You’re going broke

Last year, there was perhaps no piece of domestic federal legislation more celebrated by conservatives and reviled by liberals than the Bankruptcy Abuse Prevention and Consumer Protection Act. The act, conservatives claimed, would stop alleged widespread abuse of the bankruptcy laws. Liberals argued the new law would deprive consumers crushed by debt of the “fresh start” bankruptcy was originally designed to provide.

Greased by millions in political contributions from the credit card industry, the legislation slid through the Republican-controlled Congress and was signed into law by President Bush last April. It took effect on Oct. 17, sparking an unprecedented run on bankruptcy courts nationwide, including here in Chico, as debtors rushed to file before the new regulations took effect.

I am one of the record 2 million Americans who filed for bankruptcy before the October deadline. Like most of my cohorts, I put off the decision to file for as long as I could. My debt-to-income ratio was 15-to-1, and I am by no means unique. The coming change in the regulations finally pushed me over the edge. Negative reports in the media had convinced me and millions of others that, after the new law took effect, it would be almost impossible to file for bankruptcy.

As it turns out, such is not the case. In fact, as the new regulations enter their sixth month, the results have been quite the opposite. Most of the local attorneys interviewed for this story say that, with the exception of higher fees, it’s as easy to file for bankruptcy protection as it ever was. That’s a secret the banks, credit card companies, collection agencies and other members of the credit industry would like to keep debtors from finding out.

Fear of Financing
The last major change in bankruptcy law occurred in 1978, when the Bankruptcy Act of 1896 was supplanted by the Bankruptcy Reform Act. The new act permitted debtors to file a petition in federal court requesting relief from some or all of their debts. The basic idea was to provide a “fresh start” to consumers who had become so overburdened with debt that they’d actually ceased consuming in order to pay their bills, which is not good for them or the economy.

The act established Chapter 7 and Chapter 13 bankruptcy protection. Chapter 7 permits debtors to discharge most, if not all, of their debt. Chapter 13 prescribes a plan to pay back some, if not all, of the debt.

The reforms of 2005 attempt to force some debtors who formerly filed for Chapter 7 bankruptcy into Chapter 13. Critics say that’s problematic because most debtors fail to complete Chapter 13 payment plans and might be better served by filing Chapter 7.

“The basic theory behind Chapter 7 is to give the debtor a fresh start,” explains Chico bankruptcy attorney Frederick Schill. “I’m afraid that idea was minimized in the reform act. … The relief will be the same, but the process is going to be twice as expensive.”

The cost for debtors to file bankruptcy has gone up because of increased filing fees and documentation requirements. Formerly, the court presumed the information provided by debtors was true and correct, unless contested by creditors, all of whom are notified when a case is filed. Under the new law, debtors must provide attorneys with detailed financial records from the previous six months, and attorneys must verify that the data are accurate.

While most attorneys have shrugged off this requirement as a nuisance that increases the number of hours they must devote (and charge) for each case, Chico bankruptcy attorney David Howard has hired an outside investigator to verify the data provided by clients.

“What the legislation has done is put me in opposition to my client,” Howard said. “That’s really a conflict of interest.”

In the long run, Schill thinks the new requirements will not deter most debtors from filing for protection.

“The way the news media portrayed this, the basic story was that the credit card companies and banks were successful in changing the law,” Schill said. “They were successful, but the issue is ultimately relief. They raised the hassle factor, but what people don’t understand is that the hassle factor hasn’t been increased so much that they needn’t consider filing.”

Pay Up or Perish
The hassle factor for debtors today is certainly less than in the distant pass. In Roman times, the debtor and his family could be sold into slavery to pay off creditors. In cases where there was more than one creditor, the debtor’s body was severed into pieces and divided up. England chucked deadbeats into its notorious debtor prisons and executed more serious offenders well into the 18th century.

In colonial America, creditors branded the offender’s palm with a T (for thief) or placed him in stocks, with his ear nailed to the pillory. The ear was cut off upon release to mark the debtor for life. Think about that the next time you earmark a book.

Today’s bankruptcy code is fairly benign by comparison—filing Chapter 7 is a heck of lot more civilized than having your ear lopped off—yet the fear debtors felt in earlier times has seeped into our DNA. Emotionally, the common denominator linking the vast majority of people contemplating bankruptcy is sheer, unadulterated terror.

“A whole lot of people come in as a last resort, and if I could give them some other way of getting out of it, they’d run with it,” said Chico bankruptcy attorney Doug Jacobs. “Nobody wants to do it. They wait too long, and there’s too much stress. Stress is what makes people sick. I can relieve that stress.”

In my case, thanks to divorce, a failed business venture and expensive legal bills, I had amassed nearly $30,000 in credit card debt since 2001. For months I huddled in my apartment, paralyzed, eating rice and beans, refusing to turn on the heat, saving every last penny in order to make the payments, even after I lost my job last year. Fear and shame kept me from filing for Chapter 7 protection long after I should have bitten the bullet.

And I had it easy.

Go to the Federal Building in downtown Sacramento, where the U.S. Bankruptcy Court keeps records for California’s Eastern District, which includes Butte County, and you’ll find thousands of similar hard-luck stories. Bankruptcy filings are public record, and any citizen may peruse the files free of charge on three computers provided for that purpose. Each file depicts a unique financial disaster, naked and exposed to the public eye, the modern-day equivalent of the pillory.

Filings since the Oct. 17 deadline include: A Chico family of four with a combined monthly income of $2,400, monthly expenses totaling $2,700, and $43,000 in medical bills; a disabled man and his caretaker wife with $27,000 in credit card debt; a divorced woman stuck with the bill for her ex-husband’s repossessed four-wheeler.

“More than half of everything I see is medical debt,” say Michael Hays, who handles more bankruptcy cases in Butte County than any other attorney. He blames aggressive marketing tactics by the credit card industry for most of the other half. “The marketing of debt is what gets these people in trouble, that and medical bills.”

The vast majority of Chapter 7 bankruptcies are written from the same heartbreaking script, with the primary antagonist being illness, divorce or job loss—and sometimes all three at the same time.

Hays client Lacy Meadows, who filed for bankruptcy before the Oct. 17 deadline, is a case in point. Meadows, 28, was married to a Mexican national for 11 years until separating three years ago after her husband was convicted of a felony and deported, leaving Meadows with the bills and their 9-year-old daughter.

“He didn’t want to pay for anything,” she said. “He wanted to spend it, but not pay it back.”

Since she had co-signed for her husband’s brand new truck, she got stuck with the tab. She began using credit cards to “pay the rent, take care of my daughter and buy food.” Meadows also has type 1 diabetes, and, lacking medical insurance, she was forced to pay for expensive insulin and syringes out of pocket. In the three years since she and her husband separated, she’s accumulated more than $24,000 in debt.

Almost every case is a similar financial horror story, but the notion persists that those who file for bankruptcy are losers out to shirk their obligations and cheat the system. That stigma is encoded in the new legislation’s title, the Bankruptcy Abuse Prevention and Consumer Protection Act.

How prevalent is such alleged abuse?

“Across the board, almost without exception, my clients come in as a last resort,” said Jacobs. “I don’t see clients doing this as a matter of habit every six years. I know they’re out there, but the vast majority are legitimate.”

Jacob’s observations have been confirmed by the U.S. Public Interest Research Group, the national government watchdog organization that protects the rights of consumers. Before the new law went into effect, PIRG reported that, “Independent studies, such as those of Harvard Law School professor Elizabeth Warren, show that 90 percent or more of bankruptcies are still filed by people who get sick, get laid off, or get divorced, not by abusers. The industry can only document that 3 percent of filers may be abusers, yet the bill would harm all debtors.”

In short, most people file for bankruptcy because of circumstances outside of their own control. That didn’t stop George W. Bush, after signing the new law, from proclaiming that, “America is a nation of personal responsibility, where people are expected to meet their obligations. If someone does not pay his or her debts, the rest of society ends up paying them.”

Such sentiments are widespread. While researching this story, I got into a heated discussion on the subject with a friend who has opposed every decision Bush has made—except the new bankruptcy law. He believes people should be responsible for paying their debts. “What if something happens and they can’t pay?” I implored. “What about people like me?” was the unasked question. His laser beam eyes scorched a “T” into my forehead. People should pay their debts. Period.

Bankruptcy or Bust?
For those convinced that government has grown fundamentally dysfunctional, the first effect of the new legislation designed to reduce the number of bankruptcies was predictable: The number of bankruptcies increased at an astonishing rate. Lundquist Consulting reports that an all-time high of 2 million personal bankruptcies were filed across the country in 2005, a 32 percent increase over the year before. Debtors stampeded the Eastern District Court, filing 60 percent more cases than the previous year. According to court records, Chapter 7 and 13 filings rose from 13,000 in 2004 to 21,000 in 2005.

“Two to three weeks prior to October 17, we received about 40 percent of our annual caseload,” said Eastern District Judge Mike McManus. “My calendar has been a little busier in the last few months.” Usually, he deals with 60 or 70 motions per week. It’s been more like 100 lately.

“I filed 25 to 30 cases on the Friday before the reform took effect,” said attorney Schill. “I file four or five cases per month on average.”

You can thank the credit card industry for the frenzy. With earnings of more than $30 billion annually, it’s the most profitable business in the United States—despite the money it loses to debtors who file for bankruptcy. Charging interest rates as high as 30 percent and late fees as much as $39 a month, the industry literally rakes in cash.

Apparently, it’s not raking in enough. Since 1990, the industry has spent more than $150 million lobbying elected officials to change the bankruptcy laws, doling out roughly twice as much money to Republicans as Democrats, according to the Center for Responsive Politics. According to PIRG, Bank of America-owned MBNA, the nation’s largest credit card company, was also President Bush’s largest corporate campaign donor in 2000.

“If they were losing money, they wouldn’t be that fastest-growing sector of the financial-services industry,” Howard said.

Laura Fisher, spokeswoman for the American Bankers Association, the country’s largest banking trade association, refutes the notion that the credit industry bought and paid for the new legislation. “The financial-services industry in general has many issues before Congress,” Fisher said. “You can’t say that they contributed this money just to pass the bankruptcy bill.”

Of course, that is exactly what most critics of the legislation are saying, because the new law almost exclusively targets poor and middle-class consumers. Congress barely touched Chapter 11 bankruptcy, the protection that large corporations normally file for. But amendments designed to protect the most vulnerable debtors and regulate predatory lending practices were gutted. Debtors, obviously not the best at keeping records, are now required to provide financial records including pay stubs, tax returns and utility bills for the six months prior to filing.

“It makes it more expensive to file, there’s more hoops to jump through, more problems to comply with,” Jacobs said. Attorney Hays has raised his fee by only $100, but the fees of other local attorneys have nearly doubled in some cases—the cost of increased paperwork.

Increased court filing fees also add to the expense. The fee for filing Chapter 7, for example, increased from $209 to $254 last October. To add insult to injury, the Republican-dominated Congress buried fee increases for Chapters 7, 11 and 13 bankruptcies in its most recent federal budget. If passed, the fee for Chapter 7 will be nearly $300, an increase that will help raise an additional $553 million to cover Bush’s tax cuts.

The new requirement that debtors attend credit counseling before and after filing for bankruptcy adds yet another expense. A score of nonprofit national agencies have been approved by the U.S. Bankruptcy Court to provide such counseling services to debtors, for approximately $100 per session.

The purpose of the first session is to steer debtors out of bankruptcy and into repayment plans, a design that doesn’t appear to be paying off. According to a recent story in the Washington Post, “the overwhelming majority of debtors seen by credit counseling agencies are filing for bankruptcy instead of using repayment plans envisioned by the law’s supporters.”

Out of 14,907 people seen at one agency, only 42 signed up for a debt-management plan—or 0.3 percent. “Typically, consumers are too far gone when they get to us,” the head of the counseling service told the Post.

The most criticized feature of the new law in media reports, the “means test,” will have little effect on debtors in Butte County, according to all of the attorneys interviewed for this story. The means test is based on the median income of the state the debtor resides in. If debtors make more than the median, they are then subjected to a second set of criteria, and they are forced into a Chapter 13 repayment plan if they fail the second part of the test. However, in California the median income levels are fairly generous: $43,436 for an individual; $55,320 for a two-person household; $61,655 for a family of three.

“Of the 30 clients I’ve talked to since the new law took effect, only one has had to go to the second part of the means test,” Jacobs said.

“Quite honestly, here in Butte County, we haven’t had much problem with the means test,” Howard concurred. “The people who make more than that rarely file for bankruptcy.”

“It’s not like I’m practicing in Marin County,” Hays chuckled. “This is Butte County, an $8-an-hour county.”

If debtors fail the test and are forced to file Chapter 13, there’s still no guarantee that creditors will be paid back. The majority of Chapter 13 cases, approximately 75 percent, end in failure. Most people in dire financial straits find it too difficult to make payments for the entire three-to-five-year period. Once again, legislation designed to reduce so-called bankruptcy abuse ends with consumers unable to pay their debts. Some attorneys question whether the credit card industry got its money’s worth for the millions it contributed to Republican and Democratic politicians.

“At the end of the day, the basic bankruptcy relief that was there before the reform is there post-reform,” Schill said. “I think the credit industry is going to be very surprised. They’re not going to get what they thought they were going to get. The only benefit they have going for them is that people think they can’t file.”

Till Debt Do Us Part
The new law isn’t all peaches. Under the old law, I filed my own case without an attorney—or pro se, to use legal jargon—with little difficulty. Once the case was filed, I was granted an automatic stay, which prevented creditors from attempting to collect debts for the duration of the case. Now, if a debtor makes a mistake—such as failing to complete credit counseling before filing—the case is automatically dismissed.

When the mistake is corrected and the case refiled, the stay is limited to just 30 days, after which a creditor could, say, foreclose on a debtor’s home. Given the complexity of the new code and the potential for error, hiring an attorney, or at the very least an experienced paralegal, is highly recommended to successfully negotiate the process.

“I did divorces for 19 years, and you don’t make too many people happy in that process; you only add to their trouble,” Hays said. “In bankruptcy, you’re kind of like Moses parting the Red Sea. You’re their savior.”

There’s been a lull in bankruptcy filings in the wake of the October crunch, but the new law may soon be put to the test. Americans currently share a combined $2 trillion in consumer debt, and credit card users have just been hit with a double whammy: a new federal regulation requiring creditors to double their minimum payments has gone into effect just as the Christmas bills are coming in. The latest debt instrument of choice, home refinancing, accounted for an additional $400 billion in 2004 alone, and now foreclosures are on the rise. The federal government has its own $8 trillion debt to deal with. Interest rates are going up, the trade deficit is growing, the dollar’s value is shaky. A perfect storm is brewing. Things could get ugly quick.

Hays’ client Lacy Meadows got in before the storm hit. She was officially relieved of her $24,000 debt on Feb. 26. She feels relieved and suffers no pangs of guilt over filing for bankruptcy.

“I do know that I tried to pay my bills by myself,” she said. “That’s all I could do, was try.”

I know the feeling well. After two years of struggling to pay the bills, I found myself gathered with a dozen others in court last September. With icy stares, the trustees froze those who came before me, debating the lawyers, disputing their clients’ listed assets. As I stepped up to the bench, I expected the worst. It was over in less than 30 seconds.

“Everything appears to be in order,” one of the trustees said. That was it. I walked out of the building, jumped into the air and clicked my heels together. The official notice that my $30,000 debt had been wiped clean arrived in the mail on Christmas Eve. It’s the best present I’ve ever received.