Open Letter to Todd Zywicki on Bankruptcy “Reform”

Todd,

Thanks for you thoughtful responses throughout all of this.

I believe the political analysis in your March 16 National Review column “Credit Worthy” ignores the obvious. When you look comprehensively at the voting record of Senators like Biden (D, MBNA-DE), Stabenow (D, GMAC-MI), and a few others on the left, and even some Senators on the right, it’s clear that in this case they voted either their campaign wallets or their party-line loyalty and not their core beliefs (presupposing they have any). Financial industry contributions to the House aren’t really relevant, because the House didn’t need to get bought; they have clearly been on board in large numbers from past votes, so why throw money at them?

Sometime a bill benefits from the bubbleheaded thinking of its opponents, and this is one of those times. Though it is relevant, you have to do more than cry “women and children” without substantiation to expect to make headway in an argument. The opposition’s abortion gambit (trying to add an amendment to keep abortion protesters who lose civil suits from filing) was a clear failure to count heads and, though it worked two years ago, really backfired this year. Its result was a misdirection that has kept religious and other grass-roots conservatives so relieved about the abortion business not being in the bill that they haven’t taken the time to understand the effects of the bill at the detail level (one exception is Christian financial planner Dave Ramsey, who ripped the bill from head to toe on CNBC and left it in little pieces on the ground about 10 days ago). If they understood its apparent full impact and lack of proportionality on the creditor side (and if they understood the system at the level Ramsey appears to from personal and professional experience), I believe there’d be thousands of Dave Ramseys denouncing this bill.

Though you claim people chronically don’t tell the truth about their assets in filing for bankruptcy, it appears to me that the asset valuation methods and the reduced scope of assets to be protected in the new law are draconian, and will encourage otherwise honest people outraged at the naked greed of their creditors and the newly-legislated rigging of the bankruptcy system to lie when they wouldn’t have otherwise. Expect the storage business to spike. It may force fully honest people to sell most of their “stuff” on Ebay or at yard sales. My understanding is that you get to “keep” one TV and one VCR (you have to list all others, regardless of age, perhaps at their original cost), and that there are other similar examples of foolish micromanagement. While it’s obviously necessary to make filers list anything readily marketable that’s worth a few thousand or more, I don’t see the public-policy benefits of forcing people to always list and therefore often sell “stuff” down to this level.

Your comparison to the IRS not taking our word for things is interesting, because tax preparation and filing is largely self-reporting, especially for the self-employed, and frequently lets taxpayers use estimates. For example, the IRS lets every taxpayer assume this year that their car costs 40.5 cents a mile to drive unless the taxpayer wants to claim more. The IRS lets people out of town on business assume that meals and entertainment are certain amounts per day without asking for proof. So to be analagous, other than craven creditor avarice, why wouldn’t the bankruptcy courts simply force people to specifically identify all individual items currently worth a few grand and leave everything else alone?

There is not a great deal of love lost between me and certain lawyers, but it seems that an unreasonable level of potential liability (Item 3 at link) is being imposed on the bankruptcy bar that almost no other lawyer has to contend with, namely that if a client “lies” or “forgets” to disclose something, the lawyer is liable, even if the lawyer was diligent, and will be hit with sanctions, civil liability, and criminal liability (this may be overwrought-I’m still investigating). I’m being told the effects of the legislation on the bankruptcy bar will be harsh, and that many will just close up, find better areas to practice in, or leave the profession. The people who get out are well-educated and will probably do fine in whatever they do, but I am concerned that the cost structure for those lawyers who remain will be much higher, both because of the level of verification that will be expected of them (often involving outside appraisals and the help of outside accountants), and because of the insurance they will have to carry for potential liability. Because these costs will of course translate into higher fees, a lot of individuals and familites who really should file for bankruptcy won’t because of the legal fees, or will delay filing and make things worse then they ultimately do. Or maybe that’s what the financial industry wants to see.

On balance, there’s a lot in the bill that looks like overreach, the kind of overreach that you see when one group has undue influence over the legislative process:

- “80-20 logic” and the need to see how procedural changes work out would have led me to set the income threshold at 150%-175% of the median, so that the $80-$100K person you were so concerned about in your March 15 NRO column would be “captured” and there would be enough experience after a year or two to do a cost-benefit analysis and identify matters needing correction before deciding whether to continue, discontinue, or extend its reach to lower incomes. But I suppose the financial industry couldn’t wait for that.

- It appears to impose enormous costs and inefficiencies on the debtor side while letting all of the benefits accrue to creditors (small on a per-person level, but big to them) but doing nothing to restrain them. It doesn’t, just as one example, seem equitable, reasonable, or even humane for all creditor penalty fees and penalty-rate charges to go into the debt pool as if they’re totally legitimate balances to be repaid (sorry, they simply aren’t). If a debtor files and goes to 13, fine, set them up to pay principal plus some reasonable accrued interest (like maybe 12%), and THEN figure out a repayment schedule. You may think creditors should be entitled to collect penalty rates and fees in bankruptcy; I think it borders on (no, it IS) cruel, and is a complete distortion of what going through a bankruptcy and emerging from it are supposed to be about. The way it is, EVERY creditor feels they must pile on the interest and the fees, because if they don’t, they won’t collect as much in 13 as their competitor who does.

- It also imposes significant costs on the bankruptcy court system and the government with no visible compensation from the creditors who are its sole beneficiaries. It could be that competitive pressures will cause them to have to pass the $3 billion extra ($10 per person) they will in theory collect on to consumers (if “reform” proves the 10% fraud estimate to be correct, which I sincerely doubt). Industry consolidation, where as one example the top 10 card issuers have about 85% of the market, makes me think that at best it will be a 50-50 split between creditors and consumers. I also feel, based on my quick look at the Congressional Budget Office cost projections, that these estimated costs are significantly understated.

- One other valid but unquantifiable point: I know from what I do for a living that people who solve their debt problens are more productive workers than when they were up to their ears in debt and didn’t know what to do. Similarly, I would expect those who get a “fresh start” by emerging from Chapter 7 are more productive people in the years after filing than those who endure years of Chapter 13 (and often fail). The obvious counterargument is that this is “funny money,” but if 100,000 “fresh-start” people making $50,000 a year (the people who will be “captured” by the bill) are even 5% more productive than the same number of people who are either trying to deal with incurable debt or struggling through Chapter 13s (the 5% is a low estimate, based on some research I have seen), they will produce $250 million more in economic value. This isn’t to say that everyone should go Chapter 7, but it’s a compelling consideration that has been totally ignored in the current debate, and perhaps partially explains why the bankruptcy explosion hasn’t brought down the economy like many people thought it would. By the time you tote everything up, the ultimate net benefits of the bill appear so small that I’m left wondering, other than to enrich a special interest, why we’re wasting our time.

I have also been told that thanks to the bill, many creditors will be begin to challenge Chapter 7 filings of those who are below median income and ask that they be made into 13s (and even though below-median filers are supposed to be automatic Chapter 7 filers) using asset-based arguments (i.e., going after the furniture, etc.). If true, this makes the claim that nothing changes for Chapter 7s below the median patently false. These are also the types of 13s most likely to fail under the inflexible formulas of the new Chapter 13 regime in the bill, and will add to the already scandalous 50%-plus failure rate we see in Chapter 13 filings.

Finally (and I’m sure you totally disagree), passing this bill is a potentially dangerous political calculation for the GOP majority (especially Senators), the minority of Democrats who supported it, and the next GOP candidate for president. This isn’t welfare reform, though I’m sure attempts at a comparison will be made. No matter what one thinks of it, taxpayers have been the direct beneficiaries of the cost savings from welfare reform. Creditors are the direct beneficiaries of bankruptcy “reform,” and maybe the taxpayers will ultimately pick up a miniscule and virtually invisible benefit. Meanwhile, the creditor side of the bankruptcy equation hasn’t been dealt with and should be dealt with simultaneously (or perhaps, given the status of the legislation barring a miracle or a presidential veto, I ought to say “should have been”). If the creditor abuse stories both in and out of bankruptcy ever percolate up to national visibility, the bill’s proponents and the next GOP candidate will rue the day it was passed.

Regards,

Tom Blumer