004 was lower than 2003. Absent the reform act, it is likely that the trend would have continued. As many supporters of the reform pointed out, the economy was getting better. Assuming a similar drop from 2004 to 2005 as 2003 to 2004, about 1.4 million people would have filed. As about 2.1 million did, we can say that 700,000 people filed either: because get while thegettin was good; or they were going to file anyway and getting in under the old law was a rational choice. Adding 90% of the rush filers to the probable filers in 2006, would have given us about 1 million filers this year, roughly a 30% drop. How
much of that drop could be attributed to different factors will be left up to researchers in the future but let us look at the possibilities:

Fewer people filed bankruptcy in 2006 because:

The law made it more difficult for above median income debtors to file chapter 7

This is the reason most commonly cited by the pro reform groups/supporters. However, it generally fails to acknowledge one fact ignored IN THIS CONTEXT, the number of chapter 13 filers grew by as much as 50%. Why? These are people that are BELOW the median. They, theoretically, can file chapter 7 but CHOOSE to file chapter 13.

The cost to file bankruptcy (regardless of chapter) has increased, pricing many of the most needy out of the ability to file.

This was the reason most opponents gave for opposing the reform act. Attorney fees increased across the board and across the nation. In many areas, attorney fees had been capped by courts and kept at artificially low levels for years. In our area, fees had remained steady for more than 10 years. The increase in documentation requirements and the requirement that attorneys VERIFY AND ATTEST to the accuracy of information provided by the debtor, resulted in courts allowing higher fees. The court costs to file a chapter 7 rose by 43%. The requirement that all debtors take and pay for credit counseling added another $50 to the costs (effectively increasing the filing costs by 67%). For some people, especially the least able to afford it, the court cost increase was/is prohibitive. [Before some moron claims that the very poor can get the fees waived, they should be aware that - in general - a person represented by an attorney that gets ANY fee, is generally NOT able to get the court
costs waived. The court believes if you can afford an attorney, you can afford the court costs, even if the attorney is working for a substantially reduced fee. Given the requirement that attorneys verify and attest to the accuracy of debtor information, such a situation will become very rare, the liability issues alone cause attorneys nightmares.] Finally, many attorneys allowed clients to pay part of
their fee upfront, and the balance after filing. This gave clients relief and although most courts (when presented the issue) denied attorneys the balance of their fees post filing, bankruptcy attorneys took the risk. Under the new law, that risk is unacceptable and very few attorneys (none we know of) provide payment plans, instead requiring the full fee to be paid in advance of filing. The significant increase in attorney fees, the significant increase in court fees and the addition of secondary fees has made filing more expensive for those people most in need of bankruptcy - DESPITE claims by reform supporters that it would not hurt below median filers at all.

The means test will either weed out those that do not really need to file or force them to file chapter 13.

Reports from credit counseling services indicate that 97% of the people taking credit counseling have insufficient income to pay their bills. But only about 60% of those that have taken the counseling have actually filed. Any argument that suggests that those that have not filed after taking credit counseling were potential abusers under the old system and too scared to face the new system ignores the 97% claim. More likely, the people that don't file CAN'T AFFORD TO. Again, if 97% of the people
that take credit counseling can't afford to pay their bills and chapter 13 rates INCREASE, then people are filing chapter 13 despite the fact they will probably fail. In the past, 40% of chapter 13 filers fail to complete their plan. The reasons are many, but chapter 13 budgets are usually very tight (even under the old law) and leave little room for unexpected expenses. Failure rates will take years to determine under the new law, but if the 97% number is accurate, expect failure rates to climb.

So, why would someone with little hope to pay their bills, and below the median income, file chapter 13? And to do so increasingly under the new law?

Chapter 13 is most commonly used for people that wish to retain an asset, such as a home. People facing foreclosure can file chapter 13 and reorganize their debts allowing them to keep their home. When foreclosure rates increase, so do the number of chapter 13 bankruptcy filers. And what has happened to foreclosure rates recently? Up 50% nationwide so far this year. For the first time ever, foreclosures will number over 1 million....historical. The number of chapter 13 filers is increasing because the number of people facing foreclosure is increasing (IMO). Despite the changes in the law, the number of chapter 13 filings is down considerably LESS than chapter 7 filings.

Some words on the law itself (rather than it's consequences). When debated, Todd Zywicki, a primary drafter of the law, sat in front of a Senate committee and claimed the law was just fine, no amendments were needed. After 8 years of trying to get through Congress, the draft bill addressed all the "real" concerns of those opposing it. In action however, the law has left many judges andtrustees frustrated. In a rare display of displeasure, judges around the country are noting their frustration in written opinions. On judge cited Mr.Zywicki's testimony disparagingly. Mr. Zywicki cried foul, but the overwhelming response to his complaint that he had been taken out of context was one of dismissal. Attorneys almost unanimously felt the Judge had not erred. Recently, Senator Hatch offered an amendment to the reform law...apparently, the 'perfect' law had a consequence that hit too close to home for the Senator from Utah (the state with the highest percentage of bankruptcy filers and one of the largest percentage of charitable givers) when a judge ruled that chapter 13 filers could not continue charitable contributions.

Lastly, bankruptcy fraud. One of the chief complaints of pro reform advocates was the claim that 10% of bankruptcy cases included fraud. This percentage was thrown about very often in the debate but NO support for it was ever given. First, let me give you an example of "fraud", hiding assets: A client appeared at a bankruptcy hearing wearing a stud earring. The trustee noted that there was no jewelry listed in the personal property schedule and required the petition be amended to include the stud earring. Value, $5. This was fraud, caught by a trustee, under the old law. REAL bankruptcy fraud is so rare, that when cases were brought, the FBI issued press releases! This year, the Justice Department and the FBI investigated cases in 36 bankruptcy districts and of the 250,000 cases filed, they found 18 with fraud. 18.

How much fraud has occurred?

From 1988-1995: 1474 cases referred, 355 convictions (~7.5 million cases filed)
From 1995-2001: 6090 cases referred, 482 convictions (~7 million cases filed)

14.5 million cases, 7600 cases referred .05% fraud rate. Where oh where did 10% come from? By the way, only 837 convictions came out of those 7600 cases, or .0058%

The most recent report on the 18 cases out of 250,000 filed indicates .072% fraud rate...gee...under the new law, the fraud rate, WENT UP! We'll see what the actual conviction rate is much later.

By every measure, the number of bankruptcy filings is increasing post reform enactment. It may take time to reach previous levels, but there is no doubt it will happen. Reform promised several things: fewer filings - CHECK; more chapter 13's - CHECK; less fraud -OOPPS; continued availability for those most in need - OOPPS; lower credit interest rates for everyone (oh, you didn't hear that claim...sure, it was right there when they said that loose bankruptcy rules were costing everyone $400 a year in extra interest paid, suggesting that everyone would be paying $400 less per year when the law was changed - your interest rates on credit cards and other loans have gone down this year...haven't they?) -OOPPS.

Remember this next time some paper or news station reports that bankruptcy reform has worked, the only ones bankruptcy reform has helped, were the credit card companies that did not report a SINGLE quarter of losses due to the 2.1 million bankruptcy petitions filed last year.

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