Running Scared: Debtors Rush to File for Bankruptcy

Thousands of debtors are filing for bankruptcy in hopes of outrunning new laws that are scheduled to come into effect on October 17, 2005.

Bankruptcy reforms will make it harder for debtors to file under Chapter 7 of the bankruptcy code, a law that allows people to erase credit-card bills and some other non-mortgage loans after liquidating some assets.

Many debtors will instead have to file under Chapter 13, which allows the court to require a partial repayment of debts, depending on the debtor’s income and ability to pay.

Details

The revised law will require those who earn more than the median income in their state to repay a portion of their debts and enroll in a court-supervised financial counseling program. But many debtors who are hurriedly filing to avoid the rule change will not be affected by it. Low-income filers may still qualify for Chapter 7 bankruptcy.

After the rule change, the pace of bankruptcy filings is expected to slow, but overall, bankruptcy is on the rise. Since 1978, bankruptcies have increased eightfold, from 200,000 that year to 1.6 million last year. The projected number of bankruptcies for 2005 is 1.8 million.

Economists explain that bankruptcy is becoming more probable for more households as the average family’s debt increases and savings declines. Families with children are three times more likely to go into bankruptcy than couples without kids and single people.

Do we need bankruptcy reform?

During the debate in Congress, legislators on both sides of the aisle agreed that some bankruptcy reforms were needed. The current bankruptcy system is sometimes abused by individuals and corporations alike, and in the wake of the Enron and WorldCom scandals, lawmakers were eager to improve the system.

Of course, credit-card companies and banks, which suffer financial consequences because of the current system, lobbied heavily for bankruptcy overhaul. But consumer advocates and Democrats argued that the bill would remove a safety net for those people who can’t pay medical bills or who have lost their jobs.

Democrats’ point of view

While debating the bill, Democrats placed the bankruptcy issue inside their larger policy debate about fairness and opportunity. They cited the troubled health care system as the primary problem– unpaid medical bills are the number one cause of bankruptcy.

The minority party was also concerned about those who suffered job loss in the post 9 -11 recession as well as the women and men serving in Iraq and Afghanistan. In particular, Democrats wanted to protect military reservists teetering on the edge of financial ruin because they left high-paying jobs to serve overseas.

Unintended consequences

Legislation often has unintended consequences, and some experts say that the new bankruptcy laws may discourage entrepreneurship.

Many personal bankruptcy filings are the result of individuals who’ve tried to start a new business by maxing out personal credit cards or taking out mortgages or equity on their homes. While this may not seem like the soundest of business plans, current bankruptcy law was actually written with the intent of encouraging entrepreneurs to take chances.

Some analysts say that American business owners, both successful and unsuccessful, take greater risks than their foreign counterparts because of more lenient bankruptcy laws. This is one of the reasons for the United States’ vibrant entrepreneurial culture. And some European nations, including Great Britain and the Netherlands have modeled their own laws after ours in order to encourage entrepreneurship.

Will the new bankruptcy laws erect an unintended barrier for business owners? Women are starting up the majority of new businesses; will bankruptcy reforms impede their progress?

Other questions

The regular mention of expensive medical bills within the bankruptcy debate brings up other worthwhile questions. Is it in fact the health care system and not the bankruptcy system that needs reform? Will this bankruptcy reform bill unfairly target the 45 million Americans who don’t have health insurance?

What do you think?

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Article Posted on: 8/27/2005