Throwing Consumers to the Wolves

By Howard Karger, AlterNet. Posted March 7, 2006.

Frank Monroe is one pissed-off federal bankruptcy judge. Just before Christmas, Judge Monroe was forced to deny Guillermo Sosa, an Austin, Texas, house painter, and his wife, Melba Nelly Sosa, emergency bankruptcy protection to avoid foreclosure on their mobile home. While sympathetic to the Sosas, Judge Monroe's hands were tied by the new bankruptcy law. The so-called Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) required that the Sosas receive consumer credit counseling before filing for bankruptcy. Unaware of this stipulation, they had failed to do so, making them ineligible.

In his angry ruling [PDF], Monroe wrote that "the parties pushing the passage of the Act had their own agenda … to make more money off the backs of the consumers in this country. … To call BAPCPA a 'consumer protection' act is the grossest of misnomers."

The BAPCPA went into effect on Oct. 17, 2005. Banks and other lenders promised it would stop deadbeats from abusing the bankruptcy system, save billions, and lower interest rates for responsible borrowers. House Judiciary Committee Chairman James Sensenbrenner, R-Wis., predicted the bill would recoup "billions … in losses associated with profligate and abusive bankruptcy filings."

That did not happen. On the contrary, Bankrate data found that the average credit card interest rate actually rose 1 percent in the six months following the passage of the Bankruptcy Act.

Panicked debtors trying to beat the Oct. 17 deadline filed more than 2 million bankruptcy petitions in 2005, 32 percent more than in 2004. Some 500,000 people filed for bankruptcy in the two weeks alone before the Act took effect. This uptick in filings cost Bank of America $320 million, JP Morgan Chase predicted their credit card defaults would top $2.3 billion and Discover Card lost $180 million. On the other hand, credit card companies will undoubtedly make up this loss, and more, in the long run.

Who are the "deadbeats" Congress is trying to weed out?

Leslie Linfield of the Institute for Financial Literacy says, "Almost half [of bankruptcy filers] have incomes below $20,000 a year, and almost 40 percent indicate that their indebtedness is due to illness or injury." The other half may be workers pushed into an economic corner. A 2006 Federal Reserve study found that real median income dropped 6 percent from 2001 to 2004, while average family income fell by 2.3 percent. The gap between stagnant or declining wages and the rising cost of living is partly being made up by debt. For example, Americans who roll over credit card balances owe anywhere from $5,100 to $14,000, depending upon whose numbers are used. High debt levels are fueled by easy credit that helps lessen the pressures on business to increase wages.

The Bankruptcy Act erected four major hurdles to deter bankruptcy. First, the Act makes it harder for people to qualify for a Chapter 7 bankruptcy that would erase most of their debt. Instead, most debtors have to file for Chapter 13, in which they face a three- to five-year court-ordered repayment plan.

Second, the Act requires more documentation from filers, including pay stubs and tax returns, and subjects them to a means test based partly on their average income over the past six months.

Third, the law muzzles and restrains bankruptcy attorneys -- the bane of the credit industry. Bankruptcy attorneys are labeled as "debt relief agencies," which prohibits them from dispensing certain kinds of financial advice. Other restrictions imposed on attorneys include the responsibility of vouching for the accuracy of information provided by clients. Because of these restraints, lawyers must spend more time on each case and bill more. Houston bankruptcy attorney Jeff Norman estimates that he charges 20 percent to 30 percent more due to the new law.

Lastly, BAPCPA requires all filers to undergo credit counseling through a Department of Justice (DOJ) approved agency before and after filing for bankruptcy. Credit counseling agencies can provide filers with a counseling certificate after one or two sessions, or they can develop a debt management plan (DMP) based on consolidating credit card balances into a negotiated agreement with creditors. In turn, creditors may lower interest rates and forgive fees.

This is an inherent conflict of interest since the majority of agency revenues come from the 8 percent to 15 percent voluntary Fair Share contribution paid by creditors on each payment they receive. Because of this arrangement, credit counseling agencies are actually soft touch collectors for credit card companies.

Howard Karger is professor of social work at the University of Houston, and author of "Shortchanged: Life and Debt in the Fringe Economy" (Berrett-Koehler, 2005).

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