The Bankruptcy Bill in Action

The Washington Post ran an interesting story this morning about bankruptcy filings since the new bankruptcy rules came into effect in October of 2005. Some highlights from the article:

The law requires debtors to see credit counselors before they file for bankruptcy protection. It is a prerequisite that banks and credit card issuers hoped would steer consumers away from bankruptcy court and into plans that would allow them to repay debts over a few years.

But so far, that is not happening.

The counseling agencies say most debtors are in such deep financial trouble that they cannot qualify for a debt-management plan. “Typically, consumers are too far gone when they get to us,” said Ivan L. Hand Jr., president and chief executive of Money Management International Inc. (MMI), the nation’s largest credit-counseling organization.

…In the first 13 weeks after the new law took effect Oct. 17, only 4.5 percent of the 14,907 debtors counseled by MMI had sufficient income to be considered for a plan to pay back debts over a few years. Of those 669 debtors, only 42 have signed up so far for such a debt-management plan.

…During congressional debate, many critics of the old law suggested that bankruptcy protection was being used as a cover by spendthrifts who might be able to repay their debts with a little more discipline.

But credit counselors say that is not the type of debtor they have been seeing.

First, an imporant caveat: given the 2005 changes in the bankruptcy laws and the rush of filings just before the new law took effect (over 600,000 in October 2005 alone), it is natural that we would expect fewer bankruptcy filings in recent months. As a result, it is possible that recent filers for bankruptcy are in worse financial condition than the average filer before the changes.

Nevertheless, the data presented in the article is truly striking – though not particularly surprising. The article essentially illustrates that the people filing for bankruptcy are truly in terrible financial straits. Not exactly an earth-shattering revelation.

Yet it’s striking because the whole premise behind the change in bankruptcy rules was that many people abuse the bankruptcy system, and use bankruptcy protection to avoid repaying loans that they simply don’t want to repay, even thought they’re able to.

This premise seemed faulty from the beginning; as I’ve written about before, there were already checks in place to prevent abuse of the system, and the vast, vast majority of bankruptcy filings have always been by people in truly dire financial circumstances.

As a result, the effect of the bankruptcy law is simply to reallocate the pain of bankruptcy further away from the corporations who (often through their own faulty judgement) loaned money to people who were unable to repay, and toward the individual. As this article suggests, there is little reason to think that the bankruptcy reform will do much to reduce spurious bankruptcy filings – simply because almost all bankruptcy filings are for legitimate reasons in the first place.

And that’s exactly why the 2005 bankruptcy reform act always seemed to me to be more about rewarding financial services companies than about fixing a real policy problem.