Howard Karger

Throwing Consumers to the Wolves

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.

The $40 to $100 for a compulsory credit counseling session is a burden on already destitute filers. While creditors believe that debt counseling will push 30 percent to 50 percent of bankruptcy filers into repayment plans, this just isn't happening. A survey by the National Association of Bankruptcy Attorneys (NACBA) of six DOJ approved credit counseling agencies found that 96.7 percent of their 61,335 customers were too insolvent to repay their debts. Rather than being overspending deadbeats, 79 percent were in financial trouble due to job loss, medical bills, death of a spouse or divorce.

Institutional creditors are neither naive nor ill-informed. Armed with sophisticated information systems, most know they can't stop bankruptcies. Insolvent debtors simply cannot repay their debts. The primary goal of BAPCPA is to create a gauntlet of obstacles that will make filing more drawn out and complicated. The intent is to delay Chapter 7 bankruptcy filings for as long as possible, since each month a consumer is not in bankruptcy relief there's a chance they'll pay at least a portion of the payment. Delaying tens of thousands of bankruptcies for a month or two will result in millions for creditors. This partly explains why compulsory credit counseling was included in the law, even though a Visa-funded study found that 74 percent of consumers drop out before finishing their DMP.

Liberal credit policies and minuscule minimum payments on credit card balances kept some cardholders in debt for decades This system ticked along nicely until federal regulatory agencies became concerned about high consumer debt and required that minimum monthly payments be raised from 2 percent to 4 percent. Overnight, monthly payments on a $9,000 (18 percent APR) credit card balance doubled from $180 to $360. This was a tipping point for some consumers with high balances.

Not coincidentally, this change occurred at roughly the same time the new bankruptcy law was passed. With less possibility for a bankruptcy escape, creditors had borrowers just where they wanted them.

Prudent lenders target creditworthy consumers. Conversely, they assume a greater risk when they seek out less creditworthy customers who pay higher interest rates. Higher potential profits have always been associated with greater risks. One problem with the new bankruptcy law is that it shifts the risks from the lender to the borrower without giving the borrower anything in return. For example, the high rates charged in subprime loans are less defensible now that the risk has shifted. The Act also insulates lenders from the risk of lending by not holding them liable for their credit issuance decisions. Lenders want it both ways -- extend subprime credit to borrowers with shaky credit histories and then make it impossible for them to get out of the debt. The Bankruptcy Act is an invitation to exploit the growing subprime market with less risk for lenders.

Poor and moderate-income consumers are being forced into a corner by stagnant salaries, high debt and rising prices. John Rao of the National Consumer Law Center recounts that Congress was warned that bankruptcy filings were a symptom not a disease. Rao is right. Bankruptcy is not a disease, but a symptom of a society racing to the bottom in terms of wages and benefits -- an "ownership society" in which citizens own most of the risks, and a society where conservatism is anything but compassionate.

Not surprisingly, BAPCPA excludes anything relating to Chapter 11 or business bankruptcies, an area where consumers desperately need protection.

Judge Monroe wrote in his ruling that by passing the Bankruptcy Act, Congress ignored the scores of judges, academics and lawyers who spoke out about the flaws of the Act. "It should be obvious to the reader at this point how truly concerned Congress is for the individual consumers of this country," he wrote. "Apparently, it is not individual consumers of this country that make the donations to the members of Congress that allow them to be elected and reelected and reelected and reelected."

Swimming With the Sharks

Reverend Al Sharpton finds solace in strange places.

"When I'm out fighting for the little guy and I need quick cash, I find comfort in knowing that LoanMax is here for me."

This is from a television ad he did in early December for LoanMax, a predatory auto title lender. After some criticism, Sharpton relented and declared a moratorium on the ads, saying he wants more financial data from LoanMax.

What data does Sharpton need? To get an auto title loan, a borrowers put up their car title as collateral along with an extra set of keys. They get a 30-day loan equal to a maximum of 50 percent of their vehicle's trade-in value. If the loan is repaid on time, the borrower gets the title back. If not, the vehicle is repossessed and sent to auction. In some states, the lender keeps the full proceeds of the auction, even if it exceeds the loan. To be fair, LoanMax isn't interested in repossession since it makes more money from customers' rolling over their debt from month to month. Trapping customers in a cycle of debt is the cornerstone of fringe lending.

LoanMax makes 500,000 title loans a year through 200 stores in 21 states. Its average car title loan is $400, and at a 30 percent monthly interest rate, it makes $120 on a $400 loan for 30 days. Since LoanMax claims that most borrowers repay their loan in two to three months, in only 90 days the average customer pays $360 in interest on a $400 loan. If customers take a year to pay off the debt, they'll spend a whopping $1,440 in interest on a $400 loan. Borrowers also pay title recording fees, plus some lenders add a $50 annual membership fee.

LoanMax's interest rates would make even Tony Soprano green with envy. According to the Justice Department, one underworld crew operated a large-scale loan sharking and bookmaking operation that preyed upon employees of stock brokerage firms. The crew made illegal loans at interest rates of one percent to five percent a week, or the equivalent of a 52 percent to 240 percent APR. This would be a bargain for auto title pawn customers. In fact, the phenomenal growth of legal fringe lenders may be cutting more into Mafia profits than the FBI's anti-racketeering efforts.

Sharpton claims he was recruited for LoanMax by Lamell McMorris, a civil rights activist and founder and CEO of Perennial Strategy Group, a consulting and lobbying firm. Quoted in the New Pittsburgh Courier, McMorris said, "I know a great deal about LoanMax because the owner of the company [Rod Aycox] is my best friend. LoanMax is not a predatory lending institution. As far as I'm concerned, they're green-lining a redlined America." Perennial wrote and disseminated LoanMax's rebuttal to attacks on the Sharpton commercial.

Predatory lenders like LoanMax crave respectability, and Lamell McMorris has the credentials to deliver. In 1998 Ebony named him one of the "30 leaders of the future, 30 and under." McMorris has worked with Jesse Jackson, the Chicago Urban League, the NAACP and the Rainbow/PUSH Coalition, and was director of the Southern Christian Leadership Conference. What better friend for a predatory lender?

The fringe economy represents an economic war targeted at the old, minorities and the poor. At its root, predatory lending is a class- and race-based industry. Check the zip codes. I doubt there's a LoanMax office located in a posh or upper-middle-class neighborhood. When Sharpton and McMorris work to make a rogue industry respectable, they are little more than well-paid mercenaries in an economic war against the poor. Promoting a debt culture also doesn't help the economic base of African American communities.

The main opposition to predatory lending comes from Democrats, and if fringe lenders can divide the leadership, the industry will be more secure. Part of the industry's strategy involves neutralizing or dividing African Americans over the issue. Unfortunately, this tactic seems to be working, at least on the basis of the silence of prominent civil rights activists like Jesse Jackson, Julian Bond and Bill Cosby. So far, no black leader has commented on Sharpton's swim with the LoanMax shark.

On the other hand, Congressional Black Caucus member Stephanie Tubbs-Jones refers to predatory lending as the "civil rights issue of this century." Take heed, she's probably right.

Compassion For the Few

Americans have come to expect little from government, which is generally what we get. So when Katrina's victims receive help from the federal government, we're happy for them on one level, but envious on another. Like children living with an emotionally distant parent, even the slightest attention makes us jealous as we fight for the crumbs. It's not surprising, then, that in a city like Houston, with a large number of Katrina evacuees and an even larger number of indigenous poor, envy and bitterness are already beginning to rear their ugly heads.

The Justice Department has recently affirmed that natural disasters, such as Katrina, qualify as "special circumstances," thereby justifying the elimination of debt under the forgiveness or "fresh start" umbrella of Chapter 7 bankruptcy. In other words, Katrina's victims are exempt from the harshest part of the new bankruptcy law, one that forces debtors into Chapter 13 (debt reorganization and court-ordered debt repayment over three years). Katrina victims are also exempt from other requirements of the new bankruptcy law, including producing cumbersome documents, forced attendance at credit counseling sessions and compulsory meetings with creditors.

While the Justice Department's flexibility is good news for Katrina's victims, it's unclear how long they'll be exempt, although it better be for a long time since bankruptcy filings don't peak until three years after a disaster.

The Justice Department's ruling is based on the simple premise that victims of natural catastrophes are impoverished by an act of nature rather than by their own moral failings. In effect, this creates a category of worthy versus unworthy debtors. Since the logic is strikingly similar to the 17th-century distinction between the worthy and unworthy poor, perhaps the DoJ might want to think about resurrecting debtor's prisons.

The Justice Department's ruling brings up troubling contradictions. For instance, while Katrina's victims are considered worthy of compassion, other groups are not. Apparently, those who fall ill and quit their jobs or are forced to cut back on work hours due to illness, are considered unworthy. These individuals fall under the new bankruptcy law that took effect October 17.

In their books, As We Forgive Our Debtors and The Fragile Middle Class, authors Teresa Sullivan, Elizabeth Warren and Jay Lawrence Westbrook found that contrary to popular stereotypes, bankruptcy filers are not irresponsible spendthrifts. Instead, the reasons they fall off the financial cliff include layoffs, downward job mobility, part-time work, huge medical bills, income loss from illness or accidents, overuse of credit cards, and the financial pressure on single-family households resulting from divorce or abandonment (a divorced woman is 300 percent more likely to file for bankruptcy than her married sister).

Many causes for bankruptcy are rooted in events -- like hurricanes -- that are beyond the individual's control.

One lesson learned from the Justice Department's ruling is that if you have intractable debt but your circumstances don't warrant special consideration, move to the Gulf Coast. Anywhere from Pensacola to Houston will do. Then pray for a hurricane since that's probably the only way you'll merit compassion. Of course, the extent of that compassion will depend largely on the president's approval rating.

The Financial Storm After the Hurricanes

While the public's attention has focused on the physical recovery from Katrina and Rita, a third storm looms that will prove as devastating to the finances of Gulf Coast residents as the hurricanes: debt and federal bankruptcy reform.

Tens of thousands of Americans living in the region have lost their homes, cars and jobs. If federal predictions are correct, it will be months before evacuees can return home. In Katrina's wake, some 400,000 jobs have been lost, and Rita will only increase these numbers. The unemployment rates for the affected regions of Alabama, Louisiana, Mississippi and Texas will hover in double digits for the foreseeable future.

During the months necessary for economic stabilization, thousands of Gulf Coast residents will be without a paycheck. For some, savings will deplete within a month or two. Others never had any. While incomes plummet, bills pile up: car payments are due regardless of the operability of the vehicle; medical bills, credit card debt, car loans, mortgages and student loans have to be repaid.

One of the consequences of so many Americans living paycheck to paycheck is their extreme vulnerability during crises. About half of families roll over credit card balances every month, and balances average almost $5,000. Last year 1.6 million cardholders declared bankruptcy. To meet their financial obligations, many Americans have refinanced their homes; about 42 percent of new mortgages are refinances, and 77 percent strip equity from homeowners, leaving them with higher monthly payments. Many of the victims fell into that camp even before the hurricane. The federal bankruptcy reform is on a collision course with those left behind.

Evacuees will be eligible for disaster assistance, but such aid will be inadequate to protect them from bankruptcy reform scheduled to strike on October 17. FEMA has promised each evacuee household $2,000, which will hardly cover the expenses of hotel rooms, food and other necessities, let alone mounting loan payments. Some will be eligible for Disaster Unemployment Assistance, but beneficiaries will receive 50 to 70 percent of their weekly salary for only 26 weeks. Private charities, especially the Red Cross, will also assist victims, but such assistance is short-term and often capricious.

Apart from encouraging support for the Red Cross, credit card companies and other lenders have made only modest attempts to help Katrina's victims. Banks and credit card companies like MBNA, Chase, Bank One and Bank of America are giving hurricane victims a two- to three-month payment holiday, plus a break from cash advance and late fees. They are also promising not to file negative credit reports for 90 days. Ford and Chrysler are following suit. However, interest on loans will continue to accrue and providing 60-90 days of relief is a short-term fix for what will be a long-term financial problem.

There will undoubtedly be a credit crisis of major proportions on the Gulf Coast and government and lenders must step up to the plate. For one, Congress should revisit the federal bankruptcy law scheduled to take effect next month. Gulf Coast residents were let down once by the government. It is now time to make amends. Defenders of the bill say it has left provisions for survivors, but the bill clearly puts the burden of proof on those in debt. For those who have lost their homes, providing their financial records will be extremely difficult, and hiring a lawyer for the lengthier process may be beyond their means.

For their part, credit card companies and other lenders should institute a longer moratorium on debt repayment, during which time no additional interest or penalty fees would accrue. The moratorium would apply to credit cards, car loans, student loans and mortgages. This moratorium could be implemented on a case-by-case basis and exclude those able to repay their debt.

The failure to enact significant reforms will sabotage efforts by hurricane victims to rebuild their lives, and with poor credit scores, they will find it impossible to secure mortgages and car loans. Just as with Katrina, minorities will bear the brunt of this financial storm. According to the Federal Reserve, more than one-fourth of high-interest, sub-prime mortgages went to African Americans, contributing to their disproportionately high incidence of bankruptcy.

Natural disasters on the scale of Katrina offer an opportunity to reconsider how the nation manages its public responsibilities. Money spent on financing debts will be money not spent on education, job training, starting small businesses and other investments that can help the Gulf Coast rebuild itself. Hurricane survivors face a daunting-enough future without further impeding their efforts to rebuild their lives by imposing punitive bankruptcy reform coupled with the inflexibility of credit card companies and other lenders.

It Happened in Houston

In his press conference on Friday, Texas governor Rick Perry congratulated his staff for doing a great job in preparing for Rita. It must be a Texas thing, since I remember Bush congratulating Michael Brown. A few days later he fired him. Despite the hype by city, state and federal officials, the reality on the ground in Houston tells a different story. It is a saga of incompetence and an almost complete lack of planning.

Like many people, we tried to flee Rita's path. Thinking we could beat the traffic, we left Houston at 8pm on Wednesday -- 48 hours before Rita's expected landfall. We chose a road with normally light traffic. By 11:30 p.m., we had driven about 20 miles -- another 180 lay ahead of us. At that pace, we would have arrived in San Antonio in 24 hours, if our gas held out. Already exhausted and watching the gas needle drop, we made a U-turn and headed back home, passing an almost uninterrupted line of gridlocked traffic extending back to the city. By Wednesday night there was no viable way out of Houston.

When we returned to Houston, the gas stations were closed and every pump was bagged and empty. Stopping at a large 24-hour Kroger supermarket, most canned foods were gone, and only a couple of boxes of water remained. Not a single flashlight or C or D battery was available. The market had posted a sign "Closing Thursday at 1pm. Reopen ???" The manager said they might reopen Monday, but he wasn't sure. By Thursday afternoon, all of Houston's supermarkets had closed, if they weren't already shut down.

Those with the money to stock up on groceries did well. Others who did not have the money may face several days of hunger. One shopper on the line with a small basket of groceries said she could not afford to buy more. Her paycheck had run out.

For some of us in Houston, it was like New Orleans all over again. City, state, and federal authorities again demonstrated their incompetence in the face of a crisis. Despite the "we're in control" -- another Texas thing -- the evacuation was chaotic until late Thursday, even though a mandatory evacuation order for large parts of the city and surrounding counties were in effect a day earlier.

There were no roadside services available on Wednesday, despite the impossibility of driving -- or idling -- a vehicle for 24 hours on one tank of gas. Emergency gas for stranded motorists was not made available until late Thursday, more than 24 hours after the exodus began. The counter-lanes were also opened on Thursday, again more than 24 hours after the evacuation order. By then, most people who had turned back -- and there many -- were too weary and wary to try again. By Thursday morning, almost every gas station in Houston was out of gas, reinforcing the fact that there was no way out.

The absence of statewide coordination was obvious early on. For instance, when driving through small towns toward San Antonio, all of the traffic lights were operating. It was like a regular evening for the small town of Richmond, Texas, except for hundreds of thousands of cars trying to snake through a narrow main street lined with stoplights on almost every corner. There were no sheriffs or state troopers to keep the traffic moving.

The much-touted presence of the "new and improved" FEMA was absent. Low-income people were not provided with sufficient food before the hurricane hit. Nor was water being distributed. There were no notices on billboards or signposts announcing shelters or food depots. Helping people after a hurricane is far less effective than helping them prepare for it. Apparently, FEMA prefers the heroics of "saving people" to the more banal aspects of preparing them. Seeing the lack of preparedness of America's fourth largest city was sobering.

We can only hope that the aftermath of Rita will be handled better than the preparation for it. But, as President Bush is fond of saying, "The jury's still out."


Happy Holidays!