By Steve Bartlett
Since the turn of the 20th century, Americans have always had access to bankruptcy when overwhelmed and unable to repay their debts. This is as it should be. There is no reason to force people to toil under the burden of debts they can never repay. For this reason, the United States has had a “fresh start” enshrined in our bankruptcy laws since 1898. During the Great Depression in the 1930s, Congress created voluntary repayment plans as an alternative to straight liquidation.
However, as originally envisioned, straight liquidation under Chapter 7 was meant to be a last resort for people with no ability to pay. Congress continued America’s progressive tradition by enacting the Bankruptcy Abuse Prevention and Consumer Protection Action of 2006 (Public Law 109-8) to channel higher income consumers into repayment plans, while permitting those unable to repay to go into straight liquidation. The Financial Services Roundtable supports both the letter and spirit of these important reforms.
During Congressional debate, members of Congress pointed out that economic loss from bankruptcy filings slows economic growth. When a business – any business large or small – loses money because a customer files for bankruptcy, the business often must increase what it charges other customers. The roundtable and its member companies agreed that this is not good for consumers or the economy.
The roundtable and its member companies supported the implementation of this legislation for a variety of reasons, but there are two key provisions that should be highlighted: mandatory certified credit counseling and the means test. The roundtable supported these provisions because they ensured that those who could pay back some of their debts were obligated to do so and those who needed to have their debts discharged could.
Under this new law, all consumers who wish to file for bankruptcy must first go through pre-bankruptcy credit counseling. These credit counselors must be certified through the U.S. Department of Justice (DOJ) and have a nonprofit standing.
DOJ certification is a significant enhancement for the quality of credit counseling available to consumers. There has never before been a governmental seal of approval that identifies quality agencies. Also, the increased attention around bankruptcy reform and credit counseling has driven up the demand for traditional credit counseling.
There is enormous potential for social and economic good to come from the bankruptcy credit-counseling mandate. To file bankruptcy under the new law, a consumer must first undertake a counseling session from an approved credit counseling agency. A certificate of completion, valid for six months, is issued to the consumer upon completion of the course. A consumer who does decide to file for bankruptcy undergoes a financial education course before receiving a discharge of debt.
The DOJ believes around 10 percent of pre-bankruptcy certificates issued have not yet been used, which may indicate that some consumers who were thinking about filing for bankruptcy realize there are more options available. This is a positive sign that the credit counseling provision is working.
Also, the number of traditional credit counseling sessions this year has increased dramatically over last year. As more consumers become aware of credit counseling and options available to them, they will seek assistance to help manage their finances before they need to consider bankruptcy.
The key for success for individuals and businesses is to get to consumers as soon as possible – before they are in acute financial distress. If we just wait until consumers are completely “under water,” the counseling mandate may not live up to its full potential. To make counseling more effective, the roundtable has created a Web site (www.mymoneymanagement.net) that refers consumers to DOJ-approved agencies for credit counseling before they are considering bankruptcy. In fact, some of our member companies are now directing their customers who fall behind in payments to this Web site so those consumers can get help earlier. All of us in the responsible lending community hope this will help consumers sooner, to everyone’s benefit.
Another centerpiece of bankruptcy reform is the means test. During the last year, there have only been a modest number of legal objections to the means test. The DOJ is diligently implementing this aspect of the law.
No creditor has filed a means test objection yet, even though the new law offers that right. This is partly because higher income debtors either are not filing for bankruptcy or are self-selecting to go into Chapter 13, where consumers repay a portion of their debt, rather than having it eliminated entirely. This suggests that fears creditors would use this new right inappropriately are probably unfounded.
Another positive effect of the new law is an increase in the number of Chapter 13 cases, compared with Chapter 7 cases. This is beneficial to the economy because, to the extent that more consumers work to repay their debts in Chapter 13, the less defaulted debt the overall economy has to absorb. This is a positive trend and one of the major goals of the legislation.
Progress to Date
From the perspective of the American consumer and the U.S. economy, the new bankruptcy reform law is working quite well. Bankruptcy filings are down, more Americans than ever are getting credit counseling and, as a result, consumers are better educated about prudent financial management.
The number of bankruptcy filings has plummeted since 2004 and 2005. Some of this certainly was due to people rushing to file under the old law, but our companies and most analysts believe the drop-off in filings is also due to the means test and bankruptcy credit counseling mandate.
Consider these facts:
• Consumer bankruptcy filing rates have dropped dramatically to an annualized rate of 600,000 per year in 2006 from an average annualized rate of 1.5 million for the prior five years;
• More consumers are choosing repayment plans under Chapter 13 over Chapter 7 than under the old law. The Chapter 7 number is down to 27.5 percent from 40 percent before the new law; and
• There were 157,417 total credit counseling sessions at the Department of Justice accredited credit counseling agencies in October 2006 (73,171 for traditional counseling, 57,220 for pre-bankruptcy counseling, and 26,811 for pre-discharge education counseling), compared to an average 57,087 total counseling sessions for October 2005.
These numbers suggest the reforms are working.
The reform legislation seems to have saved the economy billions of dollars. Sen. Chuck Grassley (R-Iowa) has estimated the total cost savings to the American economy at around $60 billion. Reduced losses of this size are positive for the economy.
The roundtable looks forward to helping the new bankruptcy law be successfully implemented, achieve its goals and continue to strengthen the economy.
Steve Bartlett is president and CEO of The Financial Services Roundtable.