[Joint House and Senate Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
BANKRUPTCY REFORM
=======================================================================
JOINT HEARING
BEFORE THE
SUBCOMMITTEE ON
COMMERCIAL AND ADMINISTRATIVE LAW
OF THE
HOUSE COMMITTEE ON THE JUDICIARY
AND THE
SUBCOMMITTEE ON
ADMINISTRATIVE OVERSIGHT AND THE COURTS
OF THE
SENATE COMMITTEE ON THE JUDICIARY
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
MARCH 11, 1999
__________
Serial No. 2
Printed for the use of the Committees on the Judiciary
_______
U.S. GOVERNMENT PRINTING OFFICE
61-368 CC WASHINGTON : 2000
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
COMMITTEE ON THE JUDICIARY
HENRY J. HYDE, Illinois, Chairman
F. JAMES SENSENBRENNER, Jr., JOHN CONYERS, Jr., Michigan
Wisconsin BARNEY FRANK, Massachusetts
BILL McCOLLUM, Florida HOWARD L. BERMAN, California
GEORGE W. GEKAS, Pennsylvania RICK BOUCHER, Virginia
HOWARD COBLE, North Carolina JERROLD NADLER, New York
LAMAR S. SMITH, Texas ROBERT C. SCOTT, Virginia
ELTON GALLEGLY, California MELVIN L. WATT, North Carolina
CHARLES T. CANADY, Florida ZOE LOFGREN, California
BOB GOODLATTE, Virginia SHEILA JACKSON LEE, Texas
ED BRYANT, Tennessee MAXINE WATERS, California
STEVE CHABOT, Ohio MARTIN T. MEEHAN, Massachusetts
BOB BARR, Georgia WILLIAM D. DELAHUNT, Massachusetts
WILLIAM L. JENKINS, Tennessee ROBERT WEXLER, Florida
ASA HUTCHINSON, Arkansas STEVEN R. ROTHMAN, New Jersey
EDWARD A. PEASE, Indiana TAMMY BALDWIN, Wisconsin
CHRIS CANNON, Utah ANTHONY D. WEINER, New York
JAMES E. ROGAN, California
LINDSEY O. GRAHAM, South Carolina
MARY BONO, California
SPENCER BACHUS, Alabama
Thomas E. Mooney, Sr., General Counsel-Chief of Staff
Julian Epstein, Minority Chief Counsel and Staff Director
------
Subcommittee on Commercial and Administrative Law
GEORGE W. GEKAS, Pennsylvania, Chairman
ED BRYANT, Tennessee JERROLD NADLER, New York
LINDSEY O. GRAHAM, South Carolina TAMMY BALDWIN, Wisconsin
STEVE CHABOT, Ohio MELVIN L. WATT, North Carolina
SPENCER BACHUS, Alabama ANTHONY D. WEINER, New York
MARY BONO, California WILLIAM D. DELAHUNT, Massachusetts
Raymond V. Smietanka, Chief Counsel
Susan Jensen-Conklin, Counsel
James W. Harper, Counsel
SENATE COMMITTEE ON THE JUDICIARY
ORRIN G. HATCH, Utah, Chairman
STROM THURMOND, South Carolina PATRICK J. LEAHY, Vermont
CHARLES E. GRASSLEY, Iowa EDWARD M. KENNEDY, Massachusetts
ARLEN SPECTER, Pennsylvania JOSEPH R. BIDEN, Delaware
JON KYL, Arizona HERB KOHL, Wisconsin
MIKE DEWINE, Ohio DIANNE FEINSTEIN, California
JOHN ASHCROFT, Missouri RUSSELL D. FEINGOLD, Wisconsin
SPENCER ABRAHAM, Michigan ROBERT G. TORRICELLI, New Jersey
JEFF SESSIONS, Alabama CHARLES E. SCHUMER, New York
BOB SMITH, New Hampshire
Manus Cooney, Chief Counsel & Staff Director
Bruce Cohen, Minority Chief Counsel & Staff Director
------
SUBCOMMITTEE ON ADMINISTRATIVE OVERSIGHT AND THE COURTS
CHARLES E. GRASSLEY, Iowa, Chairman
JEFF SESSIONS, Alabama ROBERT G. TORRICELLI, New Jersey
STROM THURMOND, South Carolina RUSSELL D. FEINGOLD, Wisconsin
SPENCER ABRAHAM, Michigan CHARLES E. SCHUMER, New York
Kolan Davis, Chief Counsel
John McMickle, Counsel
Rita Lari, Counsel
C O N T E N T S
----------
HEARING DATE
Page
March 11, 1999................................................... 1
OPENING STATEMENT
Gekas, Hon. George W., a Representative in Congress from the
State of Pennsylvania, and chairman, Subcommittee on Commercial
and Administrative Law......................................... 1
WITNESSES
Hammonds, Bruce L., Senior Vice Chairman and CEO, MBNA America
Bank, N.A., Wilmington, DE..................................... 29
Jones, Edith Hollan, Judge, U.S. Court of Appeals for the Fifth
Circuit, and Member of the National Bankruptcy Review
Commission, Houston, TX........................................ 86
Kenner, Carol J., U.S. Bankruptcy Judge, District of
Massachusetts, Boston, MA...................................... 33
Klein, Gary, Esquire, Senior Attorney, National Consumer Law
Center, Boston, MA............................................. 67
Miller, Judith Greenstone, representing the Commercial Law League
of America, Birmingham, MI..................................... 91
Nuss, Larry, CEO, Cedar Falls Community Credit Union, Cedar
Falls, IA, representing the Credit Union National Association,
Inc............................................................ 37
Sheaffer, Dean, Vice President and Director of Credit, Boscov's
Department Store, Inc., Laurel Dale, PA, representing the
National Retail Federation..................................... 24
Warren, Elizabeth, Leo Gottlieb Professor of Law, Harvard Law
School, Boston, MA............................................. 103
Zywicki, Todd, Professor, George Mason University School of Law,
Arlington, VA.................................................. 97
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Boucher, Hon. Rick, a Representative in Congress from the State
of Virginia: Prepared statement................................ 22
Chabot, Hon. Steve, a Representative in Congress from the State
of Ohio: Prepared statement.................................... 19
CUNA Publication: Issue of savingteen magazine................... 39
Dodd, Hon. Christopher J., a U.S. Senator from the State of
Connecticut: Prepared statement................................ 6
Gekas, Hon. George W., a Representative in Congress from the
State of Pennsylvania, and chairman, Subcommittee on Commercial
and Administrative Law: Prepared statement..................... 2
Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa:
Prepared statement: Prepared statement......................... 4
Hammonds, Bruce L., Senior Vice Chairman and CEO, MBNA America
Bank, N.A., Wilmington, DE: Prepared statement................. 31
Jones, Edith Hollan, Judge, U.S. Court of Appeals for the Fifth
Circuit, and Member of the National Bankruptcy Review
Commission, Houston, TX: Prepared statement.................... 88
Kenner, Carol J., U.S. Bankruptcy Judge, District of
Massachusetts, Boston, MA: Prepared statement.................. 35
Klein, Gary, Esquire, Senior Attorney, National Consumer Law
Center, Boston, MA: Prepared statement......................... 70
Kohl, Hon. Herb, a U.S. Senator from the State of Wisconsin:
Prepared statement............................................. 8
McCollum, Hon. Bill, a Representative in Congress from the State
of Florida: Prepared statement................................. 21
Miller, Judith Greenstone, representing the Commercial Law League
of America, Birmingham, MI: Prepared statement................. 93
Nadler, Hon. Jerrold, a Representative in Congress from the State
of New York: Prepared statement................................ 16
Nuss, Larry, CEO, Cedar Falls Community Credit Union, Cedar
Falls, IA, representing the Credit Union National Association,
Inc.: Prepared statement....................................... 64
Sessions, Hon. Pete, a Representative in Congress from the State
of Texas: Prepared statement................................... 10
Sheaffer, Dean, Vice President and Director of Credit, Boscov's
Department Store, Inc., Laurel Dale, PA, representing the
National Retail Federation: Prepared statement................. 26
Warren, Elizabeth, Leo Gottlieb Professor of Law, Harvard Law
School, Boston, MA: Prepared statement......................... 106
Zywicki, Todd, Professor, George Mason University School of Law,
Arlington, VA: Prepared statement.............................. 99
APPENDIX
Material submitted for the record................................ 119
BANKRUPTCY REFORM
----------
THURSDAY, MARCH 11, 1999
House of Representatives,
Subcommittee on Commercial
and Administrative Law,
Committee on the Judiciary,
Washington, DC.
The subcommittee met, pursuant to notice, at 2 p.m., in
Room 2141, Rayburn House Office Building., Hon. George W. Gekas
[chairman of the subcommittee] presiding.
Present: Representatives George W. Gekas, Ed Bryant, Steve
Chabot, Asa Hutchinson, Jerrold Nadler, Tammy Baldwin, Anthony
D. Weiner, and William D. Delahunt, and Senators Charles E.
Grassley and Christopher J. Dodd.
Also present: Congressman Nick Smith of Michigan and
Senator Joseph Biden, Jr.
Staff present: Raymond V. Smietanka, Subcommittee Chief
Counsel; Peter Levinson, Full Committee Counsel; Susan Jensen-
Conklin, Subcommittee Counsel; Audray Clement, Subcommittee
Staff Assistant; David Lachmann, Minority Professional Staff
Member; Perry Apelbaum, Minority General Counsel, and Julian
Epstein, Minority Chief Counsel and Staff Director.
OPENING STATEMENT OF CHAIRMAN GEKAS
Mr. Gekas. [presiding.] The hour of two o'clock having
arrived, this extraordinary session of the Judiciary
Subcommittee on Commercial and Administrative Law will come to
order.
It is extraordinary in several different aspects, not the
least of which is that it is and will become a bicameral joint
session for the first time in several generations, as we have
been told.
Thus, we make our imprint on history right at the outset.
The plans for the day are going to be altered somewhat, through
no fault of our own, in that the Senate of the United States is
engaged in a series of votes, which are stacked, one after
another. And our Senators, who will be participating in this
hearing, are sharing the time between this chamber and that of
their own. And so we will expect them to walk in and out
throughout the whole entire process.
But in the meantime, we are going to, even though we lack a
quorum for the purposes of a hearing on the House side, we are
going to entertain now an opening statement by Senator
Grassley, who is not bound by the House rules. And he reminds
me of that quite often. So we now welcome to our chamber and
introduce to you, Senator Grassley, who has been a monumental
leader in the world of bankruptcy and, particularly, in his
efforts in the last Congress and the ones that have so famously
begun now in this session of Congress. He is, whether he knows
it or not, whether he will acknowledge it or not, an expert in
this field. And he has proved, especially during the conference
wrangling of last year, his ability to put various elements
together and to allow us to emerge with a saleable product,
which was the conference report of the last session.
With that, I allow or I switch the microphone to Senator
Grassley so that he may address our gathering.
[The prepared statement of Mr. Gekas follows:]
Prepared Statement of Hon. George W. Gekas, a Representative in
Congress from the State of Pennsylvania, and chairman, Subcommittee on
Commercial and Administrative Law
A hearty welcome to Chairman Grassley and our colleagues from the
other body. Chairman Grassley is to be commended for his tireless
leadership and hard work on behalf of bankruptcy reform.
Today is truly a most auspicious occasion for several reasons.
First, it marks what may very well be a historical occasion--a
bicameral hearing on bankruptcy reform. Second, it brings to full
circle the bicameral efforts that culminated in the last session in the
conference report on H.R. 3150, the Bankruptcy Reform Act of 1998. In
fact, the bill that I introduced last month is identical to the
conference report.
Third, this hearing marks more than four years of careful analysis
and review of our nation's current bankruptcy system--a review that
began with the creation of the National Bankruptcy Review Commission
back in 1994. The Commission then spent two years studying our
bankruptcy laws and produced a report with numerous recommendations,
many of which are memorialized in my bill.
Today's hearing on bankruptcy reform is the first of a series of
four that my Subcommittee will hold on the subject of bankruptcy
reform. Over the course of these hearings, it is anticipated that we
will hear from more than 50 witnesses, representing nearly every major
viewpoint on bankruptcy reform. These hearings complement the extensive
series of hearings that the Subcommittee held last year, during which
more than 60 witnesses testified.
Like last year, it is important to note that I have made every
effort to ensure that these hearings are fulsome and inclusive of
divergent views. To that end, I actively solicited recommendations from
our minority colleagues with respect to witnesses who represent a broad
cross-section of viewpoints. In fact, there are several witnesses that
I have invited who ardently oppose my views of bankruptcy reform.
To further ensure bipartisan involvement, we have invited our
colleagues and their staffs to several press conferences and briefings
on important issues dealing with the treatment of child support and
needs-based bankruptcy relief.
And these efforts will continue. We hope, in the near future, to
hold a comprehensive bipartisan briefing on my bill, H.R. 833, and the
bill that Mr. Nadler is reportedly preparing to introduce shortly. The
purpose of this briefing will be to assist Members and their staff in
their understanding of both bills as we undertake their consideration.
In the midst of economic well-being, we continue to be shocked by
the ever-escalating rate of bankruptcy filings, which last year topped
1.4 million. These statistics evidence that there is an overwhelming
need for comprehensive reform, not just some tinkering or minor
refinement of the current system.
Our mandate is clear and unequivocal: to reduce abuse and restore
public confidence in the integrity of the bankruptcy system. It is my
sincere hope that we can work cooperatively to achieve these goals.
Mr. Grassley. Well, most importantly, not only to
acknowledge your leadership for this meeting and to echo what
you said about me, but to say the same thing about you in the
last Congress. Because of your leadership, moving such a
comprehensive bill through the House of Representatives by such
a wide bipartisan margin made possible our moving a bill
through the Senate.
I thank you very much for your leadership, and, once again,
acknowledge a close working relationship, not only during the
last Congress, but particularly as the last Congress ended and
extending into this Congress. I thank you very much for the
sort of communication we have had that have been able to move a
bill in a more parallel fashion this time as opposed to last
time. Although in the final analysis, things worked out fairly
well as far as our compromise was concerned, but we started out
at very different points.
So I acknowledge that, and thank you once again. And I look
forward to that close working relationship hopefully over just
the next few months as opposed to the next several months to
get something to the President of the United States. And I
would apologize for not only myself by my colleagues that we do
have these nine votes coming up, and it will probably preempt
almost any involvement in this hearing beyond my statement.
I would say to you that if we do get done soon, and you are
still going, I intend to come back after the Senate's complete.
So thank you for that. And I know that we have an Iowan
testifying today, so it is my privilege also to welcome Mr.
Larry Nuss from Cedar Falls--head of a credit union that I used
to belong to when I was a factory worker in Cedar Falls, Iowa.
And I am glad that he is coming to give some Iowa common-sense
approach to the bankruptcy issue.
The Library of Congress tells me that this is the first
joint hearing on bankruptcy reform since 1932. With today's
scheduling problems, I think that I understand why because this
is an historic moment, and we should all recognize it as such.
I think that the need for real bankruptcy reform is pretty
obvious. You don't need an army of scientists or law professors
or anybody else from academia or outside to tell us that we
have a serious bankruptcy problem. These are good times in
America. Thanks to hard work of our Congress, we have the first
balanced budget in a generation, and that came since
Republicans took over the Congress. As a result, unemployment
is low. We have a solid stock market. And most Americans are
optimistic about the future.
Despite the successes I just cited, we still need to shape
up our economy. Our taxes are too high. Our bankruptcy system
needs to be fixed. About one and one-half million Americans
will declare bankruptcy this year if previous trends continue.
Since 1990, the rate of personal bankruptcy filings are up
an amazing 94.7 percent. That's almost 100 percent increase in
bankruptcies--and all during a time of very high prosperity.
Of course, bankruptcy and taxes are linked, since consumers
who pay their own way are penalized by having to pick the tab
for irresponsible bankrupts who walk away from debt.
Over 30 years ago, Senator Albert Gore, Senior, described
this connection between tax burdens and bankruptcies on the
Senate floor. He said that chapter 7 is like a special interest
tax loophole. Like tax loopholes, chapter 7 allows someone to
get out of paying his fair share and to shift costs to the hard
working Americans who play by these rules.
I think that Senator Gore had it exactly right. Bankruptcy
reform is all about closing loopholes so well-to-do scoundrels
can't get out of paying their fair share.
In the last Congress, we almost closed the chapter 7
loophole. The Senate and the House both passed good bills, and
we made them both better in conference that received
overwhelming bipartisan support.
In the conference report, we have a means testing with an
overlay of judicial discretion. We have new consumer
protections, and I think that is why the conference report
received such overwhelming support in the House of
Representatives last Congress.
In my view, last year's conference report is a good
starting point. With some modifications, I think it is a
package that will continue to have broad bipartisan support. I
have been working with Senator Torricelli, my ranking member,
and his staff on this basis, and I think that things are going
well.
I want to close with a quote on the need of bankruptcy
reform. ``I realize that we cannot legislate morals. But we, as
responsible legislators, must bear the responsibility of
writing laws which discourage immorality and encourage
morality; which honesty and discourage deadbeating; which make
the path of social malingering and shirker sufficiently
unpleasant to persuade him''--and a I can say parenthetically
or her--``at least to investigate the ways of an honest
person.''
Now, who do you think said that? Some cold-hearted
conservative? Some Republican spindoctor? No, that was Senator
Albert Gore, Senior, the Vice President's father. He said that
on January the 19th, as we was introducing at that time a bill
that was called S. 613, to impose a means test on chapter 7
bankrupts. My point is that the need to tighten up bankruptcy
laws in a meaningful way has deep roots on both sides of the
aisle. And it is based on common sense.
Last year, we came very close. This year, I hope that we
can work together on the people's business and get meaningful
bankruptcy reform finally done and to the President for his
signature. Thank you very much.
[The prepared statement of Senator Grassley follows:]
Prepared Statement of Hon. Charles E. Grassley, a U.S. Senator from the
State of Iowa
At the outset, Mr. Gekas, I want to apologize for the votes in the
Senate which have prevented me from being here or being more involved
in this hearing. I know we have an Iowan testifying today. I'm certain
that Mr. Larry Nuss from Cedar Falls, Iowa will grace this joint
hearing with some good Iowa common-sense.
The Library of Congress tells me that this is the first joint
hearing on bankruptcy reform since 1932. With today's scheduling
problems, I think I understand why. But this is an historical moment
and we should all recognize it as such.
I think that the need for real bankruptcy reform is pretty obvious.
You don't need an army of so-called scientists, law professors and
pointy-heads to tell us that we have a serious bankruptcy problem.
These are good times in America. Thanks to the hard work of a
Republican Congress, we have the first balanced budget in a generation.
Unemployment is low, we have a solid stock market and most Americans
are optimistic about the future.
Despite the successes I just cited, we still need to shape up our
economy. Our taxes are too high and our bankruptcy system needs to be
fixed. About one and a half million Americans will declare bankruptcy
this year if previous trends continue. Since 1990 the rate of personal
bankruptcy filings are up an amazing 94.7 percent. That's almost a 100%
increase in bankruptcies during a time of prosperity.
Of course, bankruptcy and taxes are linked since consumers who pay
their own way are penalized by having to pick up the tab for
irresponsible bankrupts who walk away from their debts. Over 30 years
ago, Senator Albert Gore, Sr. described this connection between tax
burdens and bankruptcy on the Senate floor. He said that chapter 7 is
like a special interest tax loophole. Like tax loopholes, chapter 7
allows someone to get out of paying his fair share and shift costs to
hardworking Americans who play by the rules.
I think that Senator Gore had it exactly right. Bankruptcy reform
is all about closing loopholes so well-to-do scoundrels can get out of
paying their fair share.
In the last Congress we almost closed the chapter 7 loophole. The
Senate and House both passed good bills, and we made them both better
in a conference that received overwhelming bi-partisan support. In the
conference report, we have means-testing with an overlay of judicial
discretion. We have new consumer protections. And I think that's why
the conference report received such overwhelming support in the House
of Representatives last Congress.
In my view, last year's conference report is a good starting point.
With some modifications, I think it's a package that will continue to
have broad bi-partisan support. I have been working with Senator
Torricelli, my new Ranking Member, and his staff on this basis and I
think that things are going well.
I'll close with this quote on the need for bankruptcy reform:
``I realize that we cannot legislate morals, but we, as
responsible legislators, must bear the responsibility of
writing laws which discourage immorality and encourage
morality; which encourage honesty and discourage deadbeating;
which make the path of the social malingerer and shirker
sufficiently unpleasant to persuade him at least to investigate
the way of the honest man.''
Now, who do you think said this? Some cold-hearted conservative?
Some Republican spin doctor?
No, Senator Albert Gore, Sr.--the Vice-President's father--said
this on January 19, 1965 as he was introducing S. 613 to impose a
means-test on chapter 7 bankrupts. My point is that the need to tighten
up bankruptcy laws in a meaningful way has deep roots on both sides of
the aisle and is based on common sense. Last year we came very close.
This year, I hope that we can work together on the people's business
and get meaningful bankruptcy reform done.
Mr. Gekas. We thank the Senator for that statement, and, of
course, he has the run of the mill here. He may leave at any
time to answer the call of the Senate. In the meantime, we
acknowledge the presence of the gentleman from Arkansas, Mr.
Hutchinson, and the gentleman from Tennessee, Mr. Bryant, their
presence accounting for a hearing quorum for the House of
Representatives, thus permitting us to proceed with this
hearing.
We also want to acknowledge the visitation by Congressman
Smith of Michigan who was the author of and for the impetus
providing a short-term extension of chapter 12 until we can
deal with it in the comprehensive way we plan to do as part of
this bankruptcy reform effort. We can report to him that the
Senate seems poised to act on the bill at a propitious stage in
their proceedings.
We acknowledge the presence of Senator Dodd. Does the
Senator wish to make a 2-minute statement?
We recognize the Senator.
Mr. Dodd. I am going to ask unanimous consent, Mr.
Chairman, that these remarks be included in the record.
Let me thank you for doing this. I think it is a wonderful
idea to have a joint hearing and to invite those of us who were
involved in last year's bankruptcy reform effort. I am not a
member of the Senate Judiciary Committee. I did, however, sit
in this very committee room as a freshman member of the House a
number of years ago. As you know, several of us here today were
very involved in last year's bankruptcy reform and were
responsible for a number of provisions in the Senate adopted
legislation, which, as you know, passed 97 to 1, and represents
a strong bipartisan commitment to bankruptcy reform.
Clearly, we need to reform the bankruptcy laws. You've been
over the statistics, the 400 percent increase in the number of
bankruptcies since 1980. The social stigma of going bankrupt
appears to be gone--and this is obviously a serious problem.
My statement today, Mr. Chairman, is really an effort to
highlight the provisions that the Senate included in its
bipartisan bill, a bill that passed the Senate by such an
overwhelming majority. I urge you in the House bill--we do not
have a Senate bill yet--to include some of these provisions.
For instance, we requested that the credit card companies
give a real life example to consumers in their credit card
statement. If Senator Dodd or Chairman Gekas have a $3,000
credit card obligation, how long will it take us to pay it off
if we pay just the minimum payment on this obligation. We
wanted to give consumers a sense of what their obligations are
going to be so they act more responsibly when they go into
financial arrangements.
Your bill has a hypothetical disclosure using a $500
example. We think it is more instructive for consumers to know
exactly what their own obligations are going to be.
We also want to raise our concerns during today's hearing
about child support and alimony. Since the turn of the century,
we have always prioritized certain creditors and spouses and
children have been at the top of the list. We now have $43
billion in child support arrears and $16 billion in current
child support due in this country. We do not want to make it
more difficult for child support payments to be made. We think
that these creditors still need to be protected and the Senate-
passed bill had some good, strong, bipartisan language that did
just that. We appreciate how helpful Senator Grassley was in
helping us to place this language in last year's bill. Again,
you are going to hear from a lot of different people today, and
I apologize for sort of racing along here this morning, but I
don't want to miss the vote in the Senate.
I will leave this testimony for you to take a look at and
urge you to consider what would get us closer to a bipartisan
proposal in both Chambers on these provisions. I commend you
again for holding this hearing today. I am sorry we didn't get
bankruptcy reform done last year. It is critically important
and necessary legislation.
[The prepared statement of Senator Dodd follows:]
Prepared Statement of Hon. Christopher J. Dodd, a U.S. Senator from the
State of Connecticut
I would like to thank Chairman Gekas, Chairman Grassley, Senator
Torricelli and Representative Nadler for scheduling today's hearing on
bankruptcy reform.
Clearly, we need to reform our bankruptcy laws. There has been a
400 percent increase in personal bankruptcies since 1980. The most
recent statistics from the Administrative Office of the U.S. Courts
state that in the year ending June 30, 1998, more than 1.4 million
people filed for bankruptcy, an all-time high. This alone represents an
8.5% increase from the previous year.
Senators Hatch, Leahy, Grassley and Durbin worked hard last
Congress to craft a strong, bipartisan and balanced bankruptcy reform
bill, a bill which passed the Senate overwhelmingly by a 97-1 vote.
While not perfect, S. 1301 took into account the interests of both
consumers and creditors.
While asking consumers to take more responsibility for their
personal debt, S. 1301 also gave consumers access to information that
would help them make better financial choices pre-bankruptcy. These
principles were agreed to on a bipartisan basis in the Senate.
Regrettably, time was short at the end of last session, and a
conference report was somewhat hastily concluded. As a result, a number
of strong provisions supported by 97 members of the Senate were
excluded from the conference report.
One of the consumer protections in the Senate bill was co-authored
by me, Senator Sarbanes and Senator Durbin--an important new consumer
protection regarding credit card debt. Today, many consumers are
unaware of the implications of carrying credit card debt and making
only the minimum monthly payment on that debt.
For instance, assume a consumer has $3000 in credit card debt. Then
assume the interest rate that the consumer is paying on that debt is
17.5%, which is roughly the industry average. If the consumer makes
only the monthly minimum payment on that debt, it will take 396 months
or 33 years to pay it off. And with interest, the consumer will have
paid a total of $9,658.
Our amendment, which we also worked on with Senators Grassley and
Hatch, would have required credit card issuers to inform consumers on
their monthly billing statement not only how long it would take them to
pay off a debt at the minimum monthly rate, but also how much money
they would have paid in interest and principal on that debt. This
amendment was based on a simple premise: the better-informed the
consumer, the better that consumer's financial decisions will be.
No one can argue with the goal of increasing personal
responsibility. However, we need to realize that a carrot sometimes is
preferable to a stick: giving consumers more information about the
long-term impact of their short-term credit decisions will encourage
them to act more responsibly.
The credit disclosure provisions included in the Senate bill last
year were balanced and fair. Yet they were replaced in the conference
report with provisions that actually could confuse consumers. For
instance, instead of the Senate provision requiring credit card issuers
to disclose specific information about a consumer's specific debt, the
conference report only required a hypothetical disclosure about a
hypothetical $500 debt. Such a disclosure would be unhelpful--and maybe
even confusing--to a consumer trying to understand the implications of
carrying a specific debt with a much larger balance over a longer
period of time. This problem is exacerbated if the disclosures are
based on a teaser rate of interest rather than the interest rate that
actually will be applied to the consumer's charges. Other provisions
were replaced with requests for future study by the Federal Reserve. I
hope that instead of studies and unhelpful disclosures, bankruptcy
reform will contain the meaningful disclosures agreed to by 97 senators
last fall.
It is also my hope that we enact bankruptcy reform that properly
protects children and families. As you know, for nearly 100 years our
bankruptcy laws have adhered to a fundamental principal: that children
and their innocent parents--to the extent possible--should not be
impoverished by bankruptcy proceedings. Last year, I and others raised
some concerns that perhaps this historical balance in favor of children
was being shifted somewhat toward creditors.
I worked with Chairman Grassley, Chairman Hatch, Senator Durbin and
others to address these concerns. We were largely successful. For
instance, we:
1. LProtected income from sources legitimately dedicated to the
welfare of children, such as child support payments, foster
care payments or disability payments from being dissipated and
misdirected towards the payment of debts unrelated to the care
and maintenance of children;
2. LEnsured that in bankruptcy, children and families are able
to keep certain household goods which typically have no resale
value. I am speaking about items such as toys, swings sets,
video cassette recorders or other items used to help them raise
their children; and
3. LAdded provisions that should help children and families
collect child support debts such as permitting the conditioning
of a chapter 13 confirmation upon the payment of child support
payments and allowing the conditioning of a chapter 13
discharge upon the payment of all post-petition child support
obligations.
I hope that we can retain these and like provisions in this
Congress.
I am aware that the National Partnership for Women and Families,
the National Women's Law Center and a variety of other women's
organizations continue to object to provisions regarding the non-
dischargeability of certain types of unsecured debt in the newly-
introduced House bill, H.R. 833. These groups continue to express their
concerns that such provisions will impede the ability of debtors to pay
both for their post-bankruptcy expenses and to care for their
dependents. I hope both the House and Senate subcommittees look into
these issues very carefully.
Finally, section 115 of the newly-introduced House bill entitled,
``Protection of Savings Earmarked for the Postsecondary Education of
Children,'' appears to be a version of my educational savings amendment
from last year's Senate bill. As most of you know, I am a lawyer, and
that provision fails, as best I can tell, to provide the exemption I
intended. And it also appears to fail to protect against the commission
of fraud. I would encourage appropriate committee staff to meet with
members of my staff regarding this particular provision so that we can
truly protect duly established college savings accounts, which were set
up for the benefit of children, from being distributed to creditors.
Just because a child's family has gone through a bankruptcy does not
mean a child should not be able to go to college.
Again, I thank you for calling this hearing. I look forward to
working with colleagues in both bodies to enact strong and balanced
bankruptcy reform that strengthens the responsibilities not just of
consumers, but also of creditors, and that protects innocent children
from impoverishment.
Mr. Gekas. Without objection, the statement of the Senator
will be included in the record. He can return to the Senate
with the assurance that the hearing--this one and the ones to
follow, plus the final version of the bill--will address the
concerns that he has addressed.
Mr. Dodd. Thank you, Chairman, very, very much. Thank you.
Mr. Gekas. We thank you. The Chair now notes the presence
of the gentleman from New York, Mr. Nadler, the ranking member
of the committee; the lady from Wisconsin, Ms. Baldwin; and the
gentleman from Massachusetts, Mr. Delahunt. Mr. Manager
Hutchinson and Mr. Manager Bryant--to revive memories--have
already been recorded in their presence. We will begin with
hearing from Congressman Sessions, who was going to be joined
by Senator Kohl to present the pros and cons of the homestead
exemption solution that we arrived at last year. Congressman
Sessions has been in the forefront of pressing for bankruptcy
reform and, indeed, is a co-sponsor of the current legislation.
He and Senator Kohl were to be supplying opening statements.
Because Senator Kohl is not here, we will instruct staff to
inform the Senator's staff that his statement will be made a
part of the record, and that we will hear from his opposite
number, Congressman Sessions at this juncture.
[The prepared statement of Senator Kohl follows:]
Prepared Statement of Hon. Herb Kohl, a U.S. Senator from the State of
Wisconsin
Thank you, Mr. Chairman. As the number of bankruptcies continues to
rise, there is little doubt that we need bankruptcy reform. Last year,
I was pleased to support the Senate reform bill, which in my view was a
balanced measure that eliminated the worst abuses without overburdening
honest debtors. As we consider reform this year, we should continue
trying to be both balanced and fair.
One provision that to my mind is essential to any meaningful
bankruptcy reform is a cap on the homestead exemption. Today, Senator
Sessions and I are reintroducing our bipartisan measure to cap the
homestead exemption at $100,000. Last year, this proposal was strongly
supported in our reform bill, although it was defeated by a very, very
narrow margin in the House. We intend to offer it as an amendment to
the Senate bill either in Committee or on the floor. I know that
Senator Grassley is a longtime supporter of this measure.
Our bipartisan measure closes an inexcusable loophole that allows
too many debtors to keep their luxury homes, while their legitimate
creditors--like children, ex-spouses owed alimony, state governments,
universities, retailers and banks--get left out in the cold.
Currently, a handful of states allow debtors to protect their homes
no matter how high their value. And all too often, millionaire debtors
take advantage of this loophole by moving to expensive homes in states
with unlimited exemptions like Florida and Texas, and declaring
bankruptcy--yet continuing to live in a style that is no longer
appropriate. Let me give you a few examples:
LThe owner of failed Ohio S&L, who was convicted of
securities fraud, wrote off most of $300 million in bankruptcy
claims, but still held on to the multimillion dollar ranch he
bought in Florida.
LA convicted Wall Street financier filed bankruptcy
while owing at least $50 million in debts and fines, but still
kept his $5 million Florida mansion with 11 bedrooms and 21
bathrooms.
LAnd last year, movie star Burt Reynolds wrote off
over $8 million in debt through bankruptcy, but still held onto
his $2.5 million Florida estate.
Now, don't get me wrong. I loved Burt Reynolds in ``Smokey and the
Bandit.'' But while the homestead exemption may not be the most common
abuse of the bankruptcy system, it is the most egregious. If we really
want to restore the stigma attached to bankruptcy, these high profile
abuses are the best place to start.
Chairman Gekas, you should be commended for imposing a two-year
residency requirement in your bill, which will prevent people from
moving to Florida or Texas solely to take advantage of the exemption.
But that only addresses half of the problem: it doesn't stop longtime
residents--like Burt Reynolds--from using an unlimited exemption to
shortchange honest creditors from their home states. That's why I hope
this Congress will reconsider including the homestead cap. Because, to
my mind, this isn't about states' rights. Anyone who files for
bankruptcy is choosing to invoke federal law in a federal court. It's
fair to impose federal limits.
A cap is not only the best policy, it also sends the best message.
It says that bankruptcy is a tool of last resort, not just a tool for
financial planning. And it gives credibility to reform by going after
the worst abuses, no matter who is involved. So I hope you will give a
homestead cap the full consideration it deserves. Thank you.
Mr. Nadler. Mr. Chairman?
Mr. Gekas. Yes.
Mr. Nadler. Before Congressman Sessions, what about opening
statements?
Mr. Gekas. I thought that we would accommodate Congressman
Sessions.
Mr. Nadler. Do we have the----
Mr. Gekas. And will right afterwards, we will accommodate
the opening statements.
Mr. Nadler. Thank you.
Mr. Gekas. We did so for Senator Dodd, and we will do it
for Congressman Sessions. You may proceed.
Mr. Sessions. Mr. Chairman, thank you. I would ask
unanimous consent that my entire write-up here, testimony, be
considered for inclusion into the record.
Mr. Chairman, thank you for allowing me to be here today. I
find it very interesting that my officemate, Mr. Delahunt, the
gentleman from Massachusetts is here. He has a great expertise
in what I am preparing to discuss today.
Mr. Chairman, that is that I am aware that there is a bill
being considered in the Senate which would place a $100,000
homestead cap on the amount that a family is allowed to exempt
from bankruptcy laws.
This is not an inconsequential change. This cap on the
homestead exemption was seriously debated last year, when the
bill reached the floor of the House of Representatives. A
bipartisan majority of members voted for an amendment on the
floor last year to replace the cap with a provision to prevent
the fraudulent use of the homestead exemption. That amendment
effectively targeted homestead exemption abuses without hurting
honest debtors and also without overriding State laws by
removing the exemption in cases of fraudulent conversion of
non-exempt assets into exempt homestead property within 1 year
of filing for bankruptcy, with the intent to avoid paying
creditors.
If the goal is to restrict further fraudulent abuse of our
bankruptcy laws, this year's bill goes even further toward that
goal by having a 2-year residency requirement before a debtor
can claim the homestead exemption available in a particular
State.
This will strengthen current laws by discouraging debtors
from what I call carpetbagging into a State with more generous
homestead laws and then pouring their assets into an exempt
home.
This, I believe, is an important States' rights issue.
Since 1792, Federal bankruptcy laws have deferred to States to
decide what property is exempted from bankruptcy. We should not
interfere with the decisions that States have made to protect
the equity that a person has in their own home. If the proposed
homestead cap is put into law, this could force a person who
owns a $110,000 home, with no mortgage, and who files for
bankruptcy to lose their home. This is because creditors
wanting the $10,000 over the $100,000 exemption can force the
individual to sell his home.
Senior citizens frequently have most of their net worth in
their homes, not in liquid assets. They could be forced to sell
their homes, even if a creditor is seeking just a small amount
over the homestead exemption.
As legislators, I believe we should not only seek to write
laws that provide needed solutions to a problem, but we should
also ensure that these laws do not have unintended
consequences.
I am for having people pay all the debts that they owe. As
you have alluded, I am a very strong supporter of bankruptcy
reform, and that is why I have co-sponsored this bill. However,
a homestead cap would do nothing toward providing the fresh
start we all in believe in, but rather would force honest
debtors into selling their homes.
I am confident that the anti-fraud provisions contained in
the House bill will provide the perfection we need without
being punitive or infringing on States' rights, such as those
we enjoy in Texas and in other States. Thank you, Chairman.
[The prepared statement of Mr. Sessions follows:]
Prepared Statement of Hon. Pete Sessions, a Representative in Congress
from the State of Texas
Mr. Chairman, thank you for your leadership on the issue of
bankruptcy reform. I appreciate the opportunity to testify about how
changes to the homestead exemption provision of this bill will greatly
affect citizens in my home state of Texas as well as several other
states.
I am a cosponsor of this bill and fully support the House version
that you, Mr. Chairman, have introduced. This legislation received the
bipartisan support of 300 Members last year, and I believe that this
compromise reform of the bankruptcy system will require high-income
debtors to pay their debts if they have the ability to do so, while
protecting those with low incomes and those who truly need the
protection that our bankruptcy system has to offer.
However I am concerned about a proposal that is reportedly being
considered by the Senate which would place a $100,000 homestead cap on
the amount that a family is allowed to exempt from the bankruptcy laws.
This is not an inconsequential change--this cap on the homestead
exemption was seriously debated last year when this bill reached the
floor of the House. A bipartisan majority of members voted for an
amendment on the floor last year to replace the cap with a provision to
prevent the fraudulent use of the homestead exemption. That amendment
effectively targeted homestead exemption abuses without hurting honest
debtors and without overriding state laws by removing the exemption in
cases of fraudulent conversion of non-exempt assets into exempt
homesteads property within 1 year of filing for bankruptcy with the
intent to avoid paying creditors.
If the goal is to restrict fraudulent abuse of our bankruptcy laws,
this year's bill goes even further toward that goal by having a two-
year residency requirement before a debtor can claim the homestead
exemption available in a particular state. This will strengthen current
law by discouraging debtors from ``carpetbagging'' into a state with
more generous state homestead laws and pouring their assets into an
exempt home.
This is an important states-rights issue. Since 1792, federal
bankruptcy laws have deferred to the states to decide what property is
exempted from bankruptcy. We should not interfere with the decisions
that states have made to protect the equity a person has in their home.
If the proposed homestead cap is put into place, the law could
force a person who owns a $110,000 home with no mortgage and who files
for bankruptcy, to lose his home. This is because creditors wanting the
$10,000 over the $100,000 exemption, can force the individual to sell
his home.
Senior citizens frequently have most of their net worth in their
homes, not in liquid assets. They could be forced to sell their homes
even if a creditor is seeking just a small amount over the homestead
exemption. As legislators, we should seek not only to write laws that
provide a needed solution to a problem, but we also must ensure that
these laws do not have unintended consequences.
I'm all for having people pay the debts they owe. That is why I
cosponsored this bill because I believe it targets debt relief only at
those who need the help and works with others to pay a portion to their
creditors. However, a homestead cap would do nothing toward providing
the ``fresh start'' we all believe in, but rather would force honest
debtors into selling their homes.
I'm confident that the anti-fraud provisions contained in the House
bill will provide the protection we need without being punitive or
infringing on states rights.
Mr. Gekas. We thank you very much, and we excuse you with
our gratitude.
Mr. Delahunt. Mr. Chairman? Before my friend departs, may I
just have a----
Mr. Gekas. I didn't hear the gentleman from Massachusetts
as he rose--to be recognized for what?
Mr. Delahunt. I would just like to inquire of my dear
friend and my corridor mate, Mr. Sessions, as to the issue that
he addressed.
Mr. Gekas. If the gentleman wishes to respond to questions,
I am willing to----
Mr. Sessions. Mr. Chairman, I would be pleased to respond
to the gentleman.
Mr. Gekas. The gentleman from Massachusetts is recognized.
Mr. Delahunt. Yes, thank you, Mr. Chairman. Is it my
understanding, then, that you would object to any caps
whatsoever?
Mr. Sessions. That would be what I--support the testimony
that I have given. I believe that States have addressed these
issues and decided by themselves, on a State by State basis,
what is necessary. And I would ask that the Federal Government
not do anything in this bankruptcy protection other than those
that we have advanced here. And that would be correct.
Mr. Delahunt. Right. But, Pete, you are aware of the fact
that States like Texas and Florida have no caps whatsoever?
Mr. Sessions. That would be correct.
Mr. Delahunt. And that there have been a number of
instances where individuals, and let us not call them
carpetbaggers, but under your proposed 2-year residency
requirement, there have been instances in which individuals
have had a primary residence worth millions of dollars--
millions of dollars. You are aware of that?
Mr. Sessions. I am aware of that, and, in addressing that
issue, I would like to say that so are the people who have
extended credit to these people; and they are aware of the laws
of the State of Texas. And we will always be able to find
people that do try and hide their assets in their homes like
this. The fact of the----
Mr. Delahunt. But I am not even suggesting that anyone, you
know, intended to defraud here. I am not even suggesting that
particular scenario. But you know there are people who hit hard
times that who, if this legislation should pass, will be
contrasted in the public's mind with some of those individuals.
Mr. Sessions. My observation in response would be then
since we are talking about millions rather than thousands that
if you put a cap at millions of dollars, then that would be the
appropriate level. I am not advocating that. I am advocating
that we defer to States. I simply believe that----
Mr. Delahunt. And I understand your concern about States'
rights and----
Mr. Sessions. Well, sir, but what I am suggesting to you is
if you are talking about millions of dollars, then put the cap
at millions of dollars, not $100,000. That is very punitive for
people who live all across this country, who are middle-class
people, who are many times people who retired, as my
grandfather did in 1971. And I don' think it is fair that we
place these types of very onerous dollar amounts on people. So
if you want to talk about millions of dollars, then address it
as millions of dollars. But please do not address it as a
million dollar problem and put it as a $100,000 answer.
Mr. Delahunt. So then you see some flexibility there in
terms of what I think most Americans would consider fair and
equitable to everyone involved so that you would not rule out
entirely any kind of cap whatsoever, since this is a Federal
statute.
Mr. Sessions. Congressman, what I have suggested to you is
that I wanted to respond to you very openly, and that is----
Mr. Delahunt. And you have, and I appreciate it.
Mr. Sessions. That is that I believe there should not be a
cap at all and that we should defer to States' rights. My point
is to say if you are talking about millions of dollars, then it
would seem that that would be the way the law was written and
then I would take a look at that. I think that millions of
dollars are more reasonable than $100,000.
Mr. Delahunt. Like maybe $1 million as opposed to----
Mr. Sessions. Perhaps that could be closer, but a hundred
thousand dollars simply is an unfair and unreasonable
assumption on my part.
Mr. Delahunt. Well, thank you, and I appreciate your
thoughtful testimony.
Mr. Sessions. I thank the gentleman.
Mr. Gekas. The gentleman from New York indicates that he
has a question for you. Do you wish to respond?
Mr. Sessions. Mr. Chairman, I will stick around for this.
Mr. Nadler. Thank you. I just want to follow up on what Mr.
Delahunt was asking. It seems to me one of the things that
people are always puzzled by, and I am puzzled by, is the
fairness of a bankruptcy system. I remember when Donald Trump
went bankrupt, the court said he could live on an expense
account of $400,000 a month, I think it was. So he could
maintain some sort of standard of living, and that money
obviously wasn't available for his creditors. And I don't
understand that kind of reasoning.
But I also don't understand the reasoning of a system in
which we say we are going to have a bill to crack down on
people who don't pay their bills. And we are going to have a
means test. And we are going to refuse chapter 7 relief for a
lot of these people, but at the same time someone can legally
shelter millions of dollars, as was said, in a homestead.
I frankly think a hundred thousand dollars is too little,
too. But I think a quarter of a million dollars should be more
than ample for any State, and I don't see why this as opposed
to anything else in bankruptcy is a matter of States' rights
except by tradition. And this House invades States' rights all
the time. I think many of the people on the other side of the
aisle think we should override States' rights on access to
their courts, and we should have tort reform that says who can
sue whom and under what circumstances and what kind of legal
fees they can pay in State courts. So it is sort of strange to
hear States' rights only here.
So how would you justify in a bill in which we are cracking
down on people, because we are saying that people are abusing
the bankruptcy system, allowing people to exempt, let us say
more than a half a million dollars in homestead?
Mr. Sessions. I thank the gentleman for his question. First
of all, I was not trying to set an arbitrary figure. I believe
it should be no cap. But I believe that if you look at, since
1792, that the Federal Government, the Congress of the United
States, has allowed these States, individually, to determine
how they would like to approach homestead exemptions in their
own States in dealing with bankruptcy. I believe it is very
important. I happen to live in a neighborhood where probably
the average house is $250,000. That is perhaps a lot of money.
But we are--what we are dealing with here is the essence of
individuals and their home, and the old saying that a person's
home is their castle I believe is a true statement; that that
which you have should be protected. You should not be thrown
out of your own home for something that you have done. And
creditors recognize this. They know that when they extend
credit to you. And I think that there is simply a balance. I am
simply saying to you, I believe that a hundred thousand dollars
is incorrect, and I believe that it is not unreasonable to
assume that we would not put a cap on. I thank the gentleman.
Mr. Gekas. The time of the gentleman has expired. We thank
you very much.
Mr. Sessions. Thank you, Chairman.
Mr. Gekas. And you are excused with our gratitude. And I
think that the gratitude of the gentleman who is looking down
at us from that portrait up there is also visited upon you. In
fact, he is looking askance at us up here as we continue. He
agrees with you, I am sure, on your position. We thank the
gentleman.
Mr. Sessions. Thank you, Chairman.
Mr. Gekas. It is now time to return to the full-blown
hearing to which we are committed. We note the presence now of
the gentleman from Ohio, Mr. Chabot, and the gentleman from New
York, Mr. Weiner. As has been said in many different ways thus
far, this is a historic moment in that the joint hearing
scheduled between the Senate and the House and those who are
engaged in bankruptcy reform signifies--signals a blending of
wills and a blending of concepts as we pursue bankruptcy reform
in the current session of the Congress.
From the very first, back in the last session and now
replicated here, this has been a bipartisan effort judging from
the votes, both the House and the Senate, and on the conference
report in the House last year. Further evidence that it is a
bipartisan approach is the fact that at the outset in this
session, we have fought consistently to bring about a
bipartisan study of the measures that and the standards that
are going to be applied. We have had several briefings for
staff for the minority and the majority. We have had visiting
lecturers on the very vexing problem of child support and its
role in the primacy that we accord certain entities in the
bankruptcy reform measures. We have had a breakfast and a
luncheon for all those purposes. These staff briefings will
continue, and the next one will be held Tuesday I am informed,
is that correct? All of these in the spirit of and in the
necessity of bringing about bipartisan understanding and
support of bankruptcy reform.
The briefings that will begin Tuesday, by the way, will
include not just the bill that we have introduced that is
before us now, but that which is potentially to be introduced,
as I understand, by Mr. Nadler, if there be one. And if there
be one, it will also be part of the presentation that will be
made to staff and to members in preparation for these hearings.
We have two concepts that have not changed and will not
change and which form the foundation of bankruptcy reform: to
guarantee the fresh start to those who are so burdened by debt
that they cannot and their families cannot survive without
giving them that fresh start; and two, an earnest effort on the
part of our society to make certain that those who are able to
repay all or part of their debt should be given a mechanism and
compelled to enter the halls of bankruptcy with a view for
repayment of some of that debt over a period of time.
Those two precepts are unarguable in their meaning. And the
debate will fasten on that I am sure as we proceed. But let no
one criticize anyone for looking at ways and means to grant a
fresh start where it is needed; nor should one be criticized
for looking at methodologies for providing repayment of some of
the debt by those who are able to pay it.
With that, I will entertain opening remarks by the
gentleman from New York, Mr. Nadler.
Mr. Nadler. Thank you, Mr. Chairman. Mr. Chairman, today we
begin our hearings on bankruptcy legislation. As you know, our
Senate colleagues will be unable to participate in today's
hearing, or most of it, because of floor votes. Senators who
had intended to present testimony to us today will be unable to
do so. I would hope that we could accommodate them when we hear
from members next week. I think our colleagues from the other
body have something to contribute. I hope we can accommodate
them.
Mr. Chairman, as you well know, I have not reintroduced the
legislation that Mr. Conyers and I introduced last year,
because I thought it necessary to take a fresh look at some of
the issues before us and approach this matter with an open
mind. To that end, we have been in contact with professionals
from across the spectrum, from business lawyers to creditor
representatives, to administrators in an effort to gain a
better understanding of what they think we ought to do to
ensure fairness, balance, honesty, and efficiency in our
bankruptcy system.
I know we have had some rather strong differences over some
parts of this legislation; that is, the legislation that you
introduced last year and that you have reintroduced. As you
know, I think it is one of the most unbalanced and one-sided
piece of legislation I have ever seen. But I would hope that we
could use these hearings as an opportunity to learn and perhaps
find creative approaches to some of these difficult questions.
Next week, I know that you have scheduled nine panels in 3
days and that our staffs have been discussing possible
witnesses to provide members with a broad spectrum of views. I
am concerned that these hearings, packed so tightly--three
panels a day in 3 days, with a possible markup the following
week--in such a short period of time may leave little time for
deliberation. Some may conclude that they are window dressing
for a pre-determined outcome. I will not say that. I hope that,
in fact, there will be some time after those hearings before
the markup; that you will not schedule a markup for the week
after so that people will have time--since they won't have time
to think between those hearings 1 day to the next, to think
about what we have heard and to talk to each other so that we
could actually reflect what we have heard in those hearings in
the legislation.
Obviously, were markups scheduled for the following week, I
would certainly conclude that there was a pre-determined
outcome and that the hearings were window dressing. I hope that
will not happen. I hope that we can actually review the
testimony and have the time to do that, and shape legislation
together that reflects the best advice we have received.
We may not agree on all points, but we may be able to
narrow the range of issues and at the very least to clarify our
points of disagreement.
I certainly hope that these hearings will not be merely an
exercise in creating the appearance of fact finding prior to a
pre-determined course of action. I hope that we do not simply
rush last year's product through the process without any heed
to the many thoughtful comments we have received and will
receive from across the professional spectrum, especially
during these hearings.
I know I was, as were many professionals, deeply
disappointed to see the reintroduction of last year's
conference report, down to all the typos, which were not
corrected, and without even correcting the technical errors
that I know had been brought to the attention of the majority
staff. I hope it does not portend the future course of this
legislation.
Mr. Chairman, despite my uneasy feeling that American
families may be about to get the bum's rush from Congress, I
begin these hearings hopefully, with an open mind and a strong
desire to work with you to improve our nation's bankruptcy
system. I know that any such attempt will result in a bill that
has yet to be written. Thank you, Mr. Chairman.
[The prepared statement of Mr. Nadler follows:]
Prepared Statement of Hon. Jerrold Nadler, a Representative in Congress
from the State of New York
Thank you, Mr. Chairman. Well, it's deja vu all over again. Or as
someone once observed, if history repeats itself, the first time is
tragedy, the second time is farce. Unfortunately, for millions of
Americans whose families, businesses, jobs, communities and futures
will be touched by the Bankruptcy Code today's travesty may be
farcical, but it is far from funny.
Let us review: The Chairman has reintroduced his conference bill
from last year, without so much as correcting the typos or the
technical errors, much less attempting to deal with the many serious
policy problems pointed out by professionals from across the spectrum--
judges, trustees, debtor attorneys, unsecured trade creditors, creditor
attorneys, academics. Anyone who does not have a special interest
provision in this bill, or who is not on their payroll, has criticized
this bill, but the Chairman has ignored the unified voice of the
profession.
We did have a hurried hearing schedule over four days. I will give
the Chairman credit for inviting some very good witnesses whose
testimony was thoughtful and informative. Unfortunately, the hearings
appear to have been merely for show and do not appear to have had any
impact on the proponents of this legislation. They were, quite simply,
hearings without listening--the legislative equivalent of one hand
clapping.
We have before us a substitute which the minority received late
last night. I hope the Chairman will not be offended to discover that
we have not had the opportunity to comb carefully through all 310
pages. Perhaps, after the markup, we will have the chance to find out
what it was we were being asked to vote on.
We really have reached a crossroads today. I wish to share with the
Chairman and the members of the Subcommittee a letter I received from
Jack Lew, the Director of OMB, reiterating the President's strong
objections to the Conference Report from last year, which is embodied
in this bill, and reiterating the President's determination to veto
this bill and work for real fair and balanced reform. Let me quote:
``We were disappointed that the Conference Report failed to
include key provisions of the Senate bill, thus failing the
test of balance. In my letter to Congressional leadership dated
October 9, 1998, I noted that the President's senior advisors
recommended that the President veto the Conference Report. Our
position from last year has not changed.''
Now, Mr. Chairman, you know that I did not introduce my bill from
last year, but have decided to take a fresh start and work with
professionals from across the spectrum, with a broad variety of
interests affected by the Code--indeed, just yesterday I met with
representatives of Visa to open a dialogue--in an effort to find a
common ground. I urge you and my colleagues on both sides of the aisle
to join me in that endeavor so that we can achieve real, balanced and
workable bankruptcy reform by the end of this Congress. Another futile
war of words will accomplish nothing.
I will not offer many amendments today, but I hope that after this
markup, we will have the opportunity to work together, to start anew,
to work with the experts, with the President and with our colleagues to
get it right this time.
Thank you, Mr. Chairman. I yield back the balance of my time.
Mr. Gekas. We thank the gentleman. Time has expired. Does
anyone from the--the gentleman from Ohio indicates that he
would have an opening statement. The gentleman from Tennessee
if recognized for 5 minutes.
Mr. Bryant. Mr. Chairman, I just simply want to say that
based on the positioning here, I am honored to be senior to
Senator Thurman, who is not here. Perhaps that is a classic
example of the bankruptcy fresh start. [Laughter.]
Mr. Gekas. The gentleman from New York, does he wish to
make an opening statement?
Mr. Weiner. I have no opening statement.
Mr. Gekas. The gentleman from Massachusetts is recognized
for 5 minutes.
Mr. Delahunt. Yes, thank you, Mr. Chairman. I am not going
to take all 5 minutes. But I want to express similar concerns
that were expressed by the ranking member, Mr. Nadler.
We had two members, two brand new members, speaking to the
concept of fresh start on this side of the aisle, Ms. Baldwin
and Mr. Weiner. This is very complicated material. Last year,
you and I had this discussion about the scheduling of hearings.
And I think it is a grave mistake to schedule three consecutive
days on this subject, with three different panels. You and I
know that there will be--it will be impossible for members to
attend to each and every one of these panels. I think that is a
mistake.
I also want to note that last year, myself and Mr. Nadler
filed a request in January 1998 with the Congressional Budget
Office for information, an analysis on the issues surrounding
personal bankruptcy. And I want to enter into the record a
letter dated March 10, 1999. It is addressed to Congressman
Nadler. Dear Congressman, I am writing in regard to your
request of January 14, 1998, for background information on
issues surrounding personal bankruptcy. The staff analysis is
almost complete. And I will review it carefully or soon get it
done. Although we have many other assignments from Congress, I
am sure that the material will be ready for release to you by
the end of March.
I think it is appropriate, since we made this request,
since there is serious disagreement in terms of various
analysis by both the credit industry and others that we wait
clearly in terms of markup until the CBO has provided us with
an independent analysis of the information I think that is
absolutely essential before we can make a reasoned, thoughtful
decision in terms of where we go.
And I would also recommend, and I think it would be very,
very fruitful, Mr. Chairman, that we consult in an informal
basis to see among members--among those of us that serve on
this committee to see where there are areas of agreement. We
didn't do it last year, and we failed to have a bill. I think
if we sit down with each other and work--in fact, my friend and
colleague from New York just asked me. He said, gee, it looks
to me as I become conversant with the issues that we are going
to be addressing here is that there is a lot that we can agree
on. I think if there is a sincere and genuine intent to do
something that would come out of the committee where we could
all support--and maybe there would be some dissatisfaction--
that it would be appropriate for us to sit down and consult in
good faith in a reasonable period of time to determine whether
is areas that we can agree on.
And I yield back.
Mr. Delahunt. Would the gentleman yield for a moment? I
yield to the chairman.
Mr. Gekas. I'll yield myself what time I may consume. I
simply refer back to my opening statement in which I took
special aim at the fact that we have provided the staff
briefings, the breakfasts, the luncheons, more staff briefings.
We have been accommodating in any request that any member of
the minority has been making. This bill is a replication, by
and large, of the issues of last year. Those that were in the
last session have a head start like all of us. Those who, like
Mr. Weiner, need to catch up are given fresh opportunities
every day to do so, with these briefings. I will not refuse to
meet with anyone on any subject at any time. And informal
discussions following staff briefings may be appropriate. But I
will not abide by any comment that we are bludgeoning our way
through this process. This is well-calculated to inform every
member, to allow full study by every member, to allow full
participation by every member, to allow full presentation of
individual views, to ask for special meetings between
interested parties, to bring outside consultants in at any time
as we have strenuously attempted to do, and we will continue to
do so. So the issue is joined. We will be accommodating, and we
will continue to be accommodating.
Mr. Nadler. Will the chairman yield?
Mr. Gekas. Not at this time. We want to proceed with the
hearing. Well, all right, Mr. Nadler, you may proceed?
Mr. Nadler. Thank you. I appreciate hearing these
sentiments. I want to pick up on one thing the gentleman from
Massachusetts said and ask the chairman if he would join me in
something. The CBO has sent me a letter dated a few days ago in
response to our request of 14 months ago that their study will
be completed by the end of March after these hearings will be
completed. We have asked if they could make available to the
committee as a witness for next week's hearings, the expert on
their staff who has been doing all the work. And they have said
that they didn't think so.
Frankly, my suspicion is someone doesn't want that
information before the committee. I don't know who that is, not
necessarily anyone on the committee. So I would ask the
chairman if he would join me in requesting the CBO to allow its
own person who is writing that report, who is largely,
according to them, has completed it, to appear as a witness
before our committee next week?
Mr. Gekas. I have no objection to your calling any witness
that you want. And I will join with you----
Mr. Nadler. Thank you.
Mr. Gekas [continuing]. On the CBO and also the Surgeon
General if you like.
Mr. Nadler. Well, I think that's a little far afield, but I
appreciate the chairman's response.
Mr. Delahunt. I would appreciate the Surgeon General, Mr.
Chairman.
Mr. Gekas. Me, too. Because my blood pressure is going up.
Mr. Delahunt. Maybe he could cut out some of the fat.
Mr. Gekas. In any event, we shall proceed with the opening
statement of the gentleman from Ohio, Mr. Chabot?
Mr. Chabot. Thank you, Mr. Chairman. My distinguished
colleague from New York, he mentioned I think he said this was
the most unbalanced and one-sided legislation that he had ever
seen. I would take issue with that. I don't think that's
accurate. I think it's good legislation. And I think it's
interesting to note that there are 23 Democratic cosponsors to
this legislation. I think if it was that one-sided, we wouldn't
see that much support from Democrats on this bill.
I would agree with Chairman Gekas that it's vital that we
work together in a bipartisan and bicameral manner to move this
legislation forward as expeditiously as possible.
This reform legislation will protect consumers and
businesses from irresponsible debtors who are capable of paying
their debts, but choose to hide behind bankruptcy protection
instead. In particular, this legislation would re-establish the
link between a debtor's ability to pay and the availability of
a legal remedy to discharge debt through bankruptcy. Under the
need-based reforms, those that have the ability to pay back
either $5,000 or 25 percent of their debts will be required to
file under chapter 13 and work out a repayment plan.
There are, of course, some people who truly have a
legitimate need for bankruptcy. At times, hard-working families
may face a serious family illness, a disability, unemployment
or the loss of a spouse which may necessitate the need for
bankruptcy protection. Too frequently, however, people who have
the financial ability or earnings potential to repay their
debts are seeking an easy way out as a growing number of
financially secure individuals attempt to use chapter 7
bankruptcy as a way simply to walk away from their debts. While
this may prove convenient for the debtor, it's not fair to
their friends and their neighbors who ultimately are stuck with
the bill.
Consumer bankruptcies have a dramatic impact on businesses
and consumers, reducing the availability of credit, and
increasing the price of goods and services in this Nation. For
example, it is estimated that the consumer bankruptcies in 1997
alone wiped out about $40 billion in consumer loans costing
every American household, we used to say $400, we now come to
find out it's $550 per family. That's essentially a hidden bad
debt tax on every single American family. That's money that
American families could use for a vacation, to go toward
education, or their children's clothing or a movie or whatever.
But that's money that we take away from American families right
now and I think that's wrong.
Nationally, consumer bankruptcies reached a record $1.4
million back in 1997 and it's projected that they'll go even
higher this year. What makes these numbers particularly
alarming is the fact that this trend began back in 1994 during
a time of solid economic growth, low inflation, and low
unemployment. The primary culprit for this dramatic increase is
a system I believe that allows consumers to evade personal
responsibility for their debts too easily. Our current
bankruptcy system allows many who can't afford to pay a
significant portion of their bills to walk away essentially
scot-free.
Mr. Chairman, I believe that your bill, H.R. 833, makes
significant steps in closing this loophole. I also believe that
the means-testing equation included in this bill will prove to
be a fair one. Despite criticism, the means-test proposed
actually protects low-income debtors, maintains flexibility to
take an individual filer's needs into account, and respects
judicial discretion in these matters.
I believe we should work closely with our colleagues to
pass this legislation quickly so that we can finally give hard-
working Americans protection from those who abuse the
bankruptcy system and leave their fellow Americans holding the
bill.
I yield back the balance of my time.
[The prepared statement of Mr. Chabot follows:]
Prepared Statement of Hon. Steve Chabot, a Representative in Congress
from the State of Ohio
Let me just take this time to welcome the esteemed members of the
Senate who have joined us today to discuss this important legislation.
I agree with the Subcommittee Chairman, Mr. Gekas, that it is vital
that work together in a bipartisan and bicameral manner to move this
legislation forward expeditiously.
This reform legislation will protect consumers and businesses from
irresponsible debtors who are capable of paying their debts, but choose
to hide behind bankruptcy protection instead. In particular, this
legislation would reestablish the link between a debtor's ability to
pay and the availability of a legal remedy to discharge debt through
bankruptcy. Under the ``needs-based'' reforms, those who have the
ability to pay back either $5,000 or 25% of their debts will be
required to file under Chapter 13 and work out a repayment plan.
There are, of course, some people who truly have a legitimate need
to declare bankruptcy. At times, hardworking families may face a
serious family illness, disability, unemployment, or the loss of a
spouse, which may necessitate the need to seek protection. Too
frequently, however, people who have the financial ability or earnings
potential to repay their debts are seeking an easy way out, as a
growing number of financially secure individuals are attempting to use
Chapter 7 bankruptcy as a way to simply walk away from their debts.
While this may prove convenient for the debtor, it is not fair to their
friends and neighbors who ultimately stuck with bill.
Consumer bankruptcies have a dramatic impact on businesses and
consumers--reducing the availability of credit and increasing the price
of goods and services. For example, it is estimated that consumer
bankruptcies in 1997 wiped out over $40 billion in consumer loans,
costing every American household $400. That's a hidden ``bad debt'' tax
on every single American family.
Nationally, consumer bankruptcies reached a record 1.4 million in
1997 and are projected to be even higher in 1999. What makes these
numbers particularly alarming is the fact that this trend began in
1994, during a time of solid economic growth, low inflation and low
unemployment.
The primary culprit for this dramatic increase is a system that
allows consumers to evade personal responsibility for their debts too
easily. Our current bankruptcy system allows many who can afford to pay
a significant portion of their bills to walk away debt free.
Mr. Chairman, I believe that your bill, H.R. 833, makes significant
steps in closing this loophole. I also believe that the ``means
testing'' equation included in this bill will prove to be a fair one.
Despite criticism, the ``means test'', proposed actually protects low
income debtors, maintains flexibility to take an individual filer's
needs into account, and respects judicial discretion in these matters.
I believe we should work closely with our colleagues in the Senate
to pass this legislation quickly so that we can finally give hard-
working Americans protection from those who abuse the bankruptcy
system, and leave them holding the bill.
Mr. Gekas. We thank the gentleman for the opening
statement. We acknowledge the presence now of a fighter in the
world of bankruptcy reform, the Congressman from Virginia, Mr.
Moran, who wants to make a brief opening statement I think.
Mr. Moran. Thank you, Mr. Chairman. We're marking a
supplemental appropriations bill, but I felt it was important
to have at least some Democratic presence in favor of this bill
because I believe it is a balanced bipartisan bill. We have a
system that is out of control now. We ought not have 1.4
million bankruptcies. We should not have such an escalating
trend under chapter 7 where you wipe out your debts instead of
working them out.
And the fact is that people like the chairman and
Congressman Boucher, a Democrat, another Democrat from
Virginia, and Mr. McCollum have been working on this for many
years. But each year that we don't pass it, the situation gets
worse. I know you've heard the statistics but it just is not
fair for every household to be paying about $400 a year to meet
the bad debts incurred by other people who, in fact, are using
the system. And we estimate that for everybody that uses
bankruptcy as a financial management tool, if you will, as a
convenience to wipe out their debts, it costs about 15 other
families to be able to make up that cost. Families who would
never think of reneging on their debts.
So that's not the kind of system that we can be proud of
nor can we accept as being sanctioned by Federal law. Fifteen
responsible borrowers are more important than the person who is
using the system which is occurring today.
We've got lots of provisions here. It is need-based. If
you're a family of four with income of $51,000, you can choose
what you want to do, clearly. And most, if they are having
financial problems, they'll choose chapter 7. We're going after
people who can clearly afford to pay off their debts. We've
added more provisions that makes it an even more palatable bill
for those who want to look out for the rights of consumers.
This bill did pass overwhelmingly. It should pass with an
even greater margin this year because a number of the
provisions, for example, a lot more information available for
debtors where we provide financial counseling for them, all
kinds of different options for working out their debts. We've
got a Debtor's Bill of Rights. And this is something that I
think is important. People who think the principal problem is
credit cards and, in fact, the statistics show that it really
isn't because only 3.7 percent of consumer debt is accounted
for by credit cards. But nevertheless, we require credit card
companies to make it clear that if you only pay the minimum
balance, then you could be paying for the rest of your life.
They have to make it clear how long the debt will be sustained
if you only pay the minimum balance. That's the kind of
consumer information that is terribly important that I think is
a very progressive addition to this bill. We also are going to
make it very difficult for these bankruptcy mills to operate
that prey upon people who are in desperate situations.
We got 300 votes on the House floor last October 9th. This
is an even better bill from the standpoint of people are
concerned about consumer's rights, rightfully so. So we've
added even more. And it retains the discretion of bankruptcy
judges. It protects low-income debtors. It takes into account
the unique circumstances of individual debtors. It really only
goes after people who are using the system. We ought to be
going after them because it's not fair for 15 families who are
paying off their debts to also have to pay off the debt of
people who are not paying their debts, who are gaming the
system today.
So it's a good bill and it's bipartisan and it's balanced
and it ought to pass this committee.
Thank you, Mr. Chairman.
Mr. Gekas. We thank the gentleman for his commentary and to
thank him for being one of the chief cosponsors, which provides
the Chair with a segue into asking unanimous consent to permit
the statements of Bill McCollum and Congressman Boucher, also
original cosponsors of the legislation, to be entered into the
record?
[The information referred to follows:]
Prepared Statement of Hon. Bill McCollum, a Representative in Congress
from the State of Florida
I commend Chairman Gekas and Chairman Grassley for holding this
joint hearing on the need for bankruptcy reform. Members from both
sides of the aisle and both Houses of Congress have dedicated enormous
time and energy to reforming the existing bankruptcy system. The
Bankruptcy Reform Act of 1999, which has been introduced in the House,
is the product of that effort.
The Bankruptcy Reform Act of 1999 clearly strikes a balance between
House and Senate reform proposals. The legislation retains the needs-
based test supported by the House but uses the Senate procedure to
determine if someone should be in Chapter 13 rather than Chapter 7. The
bill includes the most protective provisions in both House and Senate
bills to safeguard support payments to women and children. There are
expanded protections for retirement savings and education savings
accounts. There are also new protections concerning reaffirmations and
penalties against creditors who act improperly. In addition, the
legislation includes new consumer protections regarding credit lending.
The Bankruptcy Reform Act of 1999 is a well-balanced compromise
which protects support payments to women and children, provides
additional consumer protections, and restores increased personal
responsibility to the bankruptcy system. Our nation's bankruptcy laws
play an important and necessary role in our society but we must ensure
that our bankruptcy system does not unintentionally encourage those who
can take responsibility for their financial obligations not to do so.
Such an abuse of our bankruptcy laws is fundamentally unfair to those
who play by the rules and take responsibility for their personal
obligations.
Congress has a special responsibility to address this issue and to
ensure that our bankruptcy laws operate fairly, efficiently and free of
abuse. I am confident that this hearing will highlight the need for
Congress to pass bankruptcy reform legislation and look forward to
working with my colleagues towards that end.
Prepared Statement of Hon. Rick Boucher, a Representative in Congress
from the State of Virginia
Chairman Grassley and Chairman Gekas, thank you for the opportunity
to appear before you and the Members of the Subcommittee on Commercial
and Administrative Law of the House Judiciary Committee and the
Subcommittee on Administrative Oversight and the Courts of the Senate
Judiciary Committee.
I was pleased to join in a bipartisan effort with Chairman Gekas
and my friends and colleagues Rep. Bill McCollum and Rep. Jim Moran in
introducing the Bankruptcy Reform Act of 1999. This legislation is
intended to ensure that our bankruptcy laws operate fairly, efficiently
and free of abuse. Our legislation is virtually identical to last
year's conference report which garnered the support of 300 of our House
colleagues. That report was the product of nearly two years of
hearings, mark-ups, deliberation and compromise.
In an era where real per-capita annual disposable income is
growing, unemployment rates are low and the economy is strong,
bankruptcies should be rare. However, bankruptcy filings are increasing
dramatically. In fact, in 1998, filings reached a record high of 1.4
million, with an estimated $50 billion in consumer debt discharged.
Bankruptcies of convenience are driving this enormous increase.
Bankruptcy was never meant to be used as a financial planning tool, but
it is becoming a first stop rather than a last resort because our
current bankruptcy system encourages people to walk away from their
debts regardless of whether they have the ability to repay any portion
of what they owe.
Responsible borrowers and the consumers of all goods and services
pay the price for bankruptcies of mere convenience. The typical
American family pays a hidden tax of $500 each year because of
increased charges for credit and higher prices for goods and services
attributed to bankruptcies of mere convenience.
Today's consumer bankruptcy system is fundamentally flawed. The
current Bankruptcy Code makes virtually no attempt to calibrate the
level of bankruptcy protection to the level of each debtor's need.
Rather, it allows a debtor to discharge debts even if the debtor can
repay a large portion of them. Currently, approximately 70 percent of
bankruptcy filers use Chapter 7, which has no provision for debt
repayment even if the filer can repay. Only 30 percent use Chapter 13,
which sets up repayment plans. At present, individuals with significant
income and the ability to repay some of their debts can obtain the same
full discharge of debts as individuals with little or no income and
assets.
Our legislation addresses this problem by requiring that a debtor
demonstrate that he or she actually needs bankruptcy relief and, if so,
provides only the amount of relief that is needed. This needs-based
system would create a simple formula, based on a debtor's income and
obligations, to determine exactly how much relief the debtor needs.
Individuals with no means to repay their debts could file for
bankruptcy under Chapter 7, thereby obtaining complete debt relief and
a fresh start. Individuals who can repay a portion of their debts would
file under Chapter 13 and begin a repayment plan based on what they can
afford.
With this change in the Bankruptcy Code, the bankruptcy system
would protect consumers in financial difficulty without unfairly
imposing inappropriate additional costs and burdens on consumers who
continue to pay their debts.
All consumers should benefit from this legislation--every consumer
pays higher prices for goods and services and higher interest rates as
a result of bankruptcy losses. Enactment of the ``Bankruptcy Reform Act
of 1999'' will reduce the level of those bankruptcy losses, thereby
reducing the cost of credit and goods and services for all consumers.
I am pleased to be a sponsor of this legislation and look forward
to working with each of you to ensure its passage.
Mr. Moran. Thank you, Mr. Chairman.
Mr. Gekas. Thank you. Now we are poised to hear the first
panel. And we invite to the witness table Dean Sheaffer. Mr.
Sheaffer is vice president and director of credit at Boscov's
Department Stores, Inc., a regional department store chain,
located primarily in New York, New Jersey, Maryland, Delaware,
and Pennsylvania. In addition to his responsibilities with
Boscov's, Mr. Sheaffer is vice chair of the Pennsylvania
Retailer's Association and vice president of Pennsylvania's
first statewide economic development corporation, Grow
Pennsylvania Capital.
He is testifying here today on behalf of the National
Retail Federation, which is the world's largest retail trade
association with a membership representing every facet of the
retail industry. The Federation represents an industry that
encompasses 1.4 million American retail establishments, which
in turn employ more than 20 million individuals across our
Nation.
He is joined at the table by Bruce Hammonds, who has 29
years of experience in consumer lending. His current
responsibilities include overseeing MBNA credit loss prevention
and consumer finance and technology services. A graduate of the
University of Baltimore, Mr. Hammonds is a director of the
Delaware State Chamber of Commerce, the Delaware Housing
Partnership, and the Delaware Business Roundtable. He also
serves on the board of trustees of Goldey Beacom College and is
a member of the College of Business and Economics Visiting
Committee at the University of Delaware.
MBNA America Bank, N.A. is the largest independent credit
card lender in the world and one of the two largest credit card
lenders overall. It has more than 20,000 employees in 28
offices located in the United States, Canada, and the United
Kingdom. MBNA and its subsidiaries have $60 billion in managed
loans outstanding.
With them at the table is the Honorable Carol J. Kenner,
United States bankruptcy judge, District of Massachusetts.
Judge Kenner was appointed a bankruptcy judge for the District
of Massachusetts in 1986 and served as chief judge from 1994
through 1996. She also has served on the Bankruptcy Appellate
Panel for the First Circuit since 1996. Prior to her
appointment to the bench, Judge Kenner practiced exclusively in
the areas of corporate reorganization and bankruptcy law in
private firms in Boston and New York City. Judge Kenner
obtained her Juris doctor degree magna cum laude from the New
England School of Law in 1977.
To the left of the judge is Larry Nuss, the manager and CEO
of the Cedar Falls Community Credit Union since 1979. Cedar
Falls Community Credit Union is an employee-based credit union,
which currently serves 83,000 members. Prior to his assuming
his responsibilities with Cedar Falls, Mr. Nuss was employed as
a collection manager for Rath Employees Credit Union from 1976
to 1979. Since 1981, Mr. Nuss has served as the director for
the Iowa Credit Union League. And in addition, currently is
vice chairman of that League.
Mr. Nuss is appearing today on behalf of the Credit Union
National Association, an organization that represents more than
11,000 State and Federal credit unions nationwide.
The final member of this panel is Gary Klein, who is well-
known to this committee. He is a senior attorney at the
National Consumer Law Center, where he specializes in consumer
bankruptcy, consumer credit, and foreclosure law. He is also
director of the Center's Sustainable Home Ownership Initiative,
which represents low-income homeowners. Mr. Klein has authored
several books on bankruptcy, on foreclosure, and on the Truth
in Lending Act.
The National Consumer Law Center is a nonprofit
organization that specializes in consumer credit issues on
behalf of low-income people.
As is our custom, we will produce for the record any
written statement that you may have offered, as you've already
submitted. Without objection, they'll be included in part of
the record. We'll ask each one of you to speak for about 5
minutes in summarization of your full statement.
We'll begin with Mr. Sheaffer.
STATEMENT OF DEAN SHEAFFER, VICE PRESIDENT AND DIRECTOR OF
CREDIT, BOSCOV'S DEPARTMENT STORE, INC., LAUREL DALE, PA,
REPRESENTING THE NATIONAL RETAIL FEDERATION
Mr. Sheaffer. Good afternoon. My name is Dean Sheaffer. I'm
vice president and director of credit for Boscov's Department
Stores. Boscov's is a family-owned regional department store
chain operating in the Mid-Atlantic States. Our largest number
of stores is in Mr. Gekas' home State, Pennsylvania.
I'm testifying on behalf of the National Retail Federation.
Boscov's is a member of the NRF, and I'm an active member of
its Credit Management Advisory Council.
I would like to thank the chairman for providing me with
the opportunity to testify before these distinguished
committees. I would also like to take just a moment to thank
the chairman, Mr. Gekas, for all of your hard work last year on
H.R. 3150. Your unique understanding of the retail position and
the retail issues is truly appreciated.
The National Retail Federation is the world's largest
retail trade association. The NRF members represent 1.4 million
U. S. retail establishments, employs 20 million Americans,
about one in five American workers, and registered 1998 sales
of $2.7 trillion.
NRF's members and their customers are greatly affected by
the recent surge in consumer bankruptcies. In the past 3 years,
national filings have risen more than 60 percent. In
Pennsylvania, our home State, chapter 7 bankruptcies have grown
by 90 percent in that same time period. Last year, there were
nearly 1.5 million bankruptcy filings. The overwhelming
majority of which were consumer bankruptcy filings.
Today, we have a strong economy. We set another record in
the stock market yesterday. We had the lowest unemployment in a
quarter of a century. And, yet, at the current rate of
bankruptcy filings, within the next decade one in seven
American families will have filed bankruptcy.
At Boscov's in 1994, we wrote off $1.2 million in
bankruptcy losses, about 35 percent of our total credit losses.
In 1997, that number had nearly quadrupled to $4.6 million, and
50 percent of our total credit losses. It is estimated that
over $40 billion nationwide was written off in bankruptcy
losses last year. That amounts to a discharge of $110 million
every single day.
When an individual declares bankruptcy rather than paying
the $300 they may owe Boscov's or the thousands of dollars they
may owe in State taxes or other bills, it forces the rest of us
to pick up their expenses. Last year to make up for these
losses, it costs each of our households hundreds of dollars.
I want to be clear, we cannot eliminate all of these
losses. Some of them are unavoidable. Bankruptcy must remain an
option for those who have experienced serious financial
setbacks and who have no other means for recovering. Most
people who file for bankruptcy need the relief. We must be very
careful to distinguish the average filer who uses the system
properly from the smaller but important group of others who
mis-use the system for their benefit. It is with this trend
that we must be concerned, with those who use the system to
wipe out their debts without ever making a serious effort to
repay them.
In my experience at Boscov's, the vast majority of our
customers pay as agreed. In the past we would occasionally see
a few customers whose payment patterns were more erratic. They
might fall behind a few months, make a few payments, catch up,
go back and forth. Today, however, we see a very different
picture. Often our first indication that a customer is in
serious financial difficulty is when we receive their petition
of bankruptcy.
Recently, we did a study and found that almost half of our
petitions for bankruptcy came from customers who were not
seriously delinquent on our account when they made the decision
to declare bankruptcy.
Last year, we strongly supported the bill introduced by Mr.
Gekas and Mr. Moran. It provided a simple, up-front, needs-
based formula that allowed the overwhelming majority of those
who needed bankruptcy relief in chapter 7 to have it with
virtually no questions asked. But for that sub-group of filers,
for those higher income individuals who would use chapter 7 to
push their debts on to others regardless of the filer's ability
to pay, the up-front, needs-based approach would have said,
``No, pay what you can afford.'' The Senate took a different
approach in S. 1301. They relied far more heavily on tweaks to
the current system to address the problem.
For retailers such as Boscov's, a typical balance on our
card in bankruptcy may be $500 or $600. With a recovery in a
chapter 13 bankruptcy being maybe 30 cents on the dollar, it
would not make economic sense for Boscov's to spend hundreds of
more dollars, it not thousands, to try to move a customer from
chapter 7 to chapter 13 to receive maybe $3 a month or $150 in
total recoveries.
In closing, on behalf of the National Retail Federation, we
urge Members of Congress to take swift legislative action to
address the problems confronting the Nation's bankruptcy
system. If we are not careful, the costs of the rising tide of
discretionary filings may tax society's compassion for those in
genuine need. We must not allow that to happen. I believe that
it is imperative for Congress to pass common sense bankruptcy
reform legislation this year consistent with H.R. 3150.
Thank you very much.
[The prepared statement of Mr. Sheaffer follows:]
Prepared Statement of Dean Sheaffer, Vice President and Director of
Credit, Boscov's Department Store, Inc., Laurel Dale, PA, representing
the National Retail Federation
Good Morning. My name is Dean Sheaffer. I am Vice President for
Boscov's Department Stores. Boscov's is a regional department store
chain primarily located New York, New Jersey, Maryland, Delaware, and
Pennsylvania. I am testifying on behalf of the National Retail
Federation. Boscov's is a member of NRF, and I am an active member of
its Credit Management Advisory Council. I would like to thank the
Chairmen for providing me with the opportunity to testify before these
distinguished committees.
The National Retail Federation (NRF) is the world's largest retail
trade association with membership that comprises all retail formats and
channels of distribution including department, specialty, discount,
catalogue, Internet and independent stores. NRF members represent an
industry that encompasses more than 1.4 million U.S. retail
establishments, employs more than 20 million people--about 1 in 5
American workers--and registered 1998 sales of $2.7 trillion. NRF's
members and the consumers to whom they sell are greatly affected by the
recent surge in consumer bankruptcies.
Bankruptcies are out of control. In the past 3 years, national
filings have risen more than sixty percent (60%). In Pennsylvania where
we are based, Chapter 7 bankruptcies have grown by 90 percent in that
same time period. Nationally, we continue to exceed the one million
filing record set in 1996. Last year there were nearly 1.5 million
bankruptcy filings, the overwhelming majority of which (more than 95
percent) were consumer filings.
Mr. Chairman, I would like to put these numbers in perspective.
Bankruptcy filings are nearly four times higher now than they were
during the much worse economic conditions that existed in 1980. Now, we
have a strong economy, a record setting stock market, the lowest
unemployment in a quarter of a century; the public is optimistic about
the future. And yet, if the current rate of filings holds (and it's not
going down) within the next decade, 1 in every 7 American households
will have filed for bankruptcy. The system is out of whack.
It is estimated that over $40 billion was written off in bankruptcy
losses last year, which amounts to the discharge of at least $110
million every day. This money does not simply disappear. The cost of
these losses and unpaid debts are borne by everyone else. When an
individual declares bankruptcy rather than pay the $300 they may owe to
Boscov's, or the thousand dollars they may owe in state taxes or other
bills, they force the rest of us to pick up their expenses. Everyone
else's taxes are higher, everyone else's credit is tighter, and
everyone else pays more for merchandise as a result of those who choose
to walk away. The nation's 100 million households ultimately pay that
$40 to 50 billion. Last year, to make up for these losses, it cost each
of our households several hundred dollars. This year's number threatens
to be even higher.
Now I want to be clear. We cannot eliminate all of these losses.
Some of them are unavoidable. Bankruptcy must remain an option for
those who have experienced serious financial setbacks and who have no
other means of recovering. The bankruptcy system exists to help those
who have suffered a catastrophic accident, illness or divorce, or those
who have experienced the loss of a business or job from which they
cannot otherwise recover. It is both the safety net and the last resort
for people in trouble. The knowledge that the bankruptcy system exists
to catch them in a financial fall, even though it might never be used,
is important. Finally, most people who file for bankruptcy need relief.
We must be very careful to distinguish the average filer, who uses the
system properly, from that smaller, but important group of others who
misuse the system for their benefit.
It is this trend with which we must be concerned. We believe
changing consumer attitudes regarding personal responsibility and
inherent flaws in our bankruptcy process have caused many individuals,
who do not need full bankruptcy relief, to turn to the system
regardless. They use it to wipe out their debts, without ever making a
serious effort to pay. Some of this change in usage results from a
decline in the stigma traditionally associated with filing for
bankruptcy. Some of it results from suggestions by others who urge
individuals to use bankruptcy to ``beat the system.'' Whatever the
cause, it must be stopped.
My experience at Boscov's, and that of credit managers at other
stores with whom I have spoken, convinces me of this fact. For example,
for many years we tracked the payment history of those of our customers
who carry and use the Boscov's card. The vast majority of our customers
pay as agreed. In the past, however, we would occasionally see
customers whose payment patterns were more erratic. They might fall
behind by a few months, make payments to catch up, fall behind again,
attempt to recover, and so forth. This kind of payment history
suggested to us that the customer was experiencing some sort of
financial difficulty. We would monitor the account and intervene as
necessary, perhaps by suggesting consumer credit counseling or by
limiting their credit line so as to minimize the amount of damage,
prior to their possibly experiencing a financial failure.
Today, however, we see a very different picture. Often the first
indication we receive that an individual is experiencing financial
difficulty is when we receive notice of his bankruptcy petition.
Recently at Boscov's, almost half of the bankruptcy petitions we
receive are from customers who are not seriously delinquent with their
accounts. The first indication of a problem is the notice that they
have filed for bankruptcy. It appears that bankruptcy is increasingly
becoming a first step rather than a last resort.
Individuals must have a good credit history to qualify for and
continue to use a Boscov's card. Yet we, and other retail credit
grantors, have been receiving bankruptcy filings without warning from
individuals who have been solid customers for years.
We all experience temporary financial reversals in life. Most of us
learn that, if you grit your teeth and tighten your belt a notch, you
can get through it. But many people no longer see it that way. The
rising bankruptcy filings reflect this. Professor Michael Staten at
Georgetown University analyzed thousands of Chapter 7 petitions in
courts all over the country. His review of debtors' own financial
statements gives a strong indication of what is going wrong.
Individuals have a choice as to whether to file in Chapter 7, which
generally wipes out all their unsecured debts, or if they file in
Chapter 13, often known as a wage-earner plan. Instead of wiping out
everything, a Chapter 13 filer attempts to pay as much as he or she can
afford and the court discharges the rest. Not surprisingly, most people
choose to file in Chapter 7.
But many people who are filing in Chapter 7 do have the ability to
pay some or all of what they owe. I understand that various studies
have pegged this number as being anywhere from 30,000 filers per year
to eight times that number. Whatever the figure, we should not treat
bankruptcy as a ``get out of debt free'' card that can be used by
thousands of filers every month, with virtually no questions asked.
Why are so many persons asking the court to make others pay their
debts for them? Why aren't they ashamed to go into bankruptcy court? We
think that there are a number of factors.
Part of it is lawyer advertising. We have all seen the ads on TV by
lawyers promising to make individuals' debts disappear. Some don't even
mention bankruptcy--they talk about ``restructuring'' your finances. I
question whether these aggressive advertisers inform their clients
about the serious downsides of filing for bankruptcy. There are also
bankruptcy petition preparers: clerk typists who simply fill out forms
for filers. The client may never meet a lawyer. And with the widespread
use of the Internet, websites that proclaim ``File bankruptcy for as
little as $99'' are multiplying. I firmly believe these low cost
``bankruptcy mills'' are part of the problem.
I also believe that part of the problem is the declining social
stigma associated with filing for bankruptcy. At a time when 1 in every
75 households files for bankruptcy, everyone knows someone, or knows of
someone, who has recently declared. Many of these individuals keep
their house and their car. They seem to have access to credit (although
in many cases what they actually have is a secured credit card--they
put $500 in the bank and they get a card with a $500 ``credit line'').
And their friends and neighbors, not seeing the details of their life
that bankruptcy disrupts, assume that bankruptcy is not the devastating
situation they always thought. And there have been a number of high
profile celebrity bankruptcies in recent years. I can't help but think
that this sends a message to the public that the stigma of bankruptcy
is fast disappearing.
Finally, these changes have revealed a flaw in the system itself.
Our bankruptcy code allows individuals to choose the chapter they wish
to file in, regardless of need. If shame won't keep the subgroup of
filers who could pay from either filing, or from filing in the wrong
chapter, Congress needs to establish a mechanism that will. It must be
simple, fair and efficient.
Last year, we strongly supported the bill introduced by Mr. Gekas
and Mr. Moran, H.R. 3150. It provided a very simple, up front needs-
based formula that allowed the overwhelming majority of those who
needed bankruptcy relief in Chapter 7 to have it with virtually no
questions asked. But for that subgroup of filers, for those higher
income individuals who would use Chapter 7 to push their debts onto
others regardless of the filer's ability to pay, the up front, needs-
based test would have said, ``No. Pay what you can afford, and society
will wipe out the rest.''
If individuals made less than the median income, or couldn't afford
to pay 20 percent of their unsecured debts, H.R. 3150 would allow them
to file in Chapter 7 without question. On the other hand, if an
individual could afford to pay 40 percent of what he owed, H.R. 3150
would require him to pay what he could afford and the court would wipe
out the remaining 60 percent. We strongly urged Congress to adopt that
approach.
The Senate took a different approach in S. 1301. It relied far more
heavily on tweaks to the current system to address the problem. I
believe that in some cases, that approach could work. Where their were
individuals who owed large amounts to single creditors and had the
ability to pay that amount, that creditor might undertake the risks of
legal action to seek payment. But in most cases, and especially for
companies like mine, it wouldn't work.
For retailers such as Boscov's, a typical balance on a Boscov's
card for a customer in bankruptcy is approximately $500. A recover in a
Chapter 13 proceeding might be 30 cents on the dollar. It would not
make economic sense for Boscov's to spend hundreds or more dollars in
an uncertain effort to move a petition from Chapter 7 to Chapter 13 to
recover $150 at $3 a month. This is not to say that $150 isn't
important to us. With tens of thousands of individuals filing for
bankruptcy, those losses add up. It is just that the up front approach
was far more efficient. This is why the National Retail Federation so
strongly supported the simple, up front approach.
Congress reached a compromise last year. Congress abandoned the
simple, up front approach for a more discretionary system. It added
numerous provisions designed to ensure that child support obligations
were the highest priority. It also added a number of Truth in Lending
provisions. We support some of these changes. Others will make it more
expensive or difficult for us to operate. Nevertheless, we believe that
Congress should pass legislation consistent with the conference report
of H.R. 3150.
In closing, on behalf of the National Retail Federation, we urge
members of Congress to take swift legislative action to address the
problems confronting the nation's bankruptcy system. Otherwise, in the
not too distant future, we may find that among a large segment of our
society, bankruptcy filings will become the rule rather than the
exception. If we are not careful, the costs of the rising tide of
discretionary filings may tax society's compassion for those in genuine
need. We must not allow that to happen. I believe that it is imperative
for Congress to pass common sense bankruptcy reform legislation this
year, consistent with HR 3150, that is fair, simple, and workable.
Mr. Gekas. We thank the gentleman. Now we interrupt this
program to introduce to the body Senator Biden, who has a long
history of involvement in the bankruptcy issues facing our
Nation, and who is here not only as a part of the joint panel
that we have produced for today's hearing, but also because he
has a personal interest in introducing a witness. Senator
Biden?
Mr. Biden. Mr. Chairman, thank you very much. I would like
the record to show my personal history in bankruptcy does not
mean I have ever filed. [Laughter.]
And I want to assure Mr. Nadler I haven't switched sides.
It was the most convenient seat.
Thank you, Mr. Chairman. I know you know the absence of
Senators here in this joint hearing is because we have 11 votes
in a row stacked. But I did want to come over, I know several
of my colleagues have been here, because I'm particularly glad
to have the opportunity to introduce Mr. Bruce Hammonds, the
senior vice chairman and chief operating officer of MBNA.
MBNA is headquartered in my hometown, Mr. Chairman, and is
one of Delaware's most important and responsible corporate
citizens, and, quite frankly, one of our largest employers in
the State.
And I just want to state for the record that Senator
Grassley and I, as you well know, Mr. Chairman, have been
working closely on the Senate side to craft a piece of
bankruptcy legislation that we believe can stand the test that
you do not have to stand over here called a filibuster. And
stand the test of bipartisan support. I'm sure it will be
different to some degree from what the House reports out, but
it is my hope that everyone recognizes there is a need for
serious reform of the system. And Senator Grassley, myself, and
Torricelli and others on the Judiciary Committee are trying to
duplicate the outcome we had last year as it related to the
vote count anyway to make sure we have an overwhelming vote in
the Senate side.
So I look forward to working with you and all of our
colleagues in the House Judiciary Committee to see if we can
come up with a serious piece of legislation that addresses the
problems. It will not be, as we say, all everyone wants, but I
do think there's an urgent need for us to move. And I might add
we've been told by the leadership on our side, Mr. Chairman,
that if we don't get something moving on our side in the very
near term, we are not going to have it brought up this year.
Now that is not your problem, that's our problem. But we're
working very hard at it.
And the last thing I'll say, Mr. Chairman, I always enjoy
coming over to the House Judiciary Committee. For years and
years of having chaired the Senate Judiciary Committee, I've
envied you in a number respects, one of which is your platform
is so much higher than ours. [Laughter.]
I always feel so much more important when I'm here than
when I'm in the Senate side. But I realize I'm taken as
seriously here as I'm there, so it's probably better I go back
and vote.
But thank you very much, gentlemen and ladies, for the
interruption.
Mr. Gekas. By all means. We thank you for your
participation, brief as it has been. And we'll keep you posted,
which is a segue into an announcement by the Chair that the
Senate practice and many times a House practice is that the
witnesses who appear acknowledge and are willing to submit
answers to questions, written questions posed by members of the
panel, be it from the Senate or the House side. I assume by
your presence here that you're willing to answer such
questions. You can report to your colleagues that any written
questions submitted will receive answers.
Mr. Biden. I thank the entire panel. Thank you, Mr.
Chairman.
Mr. Gekas. By all means. We now proceed to the testimony of
Mr. Hammonds, if he can live up to all of this.
STATEMENT OF BRUCE L. HAMMONDS, SENIOR VICE CHAIRMAN AND CEO,
MBNA AMERICA BANK, N.A., WILMINGTON, DE
Mr. Hammonds. I don't know. Thank you, Senator.
Mr. Chairman and members of the subcommittees, my name is
Bruce Hammonds. I'm senior vice chairman and chief operating
officer of MBNA America Bank, a national bank, which is the
third largest credit card lender in the world. I appreciate the
opportunity to appear today before the subcommittees.
The skyrocketing rise in consumer bankruptcies has impacted
nearly every lender, large and small, in every segment of the
lending community. In fact, more than $40 billion in consumer
debt, about $400 for each American family, was erased as a
result of bankruptcy in 1998. This underscores the fact that
while bankruptcy is an important protection for debtors who
need it, today's system lacks adequate concern for the great
majority of Americans who continue to pay their debts and who
ultimately bear the cost of bankruptcy losses in the form of
higher prices for goods and services.
The current bankruptcy system needlessly harms everyone
because of a fundamental flaw: it allows a debtor to discharge
debts even if the debtor can repay some or all of those debts.
In fact, today, a debtor may discharge his or her debts without
ever demonstrating actual need for such relief.
To address this flaw, the Bankruptcy Code must be amended
so that a debtor who needs bankruptcy protection will receive
it, but only to the extent of that need. This is essential to
ensure fairness for consumers and creditors alike. We believe
that a need-based bankruptcy approach of the type contained in
H.R. 833 would efficiently and fairly implement the kind of
needs-based bankruptcy that is necessary. Such an approach
would establish clear, objective standards for determining a
debtor's repayment capacity.
These standards are as follows. If the debtor can pay all
of his or her secured debt payments, priority debts, and living
expenses, and still have sufficient remaining income to repay a
portion of unsecured debts, the debtor will be required to
enter into a chapter 13 repayment plan. If the debtor cannot
repay, the debtor could freely choose to fall under chapter 7.
Needs-based bankruptcy also would assign debtors to the
appropriate chapter, that is to chapter 7 or to chapter 13 at
the start of the bankruptcy case. This would drastically reduce
the number of costly and needless disputes that occur in
today's system.
This brings me to an important point, needs-based
bankruptcy would create enormous efficiencies. It would
actually reduce the overall cost of consumer bankruptcy by
decreasing the litigation and disputes that result from today's
system. A needs-based system would largely run itself. The vast
majority of cases would move routinely through the system and
disputes would be limited to exceptional cases.
Without systematic needs-based bankruptcy relief, the
system will continue to be arbitrary, wasteful, and unfair to
the great majority of consumers who pay for the system, but
don't use it. Unless this flaw is addressed, controversy about
consumer bankruptcy will continue to intensify.
Finally, I would like to address several myths that you are
likely to hear: one, is that the bankruptcy system is not
broken. Instead, some say that credit cards are the real cause
of the explosion in personal bankruptcies. This claim is
absolutely false. The evidence does not support it. More than
96 percent of credit card accounts pay as agreed and only about
1 percent end up in bankruptcy. Bank card debt comprises less
than 16 percent of total debt on the average bankruptcy
petition. And in 1997, a Federal Reserve Board survey found
that credit cards account for a mere 3.7 percent of consumer
debt. Obviously, those figures are not large enough to be the
cause of the bankruptcy crisis.
Another myth is that lenders are offering credit willy-
nilly to people who cannot handle it. Once again, this simply
is not true. Card issuers use sophisticated underwriting
techniques to ensure that those who receive credit offers have
a demonstrated ability and willingness to repay their debts.
Let me tell you how we do it at MBNA. When we receive a
customer application, we pull a full credit card and do a debt
to income analysis. We call back over 20 percent of the
customers to obtain additional information. Then an analyst
makes a decision to approve or decline the account. If it is
approved, a risk rating is applied and often a senior lender
sign-off is also required. We believe we are making the right
decision every time. In fact, the majority of bankruptcies in
our file are on customers who have been with us for more than 3
years.
I thank the subcommittees for the opportunity to present
these views, and I would be happy to answer any questions you
may have.
[The prepared statement of Mr. Hammonds follows:]
Prepared Statement of Bruce L. Hammonds, Senior Vice Chairman and CEO,
MBNA America Bank, N.A., Wilmington, DE
Chairman Gekas, Chairman Grassley and Members of the House and
Senate, my name is Bruce L. Hammonds and I am Senior Vice Chairman and
Chief Operating Officer of MBNA America Bank, N.A. (``MBNA''),
headquartered in Wilmington, Delaware.\1\ My responsibilities include
overseeing MBNA's credit, loss prevention, customer satisfaction,
consumer finance and loan review activities. I have 29 years of
experience in consumer lending, and have been a member of the MBNA
management team since 1982.
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\1\ MBNA America Bank, N.A., a national bank, is the largest
independent credit card lender in the world and one of the three
largest credit card lenders overall. MBNA America Bank, N.A. and its
subsidiaries have $60 billion in managed loans outstanding and almost
20,000 employees in 28 offices located in the U.S., the United Kingdom
and Canada.
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I appreciate the opportunity to appear today before this joint
hearing of the Commercial and Administrative Law Subcommittee of the
Committee on the Judiciary, United States House of Representatives, and
the Administrative Oversight and the Courts Subcommittee of the
Committee on the Judiciary, United States Senate (the
``Subcommittees''), to discuss our views on consumer bankruptcy issues.
I hope that this statement will be helpful to the Subcommittees in your
deliberations on the nature of the consumer bankruptcy reforms that are
presently needed.
overview
Despite an extraordinarily strong economy, personal bankruptcy
filings in the U.S. have skyrocketed in recent years. During 1998, an
all-time record 1.4 million personal bankruptcy petitions were filed,
which represents about one for every 100 households nationwide. By
comparison, the number of consumer bankruptcy filings in 1980 totaled
287,570. This means that the number of consumer bankruptcy filings in
1998 represents an increase of nearly 400% since 1980.
These bankruptcy filings generate huge losses. While MBNA's credit
card losses have consistently been among the lowest in the business,
this precipitous increase in the number of consumer bankruptcy filings
has impacted virtually every lender, large and small, in nearly every
sector of the credit granting community. In fact, it is estimated that
more than $40 billion in consumer debt--approximately $400 for each
American family--was erased as a result of bankruptcy in 1998.
Inevitably, these losses are passed on to all consumers in the form of
higher rates and higher prices for goods and services.
Despite the magnitude of these losses, bankcard issuers and the
credit granting community more broadly believe that bankruptcy is an
important protection for consumers who are severely overburdened
financially. It should be noted, however, that as bankruptcy losses
grow, it is those American consumers who continue to pay their debts
who ultimately suffer the most because it is they who bear the cost of
bankruptcy losses in the form of higher credit prices. Consumers also
are harmed by increased bankruptcies when creditors, in an effort to
reduce losses, tighten their credit standards and thereby decrease
credit availability. As the Congress considers reform of the Federal
bankruptcy system, it is critically important to keep in mind the
adverse consequences bankruptcy has on the vast majority of consumers
who continue to pay their debts. The basic requirements of fairness
demand that a balance be restored between the interests of these
consumers and the interests of those consumers who need bankruptcy
relief.
the fundamental flaw
Unfortunately, today's consumer bankruptcy system does not strike
that balance. The current bankruptcy system unnecessarily harms
consumers and creditors alike because of a fundamental flaw--it allows
a debtor to discharge debts even if the debtor can repay some or all of
those debts. In fact, under the current Bankruptcy Code, an individual
debtor may obtain a discharge from contractual debt obligations without
ever demonstrating actual need for this relief. To put it in context,
this means that in 1998 alone, the Federal consumer bankruptcy system
provided an estimated $40 billion of relief to debtors without either
objective standards or systematic procedures for determining the actual
relief needed by debtors.
This flaw undermines not only the integrity of the U.S. bankruptcy
system, but also traditional obligations of individual responsibility.
Moreover, the current bankruptcy system also fails the debtors it is
intended to help, because it provides short-term relief without helping
debtors avoid the same financial failure in the future. In short, the
lack of objective and systematic procedures for determining debtor
relief produces a bankruptcy process which, for both debtors and
creditors, is needlessly costly and time consuming. The bottom line is
that this flaw must be remedied if the consumer bankruptcy system is to
be workable and fair to consumers and creditors alike.
fair, effective needs-based bankruptcy reform
To address this flaw, the Bankruptcy Code must be amended so that a
debtor who needs bankruptcy protection will receive it, but only to the
extent of that need. This approach would match the bankruptcy relief
provided by the Code to the debtor's actual need and is essential to
ensure fairness for all parties impacted by the bankruptcy process.
Bankcard issuers believe that a needs-based approach of the type
contained in H.R. 833, a bill introduced by Chairman Gekas and
Congressman Boucher with over thirty bi-partisan original co-sponsors,
would efficiently and fairly implement the kind of needs-based
bankruptcy approach that is necessary. We are joined in our strong
support for this reform by representatives of virtually every segment
of the consumer credit granting community.
The reformed Bankruptcy Code should establish clear and objective
standards for determining a debtor's repayment capacity. These
standards are as follows: if the debtor can pay all of his or her
secured debt payments, priority debts and living expenses and still
have sufficient remaining income to repay some portion of his or her
unsecured debts above a statutory minimum, the debtor would be required
to repay that portion through a Chapter 13 repayment plan, if the
debtor seeks the protection of the Bankruptcy Code. If the debtor
cannot repay, the debtor could freely choose to file under Chapter 7.
Moreover, a needs-based system would assign debtors to the
appropriate chapter--that is, to Chapter 7 or to Chapter 13--at the
start of the bankruptcy case. This would drastically reduce the number
of costly and time-consuming disputes that occur in today's system, in
which a debtor's Chapter 7 filing usually may be challenged only after
the case is well under way and only through a separate judicial
procedure. Once the needs-based bankruptcy system is established, the
Federal bankruptcy system will largely run itself and disputes will be
limited to exceptional cases.
systematic needs-based bankruptcy creates enormous efficiencies
This brings me to a very important point. While fundamental
fairness alone dictates that a needs-based bankruptcy system be
adopted, it should be noted that its implementation also would
introduce enormous efficiencies into the bankruptcy system. A needs-
based bankruptcy approach would actually reduce the overall costs of
consumer bankruptcy by decreasing the litigation and disputes that
result from today's arbitrary bankruptcy system. Under such an
approach, based on a simple calculation which is easily verified by the
trustee, individuals who can repay some portion of their debt would
automatically enter a Chapter 13 repayment plan, and those who cannot
would be free to enter into Chapter 7. As noted above, a needs-based
bankruptcy system would largely run itself: the vast majority of
bankruptcy cases would travel routinely and efficiently through the
system, and disputes would be limited to exceptional cases.
Without systematic needs-based bankruptcy relief, the U.S.
bankruptcy system will continue to be arbitrary, wasteful and
fundamentally unfair to the great majority of consumers who pay for the
system but do not use it. Unless this flaw is addressed, controversy
surrounding consumer bankruptcy will intensify, not diminish.
several myths
Finally, I would like to take a moment to address a couple of myths
that you are likely to hear repeated, possibly today and certainly in
the coming months. One is that bankruptcy reform legislation is
unnecessary because the system is not broken. Some will claim that
credit cards are the real cause of the explosion in personal
bankruptcies, and that restricting the availability of credit through
credit cards would solve this nation's bankruptcy crisis. I understand
that for many this is a tempting and popular position, but it is false.
The evidence simply does not support such a contention.
Instead, let's look at the facts. More than 96% of credit card
accounts pay as agreed, and only about 1% end up in bankruptcy.
Moreover, bankcard debt represents less than 16% of total debt on the
average bankruptcy petition and, according to a 1997 Federal Reserve
Board survey, credit cards account for a mere 3.7% of consumer debt--
hardly large enough figures to be the cause of the bankruptcy crisis.
Another popular myth is that credit grantors are intentionally
offering credit willy-nilly to people who cannot handle it. Once again,
this contention simply is not true. Card issuers use highly
sophisticated and expensive ``prescreening'' underwriting techniques,
which involve consideration of as many as hundreds of factors about a
consumer, to ensure that consumers who receive ``pre-approved'' offers
of credit have a demonstrated ability and willingness to repay their
debts.
Let me tell you specifically how we do it at MBNA. MBNA is the
second largest lender through credit cards in the world. We receive an
application from every customer, pull a full credit report on that
customer, and do a debt-to-income analysis. We call back over 20% of
the customers to develop additional information. A credit analyst will
then make a decision to approve or decline the account. If the account
is approved, a risk rating is applied and, in many cases, a senior
lender sign-off is also required. We believe we are making the right
decision every time. The majority of bankruptcies in our file are on
customers who have been on the books for more than three years and have
had some significant change in their financial condition.
The fact is, the overwhelming majority of Americans use credit
wisely and successfully. Americans use their cards to pay at the gas
pump, the grocery store and literally millions of other places. With
the advance of on-line security systems, consumers are increasingly
using their cards to conduct business and make purchases over the
Internet. And credit has made opportunities available for millions of
Americans who might not otherwise have had them, across a huge range of
income levels.
In addition, the lending industry spends millions of dollars every
year on education programs designed to help consumers use credit
wisely. The bankcard industry works particularly closely with the more
than 1,200 Consumer Credit Counseling Services offices around the
country, which help many thousands of consumers get control of their
finances and repay their debts. We are proud of the lending community's
far-reaching efforts to inform, educate and assist consumers.
Once again, I want to thank you for the opportunity to appear
before you today. Please let me know if we can be of any further
assistance to the Subcommittees or their staff.
Mr. Gekas. We thank the gentleman. And we turn to Judge
Kenner for the proscribed 5 minutes?
STATEMENT OF CAROL J. KENNER, U.S. BANKRUPTCY JUDGE, DISTRICT
OF MASSACHUSETTS, BOSTON, MA
Ms. Kenner. Thank you, Mr. Chairman, and members of the
subcommittee. My name is Carol Kenner. I've been on the
bankruptcy bench for 12 years. During that time, I've presided
over approximately 35,000 bankruptcies. And I'm honored to be
here today.
The current Bankruptcy Code on the whole is a well-
balanced, well-conceived statute, given that it must arbitrate
and balance the diverse needs of creditors, debtors, and
others. I think it works remarkably well. It is a law that
Congress should be justifiably proud of because it provides an
effective mechanism for paying dividends to creditors while
affording debtors a fresh start. It does provide an essential
safety net for American families and individuals who have hit
hard times. And these hard times can be a job loss. They can be
divorce, separation, health problems, and other causes. But the
people I see on a day-to-day basis are compelled to file
bankruptcy because of those reasons. I'm not suggesting that
the law is perfect, but I think it only needs to be fine-tuned.
I would like to focus on the subject of reaffirmation
agreements because I think this is an area where Congress may
want to consider making some changes. A reaffirmation agreement
is an agreement between a debtor and a creditor whereby the
debtor agrees to pay part or all of the debt that would
otherwise be dischargeable. Congress put some safeguards in the
law to make sure the debtors didn't reaffirm debts imprudently
and without fulling understanding what they're doing.
Unfortunately, some of those safeguards I believe aren't
fulfilling the goals the Congress designed them for.
For example, today a reaffirmation agreement only requires
court approval if the debtor's attorney doesn't sign the
affidavit saying that he has explained to the debtor all of his
rights. But the affidavit procedure isn't working. In fact, it
drives a wedge between the debtor and his counsel because what
typically happens, as I see on a day-to-day basis, is that the
debtor says, ``I want to reaffirm the debt on my washing
machine and in order to do that, I've got to pay the $300 value
of the washing machine.'' The lawyer says, ``You can't afford
this.'' The client says, ``Sign here, please.'' And that
reaffirmation agreement escapes scrutiny of the bankruptcy
court.
I think all reaffirmation agreements should go before the
bankruptcy judge. And I know that that's going to put a burden
on me and my colleagues, but it's a burden I think we must bear
because it has such a substantial impact on whether the
bankruptcy system fulfills its goals.
Another way that reaffirmations have to be re-looked at is
I think debtors have to know what the bottom line cost is. They
come before me and they say, ``I want to reaffirm a debt on
this gas grill that's currently worth $100.'' But they're going
to pay for it over time in increments of maybe of $10, $15. The
bottom line is that the cost of that gas grill might very well
be $500 and the debtors don't understand what they're getting
into.
Sometimes debtors reaffirm debts in the mistaken belief
that it will provide them with a line of credit in the future
and that otherwise it will be difficult or impossible after
bankruptcy to obtain that credit line. That's simply
inconsistent with my experience.
My time is short, but I think the treatment of secured debt
requires some special attention. And I think that Congress
needs to examine whether there is truly a secured debt interest
in a household good, such as a mattress or a baby crib. Because
if the creditor is going to repossess the baby crib only to
take it to the town dump, then I think we need to re-examine
the protections that we're providing for American families.
As you consider the Bankruptcy Code revisions and these
questions, I ask that you address these concerns.
Thank you.
[The prepared statement of Judge Kenner follows:]
Prepared Statement of Carol J. Kenner, U.S. Bankruptcy Judge, District
of Massachusetts, Boston, MA
Mr. Chairmen and members of the Subcommittees, my name is Carol J.
Kenner. I have served as a United States Bankruptcy Judge for the
District of Massachusetts for the last 12 years and during that time
presided over more than 35,000 bankruptcy cases. I am honored to be
here today.
The current Bankruptcy Code, on the whole, is a well-balanced and
well-conceived statute, given that it must arbitrate and balance the
diverse needs of creditors, debtors and other constituencies. It works
remarkably well. It is a law that Congress should be justifiably proud
of because it provides an effective mechanism for paying dividends to
creditors while affording debtors a fresh start. My purpose today is to
offer observations, gleaned from daily administration of this law over
the last twelve years, as to whether, in practice and with respect to
discrete concerns, the current law is fulfilling the goals that
Congress intended.
I would like to focus on the subject of reaffirmation agreements. A
reaffirmation agreement is an agreement between a debtor and a creditor
where the debtor agrees to pay a debt that would otherwise be entirely
or partially discharged in the debtor's bankruptcy case. When Congress
enacted the Bankruptcy Code, it sought to protect financially-burdened
families seeking chapter 7 relief from compromising their fresh start
by making unwise agreements to pay dischargeable debt.
For example, suppose the debtor files a chapter 7 case. At the
meeting of creditors, a Bank creditor or credit card company asks the
debtor if he wants to reaffirm his $3,000 unsecured debt in exchange
for the Bank's agreeing to let him keep the credit card after the
bankruptcy. By reaffirming the $3,000, the debtor is giving up his
right to discharge that debt.
The reaffirmation agreement REVIVES the legal enforceability of the
debt. So when a debtor chooses to reaffirm a debt, that agreement
negates one of the primary goals of bankruptcy: giving the debtor a
fresh start and enabling him or her to resume a role in the economic
mainstream. Instead of exiting bankruptcy with a fresh start, the
debtor remains liable on a debt that otherwise would have been wiped
out.
Congress very wisely established safeguards that are intended to
insure that debtors do not reaffirm debts imprudently and without full
understanding of what they are doing. Most notable among these is the
requirement that, before a reaffirmation agreement can become
effective, the debtor's attorney must certify, or (if the debtor is not
represented by counsel or counsel refuses to make the necessary
certification) the Court must find, that--
1. Lthe agreement represents a fully informed and voluntary
agreement by the debtor;
2. Lthe agreement does not impose an undue hardship on the
debtor or a dependent of the debtor; and
3. Lthe debtor has been fully advised of the legal effect and
consequences of--
(i) a reaffirmation agreement and
(ii) any default under such an agreement.
As paternalistic as this safeguard may sound, experience demonstrates
that it is necessary. Unfortunately, for various reasons, the present
safeguard is not enough. The current law on reaffirmation agreements
often does not fulfill the goals that Congress intended.
Debtors often make the decision to reaffirm (1) without
understanding the legal effect of what they are doing, (2) without
understanding its financial cost, and (3) without understanding their
alternatives. Often, they must make the decision in intimidating
circumstances. Often the creditor is suddenly threatening to repossess
a necessary asset that the debtor can't afford to replace--such as the
car they need to get to work or their family refrigerator. Debtors tell
me that they feel intimidated by having to appear for their meeting of
creditors (many reaffirmation agreements are obtained at the meeting of
creditors) and by the creditor seeking the reaffirmance. Often they
have no advance warning that they will have to face this issue. And
often their attorney is not with them when the creditor approaches, if
they have an attorney at all. Although the current statute gives
debtors time to rescind agreements made imprudently and requires that
the agreement advise the debtor of this option, the creditor does not
leave a copy of the signed agreement with the debtor, so the debtor
does not know of his or her option to rescind.
Another problem is that the requirement of the attorney declaration
can drive a wedge between the attorney and client. The attorney may
recognize that the client can't afford to pay the monthly charge, yet
the client insists that the car or refrigerator is essential.
Understandably, very few attorneys resolve this tension by standing
firm against the client; most simply facilitate the client's decision
to reaffirm by providing the necessary declaration.
Congress may want to consider the following:
a.
LToday, a reaffirmation requires court approval only when
the reaffirmation agreement is filed without an affidavit from
the debtor's attorney. I believe Congress should consider
requiring court approval for ALL reaffirmation agreements. I
recognize that such a provision would place a burden on
bankruptcy judges, but this is a burden I am willing to bear
because it has such a substantial impact on whether our
bankruptcy system fulfills its goal of providing debt relief to
needy individuals and families.
b.
LThe financial impact of reaffirming a debt should be
absolutely clear. Debtors need to know the principal amount of
the debt, the interest rate, and the liquidation value of the
collateral; and, most importantly, they need to know the
bottom-line cost. Debtors need the same kinds of disclosures
that Congress requires in the Truth-in-Lending law.
c.
LSometimes a debtor reaffirms an unsecured debt in the
mistaken belief that it will permit him to obtain a line of
credit in the future and that, otherwise, it will be difficult
or impossible for him to obtain credit. This belief is
inconsistent with my experience. Debtors' attorneys tell me
that their clients are obtaining credit post-bankruptcy quite
easily. And debtors can certainly use debit cards or secured
credit cards if they need a card.
d.
LSometimes a debtor reaffirms a debt in response to a
complaint by the creditor that the debt is nondischargeable on
account of fraud. The best place for the Court to evaluate the
merits of the reaffirmation agreement is in the context of an
adversary proceeding to determine the dischargeability of the
debt.
e.
LThe treatment of secured debt requires careful thought. A
debtor who wants to keep household goods or his car needs to
understand what his options are. Most don't appreciate that one
of the options is redeeming the collateral. But, realistically
can a debtor redeem the collateral, such as a car, by paying
the creditor the current value of the car in cash, in one lump
sum payment? Most debtors I hear from can't do so. They would
have great difficulty in making lump sum payments--they live
from hand to mouth, paycheck to paycheck. They could perhaps
redeem over time--perhaps 6 months--but they simply cannot do
so in a lump sum without taking food off the table for the
family.
f.
LSometimes a debtor reaffirms a debt where the collateral is
a household item such as a mattress or a crib. In those cases,
there is rarely a market for such used goods and, as a
practical matter, the likelihood that the creditor will
foreclose is remote. I have trouble understanding why the
creditor should be permitted to repossess the mattress and then
merely cart it to the city dump.
g.
LProposed section 125 of H.R. 833 (formerly H.R. 3150) is
problematic because it defines the value as the price a retail
merchant would charge for property of that age and condition--
but in fact there is rarely a market for such used household
goods.
h.
LThe debtor needs to be given a copy of the executed
reaffirmation agreement in order to better enable him or her
(1) to reconsider the agreement and (2) to know of the option
to rescind.
i.
LIf the debtor is reaffirming a debt that is entirely
unsecured, the debtor should state why he or she is doing so.
j.
LSometimes a debtor reaffirms a debt in response to a
creditor's threat to bring a nondischargeability action. In
some cases there is little or no basis for such a suit. In
order to evaluate whether that reaffirmation agreement is
reasonable, the Court needs information from the parties. Many
families in bankruptcy simply cannot afford to defend against
claims of nondischargeability.
k.
LSometimes the debtor reaffirms an unsecured debt because
his mother-in-law co-signed the loan and he wants to protect
the guarantor. I can't understand why such a reaffirmation
would ever be in the debtor's interest: nothing prevents him
from voluntarily paying a debt that's been discharged in order
to keep peace in the family, but he need not legally bind
himself on the debt in order to do that.
As you consider the Bankruptcy Code and the need for reform, these
are the concerns I would have you address. Thank you for your
consideration.
Mr. Gekas. We thank the Judge and we'll return to her
during the question and answer period.
Mr. Nuss.
STATEMENT OF LARRY NUSS, CEO, CEDAR FALLS COMMUNITY CREDIT
UNION, CEDAR FALLS, IA, REPRESENTING THE CREDIT UNION NATIONAL
ASSOCIATION, INC.
Mr. Nuss. Good afternoon, Chairman Gekas and members of the
subcommittees. I am Larry Nuss, CEO of Cedar Falls Credit Union
in Cedar Falls, Iowa, and I very much appreciate the
opportunity to be here to tell you about our concerns with the
increasing number of bankruptcies and how this is impacting
credit unions. I am speaking on behalf of the Credit Union
National Association, CUNA, which represents over 11,000 State
and Federal credit unions nationwide. Our credit union is a $33
million State-chartered, Federally insured credit union.
Along with other creditors, credit unions are experiencing
an increase in bankruptcy filings with almost half of all
credit union losses due to bankruptcy. Cedar Falls Community
has seen a significant increase in chapter 7 bankruptcy filings
which cause the greatest loss to the credit union. I refer you
to my full written statement for the statistics.
Credit unions clearly recognize the value of financial
counseling for their members, such as a consumer credit
counseling service. However, even with financial counseling, we
certainly recognize that there are some instances in which
bankruptcy may be the only alternative for members, the way for
them to get the needed fresh start.
Credit unions want to help their members avoid financial
difficulty through learning to manage their credit. More
emphasis should be placed on consumer financial education so
people can learn how to manage credit and what the alternatives
to bankruptcy are. Therefore, CUNA strongly supports the
provision in H. R. 833 requiring the debtor to receive credit
counseling prior to filing for bankruptcy and prohibits the
chapter 7 or 13 debtor from receiving a discharge if the debtor
does not complete a course in personal financial
responsibility.
We also support the provision in the bill that requires a
consumer debtor to be given a notice about bankruptcy and a
description of credit counseling services. Any sensible
bankruptcy reform should include education provisions so
debtors have the tools to make wise decisions about filing for
bankruptcy and to succeed financially after bankruptcy.
Therefore, we support the sense of Congress in H.R. 833 that
each of the States should develop curriculum on personal
finance for elementary and secondary schools.
Credit unions are currently going into their local schools
and teaching students about money management. For example, in
the 1997, 1998 school year through the National Youth
Involvement Board, which is a network of credit union volunteer
professionals, they visited classrooms across the country to
educate students about the wise use of credit, savings options,
budgeting, and careers.
I have provided the committee members with a copy of a CUNA
publication, savingteen, which highlights financial literacy in
youth and I would ask that this publication be submitted for
the record.
Mr. Gekas. Without objection, it will be entered into the
record.
[The information referred to follows:]
Mr. Nuss. Thank you, Mr. Chairman. Through various new
initiatives, CUNA is developing an even more aggressive
strategy to promote consumer financial education.
Because we are a nonprofit, cooperative financial
institution, losses to the credit union have a direct impact on
the entire membership due to a potential increase to loan rates
or a decrease in interest on savings.
Credit unions believe that reaffirmations are a benefit
both to the credit union and to the member who by reaffirming
with the credit union continues to have access to financial
services and to reasonably priced credit. We are also aware of
concerns with cases of abusive creditor practices, but the
current Bankruptcy Code caught the violators and the size of
the penalties imposed will act as a deterrent to others. The
ability of credit unions to enter into reaffirmation agreements
with their members is so important that if reaffirmations were
severely limited or made not usable, CUNA would strongly oppose
bankruptcy reform legislation regardless of what the rest of
the bill might contain.
Reaffirmations can be vital to credit union members. We
recently had a case where a young couple with three children
accumulated too much debt. We attempted to work out a debt
consolidation loan for that family, but all creditors were not
willing to cooperate. The young mother was working part-time,
going to school to obtain a degree to try to increase her
earnings. Unfortunately, a medical problem arose last year
which pushed the limits of the family budget and they filed a
chapter 7. This couple did not want to cause a loss to their
credit union because we had worked closely with them to respond
to their financial crisis and, more importantly, they wanted to
preserve the needed access to financial services and reasonable
credit. So they did reaffirm with the credit union.
Credit unions are very anxious to see Congress enact
meaningful bankruptcy reform and believe that needs-based
bankruptcy presents the best opportunity to achieve this
important public policy goal. Credit unions believe that
consumers who have the ability to repay all or some part of
their debts should be required to file a chapter 13 rather than
have all their debt erased in chapter 7. Therefore, CUNA
supports the needs-based provision that is contained in H. R.
833.
My full written statement contains the credit union's
bankruptcy statistics and in looking over some of the cases we
have experienced over the past few years, I honestly believe
there are cases in there where the debtor could have paid at
least part of that debt under a chapter 13 filing.
In conclusion, let me say that I am very pleased you are
holding this hearing today. The 105th Congress strongly
supported needs-based bankruptcy and this hearing today shows
that the 106th Congress is continuing to move toward passage of
bankruptcy reform legislation. We encourage Congress to push
for passage of such bills before Congress' fall recess.
Thank you.
[The prepared statement of Mr. Nuss follows:]
Prepared Statement of Larry Nuss, CEO, Cedar Falls Community Credit
Union, Cedar Falls, IA, representing the Credit Union National
Association, Inc.
Good afternoon, Chairman Grassley and Chairman Gekas, and members
of the Senate and House Judiciary Subcommittees. I am Larry Nuss, CEO
of Cedar Falls Community Credit Union in Cedar Falls, Iowa, and I very
much appreciate the opportunity to be here to tell you about our
concerns with the increasing number of bankruptcies and how this is
impacting credit unions. I particularly want to tell you what affect it
is having on my credit union. I am speaking on behalf of the Credit
Union National Association (CUNA), which represents over 11,000 state
and federal credit unions nationwide. We are very pleased that this
joint hearing is being held today on the important issue of consumer
bankruptcy reform and that we have this forum to lend our support of
meaningful bankruptcy reform legislation.
Cedar Falls Community is a $33 million state-chartered, federally
insured credit union. We were first chartered in 1958 as an employee-
based credit union. Due to expansion and mergers, the credit union now
has a community charter and currently serves 8,300 members who reside
in or work for a business located in the Iowa countries of Bremer and
Black Hawk and the employees of Beatrice Cheese in Fredericksburg,
Iowa. Family members are also eligible for membership.
We invest in our members who clearly use the credit that we offer.
Currently, we have over $25.5 million in loans to our members: $13.1
million in auto loans; $1.2 million in mortgages; $5.5 million in home
equity loans; $1.5 million in other real estate loans; $1.3 million in
other secured loans; $1 million in unsecured loans; and $2.2 million in
credit card accounts.
We do offer credit cards to students, but the line-of-credit is
dependent on the member's monthly gross income. In some cases we
require the credit card to be secured by deposits in the credit union
or be co-signed by the parent. We recently approved a $2,000 line of
credit for a student when the parent agreed to co-sign because the
student applicant only qualified for a $500 line of credit. The reason
we did this was the student wanted our credit card so he could pay off
an existing credit card with a much higher interest rate.
Nationwide bankruptcy filings exceeded 1.4 million in 1998, which
was a 2.7 percent increase from the 1997 filings. In fact, bankruptcy
filings have set records in 1996, 1997, and 1998. And it is not
anticipated that there will be a decrease to these high numbers for
1999. Consumer bankruptcy filings made up 96.9 percent of those 1998
filings. Credit unions are quite concerned about this steady increase
in bankruptcy filings nationwide in the last few years because they
have seen a similar increase in the number of credit union members who
file. Preliminary data from credit union call reports to the National
Credit Union Administration show that credit unions had approximately
253,000 filings in 1998, which is an increase to the 250,000 filings in
1997. The 1997 figures were an increase of 20% over 1996 levels, and
the 1996 filings were 35% higher than the 1995 figures. CUNA estimates
that almost half of all credit union losses in 1998 were bankruptcy-
related and that those losses reached $684 million. In Iowa, bankruptcy
filings by credit union members remained near all-time highs in 1998 at
2,169 filings. In each of the last three years Iowa credit unions
reported bankruptcies per thousand members of 2.6 or higher.
Similar to the national figures, but on smaller scale, Cedar Falls
Community has seen a significant increase in chapter 7 bankruptcy
filings, which cause the greatest loss to the credit union. In 1995 we
had 17 chapter 7 filings; the number increased to 21 in 1996, to 24 in
1997, but dropped somewhat to 18 in 1998. On the other hand, we have
very few chapter 13 filings; zero in 1995; 4 in 1996; 2 in 1997; and 1
in 1998, that converted to a chapter 7. Our losses due to bankruptcy
have also increased--from almost $20,000 in 1995, doubling to just over
$40,000 in 1997, and then dropping off some in 1998 to almost $35,000.
As a cooperative not-for-profit credit union, a loss due to
bankruptcy impacts the entire membership. Therefore, we are proactive
in combating the number of bankruptcies with our careful lending
policies. We require a written application for all loans, including
credit card applications. Prior to making a decision to extend the
credit, we review the member's credit report and carefully determine
that the applicant has the ability to repay before extending credit. We
verify income and see that a reasonable debt-to-income ratio would not
be exceeded by a credit extension. We routinely monitor our credit
cards, and we do not increase the credit limit unless a member
specifically makes the request for an increase, and we do so only after
a review of the member's current debt and ability to repay.
credit unions support financial education
Credit unions clearly recognize the value of financial counseling
for their members. According to a recent CUNA bankruptcy survey, 70% of
credit unions counsel financially troubled members at the credit union.
A similar percentage of credit unions may also refer members to an
outside financial counseling organization, such as the Consumer Credit
Counseling Service (CCCS), and many do both. At Cedar Falls Community
we refer those members who are experiencing financial difficulties to
the local CCCS and have found that beneficial for the members and their
families. A credit union staffer is beginning her second year as
director of that local CCCS. In addition, we try to counsel our members
when they are confronted with credit problems. Our loan officers are
encouraged to work with members who are experiencing payment problems.
We have 55 members who have established separate saving accounts which
the credit union can access to pay designated creditors on a periodic
basis. We encourage our members to contact their other creditors to
negotiate reduced payments and and/or payoffs so the credit union can
provide a consolidation loan and /or automatic repayment for the
member. When we receive a credit application and discover the member
has outstanding collections or judgments, we work with those members.
We may suggest that they agree to a six-month payment plan to
demonstrate an effort to satisfy those obligations. Or, we may suggest
they consider a monthly deposit in an account at the credit union which
can be used to pay off those obligations. Subsequently, we will review
their credit request. Because of our belief that financial education is
so important, we even reach out to our community schools--our credit
union staff conducts classroom courses in credit at the local junior
and senior high schools.
However, even with financial counseling, we certainly recognize
that there are some instances in which bankruptcy may be the only
alternative for members, the way for them to get the needed ``fresh
start.''
Credit unions want to help their members avoid financial difficulty
through learning to manage their credit. We believe that more emphasis
should be placed on consumer financial education so people can learn
how to manage credit and what the alternatives to bankruptcy are. The
CUNA Bankruptcy Subcommittee recently reported that ``[e]ducation was
found as one of the most promising strategies to consider in attempting
to reverse the trends in bankruptcy.'' Credit unions have found that
educating their members about credit and how to use it can be an
effective deterrent to filing for bankruptcy.
Therefore, CUNA strongly supports the provision in H.R. 833, the
House bankruptcy reform legislation, that requires the debtor to
receive credit counseling prior to filing for bankruptcy and prohibits
the chapter 7 or 13 debtor from receiving a discharge if the debtor
does not complete a course in personal financial responsibility.
Recognizing that consumers need to know more about alternatives to
bankruptcy so they can make a more informed decision, we also support
the provision in the bill that requires a consumer debtor to be given a
notice about bankruptcy and a description of services from trustee-
approved credit counseling services. Any sensible bankruptcy reform
should include education provisions to give debtors the tools they need
to make wise decisions about filing for bankruptcy and to succeed
financially after bankruptcy.
In addition, credit unions recognize that financial education needs
to be made available early on and before consumers experience financial
problems. Therefore, we support the sense of Congress that each of the
states should develop curriculum on personal finance for elementary and
secondary schools. Credit unions are currently going into their local
schools and teaching students about money management. In addition, the
National Youth Involvement Board (NYIB), a national network of credit
union volunteer professionals, helps credit unions to educate young
members. During the 1997-1998 school year more than 5,000 credit union
speakers visited classrooms across the country, and as a result, more
than 110,000 students heard about the wise use of credit, savings
options, budgeting, and careers.
Many credit unions also devote office space for consumer libraries
that enable members to use a wide range of financial periodicials,
manuals, and books to learn more about money management and to research
buying decisions, retirement plans, and a host of other issues relating
to personal finance. And, through various new initiatives, CUNA is
developing an even more aggressive strategy to promote consumer
financial education.
credit unions support reaffirmations as a benefit both to the member
and to the credit union
Because we are a not-for-profit cooperative financial institution,
losses to the credit union have a direct impact on the entire
membership due to a potential increase to loan rates or decrease in
interest on savings. Therefore, we have a policy that if a member
causes a loss to the credit union, services to that member, aside from
maintaining a share account, will be withheld. Our credit union members
take this policy seriously and continue to reaffirm on their credit
union loans.
Credit unions believe that reaffirmations are a benefit both to the
credit union, which does not suffer a loss, and to the member, who by
reaffirming with the credit union continues to have access to financial
services and to reasonably priced credit. We are aware of concerns of
abusive creditor practices, recently highlighted in high profile press
coverage, but note that the current Bankruptcy Code, in fact, caught
the violators. The size of the penalties imposed will undoubtedly act
as a deterrent to others. The ability of credit unions to enter into
reaffirmation agreements with their members is so important that if
reaffirmations were severely limited or made not usable, CUNA would
strongly oppose bankruptcy reform legislation regardless of what the
rest of the bill might contain.
As I said, reaffirmations are very important to credit unions, and
they can be vital to the credit union member. For example, a young
couple, members of our credit union and parents of three children, had
accumulated too much credit card debt. We first attempted to work out a
debt consolidation loan for them, but not all the creditors were
willing to cooperate. While working part-time, the mother went back to
school to get a degree that would increase her earnings. Unfortunately,
a medical problem pushed the limits of the family budget, and they
filed a chapter 7. This couple did not want to cause a loss to their
credit union, recognizing we had worked closely with them to try to
respond to their financial crisis, and more importantly, they wanted to
preserve the needed access to financial services and reasonable credit.
credit unions support needs-based bankruptcy
Credit unions are very anxious to see Congress enact meaningful
bankruptcy reform and believe that ``needs-based bankruptcy'' presents
the best opportunity to achieve this important public policy goal.
Credit unions believe that consumers who have the ability to repay all
or some part of their debts should be required to file a chapter 13,
rather than have all their debt erased in chapter 7. Therefore, CUNA
supports the needs-based provision that is contained in H.R. 833. This
provision was a compromise developed out of the bankruptcy reform bills
that received overwhelming support in the 105th Congress.
Earlier, I cited my credit union bankruptcy statistics from the
last four years. Out of 86 bankruptcies, only 6 were in chapter 13.
And, looking over these I believe there are cases in which the member
who filed a chapter 7 would have been able to pay back some of the
debts in a chapter 13. For example, just last summer our attorney
during examination at the 341 hearing got evasive answers from a debtor
about the schedules he filed and the information he had provided on his
financial statement to the credit union. It seemed pretty clear from
our records that the debtor did have an ability to repay some of his
debts. However, our lawyer advised us that the cost to pursue the issue
would be more than we could recover, and so we did not do it. With its
random audit requirement needs-based bankruptcy should ensure that
debtors provide accurate schedules and documentation of income and
thus, those who can repay some part of their debts would be required to
do so.
Again, let me say that I am pleased you are holding this hearing
today. The 105th Congress strongly supported needs-based bankruptcy,
and this hearing today shows that the 106th Congress is continuing to
move toward passage of bankruptcy reform legislation. We encourage
Congress to push for passage of such bills before Congress' fall
recess.
Again, let me say I appreciate the opportunity to testify today
before this committee and would be happy to answer any questions.
fact sheet
cedar falls community credit union
cedar falls, iowa
Total assets: $33 million
Number of members: 8,300
Total loans: $25.5 million
Total charge-offs due to bankruptcy:
1998: $34,813
1997: $40,237
1996: $39,353
1995: $19,848
Number of filings: Chapter 7 Chapter 13 Total
1998: 18 1 (converted to 7) 18
1997: 24 2 26
1996: 21 4 25
1995: 17 0 17
Mr. Gekas. We thank the gentleman, and we turn to Mr. Klein
for the customary 5 minutes.
STATEMENT OF GARY KLEIN, ESQUIRE, SENIOR ATTORNEY, NATIONAL
CONSUMER LAW CENTER, BOSTON, MA
Mr. Klein. Mr. Chairman and distinguished members of the
joint committee. Good afternoon, my name is Gary Klein. I'm a
senior attorney with the National Consumer Law Center.
Throughout my career, I have represented working families, the
elderly, and other consumers with severe financial problems who
have little alternative other than to turn to the bankruptcy
system. It is the experiences of these families that has
spurred me to work for balanced and fair bankruptcy
legislation.
Although the views I express to you today are mine, in the
last several years, I have been joined by a wide range of
organizations, including those representing consumers, women
and children, working families, labor, the civil rights
community, older Americans, and the guardians of the system,
bankruptcy judges. These groups oppose, as do I, the kind of
one-sided, radical, and unbalanced bankruptcy overhaul that was
contained in last year's conference report and which has been
re-introduced this year as H.R. 833.
Earlier, H. R. 833 was represented to be a pro-consumer
bill. I am here today as a consumer advocate to tell you that
it is not so. I have a simple message. Last year's failed
conference report should not serve as your starting point in
developing legislation this year. You have a real opportunity
in the spirit of bipartisanship and respect for the historical
balance that has guided past bankruptcy legislation to move
expeditiously and fairly to pass a bankruptcy reform bill.
This lesson was driven home in the closing weeks of the
105th Congress when the Senate passed bipartisan legislation,
97 to 1, that required accountability from both debtors and
creditors for conduct that contributes to bankruptcy. Though I
don't agree with each and every provision in that bill, I
commend its bipartisan and balanced approach.
Unfortunately, the Senate approach was rejected in the
closing hours of the 105th Congress. And not surprisingly that
rejection, as embodied by the conference report, failed to be
enacted into law.
But there was a lesson to be learned from that experience.
It was that legislation cannot be predicated on the myths that
had permeated the debate during the first year and a half of
the 105th Congress, and which have been repeated here today. I
would like to examine a few of those myths.
Myth No. 1 is that everyone can repay their debts because
the economy is booming. The reality is that there have been
extraordinary structural changes to the economy that have left
millions of American families struggling.
First, it often takes two wage-earners to make a middle-
income family's budget work. With an increase in divorces,
single-parent households, and with the skyrocketing cost of
childcare, many women are unable to manage their debts and to
provide necessities for their children. For the first time this
decade we see more women in the bankruptcy system than men.
Second, we have millions of American families with no
health insurance. An unforeseen medical emergency increasingly
leads to bankruptcy for those families.
Third, we have rising education costs. The average student
loan debt burden for students leaving college increased from
$8,200 to $18,800 between 1991 and 1997.
Fourth, we have downsizing in many industries, and
breadwinners are going back to work at lower-paying jobs with
fewer benefits. We see those folks in the bankruptcy system as
well, when they can't pay the debts they took before they were
downsized out of their jobs.
And, finally, piled on top of all of these changes, we have
a massive increase in household debt for credit cards and home
mortgages. In 1975, total household debt was 24 percent of
aggregate household income. Today total household debt is a
staggering 104 percent of aggregate income.
Much of the recent increase in consumer debt is fueled by
an explosion in credit card marketing. More than 3 billion
credit card solicitations were sent out 1997 and again in 1998.
As the Consumer Federation of America has pointed out, every
American family was offered more than $1 million of credit in
each of those years.
Credit solicitations and other forms of marketing are
designed to encourage consumers to rely on credit. Much of the
marketing is done to people who once would have been considered
unacceptably high risk. Due to high interest rates of 16, 18,
20 percent or higher, the lending community has discovered that
it profits when families get in over their heads. Those
families cannot pay their credit card balance in full each
month, and they pay a lot of interest, but they also are
vulnerable even to small life problems, which can put them over
the edge.
Myth No. 2, there is widespread abuse of the bankruptcy
system by debtors. The reality is that a recent study published
by the American Bankruptcy Institute found that less than 3
percent of debtors had used the bankruptcy system to avoid
debts they could afford to repay. That is just 3 percent.
Industry-funded studies purporting to show otherwise, and which
show that only 15 percent can afford to pay, have been
discredited by the General Accounting Office for lack of
empirical rigor.
Myth No. 3, it is the lax bankruptcy system which causes
credit losses that are passed onto consumers in the form of
higher interest rates. The number $400 was thrown around
earlier in this hearing, and for the first time I heard a
figure of $550 in extra interest costs associated with
bankruptcy losses for each American family.
The reality is that the lending community is scapegoating
the bankruptcy system for losses associated with bad loans. If
the bankruptcy system were totally eliminated tomorrow, the
vast majority of debts which would have been discharged in
bankruptcy would be written off by lenders anyway because the
families involved simply can't afford to pay. Even the
creditors' own studies acknowledge that. The only impact of
bankruptcy is that it gives debtors a legally-enforceable fresh
start, the same second chance which has been guaranteed since
biblical times.
To a large extent, Mr. Chairman, the bankruptcy problem is
nothing but a bad loan problem. Industry analysts estimate that
50 percent of bankruptcy losses could be eliminated if the
industry instituted minimal underwriting guidelines. The
lending community has chosen not to take this step because
their current practices are quite profitable. However, as a
consequence, the banking community must accept that it is
reaching some borrowers who won't be able to pay.
Mr. Chairman, never has 5 minutes seemed so short. I was
wondering if I could have the indulgence of an additional
minute or two to finish my statement.
Mr. Gekas. You may proceed, without objection.
Mr. Klein. Thank you very much.
When we get to the fundamental truth here, after stripping
away these myths, the reality is that in crafting balanced
reform, the worst problems you need to confront are those of
families losing their homes, facing wage garnishment,
repossessions, and the hopelessness of crushing debt.
I want to close with both an observation and an appeal. The
observation is that in the last 5 years, as the American
economy has roared and the stock market has soared, the number
of people seeking assistance from consumer credit counseling
has increased faster than the number of bankruptcies. More than
2 million people sought and obtained credit counseling in 1998
alone, and these included college students, single mothers,
farmers, and the elderly. When you add that to the 1.4 million
people who filed for bankruptcy, it should be clear that there
are millions of Americans, millions of your honest
constituents, people who are not deadbeats, who have run into
real trouble with credit and keeping their families afloat.
They do need to be accountable to their creditors to the extent
possible, but bankruptcy, their only safety valve, should not
be remade into an expensive and unworkable system designed to
keep families yoked to debts they have no hope of ever
repaying.
The flip side of individual responsibility is corporate
responsibility. I agree with Mr. Nuss; there needs to be credit
education about the potential negative side of reliance on
credit. To start that process, it is essential that credit card
applications and credit card statements have prominent, plain
English disclosures that truly tell consumers the real terms
and consequences, as well as the real risks, associated with
credit.
[The prepared statement of Mr. Klein follows:]
Prepared Statement of Gary Klein, Esquire, Senior Attorney, National
Consumer Law Center, Boston, MA
introduction
Mr. Chairmen and members of the Joint Committee, on behalf of our
low-income clients, the National Consumer Law Center \1\ thanks you for
inviting us to testify today regarding consumer bankruptcies and their
impact on the banking system.
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\1\ The National Consumer Law Center is a nonprofit organization
specializing in consumer credit issues on behalf of low-income people.
We work with thousands of legal services, government and private
attorneys around the country, representing low-income and elderly
individuals who request our assistance with the analysis of credit
transactions. The National Consumer Law Center also serves as an
advocate for low-income consumers on consumer lending and bankruptcy.
NCLC publishes materials for lawyers and consumers, including the
nationally acclaimed book Surviving Debt: A Guide for Consumers. NCLC
has trained lawyers and counselors nationwide on consumer protection
issues relevant to low-income consumers.
My experience includes 14 years as an attorney representing clients
in bankruptcy, as an advocate for consumers on bankruptcy issues, as a
teacher and trainer of other lawyers, and as an author of books on
bankruptcy and consumer debt. My work also focuses on helping
homeowners with financial problems avoid foreclosure. The bankruptcy
system has always provided an important means to that end.
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There is a great deal of misinformation circulating about the
increase in bankruptcy filings and purported abuses in the system. The
reality is that more debtors use the bankruptcy system because more
debtors are having serious financial problems. American families
increasingly face foreclosure, repossession, utility shut-off, wage
garnishment and extensive collection activity on unsecured credit card
debt. In short, more American families are using the bankruptcy system,
because more American families are having trouble paying their debts.
My testimony will focus on four questions:
Why more filings?
LDoes the lending industry share responsibility for
consumer financial hardship and the increase in bankruptcy
filings?
LAre substantial costs of bankruptcy passed on to non-
bankrupt consumers?
LAre the amendments captured last year in the
Conference Report (H.R. 3150) and reintroduced this year as
H.R. 833 fair and balanced?
i. what has caused the increase in filings?
The fact that more bankruptcies are being filed is not evidence, in
itself, that debtors are abusing the system. The reality is that more
cases are filed, because more American families are faced with crushing
debt. There is much more consumer credit outstanding than ever before.
With the additional extension of credit, comes additional risk. (See
the Case Study in the Appendix for a typical example of an American
family forced to file bankruptcy because of the convergence of consumer
debt, job loss and divorce.)
The increase in bankruptcy filings is an unfortunate consequence of
several significant structural changes in the American economy. These
changes have combined to create a rise not only in bankruptcy, but also
in foreclosures,\2\ repossessions, utility disconnections \3\, credit
card defaults \4\ and visits to consumer credit counseling agencies.\5\
Nevertheless banks continue to record profits, fueled in large part by
credit card income.\6\
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\2\ Foreclosures have more than tripled since 1980. There were
approximately half a million foreclosures in 1998.
\3\ See National Consumer Law Center, ``The Energy Affordabilty
Crisis of Older Americans'' p. 23 (August, 1995).
\4\ Ausubel, ``Credit Card Defaults, Credit Card Profits and
Bankruptcy'', 71 Am. Bankr. L.J. 250 (1997); See Consumer Federation of
America, ``Recent Trends in Credit Card Marketing and Indebtedness''
(Report issued July, 1998) at p. 1.
\5\ The number of consumers who have visited consumer credit
counseling for help in the last 20 years has increased at a faster rate
than bankruptcy filings. More than two million families sought such
help in 1998.
\6\ Commercial banks earned 14.8 billion in the third quarter of
1997, the third consecutive quarter of record profits and the 19th
consecutive quarter involving profits of more than 10 billion. See
Ausubel, Credit Card Defaults, Credit Card Profits and Bankruptcy, 71
Am. Bankr. L.J. 250 (1997) for a discussion of the role of credit card
profits in the current boom in banking.
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These are the factors which have contributed to the increase in
filings:
LDownsizing, economic dislocation, income disruptions,
and underemployment. Families are increasingly impacted by
instability in employment income, particularly at the lower end
of the wage spectrum.\7\ Although unemployment remains low,
many workers file bankruptcy after being forced to shift to
lower paying jobs. A surprising statistic, based on data
compiled by Visa and MasterCard, is that no more than 29% of
bankruptcies are caused by overspending. The balance of filings
are caused by other life events over which consumers have
little or no control.\8\
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\7\ Even MasterCard recognizes this trend. In its recent report on
debt and bankruptcy, its economist states: ``Stagnation in real wages
during the last 20 years and the growing disparity in income and
wealth, . . . have almost certainly contributed to the rise in personal
bankruptcies. Declines in income caused by job loss make it more
difficult for those affected to service previously accumulated debt.''
Chimerine, ``Americans in Debt: The Reality'', p.24 (MasterCard
International 1997).
\8\ Id. at p. 25. And even the 29% figure is acknowledged to
overstate spending problems as a contributing cause of bankruptcy. Id.
LRising debt to income ratios. More families have more
debt. Part of the reason for this is that the lending community
has aggressively marketed credit card debt,\9\ because it
profits from the very high interest rates. Another factor is
the unprecedented increase in the cost of education and the
corresponding increase in student loan debt.\10\ One family in
six below $25,000 in annual income, spends more than 40% of its
income on debt service.\11\
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\9\ More than three billion credit card solicitations were sent out
in 1997 and 1998. Consumer Federation of America, ``Recent Trends in
Credit Card Marketing and Indebtedness'' (Report issued July, 1998) at
Table 2 (citing industry sources). See Hays, ``Banks Marketing Blitz
Yields Rash of Defaults'' Wall Street Journal, p. B1 (September 25,
1996). MBNA, one of the largest issuers, claims 30 million credit card
solicitations each month in 1997 together with 6 million phone
solicitations. Hansell, ``A Banking Powerhouse of Cards'', N.Y. Times,
p. C1 (October 22, 1997).
\10\ See Chacon, ``Debt Burden Soaring for U.S. Students'' Boston
Globe, p. 1 (October 23, 1997). According to the Nellie Mae study on
which the article is based, an average student's debt increased from
$8,200 in 1991 to $18,800 in 1997.
\11\ ``Family Finances in the United States: Recent Evidence from
the Survey of Consumer Finances'' Federal Reserve Bulletin, p. 1, 21 at
Table 14 (January, 1997). Overall, the rate is one family in nine.
LReliance on two wage earners to make ends meet. This
change in a fundamental condition of the economy means that
every family has double the risk. With two wage earners
vulnerable to income instability, any change for either one
creates enormous pressure on the family budget. Child-bearing
and time off to raise children mean that a family which was
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getting by on two incomes is forced to rely on only one.
LRising divorce rates. A corollary of the latter
factor is that when a family splits up, the pressure of running
a household with less total income is impossible. Bankruptcy
debtors are disproportionately single parents.\12\
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\12\ See Sullivan, Warren, and Westbrook, As We Forgive Our
Debtors, pp. 147-165 (Oxford University Press, 1989).
LUninsured medical debt. At a time when a two day stay
in the hospital to deliver a baby can cost as much as $20,000,
the uninsured have virtually no options to manage medical
debts.\13\ Bankruptcy has played an increasing role as the only
way out.\14\
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\13\ See Hildebrandt and Thomas, ``The Rising Cost of Medical Care
and Its Effect on Inflation'', Federal Reserve Bank of Kansas City,
Econ. Rev. p. 47 (Sept./Oct. 1991).
\14\ Domowitz & Sartrain, Determinants of the Consumer Bankruptcy
Decision, p. 25 (1997).
LAggressive Creditor Collection Action. Wage
garnishments, debt collection by aggressive telephone calling,
and pursuit of legal remedies push many families into
bankruptcy.\15\ Few debtors can afford to pay an attorney to
defend against a debt collection or wage garnishment action
even when they have valid legal defenses.\16\ Many bankruptcy
filers report that their attempts at non-bankruptcy payment
arrangements were rebuffed.
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\15\ See Dugas, ``Special Report: Going Broke, Wage Garnishments a
Key Factor'' USA Today, p. 1A (June 10, 1997); Hansell, ``We Like You.
We Care About You. Now Pay Up. Debt Collecting Gets a Perky Face and
Longer Arms'', NY Times, F.1 (Jan. 26, 1997).
\16\ Forrester, ``Constructing a New Theoretical Framework for Home
Improvement Financing,'' 75 Ore. L.Rev. 1095 (Winter 1996); Sterling &
Shrag, ``Default Judgments Against Consumers: Has the System Failed?''
67 Denv. U. L. R. 357, 384 (1990).
LDeregulation. As rates and terms of credit have been
deregulated, an increasing number of American families have
gotten credit on bad terms.\17\ High rate home equity loans,
credit card interest rates exceeding 18%, and consumer fraud
tied to credit are frequent contributing causes of
bankruptcy.\18\ As some borrowers are increasingly pushed into
``sub-prime'' loans at high rates, the bankruptcy system is at
the fulcrum of a ``chicken and egg'' problem. Are high risks
justifying high rates, or are the high rates causing defaults
which generate risk? \19\
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\17\ See, e.g, Adding Insult to Injury: Credit on the Fringe,
Hearing before the Subcommittee on Consumer Credit and Insurance of the
House Committee on Banking, 103rd Cong., 1st Sess. (1993). Rehm, In a
First, FDIC Warns Banks About Dangers of Sub-Prime Lending, 162 Am.
Banker 2 (May 13, 1997).
\18\ See Forrester, ``Mortgaging the American Dream: A Critical
Evaluation of the Federal Government's Promotion of Home Equity
Financing'' 69 Tul. L. Rev. 373 (1994).
\19\ Home mortgage loans with high loan-to-value ratios,
particularly so-called 125% loans, are the major component of the
recent surge in home equity lending, both in the prime and subprime
markets. Recent growth in the volume of 125% loans has been
unprecedented: 1995--$1 billion; 1996--$4 billion; 1997--$10 billion;
1998--an estimated $20 billion. Although such loans are at least
partially secured by the debtors' homes and can result in the loss of
the home, they carry interest rates much closer to those of credit
cards, in the 13-15% range. See ``A 125% Solution to Card Debt Stirs
Worry,'' Wall Street Journal, Nov. 17, 1997
LMore Credit Means More Bankruptcy. The clearest
correlation of bankruptcy cause and effect is between the
increase in the amount of credit outstanding and the number of
filings. The number of bankruptcies and the total amount of
consumer debt in our society have moved upward together in
lockstep.\20\ It is not surprising that as more Americans
borrow more money, more families have financial troubles.
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\20\ Three neutral academic studies show this remarkable
correlation. Ausubel, Credit Card Defaults, Credit Card Profits and
Bankruptcy, 71 Am. Bankr. L.J. 250 (1997); Bhandari & Weiss, The
Increasing Bankruptcy Filing Rate: An Historical Analysis, 67 Am.
Bankr. L.J. 1 (1993); Statement of Kim Kowalewski, Chief, Financial and
General Macroeconomic Analysis Unit, Congressional Budget Office,
before the Subcommittee on Administrative Oversight and the Courts,
Committee on the Judiciary, United States Courts, (April 11, 1997).
These studies stand is sharp contrast to credit industry funded studies
which purport to show otherwise.
---------------------------------------------------------------------------
ii. does the lending industry share responsibility for consumer
financial hardship and the increase in bankruptcy filings?
The reasons for the increase in bankruptcy filings are complex.
Although banks and other lenders are correct in pointing out that they
are not entirely to blame, it is disingenuous of them to assert that
they should not bear some responsibility, at least to the extent of
their own conduct.
Credit solicitations and other forms of marketing are designed to
encourage consumers to rely on credit. Much of the marketing is done to
people who once would have been considered unacceptably high risk. Due
to high interest rates, the lending community has discovered that it
profits when people get in over their heads so that they cannot pay
their balance in full each month.\21\ This generates remarkable profits
for banks. However, it also makes consumers vulnerable even to small
life problems which can put them over the edge.
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\21\ Borrowers who maintain balances pay interest at rates which
typically range from 14.5 to 19.8%.
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Every American family has a budget which represents a fixed pie.
The 55 to 60 million households that carry a credit card balance from
month-to-month have an average balance of $7,000 and pay more than
$1,000 per year in interest and fees.\22\ And, of course, the families
that wind up in bankruptcy are almost always on the high side of
average in their debt-load and the low side of average in income.\23\
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\22\ See Consumer Federation of America, ``Recent Trends in Credit
Card Marketing and Indebtedness'' (Report issued July, 1998) at p. 1.
\23\ Research shows that the median after-tax income of debtors is
under $20,000 annually. Id. $1,000 in annual debt service expenses can
thus be a very meaningful proportion of a debtor's income.
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Are consumers at fault for using the credit which is marketed to
them? Of course not. Millions of American families are not
irresponsible. They are simply using the credit offered to them for the
purposes for which it is offered. Families don't go out and borrow
$7,000 on a credit card all at once. They make small purchases over a
period of time, and make the minimum payments which the lender
requests. Few consumers understand that making only the minimum
payments means that their balance will grow and payments will take an
ever larger piece out of their monthly budget (at 18% interest or
higher) for debt service.\24\
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\24\ Industry analysts estimate that, using a typical minimum
monthly payment rate on a credit card, it would take 34 years to pay
off a $2,500 loan, and total payments would exceed 300% of the original
principal. George M. Salem and Aaron C. Clark, GKM Banking Industry
Report, Bank Credit Cards: Loan Loss Risks are Growing, p. 25 (June 11,
1996). Credit card statements, unlike mortgage loans and car loans, do
not disclose the amortization rates or the total interest that will be
paid if the cardholder makes only the minimum monthly payment See 11
U.S.C. Sec. 1637. A provision which would require new Truth in Lending
disclosures on these issues was included in the bill passed by the
Senate (Sec. 209), but deleted from the Conference Report.
---------------------------------------------------------------------------
Congress should not enact legislation which undermines effective
bankruptcy relief for struggling families. Some reform is necessary,
but that reform should be balanced and should help consumers avoid the
credit problems which contribute to bankruptcy.
We do not advocate that creditors make less credit available to low
and moderate income consumers, but rather that consumers have the tools
and information they need to use credit wisely. Appropriate consumer
protections designed to reinforce the lending community's obligation to
employ responsible credit practices include:
Lenhanced disclosure to consumers about the
consequences of making minimum payments,\25\
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\25\ Minimum payments on many credit cards will not amortize the
loan, thus sucking people in over their heads. If minimum payment terms
are offered which won't amortize the debt in two years, consumers
should be told, in clear and conspicuous language, what they need to
pay, if they make no further charges, in order to pay off the loan over
a two year period.
Lenhanced disclosures concerning teaser rates of
interest,\26\
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\26\ Low initial rates are designed to encourage consumers to use
credit in the first months after credit is granted. Many consumers do
not understand what the permanent rate will be or the impact of the
rate change on a large unpaid balance.
Lprotections against unilateral interest rate
increases which are unrelated to a change in the lender's cost
of funds,\27\
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\27\ Some lenders raise rates arbitrarily after consumer balances
reach a certain level. Interest rate changes should be tied to an
actual change in the interest rate environment so that consumers are
not caught unawares. See, Hershey, ``Sales of Credit Card Accounts Are
Hurting Many Consumers,'' NY Times, March 2, 1999, p.A1 (documenting
the effect of unilateral interest rate changes.''
Lprohibition of unilateral credit limit increases,\28\
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\28\ When a lender extends a consumer's credit limit unilaterally,
in some cases after a consumer is already struggling with the existing
balance, the message is that the lender believes that the consumer can
afford to take on more credit. Consumers would not be hurt by having to
ask for more credit, rather than having it offered unilaterally. Such a
request should trigger at least minimal underwriting requirements.
Lprohibition of security interests based in credit
card agreements,\29\
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\29\ These hidden security interests in items of property which
have no resale value to the creditor provide inappropriate leverage to
lenders in the collection process even though there is no potential
that the lender could make money in the event of repossession.
Lprotection against so called ``cashed check loans,''
\30\
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\30\ Consumers receive checks from several major lenders in the
mail for as much as $5,000. Not everyone understands that cashing these
checks can lead to acceptance of high rate credit terms. In addition,
providing preapproved credit through cashed checks eliminates the
cooling off period which more common credit application processes
provide.
Lprohibition of credit card cash advance machines in
casinos,\31\
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\31\ With credit card cash advance machines prevalent in casinos,
is it surprising that some gamblers get overextended on credit and file
bankruptcy based on those credit card debts?
Lprohibition against making credit cards available to
persons such as students who have no present ability to make
more than nominal payments,\32\ and
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\32\ Offering credit aggressively to college students who cannot
afford to pay off their debts until they join the work force some years
later is prevalent because interest mounts until the debt is paid. By
lending aggressively to college students, at a time in life when money
is scarce, our society runs the risk of saddling people early in life
with an unmanageable problem which will later preclude more important
uses of credit such as purchase of a home and car. See US PIRG, ``The
Campus Credit Card Trap: Results of a PIRG Survey of College Student''
(September 1998).
Lreregulation of interest rates.\33\
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\33\ Competition in the market has not worked to keep rates at
reasonable levels. On a procedural level, the Supreme Court has held
that credit card lenders can rely on the law in the state where they
are incorporated in setting the interest rate and many of the other
terms of credit for consumers nationwide. This has led to a ``race to
the bottom''. States deregulate in order to create the best possible
environment to encourage a credit card company to locate there in order
to export terms of credit across the country. This helps certain states
create jobs. However, it means that those other states that do want to
regulate for the benefit of their citizens can no longer do so. Either
states should be freed to create and enforce meaningful regulations or
the federal government should step in with consumer protections.
If lenders choose to resist legislation to address these problems
for consumers, they ought not be heard to complain about the
bankruptcies which are the inevitable result. Industry consultants
estimate that credit card companies could cut their bankruptcy losses
by more than 50% if they would institute minimal credit screening.\34\
---------------------------------------------------------------------------
\34\ George M. Salem and Aaron C. Clark, GKM Banking Industry
Report, Bank Credit Cards: Loan Loss Risks are Growing, p. 25 (June 11,
1996).
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iii. are substantial costs of bankruptcy passed on to non-bankrupt
consumers?
A. Is the system failing to recapture money which debtors can afford to
pay?
Nobody likes to be owed a debt which is not paid back. Yet our
society has a system of debt forgiveness which has roots in the
Bible.\35\ Forgiveness and a fresh start have always been a part of
that system.\36\
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\35\ Deuteronomy 15:1-2 (``At the end of every seven years thou
shalt make a release. And this is the manner of the release: every
creditor shall release that which he has lent unto his neighbor and his
brother, because the Lord's release hath been proclaimed''.)
\36\ Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934). See Gross,
Failure and Forgiveness, ch. 6 (Yale University Press 1997).
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A family's ability to repay its debts is limited by its income.
Data shows that Americans in bankruptcy are far poorer than their non-
bankrupt counterparts. The median after-tax income of a family in
chapter 7 bankruptcy is under $20,000, or approximately half the
national median.\37\
---------------------------------------------------------------------------
\37\ Consumer Federation of America, ``Recent Trends in Credit Card
Marketing and Indebtedness'' (Report issued July, 1998) at p. 1;
Warren, ``The Bankruptcy Crisis'' 73 Ind. L. J. 1081, 1102-1103 (Fall
1998); Sullivan, Warren and Westbrook, ``Consumer Debtors Ten Years
Later: A Financial Comparison of Consumer Bankrupts 1981-1991'', 68 Am
Bankr. L. J. p. 121, 128 (1994).
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The credit industry has focused substantial resources on attempting
to show that despite this relative poverty, there are many families who
are obtaining a bankruptcy fresh start even though they can afford to
pay. Based on this assumption, they would set up a system in which some
debtors are forced into payment plans.
However, if such plans are not entered voluntarily by the debtor,
they have little chance of success, absent extensive and impracticable
coercive mechanisms. For this reason, forced participation in payment
plans has consistently been rejected by Congress and the two most
recent government-sponsored commissions which have studied
bankruptcy.\38\
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\38\ See Report of the Commission on the Bankruptcy Laws of the
United States, Part I at 159 (1973); H.R. Rep. No. 595, 95th Cong.,
1st. Sess. 120-121 (1977); Report of the National Bankruptcy Review
Commission, Vol. 1, at pp. 89-91 (October 20, 1997).
---------------------------------------------------------------------------
Apart from this procedural difficulty, there is no empirical
evidence which shows that debtors can afford to pay. In 1989,
Professors Sullivan, Warren and Westbrook published the results of an
evaluation of a substantial statistical database and concluded:
The overwhelming majority of Chapter 7 debtors--90% by any
measure--could not pay their debts in Chapter 13 and maintain
even the barest standard of living. . . . A new bankruptcy
regime that invested more time to find and to investigate the
potential can-pay debtors would prompt only a small amount of
new repayment. This is the classic case in which a policy maker
asks if the game is worth the candle.\39\
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\39\ Teresa A. Sullivan, Elizabeth Warren, and Jay Lawrence
Westbrook, As We Forgive Our Debtors, pp. 205-206 (Oxford University
Press, 1989). This seminal book and the empirical work which underlies
it remains the single most authoritative published source for studying
bankruptcy demographics. It has been updated more recently in an
article by the same authors which concludes that debtors are now even
poorer and less able to pay their debts than they were when the initial
study was done. ``Consumer Debtors Ten Years Later: A Financial
Comparison of Consumer Bankrupts 1981-1991'', 68 Am Bankr. L. J. 121
(1994).
The creditor industry's own study released last year,\40\
purporting to show the opposite, has been severely criticized by the
General Accounting Office.\41\ Once the credit industry study's results
are adjusted to take account of the GAO critique, it shows that only
about 5% of debts could be repaid by debtors--if they undergo five year
repayment plans.\42\ This means that the creditor's own study
ultimately shows that bankruptcy debtors can afford to pay about a
penny on the dollar per year. That result was supported recently by a
study funded by the American Bankruptcy Institute showing that only 3%
of chapter 7 debtors can afford to pay back their debts in a
hypothetical chapter 13 plan.\43\
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\40\ Barron and Staten, ``Personal Bankruptcy: A Report on
Petitioners' Ability to Pay'', Monograph 33, Georgetown U. Credit
Research Center (1997). This report is reprinted as Appendix G-2.b to
the National Bankruptcy Review Commission Report.
\41\ GAO Report, Personal Bankruptcy, The Credit Research Center
Report on Debtors' Ability to Pay, GAO/GGD-98-47, p. 6 (Feb, 9, 1998)
The GAO concluded that the study's ``fundamental assumptions were not
validated''. In addition, the GAO review concluded that the credit
industry's study: failed to assess the accuracy of the data collected;
failed to account for major expenses which bankruptcy debtors have
after filing including payments on non-housing secured debt and
reaffirmed or non-discharged non-priority debts; failed to evaluate
potential differences among the sites chosen for the study; and failed
to use statistically valid research techniques.
\42\ Warren, ``The Bankruptcy Crisis'' 73 Ind. L. J. 1081 (Fall
1998); Klein, ``Means Tested Bankruptcy: What Would it Mean?'' 28 U.
Mem. L. Rev. 711 (Spring, 1998).
\43\ Culhane and White, ``Means Testing for Chapter 7 Debtors:
Repayment Capacity Untapped?'' (American Bankruptcy Institute, 1998).
---------------------------------------------------------------------------
Outside bankruptcy, no reasonable creditor would spend more than a
penny to collect a penny. Proposals to require five year payment plans
for many more debtors have a heavy price tag, including costs of
administration and monitoring, costs to resolve disputes about capacity
to repay, and costs of collecting and distributing payments.
Either the taxpayer would have to fund these costs, or if they are
debtor funded, they will reduce the receipts available to creditors in
a repayment plan. If taxpayer funded, every American would be helping
banks and other creditors collect their one cent per dollar per year.
If debtor funded, the one cent per dollar per year repayment capacity
of debtors is even further reduced.
Finally, requiring five year repayment plans would have enormous
social and human costs. People use the bankruptcy system for many
legitimate reasons. If navigating the system is made more difficult,
and if a meaningful fresh start is denied when some cases inevitably
fail,\44\ more debtors would be left with the burden of unmanageable
debts.\45\ Loss of homes, repossessions, wage garnishments, utility
shut-off and family stress associated with unmanageable debts would be
the inevitable result. While these social and human costs of denying
chapter 7 relief to debtors may be difficult to quantify, they
nevertheless remain an important part of the relevant equation.
---------------------------------------------------------------------------
\44\ 67% of repayment plan cases fail under current law. There is
every reason to think that if economically marginal debtors are forced
into involuntary repayment plans, the failure rate would be higher.
\45\ See D. Caplovitz, Consumers In Trouble: A Story of Debtors in
Default pp. 280-285 (Free Press, 1974).
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B. Are losses associated with bankruptcy being passed on to other
better off consumers in the form of higher interest rates?
The banking industry has claimed that it is losing 40 billion
dollars each year to the bankruptcy system and that it is passing those
costs on to consumers at the rate of $400 per family.\46\ These numbers
are ridiculous. Families may be discharging debt in bankruptcy, but the
creditor's own study, discussed above, shows that these are not debts
which consumers can afford to pay.
---------------------------------------------------------------------------
\46\ The unpublished credit industry-funded report which served as
the basis for this claim has also been criticized by the GAO for lack
of analytical rigor. GAO/GGD-98-116R ``The Financial Costs of Personal
Bankruptcy'' Letter from Associate Director Richard Stana to the
Honorable Martin T. Meehan.
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In reality, the lending community is scapegoating the bankruptcy
system for losses associated with bad loans. The vast majority of debts
which are discharged in bankruptcy would have been written off if no
bankruptcy had intervened. The only impact of bankruptcy is that it
gives debtors a legally enforceable fresh start--the same second chance
which has been guaranteed since Biblical times.
Equally important, there is no evidence that lenders would reduce
rates on unsecured consumer lending if they could avoid bankruptcy
losses. Between 1980 and 1992, the federal funds rate at which banks
borrow fell from 13.4% to 3.5%. Nevertheless, credit card interest
rates actually rose.\47\ How likely is it that other types of savings,
if any could be realized, would be passed on to consumers rather than
investors?
---------------------------------------------------------------------------
\47\ Medoff and Harless, The Indebted Society, at pp. 12-13
(Little, Brown & Co. 1996).
---------------------------------------------------------------------------
To a large extent, the bankruptcy ``problem'' is nothing but a
``bad loan'' problem. It could be fixed if lenders were more closely
attentive to underwriting. For the most part, the lending community has
chosen not to take this step. The present interest rate environment has
taught lenders that substantial profits can be made from extending
credit to risky borrowers, such as college students. However, in
exchange, the banking community must accept that it is reaching some
borrowers who cannot afford to pay.
iv. are the amendments captured last year in the conference report
(h.r. 3150) and reintroduced this year as h.r. 833 fair and balanced?
The bankruptcy system established in 1978 has been remarkably
efficient. It provides critical relief to financially troubled American
families at a low cost to taxpayers. Over the years, many open issues
under the bankruptcy law have been resolved by court decisions and
carefully crafted Congressional amendments.
To the extent the increase in the number of bankruptcies suggests
that there are problems in the consumer lending system, responsibility
for fixing those problems must be shared between consumers and lenders.
Congressional reform, if any, should be balanced and narrowly targeted
at abuses by both debtors and creditors.
It would be a mistake to enact reforms without addressing reckless
lender conduct which pushes people into bankruptcy. Offering additional
credit, for example, to families already struggling to pay their debts
hurts not only borrowers, but also the borrowers' honest creditors if
the new credit pushes the family over the edge. Similarly, failure by
one creditor to seriously consider payment arrangements outside
bankruptcy for families facing hardship may lead to a bankruptcy filing
which affects all creditors.
To the extent there has been a focus on debtor misconduct, the
burden of proof remains on the credit industry. To date it has not been
met. Simply saying that more people are using the system, is not proof
that people are misusing the system.
Some observers ignore the fact that the present system already has
a variety of protections which are designed to effectively root out
abuses by debtors. These include: Rule 9011,\48\ objections to
discharge,\49\ complaints to determine dischargeability,\50\ good faith
requirements,\51\ Rule 2004 examinations,\52\ creditors' meetings,\53\
dismissals for substantial abuse,\54\ and criminal sanctions.\55\
Indeed, it is unclear why the creditor community does not believe that
the small number of cases where significant repayment appears possible
are not resolvable under the ``substantial abuse'' test of 11 U.S.C.
Sec. 707(b).\56\ Perhaps additional tightening of this provision would
make it work better.
---------------------------------------------------------------------------
\48\ Fed. R. Bankr. P. 9011.
\49\ See 11 U.S.C. Sec. 727.
\50\ See 11 U.S.C. Sec. 523(a).
\51\ See, e.g., In re Barrett, 964 F.2d 588 (6th Cir. 1992)
(finding that debtor's second chapter 13 filing, when he had
insufficient income to support plan, was in bad faith but that third
chapter 13 case, after circumstances had changed was not in bad faith);
In re Love, 957 F.2d 1350 (7th Cir. 1992).
\52\ Fed. R. Bankr. P. 2004. It is hard to see why creditors
concerned about abuses can't utilize the examination process to uncover
them. If it is not financially feasible for a creditor to pursue an
examination, why should taxpayers instead bear that burden for the
creditor's benefit.
\53\ 11 U.S.C. Sec. 341. Fed. R. Bankr. P. 2003.
\54\ 11 U.S.C. Sec. 707(b).
\55\ 18 U.S.C. Sec. Sec. 151-157. Bankruptcy fraud is punishable by
fine and imprisonment for up to five years. 18 U.S.C. Sec. 157.
\56\ That is the provision which Congress added to the Code in 1984
and which has functioned to root out debtors who can afford to pay
their creditors. See, e.g., In re Kelly, 841 B.R. 908 (9th Cir. 1988);
In re Krohn, 886 F.3rd 123 (6th Cir. 1989) (substantial abuse found
where debtors could pay back their debts with ``good, old fashioned
belt tightening'').
---------------------------------------------------------------------------
An additional set of balanced reforms may be appropriate as long as
they do no harm to the majority of honest debtors who urgently need
help. Provisions should be narrowly targeted to address debtors who
truly are abusing the system without affecting lower income debtors who
would be hurt by having to litigate additional issues. Creditors should
not be allowed to obtain leverage by forcing new litigation on
consumers who cannot afford to pay the costs of defending.
Appropriate reforms should also create incentives for debtors to
use a repayment plan option in bankruptcy in order to repay their
debts. Significant actions could be taken to make the costs of those
plans more manageable and to enhance outcomes for debtors who complete
plans.\57\ Provisions in H.R. 833 which limit stripdown related to
automobiles and personal property and which require debtors in chapter
13 to litigate many new dischargeability issues will undermine chapter
13 rather than reinforce it.
---------------------------------------------------------------------------
\57\ For example, efforts should be made to provide improved credit
reporting for people who complete chapter 13 payment plans. In
addition, the discharge available in chapter 13 should be as broad as
possible in order to serve as incentive to choose that chapter. Costs
can be lowered by encouraging secured lenders to accept modifications
to their mortgages in exchange for more favorable treatment.
---------------------------------------------------------------------------
Finally, the system should penalize dishonest creditors. These
include creditors whose actions push people into bankruptcy and those
who take advantage of debtors after they file by coercing inappropriate
reaffirmation agreements.
Honest and careful creditors should always be paid before abusive
debt collectors, lenders that encourage gambling in casinos, predatory
second mortgage lenders, and lenders who are unreasonable in refusing
to accept non-bankruptcy payment plans. Lenders whose actions violate
the bankruptcy laws should be subjected to meaningful and
straightforward penalties.
conclusion
The lending community should not be allowed to scapegoat the
bankruptcy system for lending decisions which result in bad debt. The
right to participate in the bankruptcy system should require honesty
not just on the part of debtors, but also by creditors. No legislative
action should ignore the significant hardships of the millions of
American families who are overwhelmed by debt.
appendix
Case Study
Mrs. M is a 39-year old mother of three children, two of whom are
living at home. Her financial problems started in 1994 when her husband
lost his job in construction. Since that time, he has been
underemployed; his earnings have declined from an average of $52,000
annually between 1990 and 1993 to an average of $26,000 between 1994
and 1997. Starting in 1994, the family's primary income has been
$30,000 which Mrs. M earns as an administrative assistant at an
insurance company. Mr. and Mrs. M have struggled successfully to
maintain payments on a home they bought in 1987 since their financial
problems began in 1994.
Mr. and Mrs. M have also had significant credit card bills since
the late 1980's. Despite their financial problems, they avoided default
on those debts by making minimum payments between 1994 and 1997.
However, the total amount of their credit card debts increased from
about $11,000 in 1994 to about $29,000 in 1997, largely due to the
accumulation of interest at an average annual rate of 17.5%.
In 1997, Mrs. M's financial problems worsened, because Mr. M moved
out of the family home. An additional strain was created because Mrs. M
attempted to provide financial help to her oldest daughter who began
her first year of college. In family counseling, Mr. and Mrs. M
acknowledged that their marriage was breaking up largely because of the
constant pressure of financial problems and Mr. M's continuing
inability to find steady work.
Mrs. M attempted to make payment arrangements with her credit card
lenders so that she could focus on her mortgage obligation. She was
told that no payment arrangements were possible and that she should
``borrow money to pay off the debts.'' Mrs. M went to consumer credit
counseling where she was advised that her budget did not support any
payments on credit cards. She was advised to consider chapter 7
bankruptcy in order to eliminate the credit card debts so that she
could maintain her payments on the mortgage.
In September 1997, Mrs. M obtained advice from a bankruptcy lawyer
and reluctantly filed bankruptcy. She will discharge approximately
$35,000 in unsecured debts. She will reaffirm and continue to make
payments on her mortgage and car loan--totaling $1,320 monthly.
Mr. Gekas. We thank the gentleman.
The Chair now yields to itself the 5 minutes allotted to
each member for posing questions.
Mr. Klein, you acknowledged in the last portion of your
statement that there, indeed, are people who are in the
bankruptcy system who can repay some of their debt. We have
fought strenuously to make sure that those who cannot repay
will automatically have a chapter 7 fresh start. If they can
repay, and you acknowledge that there are some, even only 10
out of the 270 million people in our country, shouldn't they be
made accountable to repay or to be shown that they don't belong
in bankruptcy?
Mr. Klein. At some point, Mr. Chairman, you have to craft
the tool to the particular need in the system. If it is a small
number of people, as the American Bankruptcy Institute study
showed, what we need is a very narrowly-targeted tool, a
scalpel, to address the problem, something that can be
administered fairly and evenly.
The problem with the tool in H.R. 833 is that it is
complicated; it tries to put everyone into a cookie cutter; it
imposes unworkable spending limits on families----
Mr. Gekas. With respect to your opinion, we suggest that it
is not complicated, that we have parameters that determine who
is poor and unable to repay, who is under the median income
level that starts triggering the application of remedies. I
respectfully submit to you that you can't assert, as you did
before the American Bankruptcy Institute panel discussion that
was televised last year that, of course, there are some people
in bankruptcy who can repay, and then you pooh-poohed it as
meaningless. That is a bit offensive to those of us who are
trying to say that those who can repay some of their debt ought
to be put in a mechanism whereby they can do so. That is all
there is to that.
Mr. Nuss----
Mr. Klein. I'm sorry, go ahead.
Mr. Gekas. I have limited time.
Mr. Nuss, you and Judge Kenner are sitting propitiously
next to each other with different views on reaffirmation--not
different views, but you need to talk to each other after this
panel on how you can accommodate each other.
I, too, have always felt that reaffirmation is a good tool
for people who in certain circumstances must utilize it. The
Sears decision, Judge Kenner--we can do this back and forth,
Mr. Nuss and Judge Kenner--that wouldn't, shouldn't prevent
what Mr. Nuss is agreeing should be done with credit card
customers who need reaffirmation, should it?
Ms. Kenner. I agree with that--I am not saying, I am not
suggesting that we should do away with reaffirmation
agreements. I think they can be a good thing.
Mr. Gekas. Yes.
Ms. Kenner. I suspect that Mr. Nuss and I would disagree as
to whether a debtor should ever be permitted to reaffirm an
unsecured debt, a totally unsecured debt, in order to maintain
or obtain a new line of credit post-bankruptcy. Because I think
that what that might very well do is put the debtor back in the
same untenable, debt-ridden position that he or she was in
before bankruptcy.
But I think reaffirmation agreements are absolutely
appropriate in some instances, but, as the bankruptcy judge, I
think I should take a look at all of them.
Mr. Gekas. I want you to know--and this will be my last
comment--I wanted to ask Mr. Sheaffer and Mr. Hammonds a
question, but I want to restrict my own time, so that I can
restrict everybody else's time. [Laughter.]
This individual, the chairman, is vastly interested in
straightening out the problems of reaffirmation, and we want to
do the right thing. I want you to know that. So I will be
consulting regularly with everyone who wants to on that
subject.
The gentleman from New York is allotted 5 minutes.
Mr. Nadler. Thank you.
Mr. Hammonds, you state in your testimony that only 1
percent of all credit card accounts end up in bankruptcy, and
then 96 percent of all accounts are paid as agreed. Now we have
received testimony in the past that, thanks in large measure to
the deregulation of interest rates and the decline in the cost
of funds, the spread earned by credit card operations were
three to five times more profitable than are other banking
operations in the 1983-to-1993 period. In fact, MBNA's total
return on shares from its initial public offering in January
1991 through last quarter equaled 1,800 percent compared to the
total return of the S&P 500 of just 284 percent, or about five
times or six times more profitable.
In fact, the cost of funds now stands at about 5.5 percent
while the average credit card interest rate, not including all
those new penalties my constituents keep complaining about, is
not 5.5, but 15.7 percent. So my question to you is, how much
of that profit spread goes to cover the cost of that minuscule
1 percent of losses due to bankruptcy in your industry, and how
much goes to your shareholders?
Further, since deregulation and low interest rates have
seemed to benefit your industry more than consumers, why should
we expect any tightening of the bankruptcy rules to be passed
along to consumers? You state in your testimony that bankruptcy
costs consumers $400 a year. Since you are obviously pocketing
the profits you earn on the spread, assuming you recovered some
of that 1 percent, why would we expect you to pass it along to
consumers as opposed to increasing your profit rate.
Mr. Hammonds. Okay, I think you referred to some numbers
from 1983 to 1991, if I recall.
Mr. Nadler. 1993.
Mr. Hammonds. To 1993. I think those numbers would have
been right up until that period of time. I think if you look
recently, particularly at the bank card industry, you would
find that margins are down very significantly; that a 2 percent
kind of return is something that would be an average probably
for the credit card industry, where back in those days it was
more like 4 percent. There are many bank card----
Mr. Nadler. Well, wait a minute. From 1983 to 1993, you say
those figures were more or less accurate.
Mr. Hammonds. Right.
Mr. Nadler. So there was an 1,800 percent----
Mr. Hammonds. Well, you are speaking of our stock price
now, not profits.
Mr. Nadler. Well, which indicates the profits. I am talking
about both. The spread earned by credit card operations was
three to five more times profitable than other banking
operations in that time period.
Mr. Hammonds. I think prior to 1993, they were more
profitable than other kinds of bank products; they are not
today.
Mr. Nadler. And prior to 1993, the credit card interest
rates did not come down, did they?
Mr. Hammonds. Yes, they have come down. They were----
Mr. Nadler. Prior to 1993?
Mr. Hammonds. Well, prior to 1993, average credit card
rates were about between 18.9 and 19.8, and today they are
about 16 percent, as you accurately stated.
Many banks have exited the bank card business. There are
many fewer issuers in the country today than there ever have
been. There are many people in this business that are losing
money, but many of the big banks are today exiting this
business because, on the margin, it is a lot less profitable.
A big part of that is credit losses. You are right about
cost of funds are 5.5 percent. Credit losses have averaged
about 6 percent over the last 2 years. About half of that----
Mr. Nadler. I thought you said it was 1 percent?
Mr. Hammonds. Only 1 percent of the customers charge off,
but their balances tend to be two to three times as high as the
average balance. So it accounts for about 3 percent of the
average outstandings, but it is only 1 percent of the credit
card customers that are causing that, and then there is another
3 percent in credit losses from nonbankrupt. So your biggest
cost in the credit card business today is credit losses and
bankruptcy----
Mr. Nadler. Very briefly, please tell me why we would
expect any savings from this would be passed along to
consumers, since, obviously, the spread has been huge and it
has been obvious that credit card interest rates have not
really come down when the cost of money has really come down.
Mr. Hammonds. Well, I would not say a 1 to 2 percent spread
is huge, but interest rates today on credit cards are higher
than they should be with a 5.5 percent cost of funds because
credit losses are higher, primarily driven by bankruptcies.
Mr. Nadler. Judge Kenner, Mr. Hammonds states in his
testimony that legislation we have before us will reduce
litigation. In your experience, what would be the result of
allowing creditors to bring new motions against debtors--for
example, allowing the creditors to bring 707(b) motions?
Ms. Kenner. Right now, as you know, 707(b) motions can only
be, essentially, initiated by the bankruptcy court or the
United States Trustee. I see a danger in expanding this--and I
think this is the same danger that Congress recognized when it
restricted section 707, the current law, to the U.S. Trustee
and the judge. I think there is a danger that some debtors may
become embroiled in litigation that they simply can't
understand or defend against.
Most of the debtors that I see before me on a day-to-day
basis don't have lawyers. They are intimidated by the process.
They are scared. A lot of times when creditors bring
nondischargeability actions against them, they simply default.
They just don't show up in court.
Mr. Gekas. The time of the gentleman has expired. The
gentleman from Tennessee is allotted the customary 5 minutes.
Mr. Bryant. Thank you, Mr. Chairman, and I thank the very
distinguished panel for being here. You certainly provide a
variety of opinions on a very important issue.
I was interested in Mr. Klein's statement that we really
don't have a bankruptcy problem as much as we have a bad loan
problem. I think that is an important statement. But I see
people from the credit union here. Mr. Nuss, you represent the
National Credit Union Association. I know they tend to be very
conservative. I just wondered what your reaction would be, in
terms of how you see the bankruptcy trends going, to Mr.
Klein's statement that these are all bad loan problems, that
you are not screening people enough and evaluating credit well.
Mr. Nuss. Thank you, Congressman.
We are conservative. If I may speak from the perspective of
Cedar Falls community, we require written applications for any
credit extension. We have a very conservative credit committee
policy, if you will. Since 1998, we have had a Visa credit card
program in our credit union. Essentially, we have evaluated, or
our board of directors has evaluated, and considered the good
payers, if you will, that on occasion we would automatically
increase their line of credit. But our board, being
conservative--and I go back to my statement of we are concerned
about the members' financial welfare, and we thought, without
individually underwriting each increase in a line of credit, we
would be failing the member and failing our philosophy.
Mr. Bryant. But you are still seeing bankruptcies files?
Mr. Nuss. Right.
Mr. Bryant. Because I think he makes a fair comment there.
I want to hear it from the credit union perspective. You would
respectfully disagree somewhat?
Mr. Nuss. Yes.
Mr. Bryant. At least as far as your credit union goes?
Mr. Nuss. Right.
Mr. Bryant. All right, let me go now, if I could, to Mr.
Sheaffer. You represent the National Federation----
Mr. Sheaffer. I do.
Mr. Bryant [continuing]. Of Retailers.
Mr. Sheaffer. Right.
Mr. Bryant. Now, again, I assume your clients use credit
cards, too. But are there other ways, the old-fashioned credit
way, you know, people refinance--you finance through banks and
recourse with the banks, and those kinds of loans, and so
forth?
Mr. Sheaffer. Some of the retailers do, in fact, do that.
Mr. Bryant. Do you see people filing bankruptcies who have
gone through that particular process as opposed to using a
credit card?
Mr. Sheaffer. Well, I can only speak for my own perspective
at Boscov's directly. We do all of our own credit card
application processing internally. In addition to that, we have
a very aggressive program to monitor our existing customers. We
find, much like the banks, that bankruptcy is coming not from
brand-new customers that are establishing accounts, but,
rather, from customers that have been on the books for years
and years.
So because of this huge increase in bankruptcy, we have had
to actually tighten our credit standards quite significantly
over the past few years. Unfortunately, that affects the blue-
collar worker that is looking to buy the washing machine to
replace the one that they need, or it affects the older
customer that may never revolve and may never pay us a finance
charge on our card, but, instead, carries our card because they
are afraid to carry cash. Those are the types of people that we
are having to affect, people that are still our customers.
Whether they buy with Mr. Hammonds' credit card, whether they
purchase with my credit card, or whether they purchase with
cash, they walk into my store to buy our merchandise. Those are
the types of people we are having to affect because of this
bankruptcy issue.
Mr. Bryant. Okay. I have one other question, but I wanted
each member to respond, and it would probably take too long.
But, just a quick run down--one, two, three, four, five--
just why are people filing bankruptcy so much? Just very
quickly.
Mr. Sheaffer. Lack of stigma.
Mr. Bryant. Lack of stigma.
Mr. Hammonds?
Mr. Hammonds. Well, I think there is some percentage of
people that lack of stigma affects. I think the majority of
people who file bankruptcy, in fact, need bankruptcy. If we
make a bad loan, nobody is asking for relief from that. If we
have made a bad loan, and the customer doesn't have the
capacity to repay, and they ought to be discharged to chapter
7. But it is that small percentage of people that file that
have the ability to repay that we are asking to not impact our
underwriting system and to put those into chapter 13.
Mr. Bryant. Okay. Judge Kenner. I know there are a lot of
reasons, but just the best----
Ms. Kenner. There are a lot of reasons. I am surprised; I
agree with Mr. Hammonds. The people who file bankruptcy--the
1.4 million, or whatever it is, those are people who need to be
there, by and large. I see scoundrels in bankruptcy court, but
the number of scoundrels is very small. So I don't see that the
system is being grossly abused by debtors.
Mr. Bryant. Okay. Mr. Nuss, very quickly.
Mr. Nuss. Thank you. We see a number of issues, some of
them divorce, unemployment, but late last year I ran across an
interesting comment by a presenter at a multi-state seminar
that said that some research that he had participated in said
that the actions and the activity and the approach of
collection people sometimes drove people to the brink, rather
than being able to negotiate a compromising position, where a
member in our case, debt rating could be preserved by making
some other arrangements.
Mr. Bryant. Mr. Klein, you have the last word.
Mr. Klein. Congressman, I think the simplest way I can say
it is that the family budget is a fixed pie, and everybody
wants a bigger and bigger piece out of that pie. If a family
gets three credit cards, the interest on those cards takes a
bigger and bigger piece out of that budget, and eventually, if
there is a continuing pressure on that family and more
marketing of additional credit, the budget is going to bust.
That is what I see going on over and over again.
Mr. Bryant. Could I have one quick final question to Mr.
Klein?
Mr. Gekas. Without objection.
Mr. Bryant. Thank you, Mr. Chairman.
Mr. Klein, you were here when Mr. Moran testified about
apparently a new provision in this bill that would give more of
a disclosure as to what you would be paying in a credit card if
you paid minimum payments. Would you agree that that is a good
first step or step in the right direction?
Mr. Klein. Congressman, the provision that passed the
Senate was a good provision on that issue. It was a very
powerful provision which would have actually given people
information they need to make responsible credit decisions.
The provision in H.R. 833 actually would mislead people
because it is based on a $500 balance and a set of assumptions
that wouldn't prove accurate for those people that are going to
be in the bankruptcy system because they have a $7,000 or a
$10,000 or a $20,000 balance on their credit cards as a whole.
So it has to be based on the actual circumstances that apply to
that individual's debt.
Mr. Gekas. We will change that provision and ask you for
support of the bill. [Laughter.]
Mr. Klein. I would suppose we would be supporting that if
you do.
Mr. Gekas. The time of the gentleman has expired. The Chair
recognizes the lady from Wisconsin for 5 minutes.
Ms. Baldwin. Thank you, Mr. Chairman.
I am one of the newcomers to this subcommittee who did not
go through this debate last session, being a newcomer to the
Congress, too.
Judge Kenner, I was amazed to think that you had presided
over 35,000 bankruptcy cases.
Ms. Kenner. I am actually much younger than I look.
[Laughter.]
Ms. Baldwin. I practiced law briefly and assisted a client
with one bankruptcy in my career.
Your testimony focused mostly on reaffirmations. It would
help me if I could have your perspective as a judge on the
likely success of the means test that is part of the bill that
we are considering.
Ms. Kenner. Well, Congresswoman Baldwin, I am not really
familiar with the intricacies of how it works, but if you set a
threshold of $51,000 annual income for a family of four, I
predict that that will not affect my caseload one iota. If that
is what you choose, I don't think it is going to make a
difference. The reason is that my perception is that my chapter
7 debtors simply can't pay. I agree with Chairman Gekas that
people who can pay should pay. I think that is fundamental. But
my experience in the bankruptcy court tells me that, by and
large, these debtors can't pay. My chapter 13 cases are failing
at an amazing rate. So I just don't see that the ability is
there.
Ms. Baldwin. I wanted to follow up on one of the last
questions, the reasons for the increase in numbers of filings.
One of the things I heard in your testimony, or various
testimony, is there some difference in perception of, say, the
percentage of ``scoundrels'' among all, as they were termed.
For example, Mr. Sheaffer, in your testimony I thought I
heard a little dissonance in your saying at one point that very
few of those people who actually file for bankruptcy are doing
so with a lack of real crisis in their life. Yet, in some of
your other testimony, I think you were indicating that half of
your filers, as you reviewed the files last year, were not
seriously delinquent in their cards. I don't know if I should
take the jump to say that you are doubting that there is a
serious financial crisis in their life or not, but I wonder if
you would explain that inconsistency.
Mr. Sheaffer. No, I don't think it is an inconsistency.
What we see, as a very local retailer that is very involved in
our communities, is that our customers tend to make an extra
effort to pay us, and we are very fortunate in that. Don't get
me wrong; I absolutely agree with my fellow panelists. The huge
majority of those who file bankruptcy absolutely need relief
and should get that relief. The number, depending on who you
talk to, the number goes from 3 percent to 15 percent. But even
if the number is 3 percent, you are talking about not 10, but
30,000 people that can repay some or all of their unsecured
debt. All that we are really asking is that they are compelled
to repay what they can repay.
When I say that half of our customers that file bankruptcy
were not seriously delinquent, I mean with us. I don't mean
with anybody else. In our particular case, we are very
fortunate in that our customers are very loyal to us.
Ms. Baldwin. And you would not, from your paper records,
have any ability to see if there is a health crisis or some
other crisis?
Mr. Sheaffer. No, no, we see health crises; we see divorce;
we see automobile accidents; we see lack of insurance as the
primary driver into bankruptcy. But there is still a group of
people for whom the billboards that say, ``Question: Money
problems?'', ``Answer: Bankruptcy,'' those types of messages
that are being conveyed to them are compelling them to use
bankruptcy not as the safety net that it was initially intended
to be, but, rather, as a financial planning tool. Rather than
trying to work with the creditors or trying to work with
consumer credit counseling services, they see an easy way out,
and they are using this as a financial planning tool. But it is
a very small segment of the customers.
Mr. Nadler. Mr. Chairman?
Mr. Gekas. The time of the lady has expired. For what
purpose does the gentleman----
Mr. Nadler. I ask unanimous consent for 1 minute to ask one
question.
Mr. Gekas. Without objection.
Mr. Nadler. Thank you.
I would just like to ask Mr. Klein to reply to the question
that Ms. Baldwin asked about the effect of the means test in
this bill.
Mr. Klein. The means test is two pages of a 302-page bill,
Congresswoman, and I agree with the rest of the panelists that,
if there are people in the system who can pay, they should pay.
I think we can make the means test better and make it workable.
But on the 302 pages of this bill there is something on almost
every page that advantages lenders and disadvantages debtors.
The sum total of those provisions will be to raise the cost of
filing because debtors will have to pay more to their
attorneys; they will have to pay more to use the system,
because creditors will have more weapons to get them, force
them, or coerce them to pay back their debt. That just hurts
the people at the bottom. The people who have the most need to
be in the system are going to be the ones who are least able to
afford the more complicated and expensive relief that will be
required.
Mr. Gekas. The time of the gentleman has expired.
We want to thank the panel. You got us off to a rousing
start with some controversy and with some humor. We expect that
it will serve as a foundation for future debate on this issue.
Thank you very much.
This is a propitious time for us to recess to accord the
members the privilege of voting on a pending measure on the
House floor. We expect to return to this chamber at 20 after 4.
We are recessed until that time.
[Recess.]
Mr. Gekas. The time of 4:20 having arrived, the recess has
expired, but we are unable to proceed until one other member
should arrive, pending which time we enter into another recess.
[Recess.]
Mr. Gekas. The subcommittee will reconvene. The lady from
Wisconsin has joined us to constitute the hearing quorum.
We welcome the panel. Judge Edith Hollan Jones was
appointed to the United States Court of Appeals for the Fifth
Circuit in 1985. She played an active role in studying our
Nation's bankruptcy laws as a member of the National Bankruptcy
Review Commission. She has also served on the Advisory
Committee on Bankruptcy Rules to the Standing Rules Committee
of the Judicial Conference of the United States. Judge Jones
has testified on bankruptcy issues before the Senate, as well
as before the House, on several occasions.
Judge Jones received her B.A. in economics in 1971 from
Cornell University. She then went on to study at the University
of Texas School of Law, where she was the editor of the Texas
Law Review and graduated with honors in 1974. Prior to joining
the Federal bench, Judge Jones was a partner at the Houston
office of Andrews and Kurth. Her areas of practice included
bankruptcy law. Judge Jones is a member of the Texas Bar
Foundation and the American Law Institute.
She is joined by Judith Greenstone Miller, Esquire, of
Birmingham, Michigan, who is here on behalf of the Commercial
Law League of America. Ms. Miller received her juris doctor
degree cum laude from Wayne State University of Law in 1978.
Prior to that, she attended the University of Michigan, where
she received her bachelor of arts degree, also cum laude, in
1975.
Ms. Miller's practice focuses on bankruptcy and insolvency
matters, creditors' rights, and commercial litigation. Her
practice involves the representation of secured and unsecured
creditors, debtors, bankruptcy trustees, and chapter 11
reorganizations. She is a member of the Commercial Law League
of America, its bankruptcy and insolvency section and its
creditors' rights section. Founded in 1895, the Commercial Law
League is the Nation's oldest organization of professionals
engaged in the credit and finance industry. Its current
membership exceeds 4,600 individuals.
Professor Todd Zywicki teaches bankruptcy and contracts at
George Mason University School of Law, where he has been an
assistant professor of law since 1998. Prior to joining the
faculty at George Mason, he was an assistant professor of law
at Mississippi College School of Law from 1996 to 1998.
Professor Zywicki began his legal career as a law clerk for
Judge Jerry E. Smith of the Fifth Circuit Court of Appeals.
Professor Zywicki received his juris doctor degree from the
University of Virginia in 1993. He received a masters degree in
economics from Clemson University in 1990, and his
undergraduate degree cum laude from Dartmouth College in 1988.
He has written extensively on the subject of bankruptcy,
environmental law, constitutional law and history, among other
areas. Most recently, he has co-authored with Judge Jones a Law
Review article entitled, ``It's Time for Means Testing.''
I should make that required reading for everybody in the
room. [Laughter.]
Professor Elizabeth Warren holds the Leo Gottlieb chair at
Harvard Law School. She has authored several books and articles
on consumer and business bankruptcy issues. She has taught
bankruptcy law and other business law topics at Harvard
University, the University of Pennsylvania, the University of
Michigan, and the University of Texas, among other
institutions.
She was appointed by Chief Justice Rehnquist as a member of
the Federal Judicial Center's Committee on Bankruptcy
Education, where she planned and implemented educational
programs for bankruptcy judges. Professor Warren served as the
reporter to the National Bankruptcy Review Commission. In
addition, she is active in several organizations, including the
National Bankruptcy Conference, the American Law Institute, and
the American Bankruptcy Institute. She is currently working on
an empirical study of 3,500 business bankruptcy cases as a part
of a study sponsored by the National Conference of Bankruptcy
Judges.
I might add that Professor Warren is here, whether she
realizes it or not, at my personal invitation; thus, indicating
my masochism in that in the past I felt that some of your
criticisms were aimed right at me, but that is just me. Don't
worry about that. But you do have a lot to add to this
critique, and that is why you are here.
Judge Jones, please begin with a 5-minute limitation.
STATEMENT OF EDITH HOLLAN JONES, JUDGE, U.S. COURT OF APPEALS
FOR THE FIFTH CIRCUIT, AND MEMBER OF THE NATIONAL BANKRUPTCY
REVIEW COMMISSION, HOUSTON, TX
Ms. Jones. Yes, sir, it is a great privilege and honor to
be invited to speak to this joint session, even though some of
the members are in absentia at the moment. You know I have very
strong feelings on the subject of bankruptcy, and I am a very
strong proponent of bankruptcy reform.
I would like to address four things briefly in my time
here. First, an introductory statement about the importance of
restoring personal responsibility and public accountability to
our national bankruptcy system, and then on the specific
subject of means testing: Why should we have it? How does it
work? And what are the objections to it, or are they well-
founded?
On the introductory matter, as earlier witnesses have told,
our bankruptcy system today seems to be wildly out of control.
I don't see how one can justify the filing of 1.4 million
bankruptcies during a period of unprecedented economic
prosperity and low unemployment. The answers, the reasons for
these filings are very difficult to fathom in many instances,
but a lot of them, in my view, deal with personal inability or
lack of desire to control one's finances and with the lack of
social stigma that is currently attached to bankruptcy.
The people who disagree with this view are the defenders of
the status quo. They talk about reform. They have been very
short on proposing reforms that do anything other than limit
the activities that creditors engage in, but they never face
the consequences of two things. One of them is that unnecessary
bankruptcy or manipulation of bankruptcy are not victimless
events. They impose costs, not simply on the creditors, but
also on the wives and children. Ex-husbands are prime users and
abusers of the bankruptcy system today because they get an
automatic stay, so they do not have to pay child support from
the time they file. There is an entire volume of law review
published by the family law section of the ABA devoted to
advising how wives can find their way into the bankruptcy
courts to save themselves. This bill (H.R. 833) dispenses with
those problems and solves them.
There are also other problems of abuse that I don't have
time to cover that are accounted for and largely remedied in
this bill.
But the other burden that the defenders of the status quo
don't bear is that they don't acknowledge that a system that
runs with 1.4 million cases a year, and approximately 400
judges, is not a system in which discretion exercised by the
judge means anything. They say, well, the judge ought to be
able to decide in individual cases whether a certain person is
abusing the law. I say, look at the way the law operates right
now. You have mass hearings. You have dozens of debtors present
at one hearing. Many debtors never even see the judge. It is a
system in which there simply is not public accountability.
The telling proof of this is that no one in the bankruptcy
system believes in the veracity of the debtors' statements of
their assets and liabilities. Those are documents filed under
penalty of perjury. If our tax system were that inaccurate, we
would have no Federal Government. But nobody in the bankruptcy
system and before our Commission defended the accuracy of the
debtors' filings.
Why means testing? The short of it is--I have put several
reasons down in my paper--the short of it is, means testing, as
proposed by Congress, is a modest way to identify the small
percentage of filers who are the most well off in American
society, relatively speaking. They are all in the upper half of
the American median family income, and therefore, they are the
most able to determine and control their finances, the most
able to live within their means, and the most likely to be
abusing the system. One thinks of the profligate doctor or the
bad real estate investor, for example.
How does means testing work? Major objections raised are
that it is very difficult; that we can't understand it; that
the judges are going to be overburdened. These are nonsense.
This is a formula. The formula is income less expenses.
Expenses are based on all secured debts that exist with that
debtor and all living expenses, according to a formula that the
IRS uses every day to negotiate repayment plans. There is
computer software already in a test model that puts the
information in the right places and automatically tells whether
a debtor is going to qualify or not.
No more than 20 percent of Americans who file bankruptcy
will even be eligible for consideration under the means test.
It is easily administrable. It will not impose a burden, an
undue burden, on judges because the issues will be well-framed
for them to decide.
Among the objections, the other objections to means testing
are that nobody can really afford to pay. Well, again, how can
it be that Americans who are in the top half of the median of
all Americans cannot afford to repay a single dime to unsecured
nonpriority creditors? That doesn't make sense on the face of
it.
But the bill has a hardship provision. So it doe have a
form of clemency that can be exercised.
I see that my time is up. I have a lot more to say later
on.
[The prepared statement of Judge Jones follows:]
Prepared Statement of Edith Hollan Jones, Judge, U.S. Court of Appeals
for the Fifth Circuit, and Member of the National Bankruptcy Review
Commission, Houston, TX
Distinguished Senators and Representatives, it is an honor to
testify before you today on a subject dear to my heart, that of
bankruptcy reform. These remarks support H.R. 833, captioned ``The
Bankruptcy Reform Act of 1999''. As you are aware, I served for two
years on the National Bankruptcy Review Commission, which studied the
status of the 1978 Bankruptcy Code and the system it has engendered.
When I was in private law practice, I was a specialist in bankruptcy
law. Among the articles I have published is one with Professor Todd
Zywicki called ``It's Time for Means-Testing,'' forthcoming in ____
B.Y.U. Law Review (Feb. 1999) (copy attached).\1\
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\1\ Any earlier testimony in Congress, on which some of these
remarks are based, may be found in Symposium on Bankruptcy Reform, 52
Consumer Fin. Law Quarterly Report, Spring 1998.
---------------------------------------------------------------------------
The major theme of my presentation is simple: I strongly favor
means-testing bankruptcy relief for well-off, income-earning debtors,
as I believe such a device is necessary both to restore personal
accountability to bankruptcy and to instill public confidence in the
system. In addition, as a subsidiary theme concerning judicial
administration, I strongly urge Congress to allocate the function of
collecting data in bankruptcy cases to the United States Trustees'
office, and I advocate streamlining bankruptcy appeals to the United
States Courts of Appeals.
i. the need for bankruptcy reform
The enormous support demonstrated by both Houses of Congress for
bankruptcy reform legislation in 1998 evidences your awareness of the
problems in the bankruptcy system. Only a few vivid reminders of the
need for reform will serve as a preface to my defense of means-testing.
In 1998, over 1.4 million people filed personal bankruptcy cases,
representing approximately one in each 70 American households. To put
this number in perspective, in six months in 1998, many more people
filed for bankruptcy than during the entire decade of the Great
Depression of the 1930's. The number of filings has risen well over 50%
in the 1990's alone despite unprecedented economic prosperity and low
unemployment.
The current system of bankruptcy law permits any person to seek
relief without demonstrating financial necessity. At one time in our
history, filing bankruptcy was regarded as shameful, and filers
suffered social stigma and permanently ruined credit. The shame and
stigma are no longer compelling, and creditors cater to the
euphemistically named ``sub-prime'' market. According to testimony
before the National Bankruptcy Review Commission, many filers now
commence cases without ever having been in default on their debts. This
suggests that bankruptcy is, to them, not a last resort but a first
resort. Many debtors are well-off and continue to be fully employed
before and after filing bankruptcy. Lawyer advertising, do-it-yourself
kits, and bankruptcy mills expand the pool of potential filers. Well-
publicized celebrity bankruptcies, plus ``water cooler'' gossip about
increasing filings, have tended to reduce bankruptcy to an acceptable
alternative for personal financial management.
The integrity of the bankruptcy system has suffered from the
increased filings, because bankruptcy professionals are no longer able
to devote individual attention to the cases. Administrative oversight
is ineffective. Most debtors never see a judge. Only very recently has
the Justice Department begun to prosecute bankruptcy fraud vigorously,
and egregious cases are being discovered. But even when there is not
outright fraud, there is frequent abuse and manipulation. Debtors
routinely shade the descriptions of assets and liabilities on their
schedules and statements of affairs so that no one in the bankruptcy
system believes their filings are trustworthy. This is true,
notwithstanding that debtors' disclosures are made under penalty of
perjury. Other types of abuses include filing multiple bankruptcies;
filing to forestall eviction or foreclosure; purchasing new vehicles
just before bankruptcy; pre-bankruptcy loading-up on consumer
purchases; and moving to jurisdictions with favorable homestead and
personal exemptions. Other common abuses include filings by husbands
who wish to delay making their child support and alimony payments; by
tortfeasors who wish to discharge liability, e.g. medical malpractice,
verdicts; and by perpetrators of fraud who seek to ``reorganize'' their
liabilities through Chapter 13 cases.
Although lenders' practices do not always fulfill our ethical
expectations, I am convinced that consumer lending practices,
especially by credit card issuers, are not the cause of the
inordinately high bankruptcy filing rates. That argument is a red
herring, designed to divert attention from the fraud and abuses that
are occurring and from the problems of personal responsibility that lie
at the heart of many bankruptcies. I would be happy to delve into this
mischievous argument at greater length, as it is addressed in my
article with Professor Zywicki, but it should not distract us from the
means-testing debate.
Now is the optimum time to reform bankruptcy laws. If and when our
economy turns down, I fear that the number of bankruptcies could spiral
rapidly and could suddenly multiply business losses, devastating our
consumer credit system. The impact of bankruptcy on our economic system
as a whole should never be underestimated.
ii. means-testing
A. Why Means-Testing?
The theory behind means-testing is simple: well-off, income-earning
debtors ought to repay some of their unsecured, non-priority debts in
exchange for the privilege of obtaining a fresh start. Ability-to-pay
should be just as relevant to the availability of bankruptcy relief as
to one's income tax bracket or eligibility for social welfare programs
of all kinds. Opponents of means-testing never explain why ability to
pay is uniquely irrelevant to bankruptcy, especially where, as here,
Congress has carefully limited the group to which means-testing will
apply.
Means-testing is justified for several other reasons. First,
bankruptcy relief should be tailored to the honest but unfortunate
debtor. It is neither moral nor economically sound for our society to
permit the breaking of contracts willy-nilly for the sheer convenience
of the individual. Second, when bankruptcy is abused by those who are
able to repay part of their debts, the costs are passed on not only to
the particular creditors, but also to the rest of the public in the
form of higher costs for goods and services and consumer credit.
Bankruptcy is not a victimless act. Third, lower-income people and
minorities are particularly harmed by unnecessary bankruptcies. They
bear the brunt of the higher credit costs that result. And while they
are struggling to live within their means and pay off their debts,
others are taking advantage of debt relief through bankruptcy.
Bankruptcy serves its laudable social goal when it is reserved for
those who truly deserve and need debt relief.
Fundamental social goals will be served by inaugurating Congress's
modest means-test for bankruptcy relief proposed in The Bankruptcy
Reform Act of 1999. Public confidence in the bankruptcy system as a
refuge for the needy, rather than a haven for the crafty, will be
restored. Personal responsibility will be reinforced for those who,
because they are relatively well off, should repay some of their debts.
B. How Means-Testing Works
H.R. 833 is the same as last year's Conference Committee bill.
Under this bill, panel trustees will review Chapter 7 liquidation
petitions as they are filed. If a debtor's family income exceeds the
median American income for a family of comparable size (about $51,000
for a family of four), the debtor may be eligible for means-testing.
The trustee will next review the debtor's living expenses. The living
expenses will include actual monthly payment obligations on secured
debt, other standardized expenses determined according to criteria
utilized by the Internal Revenue Service, and priority expenses such as
child support and alimony payments. If, after deducting the living
expenses from the debtor's income, there is enough monthly income
remaining to pay at least $5,000 or 25% of the debtor's unsecured, non-
priority debts over five years, then and only then is the debtor
subject to means-testing. At that point, the trustee will file a
Sec. 707(b) motion with the court seeking to dismiss the Chapter 7
liquidation case. The debtor then has the options of proceeding in
Chapter 13 or 11 or not pursuing bankruptcy.
The test set out in H.R. 833 creates a rebuttable presumption,
which the debtor may defeat ``only by demonstrating extraordinary
circumstances that require additional expenses or adjustment of current
monthly total income.''
The means-testing formula, in short, is largely mathematical, lends
itself to information processing techniques, covers only a few of the
debtors who file bankruptcy each year, and has an escape hatch for
truly deserving filers.
C. Objections to Means-Testing
Critics of means-testing are inexplicably hostile to the philosophy
behind it, which I have tried to explain in a preceding section. Worse,
they seem ill-informed about the operation and impact of the new law.
In this section, I hope to clarify some of the misconceptions.
First, the means-testing proposal contained in H.R. 833 carefully
targets only those debtors who are in the top half of comparable
American families. It has been objected that means-testing will not be
fruitful, because ``no one'' who files bankruptcy can afford to repay
debts. Studies have accumulated which demonstrate contrary
propositions. A VISA survey of bankruptcy filers between 1988 and 1996
revealed that people who earned over $45,000 annually increased from 9%
to 23% of the filers. The WEFA group, analyzing a stiffer means-testing
formula introduced in the House of Representatives last year, estimated
that between 3.6 dnd 7.4 billion dollars of debt could be repaid if the
covered debtors proceeded in Chapter 13 reorganization cases. Other
studies are described in our attached article. The amount of debt
likely to be repaid under H.R. 833 will be smaller, because of its
narrower scope, than studies based on different proposals.
Nevertheless, the returns should be substantial.
Second, if it were correct that ``no one'' who files bankruptcy has
the ability to repay debts, that would probably mean that ``no one''
would qualify for means-testing under H.R. 833. It is contrary to human
nature, however, to suppose that when the government offers a ``free''
discharge from debt, no one will take undue advantage of the system.
The real question is how best to identify those who are misusing
bankruptcy and to make them pay for the privilege.
Third, is means-testing ``unfair''? I think not, because it is a
progressive reform in the same sense that our income tax system is
progressive. The more one has the ability to repay, the more he ought
to repay his debts while obtaining bankruptcy relief. It is not
``unfair'' to impose a price on higher income-earning debtors for the
benefits they receive from filing bankruptcy.
Fourth, the modest means-test incorporated as an amendment to
Sec. 707(b) of the Bankruptcy Code will not impose undue costs and
burdens on the judiciary, on trustees or on attorneys. Last year,
Professor Carl Felsenfeld of Fordham Law School and attorney William
Perlstein of Washington, DC, created a software program that, given
proper information about a debtor's affairs, would automatically
calculate the debtor's eligibility for Chapter 7 liquidation or a
Chapter 13 payment plan. Such software is easily usable by all
professionals in the bankruptcy system. The initial responsibility for
complying with the means-test will fall upon debtors' attorneys, as
they have an ethical duty to advise their clients how to file cases
properly. Although H.R. 833 states that the panel trustee or bankruptcy
administrator must review petitions for their amenability to means-
testing, forms can be promulgated which incorporate the available
software and yield the correct answer at a glance. Trustees ought to be
able to rely on the data gleaned from the attorneys' official work
sheets. Finally, judges will not have to reconstruct the debtors'
financial condition themselves. By the time a motion for Sec. 707(b)
relief is litigated, the precise contested issues will be framed for
the court. The court will be able to review the underlying summaries of
relevant financial information.
Some short-term costs will be incurred while the details for
administering the law are worked out and initial ambiguities are
resolved by judicial decisions, but similar costs accompany any new
statutory system. Moreover, means-testing will be relevant for at most
perhaps ten to twenty percent of consumer filers, since the vast
majority of petitions on their face will not qualify. If increased
costs are significant, they can be defrayed by higher filing fees or
trustee fees for eligible debtors.
Fifth, some argue that means-testing ``can't work'' because
debtors' schedules are unreliable. This objection essentially admits
that the present system lacks effective oversight. If debtors are smart
enough to ``game'' the system, they must be understating their assets
and ability to pay. H.R. 833 enhances the reliability of debtors'
filings by requiring pay stubs, tax returns and other documents to be
furnished timely to the trustee and by requiring random audits.
Sixth, some critics of means-testing target as ``inequitable'' the
use of standardized levels of living expenses. These schedules of
expenses are already used by government agencies, and they are adjusted
geographically. In the present bankruptcy system, each court must
determine for itself whether a debtor's ``lifestyle'' expenses, such as
private school, club memberships, or cellular telephones, are too
extravagant. In fact, bankruptcy judges routinely complain about making
these judgment calls. Substituting rough consistency for the discretion
and preference of each bankruptcy judge does not seem unfair.
Seventh, it is said that means-testing will be manipulated and that
debtors will increase their expenses or secured debt or reduce their
income in order to avoid the test. To the extent this criticism is
correct, it indicts the current system as well by admitting that
gamesmanship can and does occur. But the criticism is misplaced. If
debtors flagrantly evade the means-test formula, they and their
attorneys should be held to account and sanctioned. Even more
important, there will only be disputes about means-testing in a small
proportion of cases, and there is correspondingly little room for
evasion. Further, debtors' efforts to evade means-testing would be
self-defeating.
Eighth, a final objection is that means-testing will not work
because Chapter 13 ``doesn't work,'' inasmuch as most debtors never
complete their payment plans and receive a discharge. This criticism
overlooks the differences between current Chapter 13 debtors and those
who would be covered by means-testing. The well-off, income-earning
debtors have a lot more to lose if they fail to receive a discharge,
and their incentives to complete their Chapter 13 payments are greater.
As. H.R. 833 imposes limits on repeat filings, well-off debtors would
have to exercise care in their affairs.
iii. bankruptcy data collection
H.R. 833 directs the federal courts to compile data and statistics
concerning bankruptcy cases that will be generally useful for
researchers and policy makers. This responsibility should, however, be
placed in the hands of the U.S. Trustees, not the courts. The federal
courts' mission is to administer justice and decide cases. It is not
the courts' proper function to assist or participate in social science
data-gathering. The courts have never been asked to assemble such data
before. Consequently, as a matter of principle, the Judicial Conference
of the United States has decided that the collection of such data, if
desired by Congress, should be assigned to the United States Trustee
system instead. As a matter of practicality, the U.S. Trustees are
better equipped to collect the data that are of interest to Congress
and policy researchers, and they are in a better position to address
privacy concerns.
iv. direct appeals
Bankruptcy law is unduly vague and complex because there is no
effective system of precedent in place. Bankruptcy decisions must be
appealed first to federal district court and then to the courts of
appeals. The delays and costs of this pilgrimage are more than most
parties can afford. As a result, it is extremely difficult to pursue
cases that will yield circuit-wide precedent. The bankruptcy courts
routinely operate on conflicting legal premises.
The only solution to this problem is to facilitate appeals to the
courts of appeals. Several proposals have come forward. I personally
favor avoiding district court review wherever possible and utilizing a
model based on appeals from magistrate judge decisions. Others have
favored optional retention of bankruptcy appellate panels, with review
available by the circuit courts. Yet others favor placing a time limit
on district court handling of bankruptcy appeals. None of these
proposals should be discarded out of hand. This issue is vital to
achieving coherence in bankruptcy law. Every interested party and
constituency in bankruptcy of which I am aware has advocated direct
appeals.
Mr. Gekas. The Chair now turns to Ms. Miller.
STATEMENT OF JUDITH GREENSTONE MILLER, REPRESENTING THE
COMMERCIAL LAW LEAGUE OF AMERICA, BIRMINGHAM, MI
Ms. Miller. Thank you. I am honored to appear before the
committee today on behalf of the Commercial Law League of
America. There are a number of comments I would like to make
regarding the proposed needs-based testing.
Creditor standing under the proposed amended section 707(b)
is limited. The size of the case should not impact creditors'
standing to bring such motions. Abuse under the statute is
defined by a specific rigid needs-based formula. No formula,
however well-considered or crafted, can be flexible enough to
encompass the endless combinations or circumstances which
debtors bring to the bankruptcy court. While intended to
provide a very objective standard, such formulas have proven
historically to be the source of much litigation focused at
interpreting and defining all of the parameters.
The bill does not grant the court any discretion to
determine whether a debtor with sufficient income under the
needs-based formula should, nevertheless, be allowed to remain
in the chapter 7 proceeding. The 5-year period for calculation
of the debts is longer and inconsistent with the 3-year period
currently provided for repayment of obligations under a chapter
13 plan. The standard to rebut the presumption, extraordinary
circumstances, is rigid, onerous, and likely to lead to
increased litigation.
The National Bankruptcy Review Commission conducted an
extensive study and analysis of consumer bankruptcies.
Ultimately, though, they did not recommend the adoption of a
needs-based formula denying individuals in financial distress
access to the court. Although bankruptcy filings have increased
threefold during the last 20 years, one cannot necessarily
conclude it is solely on account of debtor abuse, unwillingness
of individual debtors to honor a promise to pay, or lack of
social stigma.
A number of the empirical studies have indicated that the
financial crises being experienced today are similar to those
of families 20 years ago. These people have no hope of repaying
their debts.
There are many factors that contribute to the filing of a
bankruptcy, which have been alluded to today by other
witnesses, whether it be layoffs, downsizing, medical bills,
failed businesses, or having to take care of aged parents. The
League concedes there is no agreement on the statistics or the
reason for the increase. However, if you take the highs and the
lows of the percentages being bantered about, anywhere from 3
percent to 6 percent that will be affected by the means test,
you have to question the legitimacy of applying it across the
board on a mandatory basis to 100 percent of the cases that are
filed.
Trustees are being asked to review each case and apply the
means test. This will unnecessarily burden the system,
particularly when they are vested with substantial
responsibility and paid a minimal fee.
If you only affect 6 percent of the cases, why require the
trustees to perform work in 100 percent of the cases? Moreover,
you require the calculations be done 5 days before the first
meeting of creditors. If, in fact, as everybody concedes, the
schedules are not accurate, wait until the first meeting of
creditors take place. Let the trustees do their job, to ask the
questions that they need to find out about the true essence of
the estate, and then determine whether or not there is abuse
that justifies the means application.
The means test further operates to the exclusion of the
trustee's significant avoidance powers. If the trustee finds
that there have been avoidable transfers that could be brought
into the estate, if the person doesn't qualify under the means
test to be in chapter 7, then they can't go after those assets
and bring them back into the estate.
The proposed means test also invites manipulation by
debtors to fit within the standard. Individuals with secured
debt are allowed deductions for secured obligations prior to
calculating their debt. Also, they could go out and get a
second mortgage or a new car and finance it before filing in
order to reduce the income available so they don't qualify.
Also, they could make contributions to charities, 15 percent of
their income, which wouldn't be calculated as part of the
income.
The League is sensitive to the concerns of sanctity of
contract and moral obligation to honor promises raised by Judge
Jones, but the means test does not remedy the problem and will
preclude too many honest debtors and first-time debtors from
obtaining redress.
Congress is operating from the premise that filing
bankruptcy is per se abusive. Rather, the focus of Congress
should be on debtors who abuse the system by serial filings and
those provisions of the Code which encourage abuse of the
system, such as unlimited exemptions. Ultimately, the courts
should be given the tools, the totality of circumstances,
including consideration of a discretionary, flexible means
test, and the express authority to determine when abuses are
present and how such abuse should be remedied.
The concept of a fresh start and maintenance of the
delicate balance between the debtor's rights and creditors'
remedies must be preserved. Under the current Code, the courts
do not have the authority to affirmatively look for abuse or
fashion an appropriate remedy except in the most egregious
circumstances. Adoption of the totality of circumstances test,
in conjunction with the discretionary means test, would
represent a major change and a vehicle by which abuse could be
addressed and remedied.
Although we do oppose the means test as currently drafted,
we recognize there is abuse in the system that has to be
addressed; we also recognize that there are a number of
provisions that are proposed as part of the Bill that are fair
and will help to maintain a balanced system. We are committed
to continuing to work with Congress in that regard.
Thank you.
[The prepared statement of Ms. Miller follows:]
Prepared Statement of Judith Greenstone Miller, representing the
Commercial Law League of America, Birmingham, MI
i. introduction
The Commercial Law League of America (the ``League''), founded in
1895, is the nation's oldest organization of attorneys and other
experts in credit and finance actively engaged in the fields of
commercial law, bankruptcy and reorganization. Its membership exceeds
4,600 individuals. The League has long been associated with the
representation of creditor interests, while at the same time seeking
fair, equitable and efficient administration of bankruptcy cases for
all parties involved.
The Bankruptcy and Insolvency Section of the League (``B&I'') is
made up of approximately 1,600 bankruptcy lawyers and bankruptcy judges
from virtually every state in the United States. Its members include
practitioners with both small and large practices, who represent
divergent interests in bankruptcy cases. The League has testified on
numerous occasions before Congress as experts in the bankruptcy and
reorganization fields.
The League, its B&I Section and its Legislative Committee have
analyzed the ``needs based'' provisions of H.R. 833, the Bankruptcy
Reform Act of 1999 (the ``Bill''). The League supports changes to the
Bankruptcy Code (the ``Code'') to limit possible abuses by debtors and
credit grantors. Any proposed change will have consequences on the
system. It is the goal of the League to help Congress carefully
consider the practical implications of each change in order to maintain
the delicate balance between the debtors' rights and creditors'
remedies and to effectuate fair treatment for all parties involved in
the process.
ii. analysis of section 102--dismissal or conversion; the ``needs
based'' provision of the bill
This section of the Bill provides the circumstances under which a
Chapter 7 proceeding can be dismissed or converted by the Court.
Congress has proposed to substantially modify Section 707(b) of the
Code as follows:
LCreditor standing to bring motions under Section
707(b) is limited under the proposed legislation. While the
League recognizes that the limit is reasonable as drafted,
nevertheless, the League believes that the size of the case
should not impact creditor standing to bring such motions.
LA case may not be converted to Chapter 13 without the
debtor's consent. The League believes that it is appropriate to
grant the Court discretion to convert a Chapter 7 proceeding
irrespective of the debtor's wishes if the debtor falls within
the parameters of the ``needs based'' provisions, particularly
when the debtor has received the benefit of the automatic stay
during the interim period. The League recommends that after
conversion to Chapter 13, the debtor should be given the right
to dismiss the case during a 20-day period from the date of the
conversion. The right to dismiss should not be subject to the
discretion of the Court.
L``Substantial abuse,'' as the standard for dismissal
has been changed simply to require ``abuse.'' The League
believes that the standard should remain ``substantial abuse.''
L``Abuse'' is defined by reference to specific, rigid
``needs based'' formula, when, in reality, as recognized by
Congress, ``abuse'' may be found to exist based upon a review
of the totality of circumstances surrounding the filing. See
e.g., subsections 3(A) and (B). No formula, however well
considered or crafted, can be flexible enough to encompass the
endless combinations of circumstances which debtors bring to
the bankruptcy court. While intended to provide a very
objective standard, such formulas have proven historically to
be the source of much litigation focused at interpreting and
defining all of the parameters of the standards. A better
approach would be to draft general standards or a more
expansive definition of ``abuse,'' which would include, but not
be limited to, a finding of ``abuse,'' based on a needs based
formula, bad faith or specific behavior or activity.
Ultimately, the Court would be required to make a finding after
a review of all of the facts and the totality of circumstances
surrounding the filing of the petition.
LThe Bill does not grant the Court any discretion to
determine, based on a totality of the facts and circumstances,
whether a debtor who has sufficient income under the needs
based formula should, nevertheless, be allowed to remain in a
Chapter 7 proceeding. The League believes that courts do a good
job generally of exercising discretion in individual cases, and
therefore, such discretion should continue to be vested in the
courts.
LThe 5-year period required for calculation and
determination of whether a debtor falls within the needs based
formula is too long and inconsistent with the 3-year period
currently provided in the Code for repayment of obligations
under a Chapter 13 plan.
LThe standard to rebut the presumption, e.g.,
``extraordinary circumstances,'' is rigid, onerous, and likely
to result in increased litigation over the evidence necessary
to prove compliance with this standard. Moreover, subsection
2(B) requires the ``extraordinary circumstances'' to be
evidenced by an itemized, detailed explanation, proving that
such adjustment is both necessary and reasonable, and the
accuracy of the information provided in the explanation must be
attested under oath by both the debtor and its attorney. This
verification requirement by the debtor's attorney is
inappropriate, unreasonable and appears to go beyond the
parameters of Federal Rule of Bankruptcy Procedure 9011 and
Federal Rule of Civil Procedure 11.
LThe needs based formula requires that ``current
monthly income'' be calculated on the basis of all income, from
all sources, regardless of whether taxable, received within
180-days from the commencement of the proceeding. The 180-day
period may be too short to obtain an accurate review of the
debtor's available sources of income, and may also be
susceptible to manipulation. The League, therefore, recommends
that the assessment period be redrafted to be one year from the
date of the commencement of the bankruptcy proceeding.
LCongress has created a new and different standard for
the award of fees and costs associated with the bringing of a
motion to dismiss or convert under Section 707(b). There is no
need to create a new standard, e.g., ``substantially
justified,'' when sufficient standards for such relief already
exist under Federal Rule of Bankruptcy Procedure 9011 and
Federal Rule of Civil Procedure 11. Appropriate sanctions are
already available when it can be demonstrated that a creditor
has filed a Section 707(b) motion solely for the purpose of
coercing the debtor into waiving a right guaranteed under the
Code. Moreover, the potential imposition of penalties on the
attorney for the debtor if the case is deemed abusive will
likely translate into increased costs and fees attendant to
preparation and filing of a bankruptcy petition. Lastly,
subsection 4(B) exempts a creditor with a claim of less than
$1,000 from the imposition of costs and fees. The amount of
one's claim should not be a consideration in the award of fees
and costs by the Court.
iii. the proposed ``needs based'' changes do not work, will not cure
the perceived abuses to the bankruptcy system and will overburden and
tax the system
The National Bankruptcy Review Commission (the ``Commission'')
conducted an exhaustive study and analysis of consumer bankruptcies
over the period it was created by Congress. While the Commission
recognized the import of a promise to pay, it also acknowledged the
need for appropriate relief for those in financial trouble and
equitable treatment for creditors within a balanced system. Bankruptcy,
in most cases, is the ``last stop'' for financially troubled individual
consumer debtors. The Commission also conceded that there were abuses
in the system, but did not ultimately recommend the adoption of a needs
based formula or otherwise denying individuals in financial distress
access to the courts.
Although bankruptcy filings have increased three-fold during the
last 20 years, one cannot conclude that the reason for this increase is
solely on account of debtor abuse, unwillingness of individual debtors
to honor a promise to repay under a contract and the lack of social
stigma associated with bankruptcy--the key factors, on which the needs
based formula is erroneously premised. The Commission, bankruptcy
organizations, practitioners, academicians and judges have dismissed
each of these factors on the basis of the following substantial
empirical data:
LThe statistical evidence shows that consumers who
file for bankruptcy relief today as a group are experiencing
financial crises similar to families of 20 years ago.
LMost families who file bankruptcy are seeking relief
from debts they have no hope of repaying. In fact, an empirical
study commissioned by the American Bankruptcy Institute from
Creighton University concluded that the means testing formula
would only affect 3% of the Chapter 7 filers because the
remaining 97% had too little income to repay even 20% of their
unsecured debts over five years. The Purdue Study, funded by
the credit card industry, which supported a means based test
because it contended that a substantial number of debtors who
file could repay their debts, has been criticized as unreliable
and misleading by, among others, the Government Accounting
Office. This is not the first time that the means testing has
been considered--Congress has resisted this attempt over the
last thirty years and should decline to endorse this proposal
without the demonstration of reliable, cognizable benefits that
do not otherwise burden and impair the system.
LThe triggering events for filing bankruptcy by
individuals depend on individual circumstances, such as
layoffs, downsizing, moving from employee to independent
contractor status, uninsured medical bills, car accidents,
institutionalized gambling, failed businesses, job transfers,
caring for elderly parents or children of siblings, divorce,
etc.
LAt the same time that individual consumer
bankruptcies have increased, there has been an increase in
available credit and massive marketing campaigns. According to
the Consumer Federation of America, from 1992 through 1998,
credit card mailings have increased 255%, unused credit lines
have increased 250%, while debt has increased only 137%. With
increased credit, the littlest financial change in a family can
have devastating consequences.
LKim Kowalewski, Chief, Financial and General
Macroeconomic Analysis Unit, Congressional Budget Office,
concluded that a study conducted and funded by Visa, USA was
``unscientific,'' ``invalid'' and ``unfounded.'' The study had
suggested that the increase in personal bankruptcies was
directly attributable to the decreased social stigma of filing
bankruptcy and increased advertising of legal assistance for
filing bankruptcy. While the League recognizes that decreased
social stigma and increased advertising are contributing
factors, that is only the beginning of the analysis and does
not constitute the sole bases accountable for the tremendous
increase in bankruptcies. Mr. Kowalewski concluded that the
increase in bankruptcies was more a function of increased debt
rather than a sudden willingness to take advantage of the
system. Is it, for example, any less embarrassing for an
individual to file a petition in bankruptcy than to have his
home foreclosed, his car repossessed or his neighbors contacted
by debt collectors?
LRequiring trustees to review each case and apply the
means test and forcing debtors into Chapter 13 will overburden
the system. Application of the standards and pursuit of a
motion is an unreasonable burden for the panel trustees. The
trustees are paid only a minimal fee (e.g., $60) for
substantial responsibility in no asset cases. The means testing
will involve not only analysis in each case, but also numerous
motions, many of which are likely to be contested by debtors.
If there are no nonexempt assets, which is generally the case
in most Chapter 7 cases, how is the trustee to be compensated?
Moreover, pursuing a Rule 9011 action against a debtor's
attorney is not likely to produce an immediately available and
certain source of recovery for the trustee. The trustee could
be required ultimately to spend a potentially huge amount of
time with little or no assurance of any repayment for such
services. This represents a tremendous burden on the system,
when according to the National Association of Bankruptcy
Trustees, only one in every ten cases subject to the means
testing and with apparent ability to propose a Chapter 13 plan
are able to actually confirm or complete the plan.
LThe establishment of the means test creates a number
of anomalies. For example, if a debtor files a Chapter 13
initially, the means formula does not apply, and in a number of
jurisdiction, the debtor could propose a zero percent plan and
discharge the same debt he would have in a Chapter 7
proceeding. This is not what Congress intended to create under
the means test.
LThe means test further operates to the exclusion of
the trustee's significant avoidance powers. For example, the
schedules may reveal a significant preferential payment that,
if recovered, would result in a distribution to creditors in
excess of what they would receive upon application of the means
test. Dismissal of the proceeding under such circumstances is
hardly the remedy in the best interest of either the debtor or
its creditors.
LThe proposed means test invites manipulation by the
debtor to fit within the standard. Individuals with secured
debt are allowed deductions for such obligations prior to
calculating available disposable net income. A debtor with too
much income could trade in an old car for a new one, deduct the
payment from the means formula and thereby become eligible for
Chapter 7 relief. Another option is for debtors with too much
income to make use of The Religious Liberty and Charitable
Donation Protection Act of 1998, which allows debtors to
contribute up to 15% of their gross income to charities. Such
contributions are not considered in making the calculation
under Section 707(b). A debtor with income of $60,000 could
thereby remove $750 per month in disposable income by making
the maximum allowable charitable contribution.
LIf a debtor does not qualify for Chapter 7 or Chapter
13, the only alternative is Chapter 11--a costly and unfeasible
alternative for most individual debtors.
LJudge Edith Holland Jones, in her Dissent to the
Final Report of the Commission, has suggested that the sanctity
of contract and one's moral obligation to honor promises to
repay necessitates establishment of a means test, absent which
bankruptcy as a social welfare program will be subsidized by
creditors and the vast majority of Americans who struggle and
succeed to make ends meet financially. The League is
sympathetic to the issues raised by Judge Jones, however, the
means test, as proposed, does not remedy the perceived abuse.
Determining eligibility merely on the basis of net disposable
available income, without consideration of the myriad of
factors contributing to the financial problem and without court
discretion, would preclude too many honest first time debtors
from obtaining redress from the court of last resort.
LCongress is operating from the premise that filing
bankruptcy is per se abusive. Rather, the focus of Congress
should be on debtors who abuse the system by serial filings and
those provisions of the Code which encourage abuse of the
system (e.g., unlimited exemptions). Ultimately, the courts
should be given the tools (e.g., the totality of the
circumstances, including consideration of a discretionary,
flexible means test) and the express authority to determine
when abuse is present and how such abuse should be remedied--
the concept of a fresh start and maintenance of the delicate
balance between debtors' rights and creditors' remedies must be
preserved. Under the current Code, the courts do not have the
authority to affirmatively look for abuse or fashion an
appropriate remedy except in the most egregious circumstances.
Adoption of a ``totality of circumstances'' test, in
conjunction with a discretionary means test, would represent a
major change and a vehicle by which abuse could be addressed
and remedied.
iv. conclusion
Maintaining and enhancing a fair, balanced and effective bankruptcy
system requires consideration and debate of all the issues. Any
individual change has an impact on the entire system, and cannot and
must not be evaluated in a vacuum. The League takes seriously its role
in this process, and believes that other options beyond the current
mandatory needs based formula should be explored that would address the
real abuses and preserve the bankruptcy system which Congress
acknowledged it was generally satisfied with in 1994 when this process
began and that the system was not in need of radical reform. Adoption
of a fixed, rigid needs based formula, as contained in the Bill,
represents ``radical reform,'' which has not been justified and will
impair the delicate balance inherent in the system; nor is it likely to
rid the bankruptcy system of the perceived abuses.
Respectfully submitted,
Jay L. Welford, Co-Chair,
Legislative Committee
Judith Greenstone Miller,
Co-Chair, Legislative Committee.
Mr. Gekas. We thank Ms. Miller, and turn to Professor
Zywicki for 5 minutes.
STATEMENT OF TODD ZYWICKI, PROFESSOR, GEORGE MASON UNIVERSITY
SCHOOL OF LAW, ARLINGTON, VA
Mr. Zywicki. Thank you, Congressman Gekas. It is an honor
to come before you today to testify on this historic occasion.
As Congressman Gekas mentioned earlier today, it has been over
60 years since there has been a joint hearing of the House and
Senate on bankruptcy, and 60 years ago we were in the midst of
the Great Depression--25 percent unemployment, rampant farm
failures, rampant bank failures, rampant business failures,
unparalleled suffering in America, and 50,000 to 100,000
bankruptcy filings was considered a massive number,
unprecedented numbers.
Today, of course, we have 5 percent unemployment, 6 percent
growth rates. The farm crisis of the 1980's is past. Business
bankruptcies are at an incredibly low level. And we had 1.4
million bankruptcy filings last year. We had more bankruptcy
filings in the first half of 1997 than in the entire decade of
the Great Depression combined.
Means testing is one of the anecdotes to this problem.
Means testing can be summed up in one basic question: Should
high-income debtors, who can repay a substantial portion of
their debts without significant financial or other hardship, be
required to do so? That's it: Should high-income debtors, who
can repay a significant portion of their debts without
significant financial or other hardship, be required to do so?
Bankruptcy should be for poor unemployed, divorced people,
basically down on their luck. As my co-panelist, Professor
Warren, said in her great book from a while back, the generous
willingness of Americans to help those in trouble is balanced
by a demand that only the truly needy be helped. I think that
is the attitude that we should have toward bankruptcy. Keep in
mind, means testing does not interfere with high-income debtors
being able to file bankruptcy. It simply says, if you file, and
can repay a certain amount of your debts, you must do so. It
does not affect low-income earners at all.
Estimates are that 80 percent of people who file bankruptcy
are below the national median income by this test. Eighty
percent of people won't even be affected. Estimates range from,
say, 3 to 5 to 10 percent--more likely, somewhere between 6 to
10 percent--of those who file bankruptcy would be affected by
means testing.
But the payoff is significant. Those same studies show that
60 to 70 percent of their debts could be repaid, approximately
$4 billion, if they were forced into chapter 13 rather than
chapter 7. Compare that to chapter 7 rates, where 95 percent of
chapter 7's make no distribution at all, and most of those who
make a distribution make only a trivial distribution.
People ask me, why do you care about bankruptcy? I think
the answer is that an analogy is to shoplifting. Nobody in this
room is a shopkeeper; none of us own a retail store, but we are
all opposed to shoplifting. Why is that? Well, first, because
we all know that the losses, when some people engage in theft
and shoplifting, the losses get passed onto other consumers. We
subsidize those losses, at least some of them.
Secondly, it is simply unfair should get benefits that they
don't have to pay for. I seem to recall a phrase a few years
ago that, those who work hard and play by the rules should be
protected in America. Those who work hard and play by the rules
should be protected in the bankruptcy system, but those who do
not should not.
Third, creditors are providing valuable goods and valuable
services, whether it is goods, credit, whatever it may be. They
deserve to be paid for that. We all deserve to be paid for the
goods that we provide.
Finally, shoplifting and bankruptcy--shoplifting is wrong;
bankruptcy is also a moral act. Bankruptcy is a moral as well
as an economic act. There is a conscious decision not to keep
one's promises. It is a decision not to reciprocate a benefit
received, a good deed done on the promise that you will
reciprocate. Promise-keeping and reciprocity are the foundation
of an economy and healthy civil society.
Do we have charity? Yes. When Jean Valjean shoplifts a loaf
of bread to feed his children, that is different from a rich
guy who shoplifts a Rolex watch. The bankruptcy system and
means testing recognize that. It protects the Jean Valjeans of
the bankruptcy system, but not the fellow who is stealing the
Rolex watch.
In law we have the doctrine of necessity. If you in a boat
at sea and a raging storm comes up, you are allowed to tie up
at the first dock that you come to. But if you are out at sea
and it is a sunny day, you are not allowed to just tie up at
the dock for a mere matter of convenience. The bankruptcy
system should be tailored to those who have the storms of their
life, but it shouldn't be the people who simply are sailing
around on a sunny day and decide to cut corners and file
bankruptcy for a mere matter of convenience.
Thank you.
[The prepared statement of Professor Zywicki follows:]
Prepared Statement of Todd Zywicki, Professor, George Mason University
School of Law, Arlington, VA
bio
Professor Todd J. Zywicki teaches Bankruptcy, Contracts, and
Commercial Law courses at George Mason University School of Law in
Arlington, VA, where he has been an Assistant Professor of Law since
1998. Prior to joining the faculty at George Mason, he was an Assistant
Professor of Law at Mississippi College School of Law in Jackson, MS
from 1996-1998. Prior to that, Professor Zywicki clerked for the
Honorable Judge Jerry E. Smith on the United States Court of Appeals
for the Fifth Circuit, and practiced bankruptcy law with Alston & Bird
in Atlanta, GA. He received his J.D. from the University of Virginia in
1993, a Master's Degree in Economics from Clemson University in 1990,
and his undergraduate degree cum laude with distinction in his major
from Dartmouth College in 1988. Professor Zywicki is the author of over
20 published articles, essays, and book reviews in both law reviews and
economics journals. He has written widely in the areas of bankruptcy,
environmental law, constitutional law, constitutional history, and
economic analysis of law. Professor Zywicki is also a Contributing
Editor to the Norton Bankruptcy Treatise and Co-Chair of the Bankruptcy
Subcommittee of the Federalist Society's Financial Institutions
Practice Group. He has previously testified on bankruptcy issues before
the United States Senate, Judiciary Committee, Subcommittee on
Administrative Oversight and the Courts. Recent publications on
bankruptcy law include, ``It's Time for Means-Testing'' (co-authored
with Judge Edith H. Jones), 1999 BYU L. Rev. (forthcoming 1999);
``Rewrite the Bankruptcy Laws, Not the Scriptures: Protecting a
Bankruptcy Debtor's Right to Tithe,'' 1998 Wisconsin L. Rev. 1223;
``Mend It, Don't End It: The Case for Retaining the Disinterestedness
Requirement for Debtor in Possession's Professionals,'' 18 Mississippi
College L. Rev. 291 (1998).
statement
Distinguished Senators and Representatives, it is a distinct honor
to testify before you today on the subject of consumer bankruptcy
reform. I have practiced, taught, and published articles on the subject
of consumer bankruptcy. Most recently I am a co-author with Judge Edith
H. Jones of the forthcoming article, ``It's Time for Means-Testing,''
which will be published in the B.Y.U. Law Review, a copy of which Judge
Jones and I have inserted into the record, and the author of a working
paper on ``Credit Cards in Bankruptcy.''
The debate over means-testing boils down to a simple question:
Should high-income debtors, who can repay a substantial portion of
their debts without significant financial or other hardship, be
required to do so? To this question, I believe the answer must be
``yes.''
Bankruptcy has traditionally been intended as a last resort for
those who are poor, unemployed, suffering from health problems, or
otherwise down on their luck. Bankruptcy should not be a first resort
for those who simply and consciously choose not to live within their
means. Nor should bankruptcy be a mechanism for people to strategically
take advantage of the system for financial gain. Means-testing will
improve the administration of the bankruptcy system, increase the
recovery from high-income debtors, protect low-income debtors, and
increase public confidence in the fairness and efficiency of the
bankruptcy system. At the same time, it will protect the poor and
unfortunate debtors for whom bankruptcy is intended.
Opponents of means-testing have engaged in a high degree of
hyperbolic rhetoric designed to obscure the central issue of whether
high-income debtors should be required to repay their debts if they
can. But an inspection of the goals and practical effect of means-
testing shows these concerns to be without merit. Means-testing does
exactly what its name suggests; it requires those who have the
``means'' to repay their debts to do so. By definition, means-testing
does not apply at all to the great bulk of bankruptcy filers, the
roughly 80% of Chapter 7 filers whose incomes are below the median
national income. Studies repeatedly indicate that means-testing would
affect a maximum of 10% of all bankruptcy filers, all of whom, by
definition, earn incomes that exceed the median national income,
adjusted for family size.
Although means-testing would cover a relatively modest number of
bankruptcy filers, its financial impact would be substantial. It
targets an extremely well-defined group of bankruptcy filers who could
pay all or substantially all of their outstanding debt with minimal
hardship. Studies repeatedly conclude that those affected by means-
testing could pay approximately 60%-70% of their unsecured debts if
they filed under Chapter 13, which amounts to a total of over $4
billion. By contrast, 95% of Chapter 7 bankruptcy filings make no
distribution at all to unsecured creditors, and those that do rarely
pay out more than a trivial amount. Despite the much larger payout made
to creditors in a Chapter 13, debtors usually are advantaged by filing
under Chapter 7. As a result, 72% of individual cases are filed under
Chapter 7. More detailed summaries of the findings of the relevant
studies and the mechanics of how means-testing would work in practice
are provided in the article authored by Judge Jones and myself. But one
thing is clear, even though the reach of means-testing is small in
terms of the number of filers impacted, its impact would be large in
terms of the amount of money collected. Moreover, it is likely that the
economic and other benefits of means-testing, such as uniformity,
fairness, and confidence in the operation of the bankruptcy system,
would more than offset any increases in administrative costs--if any--
that might result from its adoption.
Consider, for instance, the recent case of Dr. Robert N. Kornfield.
See In re Kornfield, 164 F.3d 778 (2d Cir. 1999). Dr. Kornfield is a
gastroenterologist in New York who earned $472,445 in 1994, and
$404,593 in 1995, before his income ``plummeted'' to a ``mere''
$276,000 in 1996. He had an additional amount of $390,216 in pension or
profit-sharing plans. As for debt, he had $508,664.85 in two mortgages,
and additional debt of $76,029.15. He also was spending $53,640 per
year in private schools for his children, despite a specific finding by
the bankruptcy court that appropriate public schools were available for
educating Dr. Kornfield's children. In sum, the bankruptcy court
``found that the debtors had incurred substantial debts largely because
of an extravagant lifestyle that they declined to alter in the face of
lowered income,'' Kornfield, 164 F.3d at 783, and the Second Circuit
concluded that the debtor was ``enjoying a substantial income but
seeking to transfer the cost of an unnecessarily extravagant lifestyle
to creditors,'' id. at 784.
Is Dr. Kornfield representative of the vast bulk of individual
debtors in the bankruptcy system? No, he is not. But is he
representative of a certain class of debtors in the bankruptcy system--
those who file bankruptcy not as the result of financial hardship as
conventionally understood, but merely as a convenience to maintain ``an
unnecessarily extravagant lifestyle'' and to transfer the cost to
creditors? Yes, he is. And this class of opportunistic debtors grows
larger every day. In the end, Dr. Kornfield's Chapter 7 case was
dismissed for ``substantial abuse'' under '707(b), but his case
provides an illustration of the problems with the current regime for
policing opportunistic debtors such as Dr. Kornfield and why means-
testing is a necessary antidote.
Before Dr. Kornfield's case was finally resolved, he had contested
the issue in the bankruptcy court, district court, and all the way to
the court of appeals. At that point the Second Circuit adopted a
``totality of circumstances'' test to determine whether a particular
case should be dismissed for ``substantial abuse.'' Under this
approach, in every case the court will be required to consider all of
the factors that might be relevant as to whether a case should be
dismissed for ``substantial abuse,'' of which ability to pay is perhaps
the most important factor, but not the only factor for the court to
consider. The adoption of a ``totality of circumstances'' test means
that in every case where dismissal is sought under '707(b), courts will
have to engage in detailed fact-finding and sifting and weighing of
evidence with little guidance as to the proper legal standard to apply.
As a result, the outcome in any given case will be highly dependent on
the judge's inclinations and the debtor's ability to find and fund
talented counsel. Moreover, the case was dismissed, but only after a
lengthy and expensive process that involved an initial hearing,
followed by two layers of appeals. Thus, the lack of clear rule of
decision spawns delay, expensive hearings, and repeated appeals that
impose a significant financial cost on the bankruptcy system and the
court system generally.
Dr. Kornfield's case also illustrates the unfairness and non-
uniformity of results under the current system. Egregious cases pass by
unnoticed every day in bankruptcy courtrooms throughout America. Dr.
Kornfield had the misfortune to draw a particular U.S. Trustee and
particular Bankruptcy Judge who would not let his case pass without
objection. Similarly-situated debtors who file in other districts or
even those who file in front of other judges in the same district may
receive very different treatment. Given the rule-less inquiry
established by the current law, the outcome in any given case is quite
unpredictable and may be expensive to litigate. This phenomenon of
similarly-situated debtors receiving disparate treatment has created
both a reality and a perception of unfairness and non-uniformity.
Finally, Dr. Kornfield's case reflects a disturbing trend in modern
bankruptcy law--the seemingly cavalier attitude of some towards filing
bankruptcy and repudiating one's debts. As the bankruptcy court noted,
Dr. Kornfield's bankruptcy resulted from a conscious decision to try to
maintain his ``extravagant lifestyle'' in the face of lowered income.
Rather than moving into a more modest house or sending some of his
children to public school, he chose to file bankruptcy and force his
creditors to subsidize his decisions. Dr. Kornfield hardly fits the
image of the poor and/or unfortunate debtor looking for a fresh start
to get back on his feet. Instead of tightening his belt, he filed
bankruptcy and repudiated his obligations.
Means-testing will mitigate many of the problems illustrated by Dr.
Kornfield's case. By establishing a clear, bright-line rule for Chapter
7 eligibility, means-testing will reduce the high administrative costs
associated with the current system. Debtors and creditors will know
with a very high degree of predictability whether the debtor will be
eligible for Chapter 7. As a result, there will be less uncertainty
involved in the decision whether to bring an action or for a debtor to
contest an action. Eligibility challenges will be limited to an
extremely small set of cases. Most cases will either plainly qualify
under the test or not qualify, and there will be only a small number of
cases where the debtor's eligibility under the ability-to-pay test will
be in doubt. Under the current approach, by contrast, there is little
predictability or justice in who might be the subject of a challenge.
Extremely high-income debtors will often avoid eligibility challenges,
while many debtors of relatively modest means will suffer challenges.
Moreover, means-testing will ensure that those who can repay all or
substantially all of their debts under Chapter 13 will be required to
do so, thereby eliminating the incentive to file bankruptcy and
encouraging those debtors to work out voluntary repayment arrangements.
Thus, these cases will not even be filed in the first place,
eliminating the administrative costs of dealing with them. Moreover, as
illustrated by Dr. Kornfield's case, many of these cases will be those
with high administrative costs, with multiple and complex evidentiary
hearings and appeals, thus the savings on these cases will be
substantial.
Means-testing will also provide much-needed guidance to courts and
trustees seeking to prevent abuse of the bankruptcy process. Rather
than a free-ranging ``totality of circumstances'' test and the cost and
uncertainty associated with interpreting and applying it, means-testing
will channel the court's discretion into a much more narrow and
predictable range of inquiry, thereby limiting strategic challenges by
both creditors and debtors. Forcing all judges to focus on the same
factors and weigh them consistently, will also make decisions more
predictable and uniform. This will increase public confidence in the
bankruptcy system by reducing the real and perceived unfairness
associated with the current regime where who gets caught and who does
not appears to be mere happenstance.
Finally, means-testing will have non-quantifiable intangible
benefits associated with reasserting the moral premise that people
should be required to repay their debts to the extent that they can,
especially if doing so would impose minimal hardship on them and their
standard of living. This, moral signal must be weighed as one of the
benefits of means-testing.
Although an extreme example, Dr. Kornfield's case is all too
typical of the modern bankruptcy system. Bankruptcy filings have
exploded in recent years, despite low unemployment and robust economic
growth. There are two explanations for this surge in filing rates: a
change in the relative economic costs and benefits of filing
bankruptcy, and a decline in the personal shame and social stigma
traditionally associated with filing bankruptcy. See generally Edith H.
Jones and Todd J. Zywicki, ``It's Time for Means-Testing,'' 1999 BYU L.
Rev. (forthcoming).
Beginning most noticeably with the liberalization of bankruptcy
laws ushered in with the 1978 Code, there has been a predictable upward
trend in bankruptcy filing rates. The 1978 Code significantly reduced
the economic costs and increased the economic benefits of filing
bankruptcy. Indeed, economist Michelle White estimates that 15%-20% of
American households would financially benefit from filing bankruptcy,
especially if they engaged in some planning prior to filing.
This increase in the financial benefits of filing bankruptcy has
been accompanied by an offsetting decrease in the associated costs. In
particular, there has been a substantial reduction in the ``search
costs'' associated with learning about bankruptcy. The spread of
attorney advertising in the 1980s made it easier to inform individuals
about the availability of bankruptcy as a financial planning tool.
Daytime and late-night television, as well as newspapers, magazines,
and telephone books, are now awash in bankruptcy advertisements by
lawyers. Equally important is the ``water cooler'' effect: a huge
number of people learn about bankruptcy from friends and family who
have been through the process and report that it was cheap, easy, and
put an end to creditors' collection efforts.
As performer Toni Braxton memorably told a reporter after filing
bankruptcy in 1998, ``I'm going to go out and enjoy myself.'' At the
time of her bankruptcy, Braxton's albums had earned $170 million in
sales and she owned a baby grand piano, a Porshe, and a Lexus. Most
private companies have to pay celebrities large sums of money to
endorse their products in advertisements; the ease with which Braxton,
Kim Basinger, Burt Reynolds, John Connolly, M.C. Hammer, and others
have sailed through bankruptcy is equivalent to free advertising for
the bankruptcy system. Nor is Braxton's attitude limited to the very
well-to-do. Consider the sentiment expressed by a middle-class filer
from New York who used the bankruptcy system to maintain their
unrealistic standard of living, ``We're not doing the pauper thing. . .
. We have a nice house. We go to Foxwoods. We have his and her cars. It
took us a long time to go from Brooklyn to Queens. We can't go back.''
Finally, the sheer volume of bankruptcy cases has spawned a cottage
industry in ``do-it-yourself'' bankruptcy kits and so-called bankruptcy
``mills'' that represent debtors in high-volume, repetitive cases.
These too have further reduced the costs associated with learning about
and filing bankruptcy.
There has also been a reduction in the shame and stigma associated
with filing bankruptcy. Bankruptcy represents a repudiation of one's
promises, a decision not to pay someone back for a benefit that they
have bestowed upon you. This ethic of reciprocity and promise-keeping
is the foundation of a free economy and a healthy civil society. We
teach our children from a very young age to keep their promises and to
reciprocate benefits bestowed upon them. We also internalize these
lessons through our consciences and often feel personal shame when we
fail to keep our promises; when we take without giving back. As a
result, filing bankruptcy traditionally has been treated as a socially
and personally shameful act. Part of Harry Truman's lore was his
decision to voluntarily repay the debts of his failed haberdashery. It
took him 15 years to do so, but in the end he did and was applauded for
it.
But this ethic of paying one's promises now seems old fashioned and
out of vogue. In short, there are too many Robert Kornfields and too
few Harry Trumans on the current bankruptcy landscape. To paraphrase
Senator Moynihan, we have ``defined bankruptcy deviancy downward'' to
the point where many see it as simply an alternative financial planning
device. Moreover, because the financial benefits of filing bankruptcy
are greatest for upper-income debtors, the role of personal shame and
social stigma has had its greatest marginal impact in restraining those
individuals from filing bankruptcy opportunistically. The underlying
dynamics driving the surge in personal bankruptcies predicts an ever-
growing influx of high-income debtors into the bankruptcy system in
coming years and thereby reinforces the urgency of means-testing.
Who are the beneficiaries of means-testing? We all are. To see why,
consider that although few of us actually own retail shopping stores,
all of us oppose shoplifting and believe that it should be forbidden.
The reasons why we support laws against shoplifting are analogous to
the justifications for means-testing. First, when people shoplift or
don't pay their bills, we all suffer in the form of higher prices for
goods and for credit, as at least some of those losses are necessarily
passed on to us as fellow consumers. Second, allowing some people to
obtain goods, services, or credit without paying for it is simply
unfair to those who do act responsibly and pay for the benefits they
receive. Third, retail sellers and those who extend credit are selling
a useful product or providing a socially-beneficial service for which
they are entitled to be paid. We all have to work for a living and we
are all entitled to be paid for the goods and services that we provide.
Finally, shoplifting simply is wrong; it violates trust and it breaks
promises. You shouldn't take it if you aren't going to pay for it. Just
as one need not be a shopkeeper to be opposed to shoplifting, one
similarly need not be a banker to be in favor of means-testing.
Rather than facing up to the existence of abuse in the bankruptcy
system by some unscrupulous high-income debtors, critics of means-
testing have chosen to point fingers at creditors for causing
bankruptcy, with credit card issuers identified as the primary
villains. As an explanation for the massive rise in bankruptcy filing
rates in recent years, this ``blame the creditors'' mentality has
tremendous popular appeal. But it also has little credibility as an
explanation for spiraling bankruptcy filing rates.
Several commentators have argued that increases in overall consumer
debt and debt-to-income ratios explain the recent surge in bankruptcy
filing rates. There are several problems with this thesis. First, it
incorrectly treats debt levels as an exogenous variable, unaffected by
the relative ability of borrowers to discharge those debts in
bankruptcy. But a borrower's willingness to take on debt clearly will
be related to the ease with which he can later discharge those debt
obligations if he chooses to do so. Hence, debt levels are an
endogenous variable as well, and will be a function of the overall
bankruptcy system. Second, those who have postulated a link between
debt and bankruptcy have failed to provide a persuasive explanation as
to how debt could ``cause'' bankruptcy for individuals, as opposed to
businesses. Significantly more important would be the relationship
between current debt--the amount that a debtor is required to pay each
month--and bankruptcy. Individual bankruptcy would seem to be the
result of an inability to meet one's obligations as they come due, not
insolvency in some type of balance-sheet accounting. Because of the
extremely low interest rates of recent years, current debt levels have
fallen even as overall debt levels have risen. As a result of these low
interest rates, borrowers should be able to carry the same or even
marginally greater debt levels at greater ease than before, thereby
contradicting the ``debt causes bankruptcy'' thesis. Third, debt does
not exist in a vacuum, it accumulates through the decisions of
consumers to purchase goods and services. Thus, ``too much debt'' in
many cases could simply be recharacterized as ``too much spending,'' as
was the case with Dr. Kornfield. It is not debt that causes bankruptcy
for many people, it is a conscious choice not to live within one's
means and to finance an extravagant lifestyle through borrowing rather
than belt-tightening. Finally, statistics on debt simply do not provide
an explanation for the rapid run-up in bankruptcy filing rates of
recent years. As one commentator has observed, even if debt-to-income
ratios have worsened, they have done so gradually: ``They did not get
worse by 29% in 1996 over 1995, but bankruptcies did. They did not
worsen again by 20% in 1997 over 1996, but bankruptcies did.''
Nor will it do to blame credit card issuers. Because of their
visibility, credit card issuers have become easy villains for those
seeking to blame creditors. As Judge Jones and I wrote, ``[C]redit card
issuers have become the modern equivalent to William Jennings Bryan's
'Cross of Gold,' crucifying consumers in the pursuit of ever-greater
profits.'' But blaming credit card issuers for the bankruptcy boom is
implausible on its face. First, the total credit card debt burden of
$529 billion pales in comparison to overall housing debt of $4
trillion, and housing debt has been increasing much faster than
revolving debt in recent years. Second, most Americans are
``convenience'' users of credit cards who pay off their balances each
month and therefore accrue no interest fees or service charges.
Focusing on those who revolve balances from month-to-month ignores the
reality that few Americans fit this profile.
Those who would vilify credit card issuers also misunderstand the
role that they play in the modern American economy. Entire segments of
our economy, such as internet and catalogue shopping, would not exist
without consumer access to credit cards. Credit cards enable
individuals to deal with short-term emergencies like car and home
repairs, without having to hoard large amounts of cash in non-interest
bearing checking accounts, not to mention all the fringe benefits of
frequent flyer miles, rental car insurance, purchase price protection,
and even cash back bonuses. Moreover, the credit card industry has
revealed itself to be ferociously competitive. In a market with 6,000
issuers and millions of consumers it is hard to imagine it being
otherwise. And, indeed, after an early period of high profitability
following deregulation, profits on credit card issuers have decreased
substantially in recent years.
Access to credit cards are especially important for low-income
borrowers, as they lack the options of more wealthy borrowers. For
instance, low-income borrowers obviously will have less access to home
equity loans than the rich. Absent credit cards, low-income borrowers
faced with a short-term need for cash, such as the need for a new
transmission for a car, will face an array of unfavorable options:
selling personal assets, taking them to a pawn shop, or trying to get a
short term loan from a bank that will probably charge them fees and an
interest rate that substantially exceed that available on credit cards.
Dagobert Brito and Peter Hartley, economists at Rice University,
observe that there are few substitutes for the low transaction cost
access to short-term credit offered by credit cards. As a result,
despite the seemingly high rates of interest charged by credit cards,
it is actually quite rational for many people to revolve balances on
credit cards. See Dagobert L. Brito & Peter R. Hartley, ``Consumer
Rationality and Credit Cards,'' 103 J. Pol. Econ. 400 (1995). Access to
credit cards have democratized credit, making its advantages available
to all when it previously was available only to the elite.
Means-testing is an idea whose time has come. Courts are already
applying a variation of means-testing, but with highly unpredictable
and unfair results. Means-testing will improve the administration of
the bankruptcy system, increase the recovery from high-income debtors,
protect low-income debtors, and increase public confidence in the
fairness and efficiency of the bankruptcy system.
Mr. Gekas. I thank the witness and turn to our final
panelist, Professor Warren, for 5 minutes.
STATEMENT OF ELIZABETH WARREN, LEO GOTTLIEB PROFESSOR OF LAW,
HARVARD LAW SCHOOL, BOSTON, MA
Ms. Warren. Thank you, Chairman Gekas. I also say, as
others have, it is an honor to be here, and particularly a an
honor to be here at your personal invitation.
I will start as Judge Kenner did. She caused me to do a
calculation, and that is, I have now been teaching bankruptcy
and business law for 20 years, and I think that means that I
have now seen the coming of age of about 4,600 lawyers, a much
scarier concept, isn't it?
I thought I would start today by talking just a little bit
about who is in the bankruptcy system. We have heard from
creditors; we have heard from judges; we have heard from
academics. The people we haven't heard from are the debtors,
the people who are affected by this system. I just want to give
a sketch of a few things that we know about these people.
We know that two out of every three debtors who file for
bankruptcy have suffered a significant period of unemployment
or job interruption in the 2 years before they have filed.
These are people who have been downsized, outsized into jobs or
into smaller jobs, lesser jobs, unemployment, independent
contractor status that carries no benefit and many weeks
carries no income.
We know about divorce. We know that the people who file for
divorce are more likely also to file for bankruptcy. If I know
nothing more about the women in this room other than the fact
that their current marital status is that they are divorced, I
know that they have a 300 percent greater likelihood of being
in bankruptcy this year alone than their cohorts who are single
or who are married.
Medical debts. About one in five of the debtors who file
for bankruptcy identify themselves as having significant
medical debts before they filed for bankruptcy and identify
this as the source of their problems. Lack of insurance is felt
in the bankruptcy courts. This is the only place to deal with
it.
Homeowners some of the most trying stories in bankruptcy.
About half of the people who file for bankruptcy are homeowning
folks, people who have passed the most rigorous credit
standards at some point in their life. And why are they in
bankruptcy? They are in bankruptcy because they are trying to
save their homes. What we know about these people,
particularly, is that they are the most fragile homeowners.
African-American homeowners and Hispanic-American homeowners
have a much increased percentage of bankruptcy relative to
white homeowners. These are people who have suffered from
discrimination both in housing and in the workplace, and those
forms of discrimination make their way into the bankruptcy
courts.
We know that the elderly are also in bankruptcy. About
280,000 people filed for bankruptcy last year who are older
than 50. We know that about 50,000 of the filers are older than
65. What is one of the principal reasons that they file for
bankruptcy? They file for bankruptcy because they are
disproportionately the victims of the scams in the credit
industry. They file to try to deal with aggressive creditors.
They say, quite simply, they can't cope with the phone calls
anymore; they can't cope with the people visiting them. These
are people who use bankruptcy as a way to stop abusive
collection practices.
Small business owners. Those are also among the people we
haven't heard about today. One in five Americans who files for
bankruptcy is a failed entrepreneur. If you start your own
business you have a three times greater likelihood of ending up
in bankruptcy court than anybody else in America. Entrepreneurs
are about 7 percent of our population, but they are 20 percent
of those who are in bankruptcy. Why are they in bankruptcy?
They are in bankruptcy because little businesses are fragile,
and they have had to guarantee personally all of the debts.
Even if they are not trying to keep their businesses afloat, if
they have given up on the notion that they can keep the store
open or keep working as an independent person, the idea of
going back to a wage-earning job no longer works for them
because they are $50,000, $75,000, $100,000 in debt from their
failed businesses.
These are the people who are not represented in this room
today, but we have to think about when we think about
bankruptcy reform.
What does this bill do? This bill is more than 300 pages
long. The consumer provisions go on for a long, long time--and
I say that as an academic who is used to reading lots and lots
of statutes.
I want to make a global point. This debate isn't about
means testing or at least not means testing alone. That has
been a flash point. That has been the lightning rod, and it is
important to hear. But this is about a thousand traps that have
been set for debtors in this bill. Means testing is there to
push debtors out of chapter 7.
Increasing nondischargeability of credit card debts claps
them on the other side. It says, you went through bankruptcy,
but you didn't get much help from it, because many of your
creditors will still be there on the other side.
Reducing eligibility for chapter 13 means these people
can't move from chapter 7 over to chapter 13 to repay. It just
means they move back out of the system, so that their creditors
can pick them apart however they want.
Allowing creditors' motions under 707(b) means that
creditors who have much more money and much more leverage can
just squeeze debtors harder. That is the key point.
What is this bill about? This isn't about whether or not we
get a few people to pay more. It is whether or not we can
squeeze people to pay outside bankruptcy, often by signing more
reaffirmations. This is where the major scandal in this system
is. What this bill does is it lets the creditors increase the
size of their club, at the same time that it says you can as
many reaffirmations as you want. There is no effective control
over reaffirmation.
Let me make this clear: The Sears case, under this bill,
could no longer be brought. Any attempt of debtors to get
together and bring a class action for any of the abuses of the
system would be gone.
I would like to close, if I could, by just reading from one
debtor in the Sears litigation. She says about her Sears
reaffirmation, ``I truthfully wasn't paying attention when the
Sears lady asked me for the reaffirmation because I was crying
and so upset that I had failed to be able to pay my debts in
the first place. Otherwise, I wouldn't be in a bankruptcy
court. Well, I worked two full-time jobs for almost 7 years
after my divorce with my seven children. The two full-time jobs
affected my health, and I couldn't work them anymore. That is
when I stopped paying Sears $150 a month.''
She goes on to say that she lost her home. Let me make it
clear: This was a legal reaffirmation. This one was denied
under the Sears settlement.
[The prepared statement of Professor Warren follows:]
Prepared Statement of Elizabeth Warren, Leo Gottlieb Professor of Law,
Harvard Law School, Boston, MA
the need for reform
All legal systems benefit from periodic adjustment to account for
changed circumstances, to address unforeseen consequences, and to
reconcile divergent court interpretations. The bankruptcy system is no
different. For one hundred years, Congress has periodically adjusted
the Bankruptcy Code to reflect these kinds of adjustments. This is a
healthy process that helps insure efficiency, effectiveness and, most
importantly, public confidence in the system.
No one doubts that the bankruptcy system could be improved by
amending the Bankruptcy Code to address identified and documented
ambiguities and problems. But any reform must be balanced. The
bankruptcy community--judges, lawyers, accountants, academics,
trustees, and others--has been engaged in a continuing dialogue.
I favor reform. But not all change is reform.
The key to bankruptcy reform, like other types of real reform, is
to make changes in a narrowly targeted and carefully crafted fashion so
that the cost of these changes does not outweigh the anticipated
benefit for parties in these cases and for the public at large.
A good example of the failure of the cost-benefit analysis is
evident in the proposed means test. The credit industry for forty years
has pressed for a means test of the kind proposed in H.R. 833. Twenty
years ago, they claimed that without means testing consumer credit
would dry up. They claim today that without these reforms bankruptcy
costs every American family $550. The accuracy of that statement has
been challenged by research supported by the American Bankruptcy
Institute, an independent organization of professionals representing
both debtors and creditors. That research, conducted by Professors
Marianne Culhane and Michaela White, suggests that the means test in
H.R. 833 would produce very little benefit. If even the most optimistic
estimates of the debtors' capacity to repay come true (what Culhane and
White deem ``the impossible dream'') and even if many of the
administrative costs of implementing and enforcing a means test were
ignored, the independent study shows that the proposed change would
increase recoveries for creditors by a total of about 90 cents each
year for each household. \1\ This is not narrowly tailored, cost-
effective reform.
---------------------------------------------------------------------------
\1\ Marianne B. Culhane and Michaela M. White, Taking the New
Consumer Bankruptcy Model for a Test Drive: Means-Testing Real Chapter
7 Debtors, American Bankruptcy Law Review (forthcoming 1999).
---------------------------------------------------------------------------
When dealing with the bankruptcy system, it is especially important
to take a careful cost-benefit approach. Bankruptcy is a collective
proceeding involving a limited pool of resources. If the law gives more
benefits to one creditor, other creditors suffer. Bankruptcy is the
ultimate zero-sum system. Creditors compete for the limited dollars of
the people who have declared themselves bankrupt. More to one creditor
is necessarily less for another.
Who are these creditors? Creditors are not just car lenders, credit
unions, and credit card companies--the people we hear from today. Some
creditors are women and children collecting support. In addition, they
are utilities, landlords, doctors, hairdressers, plumbers, the paper
girl, neighbors, federal state and local taxing authorities, and many
others. These creditors have interests that, by definition, are adverse
to each other--not just to the debtor. More money for retailers issuers
means less money for car lenders; more money for banks is less money
for landlords; more money for credit card issuers is less money for
mothers collecting child support. And more money for administrative
costs means less money for everyone. Bankruptcy does not create money;
it creates only collection priorities among creditors for the very
limited dollars of the debtors.
h.r. 833 is not reform
Almost every day, someone asks me about this bill. And, almost
every day, I respond that I am deeply, deeply concerned about this
bill.
Am I concerned because I oppose reform?
Am I concerned because I think that some people should get a
free ride at the expense of everyone else because I do not care
whether I pay a hidden bankruptcy tax?
Am I concerned because I do not care if people exercise
personal responsibility?
Of course, the answer to all of these questions is no, a loud and
resounding no.
Then why does this bill worry me so much? Because change does not
equal reform. The definition of reform is ``to improve by correction of
error or removal of defects.'' A secondary meaning is ``to abolish
abuse.'' This bill does neither.
Instead, the bill will cause chaos. It is loaded with complicated
and conflicting policy choices added to try to satisfy competing
special interests. It is rife with sloppy technical work that will
create ambiguities to be litigated for twenty years or more.
Moreover, the bill is one-sided. It has more than 120 pages of
amendments affecting consumer cases, and they all head in the same
direction: They give a few creditor interests more opportunities to try
to recover from their debtors while they reduce the protection for
other creditors and for debtors. Although the bill contains a few
provisions bearing labels that suggest they provide needed protections
for consumer or address creditor abuse, a careful reading of those
provisions reveals that they will do little in practice.
Among the most objectionable features of the current proposals
are:
The failure to introduce real reform for debtor abuses by
limiting property exemptions
Provisions to increase the number of nondischargeable debts for
every family in bankruptcy, including the very poorest
Changes that will permit fewer debtors to qualify for repayment
plans, thereby reducing--not increasing--the number of Chapter
13s
Conflicts among provisions that push debtors out of Chapter 7
(means testing) but restrict access to Chapter 13 (increasing
payments to secured creditors required to confirm a plan)
A means tests that is impossible to administer, that will swamp
the bankruptcy courts, and that invites creditors to use their
superior resources to leverage debtors into making improvident
repayment agreements
No review of reaffirmation agreements despite the scandals in
the bankruptcy courts in the last two years
Let me be clear. Although I believe that this bill can be improved from
its current state, I fear that it is flawed to its core. It is flawed
because its underlying structure is not designed to stop abuse or to
increase personal responsibility. Whatever the intent of the drafters,
the bill will make the system dysfunctional. This is why bankruptcy
professionals in organized groups (such as the National Bankruptcy
Conference), on their own (such as the bankruptcy judges and the
bankruptcy law professors), and as representatives of responsible
creditors (such as the Commercial Law League) have opposed this
approach to reform.
As lawmakers, you are entitled to make the policy decision to shut
down the bankruptcy system. If this is your goal, however, it would be
more efficient to simply repeal parts or all of Title 11.
elements of real bankruptcy reform
Real reform is within your reach. Among the provisions that would
improve the system for everyone--both debtors and creditors--are:
Restrict repeat filings
Limit property exemptions that are too high
Deny bankruptcy distributions to creditors who do not play by
the rules, particularly creditors who violate rules on
predatory lending practices
Implement systematic audits in combination with data
collection, making it possible to develop a more accurate
picture of what is happening in the system
Reduce creditor overreaching by restricting access to
reaffirmations
Improve credit disclosures so that borrowers can know their
actual balances, amortization rates, and effective interest
rates
Require that advertisements and applications for home equity
loans and lines of credit disclose limits on the tax
deductibility of such loans
Restrict the use of teaser rates, hidden fees, shortened
payment periods, and other practices that are designed to take
advantage of unsuspecting consumers
Give courts wider latitude to dismiss Chapter 7 cases for
debtors who do not need bankruptcy relief, while avoiding
arbitrary guidelines that are easy for abusers to evade
why do all this work?
Meaningful bankruptcy reform is a lot of work. Twenty-six disparate
groups ranging from the Family Law Section of the American Bar
Association to the Leadership Conference on Civil Rights to Mothers
Against Drunk Driving have told you that this bill is not a good
approach and that it is in fact counter-productive.
The effort is worthwhile. The people who rely on this system are
the people who are not here today.
They are the owners of small businesses who struggle to get
back on their feet after their businesses have failed
They are divorced women trying to raise families and stabilize
their financial lives
They are elderly Americans who are disproportionately victims
of creditor scams and fraud
They are families in which one or both parents have lost a job
or been downsized or outsourced into a job that pays less and
provides fewer benefits
They are African American and Hispanic American homeowners who,
facing every form of housing, mortgage and insurance
discrimination, are making a last ditch effort to hang on to
their homes
They are students, beginning their adult lives already so
deeply in debt with credit cards that they will never be able
to buy a home or support a family
They are families without insurance and families with too
little insurance for the medical catastrophes that have come
their way
These people don't see themselves as debtors. They see themselves for
what they are: nurses and construction workers, factory workers and
shopkeepers, retired people and college students, teachers and
cabinetmakers. They could be anyone in this room.
The people who rely on this system are the people who live in your
districts. On average, about one out of every 72 of the households in
your districts will file for bankruptcy this year. Since 1994, about
one in 20 of the households in your hometowns has declared bankruptcy.
\2\ These are your constituents. They vote, use our public schools and
libraries, go to our churches or other religious services, pay taxes.
Most of them, as even the most aggressive proponents of the bill have
conceded, find themselves in bankruptcy due to a catastrophic event
that they could not weather. Some are profligate; most are not. All of
them are overwhelmed by debt.
---------------------------------------------------------------------------
\2\ Calculated from data provided by the Administrative Office of
the United States Courts, March 1, 1999.
---------------------------------------------------------------------------
Bankruptcy law is the last safety net of the middle class. A change
that unbalances the system is not reform--it is wholesale revision that
substitutes complex special interest legislation for a carefully
balanced system that has worked for more than a hundred years.
Bankruptcy is the last hope for the small businessman, the divorced
woman, the African-American homeowner, the displaced executive, and the
elderly couple facing a sharp slide out of the middle class into the
lower class. It is a system worth saving.
Mr. Gekas. Well, we thank Professor Warren.
The Chair will allot itself 5 minutes for questions and
answers.
Professor Warren, reaffirmation is possible under current
law, isn't that correct?
Ms. Warren. Yes.
Mr. Gekas. And so the evils that you attach to
reaffirmation are not made worse by the provisions that we have
in our bill, especially since they try to follow the Sears case
guidelines. Don't you agree?
Ms. Warren. No, Congressman, I don't. What you are doing
with this bill is at every turn you are increasing the leverage
of creditors to secure reaffirmations from debtors than you are
doing----
Mr. Gekas. What leverage do they now have in reaffirmation?
Ms. Warren. I'm sorry?
Mr. Gekas. What leverage do they now have in reaffirmation?
Ms. Warren. They can threaten to bring lawsuits.
Mr. Gekas. I'm saying, under the current law.
Ms. Warren. They can threaten to bring lawsuits. They can
say----
Mr. Gekas. So reaffirmation under the current law is a tool
of the creditors, you are saying?
Ms. Warren. Yes, and you are increasing the power of that
tool by giving them more reaffirmation--more
nondischargeability provisions, by giving them the ability to
bring an action under 707(b), and by cutting off their access
to chapter 13, where they could deal with their debts in a
repayment plan.
Mr. Gekas. You mean separate from reaffirmation?
Ms. Warren. That is right. All the other things----
Mr. Gekas. What I am saying to you is that reaffirmation in
our bill is not that distant from reaffirmation under the
current law. If you can consider it as an evil tool of
creditors to crush the debtor, it exists now, and what reform
measures do you have for reaffirmation as of now?
Ms. Warren. I believe that what we should do is we should
restrict reaffirmation. If what we are going to try to do is
find that 3 percent that----
Mr. Gekas. Until this reform measure came up, had you
offered----
Ms. Warren. Yes, sir, I have.
Mr. Gekas. To whom?
Ms. Warren. To the National Bankruptcy Review Commission.
Mr. Gekas. Did they adopt those?
Ms. Warren. I am trying to remember. There were so many
provisions----
Mr. Gekas. I think not. I think not. But the point is, that
is just one set of problems.
Another set: You state in your written statement, and you
made mention of it in your oral statement, that the people who
are the debtors, the ones who are not witnessed here, I believe
that we are taking into account their plight by setting the
median income as a test pattern that puts most of them in full
fresh-start status in chapter 7. We believe that. You may
disagree with that, but the very litany of groups of people
that you talk about we protect. African-Americans and Hispanic-
American homeowners we protect if they need protection.
Students, families without insurance and families with too
little insurance, all the catastrophes that you outline in your
written statement, and which you reiterate in your oral
statement, are protected in our bill. Do you dispute that?
Ms. Warren. Yes, Congressman, I dispute it, and I dispute
it vigorously.
Mr. Gekas. Well, then we will have to continue the dispute
and see----
Ms. Warren. Well, would you like me to say why?
Mr. Gekas [continuing]. Who can foster----
Ms. Warren. Do you want me to say why?
Mr. Gekas. Yes, of course.
Ms. Warren. Good. I dispute it because the
nondischargeability provisions have no income floor. They will
apply to people who make $10,000. They will apply to people who
make $8,000 a year. They will apply to everyone. There is no
income floor on that.
Mr. Gekas. What is the nondischargeability status today?
Ms. Warren. There is some nondischargeability. You are
increasing it, and you are making it worse for various
debtors----
Mr. Gekas. Even without our reform?
Ms. Warren. If you are asking me, is the system bad today,
I would say, yes, I think there are some tough parts in the
system, but you are making it much worse.
Mr. Gekas. It is bad, you are saying, the system today?
Ms. Warren. Some parts of it. Yes, I think there are some
of the nondischargeability provisions today that make no sense.
But you are not making it better; you are making it worse; you
are adding to them.
Mr. Gekas. In a large sense, the criticisms that you visit
against our reform measure exist in your criticism of the
current system?
Ms. Warren. No, Congressman. What I am saying is, you are
taking a system that has balanced the power between debtor and
creditor. Is it perfect at every point? No. I think there are
some places where creditors have the advantage; I think there
are some places where debtors have the advantage. And what you
are doing, Congressman, is that you are adding 300 pages of
provisions that do nothing but add leverage to the hands of the
creditors.
Mr. Gekas. Judge Jones, you mention in your Law Review
article, and Professor Zywicki, that the critics of the means
test, for instance, seem to put the blame on the credit card
issuers, no matter what the cause of bankruptcy is. What do you
say to that?
Ms. Jones. Well, I think we demonstrated that the
conventional wisdom in the bankruptcy community, which is
precisely that argument against credit card issuers, is not
just well-founded, for a number of reasons. A couple of them
were stated by the MBNA fellow earlier here. But among those
are we have seen a sea change in the way in which credit cards
are used by the American people, and the terms and conditions
of those credit cards--he referred to competition; that the
card industry has gotten so much more competitive, that
interest rates are going down; fees are being waived; a lot of
other benefits are being given to customers. Most customers
roll over their accounts every 30 days. Most customers never
even incur a finance charge. So that whole argument is a house
of cards and a red herring.
May I make an observation about Professor Warren's comments
on reaffirmation?
Mr. Gekas. Yes, without objection.
Ms. Jones. I was on the Commission. Professor Warren was
the advisor to the Commission. I wrote 250 pages of dissents to
the Commission report. Precisely what the Commission, the five-
member majority recommended was essentially to do away with
reaffirmations altogether, because there is that paternalistic
element in the bankruptcy academic community which says the
debtors are too stupid to decide when they should take on more
debt.
The real problem in reaffirmations is twofold. One is that
attorneys are not fulfilling their ethical responsibility to
counsel their clients about whether a reaffirmation is a good
deal or not. The Sears case is entirely separate because that
was illegal activity taking place totally outside the
supervision of the bankruptcy court. If the debtors' attorneys
were doing their job, and even Mr. Klein I think recognized
before the Commission, as did many, many practitioners and
judges, the debtors' attorneys do not represent their clients
well here. Furthermore, many courts do not take their
responsibility seriously enough to oversee the reaffirmation
agreements, as they required to do. So that problem could be
cured today.
Mr. Gekas. Yes. Thank you, Judge Jones.
The gentleman from New York is recognized for 5 minutes.
Mr. Nadler. Thank you.
I would point out, of course, that Judge Jones' comments
are a little in-apropos since most debtors do not have lawyers
because they are representing themselves; they are pro se. So
it isn't a question----
Ms. Jones. That is not true, sir.
Mr. Nadler. Well, it is true.
Ms. Miller, you represent the Commercial Law League, which
represents creditors as well as debtors, correct?
Ms. Miller. That is correct, sir.
Mr. Nadler. Now Mr. Hammonds from MBNA said in his
testimony that this legislation would reduce litigation. Do you
agree? And what would be the impact on commercial cases if we
flood the bankruptcy courts with this sort of consumer
litigation? How would that impact business liability, the
payment of commercial debts, and jobs?
Ms. Miller. Let me suggest the following: No. 1, I don't
agree with his observation. If anything, the means test opens
up the door to loads of litigation, not only in terms of
whether or not you fall within or outside the standard, but
also under the IRS standard--there is all sorts of litigation
regularly over whether or not you fall within the standard.
That same litigation is going to take place in this context.
Once a trustee determines that a debtor doesn't meet the
standards, he files a motion to have the case dismissed. The
debtor is not going to necessarily roll over and not appear at
that hearing. After that takes place, then he is going to--the
next motion is going to be, nevertheless, I fall within the
extraordinary circumstances to justify being here. That is
going to be an intense factual determination. Then, provided
you get past that, then you are going to have the trustee's
motion filed against debtor's counsel for abuse.
Now with all of these matters being brought before the
court, it has to clog the docket and increase the cost and
expense of administering these cases. And who is going to pay
for that? Who is going to pay for the trustee's time to do
that? Who is going to pay for the court's time?
Mr. Nadler. How would this impact on commercial cases?
Ms. Miller. With regard to commercial cases, it is not just
the needs-based testing, but you have to look, as Professor
Warren has indicated, and some of the other proposals that are
in the Bill, the presumed nondischargeable in many cases pits
the nondischargeable creditors against the trade creditors, the
unsecured creditors who are looking for the same dollars. By
increasing the nondischargeable class of creditors in a chapter
13, and not considering classification issues at the same time,
you are not making a chapter 13 plan feasible anymore.
Another provision where you have an anti-lien-stripping
provision for 5 years, if, in fact, you require that all of
these claims be paid the full amount, whether or not it would
be a secured claim under applicable State law, or would
otherwise fit within section 506(a), again, there won't be
anything left for the unsecured creditors. This is not a Bill
that helps unsecured creditors get paid. It really is special
interest in many, many ways.
Mr. Nadler. Thank you. Let me ask one other question
quickly, because I want to turn to Professor Warren.
The Small Business Administration has criticized the
inflexibility and the burdensome nature of the requirements on
small business reorganizations. Do you believe that this
section would needlessly force many small businesses into
liquidation instead of survival?
Ms. Miller. The Commercial Law League of America and the
National Bankruptcy Conference have sponsored a joint small
business proposal which differs in a number of important
respects from the current small business proposal that is
contained in Title 4 of H.R. 833. Let me see if I can tell
you--and I do think that, without the changes that are
contained in our joint proposal, the ability of a small
business to succeed and successfully reorganize is going to be
hampered significantly.
Mr. Nadler. So don't go into details, except to say right
now that, under this bill as written, you think it true that
businesses that could survive now through reorganization would,
in fact, be forced into liquidation?
Ms. Miller. Particularly with the stringent deadlines and
the lack of flexibility and the amount of small businesses, 85
percent of them would fall within the debt limits that are
currently----
Mr. Nadler. Thank you. Thank you.
Professor Warren, the National Bankruptcy Review Commission
overwhelmingly rejected the type of means test in this bill,
correct?
Ms. Warren. That is correct.
Ms. Jones. That is not correct. We didn't consider it.
Mr. Nadler. Excuse me.
Ms. Jones. I'm sorry.
Mr. Nadler. Oh, I am sorry. Can I ask unanimous consent for
additional time, so that Judge Jones can continue her
interruption?
Ms. Warren. Why don't you let her do that?
Mr. Nadler. Seriously. Without taking off my time, I would
like to hear from her.
Mr. Gekas. I might take it off your time.
Mr. Nadler. Well, then I don't want to hear from her.
[Laughter.]
Mr. Gekas. Then we will do it on my time.
Mr. Nadler. That is fine. By all means.
Mr. Gekas. What is the official action or non-action taken
by the Commission relative to means testing?
Ms. Jones. There was no action. We did not discuss or vote
on means testing. Two Commissioners, myself and Jim Shepherd,
alluded to it in our dissent with no specifics.
Ms. Warren. I think we might want to add that it was a
proposal that was in front of the Commission, and it was
withdrawn by Judge Jones.
Mr. Nadler. Okay. Now I was going to ask you, Professor
Warren--thank you--I was going to ask you, I think in your
dialog or your colloquy a moment ago, a few minutes ago, with
the chairman, I think you were talking past each other,
frankly. Forget the means test. We are not now talking about
the means test. Is it your testimony that other provisions in
this bill, in addition to the means test, such as the
nondischargeability, various increases will greatly burden low-
income people, people who would never pass a means test?
Ms. Warren. Congressman, I don't support this version of
the means test.
Mr. Nadler. I understand that.
Ms. Warren. But if this Congress passed just this means
test, and not another word that is in this bill, it would have
this much [indicating] impact on debtors----
Mr. Nadler. Very modest?
Ms. Warren. If it turns out that they passed all of the
other provisions and left out means testing, the effect on the
very poorest debtors, the effect on the most stressed debtors,
the effect on the debtors who can least afford to go into court
and litigate it would be the same.
Mr. Nadler. Thank you. I have one further question. I was
talking last night to a legislative affairs representative of
one of the major credit card companies, who specifically told
me I was wrong in one aspect of my understanding of this bill.
I won't tell you what I said. So let me just ask you the
question. The question is----
Ms. Warren. We will see if I can guess.
Mr. Nadler [continuing]. Is it correct or not--does this
bill operate in such a way that the bill provides that in
chapter 13, you cannot confirm a plan unless the debtor can
make certain payments? Now is it correct that some debtors,
could be faced with a Catch-22 situation that they failed the
means test because they are too rich for chapter 7; they are
pushed into chapter 13, but, because they don't have enough
income, they don't have enough actual disposable income, they
cannot make the minimum payments; therefore, a plan cannot be
confirmed? So they are too rich for chapter 7 and too poor for
chapter 13, and can't get any relief at all?
Ms. Warren. Yes, Congressman, that will happen.
Mr. Nadler. Could you explain that, how that could happen?
Ms. Warren. We are driving them out of 7 with the means
test, but at the same time we are making it much more difficult
to confirm a plan in chapter 13. We make it more difficult
through eligibility. We make it more difficult through the
requirements of what must be paid, how secured creditors must
now be paid their entire debt under this bill, and interest. We
make it more difficult for them to get into chapter 13. So that
leaves, or will leave, a significant portion of people with is
the ultimate Catch-22. They will be, as you quite rightly
state, too rich for chapter 7 and too poor for chapter 13,
which means their creditors can continue to collect from them
forever.
Mr. Nadler. Can I ask the Chair if we can continue for two
more minutes? I have one question of Professor Warren and one
of Ms. Miller, please.
Mr. Gekas. We will compromise: 1 minute and 48 seconds, not
a second more.
Mr. Nadler. Thank you.
Ms. Miller, could you just comment on what Professor Warren
has just said? Do you agree with that?
Ms. Miller. I agree with it, but I also would like to
elaborate on the following: You also could have someone that
doesn't meet the qualifications of 7 because they are too rich
and, based upon their amount of debt limit, may not fit within
chapter 13, and may be forced into an 11, which is completely
unfeasible for individuals; it is very costly, extremely
costly.
Mr. Nadler. Thank you.
And my last question is for Professor Warren. It is a
different question. It is just for clarification. Now assuming
that I had a job at which I was making $75,000 a year, and I
was laid off from that job. I made $75,000 a year for the last
6 years, and now I have very little or no income. I am making
$15,000 or $20,000 a year for the last month since I got a job.
Do I pass the means test because it looks backward? In other
words, is the means test backward-looking, which may not
reflect my current status? Second, is a chapter 13 repayment
schedule supposed to be based on my presumed prospective
ability to repay, so I assume that the means test and the
repayment plan could look at completely different things?
Ms. Warren. Yes, Congressman, I think that is exactly
right. Not only is it backward-looking, which means you can
pull in a period of high income, but it has a particularly
pernicious effect on an area like bankruptcy, where the one
thing we know about debtors in bankruptcy is they have highly
erratic work schedules. These are people who have fallen off
the high-income ladder and are on their way down.
Many of the debtors in bankruptcy who have high annual
incomes--I say, ``high''; this is all relative--$30,000,
$40,000, $50,000 a year--have them because of earnings in the
first part of the year. They have much lower earnings by the
time of the filing, and will have much lower earnings in the
future.
Mr. Nadler. Because they got laid off or something?
Ms. Warren. That is right. We have to remember that these
debtors not only will fall into the means test screen, but they
are not disaster-proofed because they filed for bankruptcy. The
same problems that caused them to have trouble with their jobs
beforehand are likely to continue to be there post-bankruptcy.
Mr. Gekas. The time of the gentleman has expired.
Mr. Nadler. Let me thank the chairman for his indulgence.
Mr. Gekas. Seizing the gavel for a moment, Ms. Miller, in
response to some of the questions, you felt that the means test
would cause additional litigation and more cases going to
appeal and for fact-finding, and all of that. Is that correct?
Ms. Miller. Absolutely, sir.
Mr. Gekas. Do you recall the testimony of Judge Kenner in
which she was worried about reaffirmations, and that she felt
that what should be done in any reform is to compel every
reaffirmation to have judicial review. Do you agree with that?
Ms. Miller. I am not prepared today, on behalf of the
League----
Mr. Gekas. Oh, you are not prepared?
Ms. Miller [continuing]. To tell you whether or not I do or
I don't----
Mr. Gekas. I ask you to prepare for it.
Ms. Miller [continuing]. But I will be happy to get you a
position on that.
[The information referred to follows:]
Commercial Law League
of America,
Chicago, IL, March 17, 1999.
Hon. George W. Gekas, Chairman,
Subcommittee on Commercial
and Administrative Law,
Committee on the Judiciary,
House of Representatives, Washington, DC.
Dear Representative Gekas: During the Joint Hearing of the
Subcommittee on Commercial and Administrative Law of the Committee on
the Judiciary of the United States House of Representatives and the
Subcommittee on Administrative Oversight and the Courts of the
Committee on the Judiciary of the United States Senate held on March
11, 1999, Judge Carol J. Kenner from the United States Bankruptcy Court
for the District of Massachusetts, Boston, Massachusetts, recommended
that all reaffirmation agreements be subject to court approval. During
my subsequent testimony at the Joint Hearing you asked whether the
Commercial Law League of America (the ``League'') supported this
recommendation and whether it would result in ``clogging the courts,''
a criticism advanced by the League with respect to adoption of the
``needs based'' provisions of the Bankruptcy Reform Act of 1999, H.R.
833 (the ``Bill'').
Prior to the Joint Hearing, the League had not yet considered
whether all reaffirmation agreements should be subject to approval, and
therefore, I was unable to respond to your question. Since the
conclusion of the Joint Hearing the League has considered Judge
Kenner's suggestion. While the League has supported the standards for
reaffirmations contained in Section 110 of the Bill, it does not
believe that it is necessary for the court to oversee and approve
whenever a debtor seeks to reaffirm a debt.
Prior to the 1994 amendments, Section 524 of the Bankruptcy Code
(the ``Code'') required the court to approve reaffirmation agreements.
In many cases, the courts did not conduct hearings, and the requirement
of court approval was merely a procedural formality. That section of
the Code was amended in 1994 to provide that the reaffirmation
agreement be accompanied with a declaration or affidavit of the
attorney that represented the debtor during the course of negotiating
such an agreement. The declaration or affidavit must state that such
agreement represents a fully informed and voluntary agreement, such
agreement does not impose an undue hardship on the debtor or a
dependent of the debtor, and the attorney full advised the debtor of
the legal effect and consequences of the agreement and a default under
the agreement. The court is only required to approve the reaffirmation
if the debtor is not represented by counsel. See, 11 U.S.C.
Sec. 524(c)(3)(A), (B) & (C). To return to the prior procedure is
unnecessary and would clog the courts. Moreover, Judge Kenner believed
that amendment of the procedure would address some of the abuses
recently publicized in the Sears litigation. That litigation, however,
was not the result of the standards for reaffirmations set forth in the
Code, but rather creditors' failure to comply with these standards.
Requiring all reaffirmations to be subject to court approval would not
remedy that abuse.
The League was honored to testify at the Joint Hearing last week,
and would be pleased to comment on any additional concerns or queries
regarding the pending bill or other matters of concern to your office.
Very truly yours,
Judith Greenstone Miller,
Co-Chair, Legislative Committee,
the Commercial Law League of America
and its Bankruptcy & Insolvency Section.
cc:
Louis A. LeLaurin III, President of the League
Mary K. Whitmer, Chair B&I Section
Jay L. Welford, Co-Chair, Legislative Committee
Max G. Moses, Executive Vice President
David P. Goch
Mr. Gekas. Because those two positions are a little bit
opposite. On the one hand, if you agree with Judge Kenner, you
are increasing caseload, number of cases, number of reviews, et
cetera. In rejecting our means test, which you say is
overloaded with the possibility of more cases, you have to
bring that into balance for me.
Ms. Miller. Let me suggest the following: You need to make
a distinction----
Mr. Gekas. I have already.
Ms. Miller. No, no, no, no. There is a different
distinction that I wanted to bring to bear. You need to make a
distinction between a mandatory means test that must be applied
in 100 percent of the cases, so that it potentially triggers
more litigation before the court, versus a discretionary means
test that gets applied when there is evidence that it needs to
be applied.
Mr. Gekas. But Judge Kenner's proposal doesn't account for
any discretion at all. Her position is that every case should
be reviewed in reaffirmation.
Ms. Miller. But I am talking----
Mr. Gekas. That is what she said.
Ms. Miller. My discretion is not--my discretionary,
flexible totality of circumstances test is with regard to the
application of a means test----
Mr. Gekas. I understand that.
Ms. Miller [continuing]. And abuse, not with respect to
reaffirmation.
Mr. Gekas. But I am saying to you, it is possible that you
don't mind, because you haven't made that clear yet, the
prospect of having every single affirmation become the subject
of a judicial review, but you do worry about the extension of
the----
Ms. Miller. I am not prepared to say that, although----
Mr. Gekas. Yes, that is what I say.
Ms. Miller.--I will say that this:
Mr. Gekas. Thank you.
Ms. Miller. The one thing I can say is we have been on
record that sections 116 and 117 of the Bill that attempt to
preclude remedies for abusive reaffirmation practices by
precluding class actions, and, ultimately, what would have
precluded the Sears litigation, is inappropriate, and, rather,
you have to define your abuses more carefully.
Mr. Nadler. You say inappropriate----
Ms. Miller. Inappropriate to take a remedy away from those
who don't have any other feasible remedy in order to remedy the
abuse.
Mr. Gekas. The time of the gavel has expired. The lady from
Wisconsin is recognized for 5 minutes.
Ms. Baldwin. Thank you, Mr. Chairman.
Had my time not expired in the questioning of the last
panel, I had intended to ask a question concerning the role
that consumer education, might play in responding to the crisis
being articulated today. I recognize that much of that can't be
reached through the bankruptcy code, although there are
provisions certainly that can reach that. I am interested in
the impact of real prevention in terms of consumer education in
public schools all the way through counseling in the context of
avoiding a bankruptcy at the other end.
I am intrigued, Professor Warren, after hearing your
research about the typical debtor, and the circumstances that
they have experienced that might have led them to file
bankruptcy. I am concerned that that might have diminishing
effects of consumer education, if, in fact, the crisis is, for
example, a healthcare crisis. I am actually surprised by how
low the figure is, one in five. I know last October when the
Census Bureau indicated 43.4 million uninsured Americans, and
the number is going up. I am sure many of those people filing
bankruptcy are healthy; yet, I am surprised that there isn't a
greater crisis with regard to a healthcare origin.
What do you think the role of education can be in
responding to some of the tremendous increases we have seen in
bankruptcy filings?
Ms. Warren. Congresswoman, you ask a very thoughtful
question. I can only give this answer: These are people, by and
large, who just had problems. They stumbled in the road, that
is the right way to think of them. For some of them, it would
make no difference how educated they are. If a child develops
leukemia and the expenses far exceed their medical coverage,
this is a family that will end up in bankruptcy. A million
dollars' worth of medical debt will do that to virtually
anyone.
But there is a factor that matters here: how much consumer
debt these people take on during times that are not the
troubled times. If we look at the data over this century,
consumer debt and consumer bankruptcies move almost in perfect
track. So that when Professor Zywicki wants to talk about
whether there was a time when there was a lot less bankruptcy--
yes, and there was also a time when there was a whole lot less
consumer debt. This data comes from Congressional Budget Office
research and other research, Professor Ausubel, economist,
independent economists, Professor Moss at the Harvard Business
School. But when you look at it, consumer debt and bankruptcy
are moving together.
Where education can make a difference is to warn people, in
effect, about the dangers of ever having taken on that much
debt. A family that divorced in 1970 statistically had about
$250 worth of consumer debt when they divorced. A divorce was
still tough economically. You had to get two places to live,
and you had to divide an income or two incomes that had
supported one household, and break it into enough to support
two households. That same family today, when it divorces, as we
have seen them picked up in bankruptcy, is often carrying
$15,000, $20,000, $30,000 worth of credit card debt. They
simply cannot survive. They have spent so much of their future
income, so much of their marginal income, they can't divide
into two households and still manage to survive.
The real point here, if you really want to talk about
education, is in disclosures; it is in getting information to
people to understand the risk they take on when they take on
this kind of consumer debt. I fear, Congresswoman, that the
world that we are living in is a world in which the financially
sophisticated are learning how to prey on the financially
unsophisticated. If we don't find ways to balance that, then we
are in a lot bigger trouble than what is happening in this
bankruptcy system.
Ms. Baldwin. I would be happy to yield the rest of my time
to the gentleman from New York.
Mr. Nadler. Thank you.
I would just ask, Professor Warren, you said you fear that
the world we are living in is a world in which the financially
sophisticated are learning new ways to prey upon the
financially unsophisticated. Would it be a fair
characterization of this bill to say that this bill, at best,
would be a new way for the financially sophisticated to prey on
the financially unsophisticated, as drafted?
Ms. Warren. Yes, Congressman Nadler, I would say that.
Mr. Nadler. Thank you.
Mr. Gekas. That is on the verge of being insulting, but I
will accept the insult as being the last note of the day.
This hearing is now adjourned, with the thanks to the
members of the panel who presented views that will get us
thinking, I am sure. Thank you very much.
[Whereupon, at 5:24 p.m., the subcommittee was adjourned.]
A P P E N D I X
----------
Material Submitted for the Hearing Record
Prepared Statement of Hon. Russ Feingold, a U.S. Senator from the State
of Wisconsin
I want to thank Mr. Chairman Gekas for hosting this joint hearing
with the Senate Subcommittee on Administrative Oversight and the
Courts. I appreciate his hospitality and willingness to accommodate the
schedules of those of us from the Senate.
I also want to thank Mr. Chairman Grassley for the work he has done
on the bankruptcy issue, and the courtesy that he and his staff have
extended to those of us who have different views of what needs to be
reformed in this bankruptcy system. I sincerely hope that once again we
can work together to develop a product that will win a near unanimous
vote in the Senate as last year's bill did.
Bankruptcy legislation is obviously a challenging issue for all of
us. The stakes are high and the different viewpoints are passionately
expressed by all of the players involved, from the different types of
creditors to bankruptcy judges, trustees, and practitioners, to
consumers and debtors. My view is that the legislation that came out of
conference last year and that is now embodied in this year's House bill
is not a balanced piece of legislation. It tilts the scales too far in
favor of creditors, creating a new special status for certain credit
card debts to the detriment of women and families in this country
seeking to collect alimony and child support and state and local
governments seeking to collect tax liabilities.
The bill contains some provisions that in my view are almost
indefensible, such as the requirement that debtor's attorneys bear
personal responsibility for the trustee's costs and fees if the debtor
loses a motion to convert a Chapter 7 filing to Chapter 13. That
provision will have the result of denying many debtors adequate legal
representation, making them even more subject to abusive and predatory
practices by creditors.
I am very concerned that we are moving too quickly on this issue,
and that if reform such as that contained in this year's House bill
becomes law its unintended consequences may be even worse for consumers
than the consequences we know about now. In light of that fear, Mr.
Chairman, I cannot leave you without commenting on what to me is a very
troubling aspect of this debate.
More and more the sense I get from talking to both experts in the
field and average folks is that while there are some helpful and
discrete reforms that could be made to our bankruptcy system, it is not
in need of the wholesale revision contemplated by many in this room.
And yet, there has been a massive lobbying push by creditor interests
for this legislation. New analysis of reports recently filed under the
Lobbying Disclosure Act shows that banks and other financial services
firms spent more than even the tobacco industry on lobbying in the last
six months of 1998.
And reports from good government organizations have noted that this
lobbying is accompanied by substantial and highly targeted campaign
contributions. I'm informed for example that one company gave a total
of $25,000 in soft money to my party within days of the House passage
of the bill last June. And another company gave $200,000 to the
Republican party just two days after the conference report was issued
last year, the very day that the report passed the House. Soft money
giving by the consumer credit industry to our political parties
increased from $1.2 million in the 1992 election cycle to more than
$5.5 million in the 1996 cycle.
Mr. Chairman, I ask that studies by Common Cause and the Center for
Responsive Politics on campaign contributions by the consumer credit
industry be placed in the record of this hearing.
We need to be cognizant as we proceed here of the extent to which
bankruptcy reform has come to be seen as a gift to certain special
interests. We bear a heavy burden, I believe, to make sure that we are
serving the public interest with this land of far reaching legislation.
We cannot meet that burden unless we slow down and open our minds to
the recommendations of nonpartisan experts in this field and try to
make sure we don't make some very big mistakes with this bill.
__________
Prepared Statement of Hon. John Conyers, Jr., a Representative in
Congress from the State of Michigan
The legislation introduced by Rep. Gekas being considered by the
House and Senate is an extreme and one-sided bill. Although the
legislation is good for the credit card industry, it is bad for low
income people, bad for women and children, bad for minorities and
seniors and bad for working Americans. I plan to do everything in my
power to fight this legislation and see that it is either defeated or
vetoed.
First off, the bill's means test is fatally flawed--The legislation
attempts to impose a one-size fits all income and expense test based on
IRS standards to determine who is eligible for bankruptcy relief and
how much they are required to pay their creditors. The problem is that
the formula fails to take specific account of such important items as
child care payments, health care costs, the costs of taking care of ill
parents, and educational expenses, to name but a few glaring loopholes.
Secondly, the bill grants creditors unfettered new rights to file
threatening new discharge motions against persons with income well
below the median. These motions intimidate poor debtors into
reaffirming their credit care and other unsecured debt, often at the
expense of being able to pay their mortgage and other priority
obligations.
__________
Questions from Senator Grassley for Panelists
questions for panel one:
Larry Nuss
1) How much has the Cedar Falls Credit Union lost due to bankruptcy
filings?
2) Could you comment on how many chapter 7 cases you encounter
versus the number of chapter 13 cases you encounter?
Bruce L. Hammonds
1) How do you respond to criticism that the credit card industry is
largely responsible for the explosion of bankruptcy filings by passing
out credit too easily?
2) Your industry has experienced high losses recently due to
bankruptcy. If we don't do bankruptcy reform, in your view, will we see
a rise in interest rates for loans to consumers?
Dean Sheaffer--National Retail Federation
1) In light of the Sears case, is the Retail Federation currently
developing guidelines for its members on how to lawfully seek
reaffirmations?
Judge Kenner
1) I am very sympathetic to idea that there's a problem with
debtors being coerced into reaffirmations by abusive or deceptive
creditor practices. However, it seems to me that there are already
harsh sanctions in place to punish improper creditor conduct. Just look
at the Sears case where post-discharge injunction combined with State
and Federal deceptive practices law resulted in Sears paying over 160
million dollars to settle class action settlements, and penalties.
Given what happened to Sears, why shouldn't conclude that what we need
is better law enforcement of existing laws, not new laws?
2) As you know, the judicial conference uses a formula that
assesses the workload of bankruptcy judges in order to figure out when
to request new bankruptcy judges. In your written statement, you
suggest that we need more court hearings and judicial review of
reaffirmation. Of course, those proposals are likely to cause the
formula to show that we need more and more bankruptcy judges. Have you
considered how your proposal to require court approval for all
reaffirmations affect the staffing formulas? Have you run your
proposals by the relevant committees of the judicial conference?
questions for panel two:
Judge Jones
1) You are a Federal Appeals Court judge who hears bankruptcy
appeals. Do you think a bright-line rule with respect to means-testing
helps judges make clear and consistent decisions?
2) During your tenure on the Bankruptcy Review Commission, did you
propose a means-testing provision?
Professor Zywicki
1) You mentioned that means-testing would affect a maximum of all
bankruptcy filers, do you know what percentage of filers are reported
to be repeat users of their ``fresh start'', and can you comment on
what this number suggests about the current remedies in the consumer
bankruptcy system?
2) How will means-testing improve the consistency and objectivity
in the application of the bankruptcy code?
__________
Followup Questions from Senator Torricelli
for mbna:
In the Senate bill that passed 97 to 1 last year, there was a
provision requiring that credit card monthly statements disclose
additional information about the cost of that credit, most of which I
imagine you already have in your computers. That provision did not
survive in the Conference Report and is not in the new Gekas bill. In
its place appeared a provision that gives more standard information,
but that most people believe will not be very helpful, and some people
believe may be misleading. Do you support the idea of giving consumers
more information about the cost of their credit?
If we are going to overhaul the bankruptcy system in response to
concerns about credit industry losses, we are going to need to evaluate
the actual loss data. Can you provide us with that information?
It generally is reported that credit card lending may be the most
profitable lending activity, notwithstanding all of these bankruptcies.
Except for teaser rates (or ``permanent introductory rates'') the
average interest rate on credit cards remains pretty high, particularly
for many middle class and the working poor, even though your cost of
funds is low. How can I be sure that if we make the changes you want,
that this time you are going to pass along the savings to my
constituents?
It is all well and good to encourage people to file for chapter 13
to pay more of their debts. However, the current success rate in
chapter 13 is not so good--\2/3\ of confirmed plans fail, many before
paying any unsecured debt. Do you have any data on how you fare in
chapter 13 today?
How would the proposed change to the valuation of secured claims
(e.g., the elimination of the stripdown and adding to the value any
past interest and penalties) affect the goal of the means test to
increase the return of unsecured creditors?
for judge kenner:
Based on your experience over the past several years, if you had to
choose between the bankruptcy laws as of 1983 (mandatory court
reaffirmation review) and the bankruptcy law of today (no mandatory
court reaffirmation review), which do you think best fulfills our
intent to provide meaningful debt relief in chapter 7 for honest,
hardworking, middle class American families?
You mentioned in your testimony that some debtors reaffirm debts
after being accused by a credit card company of committing an act that
makes those debts nondischargeable, whether or not they are guilty,
because they cannot afford to defend themselves in a court hearing.
What will be the effect of adding more exceptions to discharge that
make it easier for credit card companies to argue that their debts are
nondischargeable?
Some creditor representatives have dismissed suggestions that
widespread illegal reaffirmation practices demonstrate that
reaffirmation review not necessary because ``the system works.'' Are
they right?
for gary klein:
We have been told in the past that there is a difference between
provisions that are ``debtor friendly'' and those that are ``consumer
friendly''. For example, some people have argued that provisions
protecting the fresh start for honest families work hardship on other
consumers who never file for bankruptcy. And, on the flip side, we have
been told that by restricting debtors' rights, we will make the price
of credit, goods and services cheaper for nonbankrupt consumers. As an
advocate of both debtors and of consumers, can you comment on whether
this distinction is real? Are the interests of bankrupt debtors and
middle class consumers conflicting?
for credit union representative:
Credit unions tend to be very careful lenders, leading to far lower
loss rates than other types of creditors. Some of your members/
borrowers find in their mailboxes solicitations for more credit.
Certainly no one is forcing them to accept it, but some of them
underestimate their financial vulnerability and are attracted by the
``teaser'' interest rates. With this extra debt burden, they cannot
weather hard times and default on their obligations. Does it bother you
that the lending practices of large for profit lenders are increasing
your losses? Do you think you deserve better treatment in bankruptcy
because you at least are trying to lend only to those people who are
more likely to be able to repay?
for bon ton representative:
In light of the problems retailers have had with their
reaffirmation practices, how can one justify banning class actions for
illegal reaffirmation practices when class actions often are the only
way that middle class people have a remedy for wrongdoing against them?
In light of the problems retailers have had with their
reaffirmation practices, do you agree that more should be done in this
bill to respond to creditor overreaching? What is the justification for
focusing almost exclusively on debtor abuse?
Do you offer shoppers one time incentives to sign up for a Bon Ton
charge card? Are obligations on Bon Ton charge cards secured or
unsecured by the items your customers purchase in your store? If they
are secured, how do you make your clients aware that their purchases
are secured? If they are secured, does this mean that you offer an
interest rate that is lower than the interest rate on the average
unsecured credit card?
Let's say I am a Bon Ton customer. I buy a variety of reasonably
priced items at your store and have carried a balance on my charge card
over the past several years, making only the minimum payment each
month. If I file for bankruptcy today, is my debt to your store secured
by all of these items? Can you come and take them away if I do not pay
after bankruptcy?
for professor warren:
Although there has been a lot of focus on the means test, can you
explain the practical effect on families and children of making it
easier for credit card companies to claim that their debts are
nondischargeable and survive bankruptcy? The First Lady, women and
children advocates, and others have expressed a lot of concern about
those provisions.
In the prior panel, Judge Kenner explained how current
reaffirmation law was not fulfilling our Congressional intent to
prevent certain more aggressive creditors from nullifying the
discharge, to the detriment of other creditors and the debtor's family.
Why shouldn't the debtor be free to agree to pay debts if he so
chooses?
You have told us that changes to one provision can have unintended
effects on other provisions. Can you close the link for us? What is the
connection between imposing a means test, increasing the exceptions to
discharge for credit card debts, and failing to reform reaffirmation
practice?
You and others have linked the bankruptcy filing rate to consumer
debt such as credit cards and the like. Yet, the consumer credit
industry has told us that this explanation cannot be correct because
the percentage of credit card debt in bankruptcy cases is under 20% and
therefore is too small as compared to the total debt in bankruptcy to
be the culprit for the filings. How do you respond to this?
No one can refute that the filing rate is very high. Can you
explain why your research and research being done at the Harvard
Business School suggests that the increase is not attributable to a
decline in stigma?
for judy miller (commercial law league):
Some people have argued that individuals and groups voicing
opposition or concerns about the bill are simply trying to block reform
and believe that abuses should not be addressed. If this is the case,
why is a creditor oriented group like the Commercial Law League of
America voicing objections about the bill?
You seem to have some serious concerns about the means test in this
bill and its ability to identify debtors who can pay back their
unsecured debts. As a representative of many unsecured creditors, your
opinion on this is obviously significant. Are you saying that unsecured
creditors are unlikely to benefit from this means test? If so, how
should we fix this problem?
for judge jones:
You have commended Congress for rejecting findings of the National
Bankruptcy Review Commission, of which you were a member. However, 7
out of 9 Commissioners chose not to recommend to Congress that it
consider a formal means testing system. Now we have heard that the only
recent independent study on this subject, sponsored by the American
Bankruptcy Institute, found that even if we did turn the system upside
down, only a small portion of chapter 7 debtors could pay even 20% of
their debts. In addition, we have a witness here who often represents
unsecured creditors and who is telling us that she thinks the means
test does not work. In light of these factors, why should we move to a
formulaic means testing system?
Supporting the concept of needs based bankruptcy is one thing;
supporting the details of this bill's means testing approach is
another. Even if you support a ``means based'' system in theory, aren't
you concerned by the logistical problems that have been identified
regarding this means test by the Commercial Law League, trustees,
judges, and the National Bankruptcy Conference?
As a judge, do you think it is appropriate to make debtors' lawyers
personally and financially responsible if their clients are found to
have filed under the wrong chapter?
Even if we make it less ``easy'' to file for bankruptcy so that the
filing rate goes down, it seems to me that we have looked at only one
half of the problem because some people are going to default on their
obligations whether or not they ``discharge'' their debts in
bankruptcy. Can you comment on this? Do you think that more needs to be
done to help prevent people from incurring so much debt in the first
place?
Using conservative economic theories, some researchers believe that
restricting bankruptcy laws will increase defaults and ultimately
increase bankruptcy filings. Do you disagree with those conservative
economists?
for professor zywicki:
The means test in this bill relies heavily on the IRS collection
allowances. We have heard lots of concerns about these allowances, even
from those who take no position on the bill generally. One problem is
the ``other necessary expense'' category. Since it clearly was not
designed for this purpose, the items that fall into the category are
totally discretionary with the IRS and are approved on a case by case
basis (see IRS regulations 5323.434). Thus, we have no guarantee that
these expenses may be deducted from the means testing formula. This is
not simply a minor inconvenience; families in bankruptcy will need to
use this category for such things as health care, child care,
disability insurance, union dues, and court-ordered payments (such as
support), because the IRS collection allowances do not cover these
critical expenses anywhere else. How is this supposed to work?
The means test in this bill requires a trustee to do a complete
ability to pay analysis under the means test in every single chapter 7
consumer case at the very beginning of the case, 10 days before the 341
meeting, before the trustee has even met any of the debtors. People who
actually work in the bankruptcy system say that this simply is not
feasible. In addition, the trustees would not even be compensated for
this extraordinary expenditure of time. Don't you think that there are
serious feasibility requirements with the means test?
As a law professor who has studied the bankruptcy system, do you
believe that it is appropriate to give lawyers a financial disincentive
to file chapter 7s for their clients if they believe that doing so is
in the best interest of their clients? Are you concerned that creating
such financial disincentives for lawyers to act in their clients' best
interests will run afoul of other ethical requirements?
__________
Followup Questions from Senator Russ Feingold
to bruce hammond:
1. You testified that the number of consumer bankruptcy filings in
1998 represents an increase of nearly 400% since 1980.
A) Please provide comparative information on the amount of
credit card debt issued by MBNA in 1980 and 1998.
B) Please provide comparative information on MBNA's non-
bankruptcy losses in 1980 and 1998.
C) Please provide comparative information on MBNA's
bankruptcy losses as a fraction of total credit card debt
outstanding in 1980 and 1998.
D) Please provide the same information for the industry
generally.
2. You testified that it is ``estimated that more than $40 billion
in consumer debt--approximately $400 for each American family--was
erased as a result of bankruptcy in 1998.'' Putting it another way, you
later testified that the ``Federal consumer bankruptcy system provided
an estimated $40 billion of relief to debtors without either objective
standards or systematic procedures for determining the actual relief
needed by debtors.'' We also heard in the hearing that the ``hidden
bankruptcy tax'' is now up to $550 a year per family, leading to the
suggestion that bankruptcy legislation will result in a $550/year
rebate to the American people. Please respond to the following
questions:
A) Do you have a source for the $400/$550 a year figures
other than the last year's WEFA Group study, which the General
Accounting Office determined was not reliable? See ``The
Financial Costs of Personal Bankruptcy'' Letter from Associate
Director Richard Stana to the Honorable Martin T. Meehan, GAO/
GGD-98-116R.
B) Can you explain why the bankruptcy loss figure grew by 35%
(from $400 to $550 in a single year) when the growth in
bankruptcy filings for the same period was about 1%?
C) Does the $40 billion figure account for debts that were
found to be nondischargeable or that were reaffirmed?
D) Does the $40 billion figure account for the fact that more
than half of all chapter 13 debtors never discharge any debt?
E) Does the $40 billion figure account for losses that you
would have experienced even if the borrowers never filed for
bankruptcy?
3. You testified: ``Inevitably, these losses are passed on to all
consumers in the form of higher rates and higher prices for goods and
services.'' However, over the past decades there has not been a
correlation between the cost of credit and the cost of funds or the
number of bankruptcy filings; indeed, interest rates have remained
remarkably constant over the past 18 or so years, even though the
bankruptcy rate was not. If one argument for reforming the bankruptcy
laws in the ways that you support is that it will lower interest rates
and prices for our constituents, can you provide us with data showing
how losses from bankruptcy have affected the price of credit offered by
MBNA in the past?
4. You testified: ``Consumers also are harmed by increased
bankruptcies when creditors, in an effort to reduce losses, tighten
their credit standards and thereby decrease credit availability.''
Similar testimony has been submitted throughout the 20th century in
connection with requests for changes to the bankruptcy system,
particularly in the early 1980s when Finn Casperson of Beneficial
Finance and other representatives of the credit industry warned that
consumer credit would grow scarce if the bankruptcy system was not
reformed--and specifically if means testing were not adopted.
A) What happened to the industry prediction of the 1980s?
Hasn't credit grown in the intervening years, not contracted?
B) If credit restriction is the predicted result of high
bankruptcy filings and losses, have you restricted credit to
reduce your losses following the big jump in bankruptcy filings
in 1996? If so, how?
5. What are MNBA's policies on extending credit to families that
have filed for bankruptcy?
A) Does MBNA offer credit to individuals within 2 years after
they receive a chapter 7 discharge? If so, on what terms?
B) What are the industry practices on offering credit to
individuals who have filed for bankruptcy?
6. With respect to Chapter 7 cases involving debt owed on and MBNA
credit card:
A) In what percentage of such cases does MBNA challenge the
dischargeability of the debtor's debt to MBNA?
B) Of those cases where dischargeability is challenged, how
many cases are actually litigated?
C) What percentage of debtors do not contest your charge and
either admit nondischargeability or reaffirm the debt without
any specific findings of fraudulent behavior?
7. I understand that some 3.5 billion credit card solicitations and
offers go out each year. Do you think that the credit industry bears
any of the responsibility for the increase in personal bankruptcies in
this country?
8. You testified that the current bankruptcy system's lack of means
testing ``undermines not only the integrity of the U.S. bankruptcy
system, but also traditional obligations of individual
responsibility.''
A) Do you believe that MBNA and the consumer credit industry
generally has a corporate responsibility to verify the ability
to pay of the consumers to whom you offer credit cards?
B) Please explain how many bankrupt consumers with relatively
low incomes who end up in bankruptcy have so many credit cards.
9. You testified that ``the current bankruptcy system also fails
the debtors it is intended to help, because it provides short-term
relief without helping debtors avoid the same financial failure in the
future.''
A) Please explain how the means test in H.R. 833 helps
debtors avoid the same financial failure in the future,
particularly when the means test benefits those debtors who
take on larger debts and declare higher expenses.
B) Do you agree that including additional disclosures on
monthly credit card statements that help borrowers understand
the cost of credit they are incurring by advising them of their
amortization rate and the long term financial effect of making
only the minimum monthly payment would help borrowers avoid
financial failure in the future?
10. You testified that the implementation of means testing would
introduce enormous efficiencies into the bankruptcy system.
A) Section 102 of H.R. 833 requires that trustees conduct a
means test review of every single chapter 7 debtor, even those
with incomes far below the national median, or even below the
poverty level. Do you believe it is efficient to test all
chapter 7 debtors, regardless of their income?
B) If an individual with income below the poverty level can
pay 20% of her debts because her debts are not large in an
absolute sense although they may be overwhelming as compared to
her disposable income, do you think such an individual should
be denied chapter 7 debt relief and instead should be required
to obtain relief only after completing a 3 to 5 year payment
plan?
C) The means test in H.R. 833 relies on the Internal Revenue
Service collection allowances. However, many expenses do not
fit the categories of expenses that are automatically permitted
under the IRS allowances. Instead, according to IRS regulation
5323.434, such expenses as health care, child care, dependent
care for elderly invalid or disabled, or disability insurance
are permissible only on a case by case basis by the IRS. Since
the bill requires trustees to scrutinize all chapter 7 filers
for ability to pay, how would an elderly person filing for
chapter 7 obtain the necessary permission to include her
expenses for health care and dependent care?
11. You testified that those debtors who were found to be able to
pay the requisite portion of their debts under the means test ``would
automatically enter a Chapter 13 repayment plan.'' However, the means
test as currently constituted in the House bill does not account for
several significant factors, e.g., amounts in default on secured debts
and chapter 13 administrative expenses.
A) Isn't it the case that some debtors who are ejected from
chapter 7 under the means test in fact will not be able to pay
20%--or any--of their unsecured debts once sent to chapter 13?
B) If so, is it cost-justified to send such debtors to
chapter 13 when the annual costs of administering a chapter 13
case (approximately $1,200 per year per case under the current
system) outweigh the distributions made to unsecured creditors?
12. Do you disagree with the testimony of Judith Greenstone Miller
of the Commercial Law League of America, who cited the finding of the
National Association of Bankruptcy Trustees (chapter 7 trustees) that
no more than 1 in 10 cases converted under the proposed means test will
actually be able to confirm or complete a repayment plan? If you do
disagree, please provide any studies or data that support your view.
13. You stated in your testimony that ``bankcard debt represents
less than 16% of total debt on the average bankruptcy petition.''
A) Please provide us with the source of this statistic and
the underlying data supporting it.
B) Since the 16% figure presumably includes secured debt,
what percentage of unsecured debt on the average bankruptcy
petition that is bank card debt?
C) What percentage is credit card debt, including non-bank
card debt?
14. You mentioned in your testimony that credit cards cannot be the
cause of the high bankruptcy filing rate because credit cards accounted
for a mere 3.7% of consumer debt in 1997 according to the Federal
Reserve Board. However, you also have told us that in bankruptcy,
bankcard debt alone (presumably a subset of all credit card debt that
would include cards of retailers and other types of credit card
issuers) is 16% of all debt, including secured debt--meaning that
bankcard debt and total credit card debt are a far higher percentage of
total unsecured debt in bankruptcy than outside of bankruptcy. Doesn't
the disproportionately high amount of credit card debt in bankruptcy,
as compared with the population generally, indicate that credit card
debt is a serious problem for those individuals who ultimately file for
bankruptcy?
15. Your testimony indicates that more than 96% of credit card
accounts pay as agreed, and only about 1% end up in bankruptcy, leaving
the other 2 or 3% of credit card accounts to be in default without
resorting to bankruptcy. This suggests that more credit card accounts
default without bankruptcy than with bankruptcy.
A) Even if we restrict the bankruptcy laws as you recommend,
what makes you think that this 1% will be collectible when 2 or
3% of your accounts default without discharging their debts
under the bankruptcy system?
B) What are MBNA's losses, in dollars, from nonbankruptcy
defaults?
C) How do you address the 2 to 3% of accounts that default
without bankruptcy? What types of collection or enforcement
procedures do you typically use?
16. Most discussions of bankruptcy reform have focused on the means
test, which was the subject of the panel on March 11. However, as Gary
Klein pointed out at the hearing at which you testified, the bankruptcy
bill spans 300 pages and contains hundreds of amendments affecting
consumer bankruptcy, many of which we have had little or no opportunity
to debate, but we know are quite significant. Since your testimony
indicates that means testing is extremely important to you, does this
mean that you would be willing to accept a means testing amendment and
forgo the remainder of the other consumer bankruptcy amendments, such
as the various provisions expanding the nondischargeability of credit
card debt?
17. I am interested in your view of the appropriate public policy
to be served by a bankruptcy system. Please rank the following
potential creditors in a hypothetical bankruptcy case. Who should be
paid first, second, etc. from the limited pool of funds available in a
bankruptcy case?
Credit card company.
Secured lender on a purchase of an automobile.
Other secured creditor.
Taxing authorities.
Spouse who is owed child support and/or alimony.
18. Please compare two hypothetical cases. (1) Suppose someone
takes out a cash advance of $500 on one of your credit cards to go
gambling. She loses every penny. A month later she declares bankruptcy.
(2) Suppose another person takes out a cash advance of $500 to pay for
food for her children and an unexpectedly high heating oil bill. A
month later, she files for bankruptcy. Should those two debts to you be
treated the same way in bankruptcy?
19. On October 9, 1998, two days after the conference report was
filed and the very day that the House passed the conference report,
MBNA contributed $200,000 to the National Republican Senatorial
Committee.
A) As CEO, are you involved generally in the decisions to
make soft money contributions to the political parties?
B) Were you involved in the decision to make this particular
donation?
C) How are decisions on soft money contributions made in your
company? Who participates in such decisions? What criteria are
followed in making such decisions?
D) Why did MBNA make a $200,000 donation to the NRSC on
October 9, 1998?
20. Do you believe there are any creditor abuses in the bankruptcy
system that should be addressed in bankruptcy reform legislation? If
so, what are they?
to larry nuss:
1. You report in your testimony that National Credit Union
Administration data show that credit unions had approximately 253,000
members file for bankruptcy in 1998, an increase over the 250,000
filings in 1997.
A) What was the total number of members in the credit unions
that were the subject of the NCUA statistic in 1998 and 1997,
and the percentage of credit union accounts in bankruptcy in
those two years?
B) Unless credit union membership declined significantly in
1998, a 3,000 increase in credit union member bankruptcy
filings in 1998 (just over a 1% increase from the previous
year) is probably far below the nationwide filing rate
increase. Do you attribute this lower increase to self-
correction in lending and/or the high standard of care
generally used by credit unions when lending to their members?
2. You report that the Credit Union National Association estimates
that almost half of all credit union losses in 1998 were bankruptcy-
related and that those losses reached $684 million.
A) Does this mean that the bankruptcy losses are $684 million
or the total losses are $684 million?
B) To enable us to determine the overall credit union default
rate and bankruptcy default rate, what was the aggregate loan
portfolio of all credit unions included in these statistics?
3. According to your testimony, your credit union currently has
8,300 members. In 1998, 18 of your members (approximately .02%) filed
for bankruptcy. The filing rate among your membership is far lower than
the national filing rate. Although the national nonbankruptcy filing
rate has increased substantially since 1995, your filing rate in 1998
(approximately .02%) is the same as in 1995 (assuming you had 8,300
members then as well).
A) To verify that your filing rate was approximately the same
in 1995 as it is in 1998, how many members did you have in
1995?
B) Do you think that if other lenders were as careful as you
are, that the market would fix the current ``bankruptcy
crisis'' without the proposed government intervention?
C) Although your filing rate is nearly identical in 1998 to
your 1995 rate (assuming that the number of members has not
changed substantially), your losses appear to have increased
from $19,848 in 1995 to $34,813 in 1998. If you adjusted your
numbers for inflation and reported your 1995 losses in 1998
dollars, how would your losses compare in those two years? If
there still is a substantial difference, what accounts for that
difference in losses?
4. The losses in dollars that you experienced in 1998 that you have
attributed to bankruptcy are only .014% of your loan portfolio. Does
this extremely low dollar loss rate, along with your low filing rate,
provide further evidence that bankruptcy losses can be contained by the
market without unduly restricting credit availability overall?
5. You testified that reaffirmation agreements have been a
significant factor in reducing your losses.
A) How many of your bankrupt members reaffirmed one or more
debts to your credit union in 1997 and 1998?
B) What proportion of those reaffirmations was for partially
secured car loans?
C) What proportion was for credit cards or other unsecured
debts?
D) What was the total dollar amount of debt that your members
reaffirmed in 1997 and 1998?
6. Your testimony indicates that you believe that your
reaffirmation agreements confer a benefit on the debtors who reaffirm
those debts. As you know, you may be one of several lenders asking a
debtor to reaffirm her debts, and it may be financially infeasible for
that debtor to honor all of those commitments. Reaffirmation of other
debts may interfere with the debtor's ability to repay your credit
union, and other lenders might use more aggressive collection practices
and higher fees to encourage the debtor to pay them first.
A) If debtors were not allowed to reaffirm any unsecured
debt, would most of your members continue to pay you
voluntarily?
B) Do you believe that the benefits your members receive from
reaffirming debts to you would make them more likely to pay you
than some of their other creditors?
C) Would you support court review of reaffirmation agreements
if it did not necessarily require a hearing and could be done
inexpensively?
D) Do you believe that reaffirmation agreements should
clearly state the terms of the agreement so that debtors can
understand the financial consequences of the reaffirmation,
similar to the Truth in Lending Act requirements? If not, why
not?
7. You testified that you support needs based bankruptcy, in part
because you believe that more of your members could repay some of their
debt in chapter 13. However, the national statistics on chapter 13 plan
completion are low, and many do not distribute much, if any, payments
to unsecured creditors.
A) Of the chapter 13 cases your members have filed since
1995, how many were completed or still in payment?
B) How many dollars of unsecured debt have been collected
from in the chapter 13 cases of your members since 1995?
C) If one of your members files for bankruptcy, are you
better off financially if the member files for chapter 7 and
reaffirms her debt to you in full rather than filing for
chapter 13 and paying all of her debts pro rata over several
years?
8. Most discussions have focused on the importance of the means
test, which was the subject of the panel on March 11. However, as Gary
Klein pointed out at the hearing at which you testified, the bankruptcy
bill spans 300 pages and contains hundreds of amendments affecting
consumer bankruptcy that have received little or no attention. Would
you be willing to accept a means testing amendment and forgo the
remainder of the other significant consumer bankruptcy amendments, such
as the various provisions expanding the nondischargeability of credit
card and retail charge card debt and the provisions inflating the value
of nominally secured debt?
9. In recognition of the lower loss rates and sometimes more
responsible consumer lending practices of credit unions, should there
be special provisions in this legislation that apply only to credit
unions? Should credit unions be treated differently with respect to
reaffirmation?
10. Do you believe there are any creditor abuses in the bankruptcy
system that should be addressed in bankruptcy reform legislation? If
so, what are they?
to dean scheaffer:
1. Your testimony on behalf of the National Retail Federation
focuses exclusively on abuse of the bankruptcy system by debtors and
does not make any mention of the fact that quite a few retailers have
admitted to committing bankruptcy fraud on a widespread basis.
A) Has Boscov's engaged in any post-bankruptcy collection
activity without filing reaffirmation agreements?
B) Does Boscov's think that the current laws supervising
reaffirmation agreements have been adequate?
C) Does Boscov's support the provisions in the House bill
that eliminate class actions to pursue creditors who have
systematically violated bankruptcy law to the detriment of
consumer debtors? If so, why?
2. Do you believe there are any creditor abuses in the bankruptcy
system that should be addressed in bankruptcy reform legislation? If
so, what are they?
3. How many of your bankrupt customers reaffirmed their debts to
Boscov's in 1997 and 1998? What was the average amount of the debt?
4. How many dollars owed to Boscov's were reaffirmed in bankruptcy
cases in 1997 and 1998?
5. How many dollars has Boscov's received in chapter 13 cases filed
by its customers since 1995?
6. Do you believe that reaffirmations are a preferable method of
reducing Boscov's bankruptcy losses as opposed to chapter 13 plans, in
which Boscovs might only receive, as you testified, 30 cents on the
dollar or even less?
7. You testified that ``it is estimated that over $40 billion was
written off in bankruptcy losses last year, which amounts to the
discharge of at least $110 million every day. . . . The nation's 100
million households ultimately pay that $40 to 50 billion.''
A) Do you have a source for this data other than the WEFA
Group study that has been called into question by the General
Accounting Office? See ``The Financial Costs of Personal
Bankruptcy'' Letter from Associate Director Richard Stana to
the Honorable Martin T. Meehan, GAO/GGD-98-116R. If so, can you
provide us with the supporting data?
B) Assuming that the $40 to $50 billion figure is correct,
producing a ``hidden tax'' on every American family of $400 or
$550 a year, can you estimate what portion of that amount
actually could be recouped by the Bankruptcy Reform Act of
1999?
C) Have the interest rates on Boscov's charge cards
increased/decreased in the past in step with bankruptcy filings
and losses that you have attributed to bankruptcy? If so,
please document these changes.
D) Has the cost of merchandise at Boscov's increased/
decreased in the past in step with bankruptcy filings? If so,
please document these changes.
8. You testified that ``everyone's credit is tighter'' when people
use the bankruptcy system as a means of walking away from their debts.
Can you document that you restricted your lending, or that the industry
generally restricted its lending as a result of the increase in
bankruptcy filings?
9. Representing the National Retail Federation, you testified that
the emergence of a new phenomenon, surprise bankruptcy filings, is an
indication that bankruptcy is becoming a first step rather than a last
resort. You said: ``Today, we see a very different picture. Often the
first indication we receive that an individual is experiencing
financial difficulty is when we receive notice of his bankruptcy
petition. . . . The first indication of a problem is the notice that
they have filed for bankruptcy.'' In 1983, a representative of the
National Retail Merchant's Association and American Retail Federation
similarly testified that ``a new and substantial class of debtors--one
different from the traditional debtor--was also found. These persons
were current on their required monthly payments, had little or no
previous history of delinquency, and some even had additional credit
available on the account at the time the bankruptcy notice was received
by the creditor.'' See Statement of Raymond W. Klein, H.R. Macy & Co.,
Inc., representing the National Retail Merchants' Association and the
American Retail Federation before the Senate Judiciary Committee
Subcommittee on Courts (January 24, 1983). Are you identifying the same
``new'' phenomenon as Mr. Klein did in 1983? If not, how are they
different?
10. You testified that the system should be changed to incorporate
means testing regardless of what percentage of individuals currently
choosing chapter 7 actually could pay any of their debts. However,
legislators need to have a better sense of how many chapter 7 debtors
are solvent because it is relevant in determining whether the
substantial change would be cost-justified. We first heard that
industry funded studies predicted that one third of chapter 7 debtors
could pay some or all of their debts. Later industry funded studies
predicted lower and lower numbers, the latest being 11%. A recent non-
industry study sponsored by the American Bankruptcy Institute found
that the most optimistic number of chapter 7 debtors able to pay even
\1/5\ of their debts over 5 years is under 4%, and that the amount of
dollars the credit industry will recoup directly from this change is
likely to be a fraction of the industry's estimate.
A) Approximately what percentage of chapter 7 debtors do you
believe can repay a substantial portion of their debts.
B) How many dollars you believe you will recoup from that
system so that we can compare that to the cost to the taxpayers
of the change.
11. Most discussion has focused on the importance of the means
test, which was the subject of the panel on March 11. However, various
versions of the bankruptcy bill span 300 pages and contain hundreds of
amendments affecting consumer bankruptcy. Would you be willing to
accept a means testing amendment and forego the remainder of the other
significant consumer bankruptcy amendments, such as the various
provisions expanding the nondischargeability of credit card and retail
charge card debt and the provisions inflating the value of nominally
secured debt?
to professor todd zywicki:
1. You testified that ``studies repeatedly conclude that those
affected by means-testing could pay approximately 60%-70% of their
unsecured debts if they filed under Chapter 13, which amounts to a
total of over $4 billion.'' Do you have a source for this $4 billion
number, other than the report of the WEFA Group study that did not
provide sufficient information for the General Accounting Office to be
able to assess the reliability of the data, the reasonableness of the
report's assumptions, and the accuracy of the report's estimates of
creditor losses and the bankruptcy system's costs in 1997? See ``The
Financial Costs of Personal Bankruptcy'' Letter from Associate Director
Richard Stana to the Honorable Martin T. Meehan, GAO/GGD-98-116R.
2. You testified that ``95% of Chapter 7 bankruptcy filings make no
distribution at all to unsecured creditors, and those that do rarely
pay out more than a trivial amount'' and went onto suggest that
creditors receive a much larger payout in chapter 13 cases. However,
VISA U.S.A. studies and the Creighton University reaffirmation study
both indicate that a substantial portion of chapter 7 debtors reaffirm
their debts and thus continue to pay one or more of their unsecured
debts, notwithstanding the fact that they have no nonexempt property to
be liquidated in the course of the bankruptcy case. The chapter 13 plan
completion rate is low, and many times plans are terminated before
payments to unsecured creditors are commenced. Moreover, some plans are
0% plans and never intend to pay unsecured creditors at all.
A) Do these factors affect your comparison of the benefits of
the two chapters?
B) Do you have any data to make a more complete comparison
between the payouts from chapter 7 and chapter 13 debtors?
3. You testified that the reach of means-testing is small in terms
of the number of filers impacted but that its impact would be large in
terms of the amount of money collected. In light of this view, do you
believe that it is necessary or efficient to review all cases for
ability to pay under the means test, even cases of debtors with income
below the poverty level, as section 102 of H.R. 833 currently requires?
4. Your testimony suggests that a means test should identify those
debtors with high incomes who could repay creditors, such as the doctor
in the case of In re Kornfield, 164 F.3d 778 (2d Cir. 1999). Your
testimony also suggests that although the current system has been
successful in denying relief to debtors such as Dr. Kornfield, current
law permits those debtors to continue to contest the denial of relief
by filing and litigating appeals. You probably would get little or no
argument from debtor advocates that individuals like Dr. Kornfield may
not be deserving of chapter 7 relief. However, some observers have
questioned whether the means test in H.R. 833 will actually be able to
catch someone like Dr. Kornfield; after all, an individual with his
sophistication and legal resources will be able to inflate and shape
his debts and expenses to escape the means test.
A) Do you agree that the means test in H.R. 833 provides
leeway for wealthy and savvy individuals, the Dr. Kornfields of
the world, to escape the means test?
B) How would H.R. 833 prevent Dr. Kornfield from taking
several appeals as he did under current law? After all, with
his legal resources, he could contest the ``other necessary
expense'' category of the IRS collection allowances, which are
determined on a case by case basis, and he also could contest
any determination of whether he had ``extraordinary expenses.''
5. You testified that the 1978 Code significantly reduced the
economic costs and increased the economic benefits of filing
bankruptcy. However, the Code was tightened with amendments proposed by
the credit industry in 1984, only to be followed by a sharp increase in
filings notwithstanding decreased debt relief. How do you explain this
trend?
6. You testified that economist Michelle White estimates that 15%-
20% of American households would financially benefit from filing
bankruptcy, especially if they engaged in some planning prior to
filing. Since a far smaller percentage of American households file for
chapter 7 bankruptcy, doesn't this mean that bankruptcy still carries
stigma sufficient to deter the vast majority of families who would
benefit from filing?
7. Your testimony indicates that you believe that every individual
who borrows money or purchases an item should be required to repay it.
Drawing the analogy between bankruptcy and shoplifting, you state that
``you shouldn't take it if you aren't going to pay for it.''
A) If this is the case, do you think that Congress is wrong
to provide a discharge in bankruptcy at all?
B) Should society recognize that changed economic
circumstances caused, for example, by illness, disability,
divorce, or loss of employment might make it impossible for
consumers to satisfy debts they had every intention of paying
when they incurred them?
C) Are you concerned that the lack of a bankruptcy safety
valve will hamper entrepreneurs, who currently comprise one in
five consumer bankruptcy filings, from engaging in the
appropriate level of risk-taking activity?
8. You state in your testimony that ``a borrower's willingness to
take on debt clearly will be related to the ease with which he can
later discharge those debt obligations if he chooses to do so.'' This
statement assumes that consumers incur obligations with the
understanding of their true costs. Some economists believe that many
consumers systematically underestimate the extent of their borrowing
and the cost of repayment and therefore make sub-optimal borrowing
decisions. If this is the case, changing the bankruptcy law will not
affect the borrowing decisions of many consumers. To enable consumers
to make more rational borrowing decisions that will be less likely to
lead them into financial distress, particularly if the bankruptcy laws
are going to be tightened and consumer credit remains freely flowing,
do you believe that open end credit should be accompanied by additional
disclosures that reveal to the potential borrower the actual costs of
credit?
9. You testified that consumer credit is not to blame for the
bankruptcy filing rate. The credit industry witnesses agreed with you,
noting that credit card debt is only 3.7 of consumer credit overall and
bank card debt (presumably a subset of all card debt) is only 16% of
all debt (including secured debt) in bankruptcy. However, don't these
numbers alone indicate that the individuals and families who ultimately
resort to bankruptcy have inordinately high credit card debts as
compared to the population as a whole?
10. You testified that ``the credit card industry has revealed
itself to be ferociously competitive.''
A) If that is the case, why have average interest rates on
credit card hardly varied over the past 2 decades since the
industry was functionally deregulated by the Marquette Supreme
Court case, even though the cost of funds declined dramatically
in this period?
B) Why have profits in the consumer credit consistently
exceeded profits for all other lending activities?
12. As further support for the proposition that the time has come
for means testing, you testified: ``Access to credit cards are
especially important for low-income borrowers, as they lack the options
of more wealthy borrowers.'' However, the means testing provision is
one of dozens of changes to the consumer bankruptcy system in the
pending legislation. Some of the provisions in the bill will decrease
the amount of the debtor's income available for payment of unsecured
debt in chapter 13, and in fact may further suppress the chapter 13
plan completion rate. How will these provisions affect the cost of
unsecured credit and its availability for low income borrowers?
13. As a professor who has argued vigorously in favor of retaining
disinterestedness requirements on chapter 11 debtors' lawyers to ensure
that they act in their clients' best interests, do you believe it is
appropriate for the bill to impose financial disincentives on lawyers
to help their debtor clients file for chapter 7 if those lawyers
believe that the debtor is an eligible candidate for chapter 7 and that
it is in the best interest of the debtor to seek that relief?
14. As a professor who has studied the bankruptcy system closely,
do you see any creditor abuses in the system that should be addressed
in bankruptcy reform legislation? If so, what are they?
__________
Question from Senator Kohl for Judge Edith Jones:
The National Bankruptcy Review Commission, which you served on,
recommended a $100,000 cap on homestead exemptions. I have introduced
legislation that would establish such a cap. We have heard from some of
the states with unlimited homestead exemptions that a $100,000 cap
would unfairly infringe on states' rights. Cap supporters argue that
debtors are using federal courts and federal laws to get bankruptcy
relief, and it is fair to make them subject to federal limits in order
curb egregious abuses, like the recent example of long-time Florida
resident Burt Reynolds who wrote off over $8 million in debt through
bankruptcy while still holding onto his $2.5 million estate. Do you
agree with this recommendation of the NBRC? Please explain your
response, including your reaction to arguments from both sides.
__________
Dean E. Sheaffer's Responses
Boscov's Department Store, Inc.,
Reading, PA, March 25, 1999.
Hon. Henry J. Hyde, Chairman,
Committee on the Judiciary,
House of Representatives, Washington, DC.
Dear Mr. Hyde: Thank you for allowing me to testify before the
Joint Hearing of the House Subcommittee on Commercial and
Administrative Law and the Senate Subcommittee on Administrative
Oversight and the Courts on Bankruptcy on March 11, 1999.
The following are responses to the additional written questions
attached to your letter of March 15, 1999.
senator chuck grassley
1) In light of the Sears case, is the Retail Federation currently
developing guidelines for its members on how to lawfully seek
reaffirmations?
NRF's members are keenly aware of the requirements of the law,
especially in light of the recent cases involving retailers and other
companies that were required to pay huge penalties. The NRF also has
held educational meeting for its members emphasizing reaffirmation
requirements.
senator torricelli
1) In light of the problems retailers have had with their
reaffirmation practices, how can one justify banning class actions for
illegal reaffirmation practices when class actions often are the only
way that middle class people have a remedy for wrongdoing against them?
There is no need for individual class actions; state and federal
authorities have more than adequate authority to enforce the law and to
recover substantial consumer remedies, as was seen in the Sears case.
2) In light of the problems retailers have had with their
reaffirmation practices, do you agree that more should be done in this
bill to respond to creditor overreaching? What is the justification for
focusing almost exclusively on debtor abuse?
The issue in the Sears case was not overreaching, rather it was a
failure on the part of the Company to follow proper procedures
requiring them to file with the court records of reaffirmations. These
creditor requirements are already in the law. We believe fair
procedures should be established both for creditors and for debtors and
they should be followed.
3) Do you offer shoppers one-time incentives to sign up for a
Boscov's charge card? Are obligations on Boscov's charge cards secured
or unsecured by the items your customers purchase in your store? If
they are secured, how do you make your clients aware that their
purchases are secured? If they are secured, does this mean that you
offer an interest rate that is lower than the interest rate on the
average unsecured credit card?
Boscov's does offer an incentive for customers to sign up for our
charge card, usually in the form of a discount on their first charge
transaction. While Boscov's asserts a ``purchase money security
interest'' in all states except New York, this is a much lower level of
security interest than that taken by a traditional secured lender. Our
credit card is priced competitively in this market.
4) Let's say I am a Boscov's customer. I buy a variety of
reasonably priced items at your store and have carried a balance on my
charge card over the past several years, making only the minimum
payment each month. If I file for bankruptcy today, is my debt to your
store secured by all of these items? Can you come and take them away if
I do not pay after bankruptcy?
If you file for Bankruptcy, in general, Boscov's would not take
away any items purchased on our card prior to a bankruptcy. The only
possible exception is that we legally could recover items obtained
fraudulently or items which are determined by law to be non-
dischargeable.
senator feingold
1) Your testimony on behalf of the National Retail Federation
focuses exclusively on abuse of the bankruptcy system by debtors and
does not make any mention of the fact that quite a few retailers have
admitted to committing bankruptcy fraud on a widespread basis.
A) Has Boscov's engaged in any post-bankruptcy collection
activity without filing reaffirmation agreements?
Boscov's does not engage in post-bankruptcy collection
activity without filing reaffirmation agreements as required.
B) Does Boscov's think that the current laws supervising
reaffirmation agreements have been adequate?
Boscov's believes current law supervising reaffirmation
agreements are adequate.
C) Does Boscov's support the provisions in the House bill
that eliminate class actions to pursue creditors who have
systematically violated bankruptcy law to the detriment of
consumer debtors? If so, why?
For the reasons mentioned above, compliance with
reaffirmation procedures is not a major problem for Boscov's.
However, we believe the existing governmental authority to curb
reaffirmation abuses is adequate and has been quite effective.
2) Do you believe there are any creditor abuses in the bankruptcy
system that should be addressed in bankruptcy reform legislation? If
so, what are they?
The bankruptcy abuse that have been brought to my attention, such
as a failure to file affirmations, are already addressed severely under
current law.
3) How many of your bankrupt customers reaffirmed their debts to
Boscov's in 1997 and 1998? What was the average amount of the debt?
Sixty-five (65) customers reaffirmed their debts with Boscov's in
1997 and 1998 combined. The average amount of the debt was $621.25.
4) How many dollars owed to Boscov's were reaffirmed in bankruptcy
cases in 1997 and 1998?
A total of $40, 381.53 was reaffirmed in 1997 and 1998 combined.
5) How many dollars has Boscov's received in chapter 13 cases filed
by its customers since 1995?
Boscov's received $160,473 in Chapter 13 cases from 1995 through
1998 inclusive.
6) Do you believe that reaffirmations are a preferable method of
reducing Boscov's bankruptcy losses as opposed to chapter 13 plans, in
which Boscov's might only receive, as you testified, 30 cents on the
dollar or even less?
Both Chapter 13 plans and reaffirmations, in Chapter 7 cases, may
be necessary for customers to honor those payments they can, while
affecting a true ``fresh start''. If a customer seeks to preserve,
post-bankruptcy, a small line of credit from a local merchant to
purchase necessary items such as school clothes, a reaffirmation may be
most appropriate. On the other hand, if an upper-income customer is
able to repay 30 cents on the dollar through a Chapter 13 plan, they
should be required to do so.
7) You testified that ``it is estimated that over $40 billion was
written off in bankruptcy losses last year, which amounts to the
discharge of at least $110 million every day. . . . The nation's 100
million households ultimately pay that $40 to 50 billion. ``
A) Do you have a source for this data other than the WEFA
Group study that has been called into question by the General
Accounting Office? See"The Financial Costs of Personal
Bankruptcy'' Letter from Associate Director Richard Stana to
the Honorable Martin T. Meehan, GAO/GGD-98-116R. If so, can you
provide us with the supporting data?
Although I do not have specific citations, I believe the
Administrative Office of the Courts has reported the level of
bankruptcy discharges has exceeded $40 billion per year. It is
commonly reported that there are approximately 100 million
households in the U.S.
B) Assuming that the $40 to $50 billion figure is correct,
producing a ``hidden tax'' on every American family of $400 or
$550 a year, can you estimate what portion of that amount
actually could be recouped by the Bankruptcy Reform Act of
1999?
I believe that a nationally representative Ernst and Young
Study, presented to the House Judiciary Committee last year,
estimated that approximately 10 % of the dollars now lost to
bankruptcy could be recouped.
C) Have the interest rates on Boscov's charge cards
increased/decreased in the past in step with bankruptcy filings
and losses that you have attributed to bankruptcy? If so,
please document these changes.
Boscov's credit finance charge rates were raised in early
1997. The increase was in response to increases in credit
losses (primarily attributable to increases in bankruptcy
losses). The percentage of Boscov's charge sales to total
Boscov's sales has decreased every year for at least the last
five years. This is partially attributable to the tighter
lending practices we have been forced to pursue.
D) Has the cost of merchandise at Boscov's increased/
decreased in the past in step with bankruptcy filings? If so,
please document these changes.
The cost of merchandise at Boscov's is related to a
tremendous number of variables (e.g. the cost of goods, the
cost of money, shipping, labor, utilities and rent) including
changes in bankruptcy losses. It is not possible to directly
determine the net effect bankruptcy has on consumer prices.
8) You testified that ``everyone's credit is tighter'' when people
use the bankruptcy system as a means of walking away from their debts.
Can you document that you restricted your lending, or that the industry
generally restricted its lending as a result of the increase in
bankruptcy filings?
Boscov's implemented an on-going portfolio monitoring program in
1995 in direct response to increasing credit losses (primarily
attributable to increases in bankruptcy losses). Through this program,
Boscov's has closed or reduced the credit limit on tens of thousands of
accounts, including accounts, which were not delinquent at Boscov's.
This is the most aggressive limit management program Boscov's has ever
implemented.
9) Representing the National Retail Federation, you testified that
the emergence of a new phenomenon, surprise bankruptcy filings, is an
indication that bankruptcy is becoming a first step rather than a last
resort. You said: ``Today, we see a very different picture. Often the
first indication we receive that an individual is experiencing
financial difficulty is when we receive notice of his bankruptcy
petition. . . . The first indication of a problem is the notice that
they have filed for bankruptcy.'' In 1983, a representative of the
National Retail Merchant's Association and American Retail Federation
similarly testified that ``a new and substantial class of debtors--one
different from the traditional debtor--was also found. These persons
were current on their required monthly payments, had little or no
previous history of delinquency, and some even had additional credit
available on the account at the time the bankruptcy notice was received
by the creditor.'' See Statement of Raymond W. Klein, H.R. Macy & Co.,
Inc., representing the National Retail Merchants' Association and the
American Retail Federation before the Senate Judiciary Committee
Subcommittee on Courts (January 24, 1983). Are you identifying the same
``new'' phenomenon as Mr. Klein did in 1983? If not, how are they
different?
Although I do not have direct knowledge of the 1983 statement, I
believe Mr. Klein saw the beginnings of the problem. What is new, in my
experience, is the dramatic increase in the numbers of customers making
the decision to file without being seriously delinquent with Boscov's.
10) You testified that the system should be changed to incorporate
means testing regardless of what percentage of individuals currently
choosing chapter 7 actually could pay any of their debts. However,
legislators need to have a better sense of how many chapter 7 debtors
are solvent because it is relevant in determining whether the
substantial change would be cost-justified. We first heard that
industry funded studies predicted that one third of chapter 7 debtors
could pay some or all of their debts. Later industry funded studies
predicted lower and lower numbers, the latest being 11%. A recent non-
industry study sponsored by the American Bankruptcy Institute found
that the most optimistic number of chapter 7 debtors able to pay even
\1/5\ of their debts over 5 years is under 4%, and that the amount of
dollars the credit industry will recoup directly from this change is
likely to be a fraction of the industry's estimate.
The number of persons who it is estimated can repay their debts
keeps changing because Congress keeps changing the standards in the
proposed needs based system. Earlier versions of bankruptcy reform
proposals were directed at bankruptcy filers earning more than 75% of
the median income and who could repay 20% or more of their debts, thus
a higher percentage of repayment capacity was properly reported. More
recent reform proposals have restricted the needs based formula to
those filers who are at or above the national median income and who
could repay more than 25% of their debt. Accordingly, a smaller
repayment capacity was reported. (As to the 4% figure contained in the
American Bankruptcy Institute study, I also understand that ABI used
old data.)
A) Approximately what percentage of chapter 7 debtors do you
believe can repay a substantial portion of their debts?
Under the current needs based reform proposal (H.R. 833), we
believe approximately 10% of Chapter 7 debtors could repay a
substantial portion of their debt.
B) How many dollars you believe you will recoup from that
system so that we can compare that to the cost to the taxpayers
of the change?
We believe repayment ability is approximately $4 billion per
year.
11) Most discussion has focused on the importance of the means
test, which was the subject of the panel on March 11. However, various
versions of the bankruptcy bill span 300 pages and contain hundreds of
amendments affecting consumer bankruptcy. Would you be willing to
accept a means testing amendment and forego the remainder of the other
significant consumer bankruptcy amendments, such as the various
provisions expanding the nondischargeability of credit card and retail
charge card debt and the provisions inflating the value of nominally
secured debt?
Many of the provisions in the bill are inter-related. Provision
such as consumer education, auditing, and changes designed to improve
the system's operations and to diminish cheating and other abuses are
all important to the proper operation of the bankruptcy system.
Sincerely,
Dean E. Sheaffer,
Vice-President--Director of Credit.
cc: Honorable George W. Gekas
__________
Bruce Hammonds' Responses
senator torricelli's questions
Question 1.
We strongly support providing customers information that
facilitates their wise use of consumer credit. Through account-opening
documents, cardholder credit agreements, monthly account statements and
annual transaction reports, bankcard customers are provided with an
immense variety of account-related information presented in precise
detail.
The Conference Report on H.R. 3150 of the 105th Congress did
provide for new disclosure requirements related to minimum payments on
account balances, which are different in form and detail to those in an
amendment offered by Senator Durbin and contained in the Senate's bill.
Our experienced judgement is that the Conference Report's format very
effectively informs consumers of the implications of repaying a credit
balance solely through minimum payments. It does so at considerably
less cost than the Durbin approach, which we assume is an important and
valid consideration.
The Conference Report also directed the Federal Reserve Board to
conduct a highly comprehensive study of consumer use and understanding
of minimum payments, to report its findings to the Congress, and to use
its extensive regulatory authority under the Truth In Lending Act to
promulgate such additional disclosure requirements as the study may
deem useful.
Three decades of experience with the Truth In Lending Act has
proven the wisdom and utility of using Federal Reserve studies
(typically involving rigorous consumer testing) as the fact-finding
foundation for new disclosure requirements. It would be ill-advised for
Congress to statutorily impose a costly and burdensome scheme without
allowing the Federal Reserve to fully evaluate it's impact on the
industry and on consumer behavior.
Question 2.
There is no national data base reporting the annual credit losses
attributable to the discharge of loan obligation by Federal Bankruptcy
Courts in proceedings under Chapters 7 and 13. However, studies by
nationally-recognized research organizations present findings which we
believe have been carefully and soundly formulated.
SMR Research published a 1997 study estimating consumer bankruptcy
system losses at $40 billion for 1996. The WEFA Group presented a
report to the Senate Banking Committee in February of 1998 estimating
losses for 1997 at approximately $44 billion. Also in 1998, Ernst and
Young reached a similar (somewhat higher) estimate of total Chapter 7
bankruptcy debt to WEFA's estimate for 1997. The Ernst & Young analysis
is based upon a statistically reliable national data base using 1997
bankruptcy petition data. Adjusting these very consistent findings for
the growth in consumer bankruptcy filings in 1998 and the projections
for 1999, it is reasonable to assume that losses from the consumer
bankruptcy system for 1999 will approach $50 billion.
Question 3.
With over 7,000 financial institution competing in the credit card
industry, it remains one of the most competitive industries in the U.S.
As a result of that competition, profits from credit card portfolios
across the industry have declined over the past 5 years.
As is true generally for the financial services industry,
technology has fostered changes leading to greatly intensified
competition among issuers of bankcards and credit cards. In the 90's,
interest rates on card offerings have declined some 200 basis points,
annual fees are nearly non-existent, reward and purchase-discount
programs are widely available, and customer service has been
dramatically improved. In this competitive environment, it is a
certainty that a reduction in losses will translate into a variety of
consumer benefits, including price reductions or improved product
quality.
Question 4.
Using generalized historical experience in Chapter 13 under the
existing provisions of the Code is not a reliable basis for predicting
future performance under the system which will develop with the reforms
proposed in H.R. 833 and S. 625. In a reformed system, the vast
majority of the cases in Chapter 13 will be there because Chapter 7
will no longer be a legally-available alternative for relief.
The reasons for failures in Chapter 13 have not received sufficient
systematic and statistically-valid analysis to justify broad
generalizations. There is, however, extensive anecdotal experience to
justify a conclusion that in many Chapter 13 cases a primary motivation
is to preserve use of a secured asset (home or car) by curing
arrearages and bringing cash flows into balance. Once that goal is
accomplished, the economic incentive of remaining in Chapter 13 is
significantly reduced. Some, at least, then proceed to Chapter 7 to
eliminate unsecured obligations. Reform cuts off that option.
There are a few bankruptcy court districts in which the judge-
created culture of many years has educated lawyers and debtors that
Chapter 13 is a preferred alternative. In these districts the plan-
completion success rate has been well above the national norms.
Question 5.
Members of Congress have the best ``hands-on'' understanding of the
essentiality of compromise in accomplishing worthwhile reform. In
today's setting, secured lenders enjoy generally satisfactory outcomes
under Chapter 7. Both lender and debtor have incentives to reach
reaffirmation agreement thus permitting the debtor's continued use of a
valuable asset such as a car. Unsecured lenders more often than not get
nothing. If a reformed system is to require debtors with demonstrated
repayment capacity to seek relief in Chapter 13, where plans will
require repayment of some portion of unsecured obligations, that
reformed system must deal in a balanced manner with secured creditors.
Providing reasonable protection from cram down is a practical
accommodation to the achievement of major improvements in the consumer
bankruptcy system.
senator grassley's questions
Question 1.
I categorically reject the notion that credit card lending is
responsible for the dramatic rise in consumer bankruptcy filings!
The Federal Reserve's most recent Survey of Consumer Finance,
released in January, 1997, reports that the total household debt held
by all families credit card debt represents 3.7 percent of total
indebtedness. To allege that this small segment of total consumer debt
bears a principal responsibility for the rise in consumer bankruptcies
makes no sense.
Unquestionably, the availability of credit to American households
has expanded dramatically throughout the last half of this century.
However, according to recent information from the Federal Reserve, the
absolute level of consumer debt as a percentage of assets has remained
at 5% since 1970. In short, debt, as a percentage of assets, has not
increased over the past 29 years, which directly refutes the
``explosion'' of credit theory. Indeed, for the past thirty years this
trend has been steadily intensified through the powerful influence of
Federal statutory and regulatory mandates.
Moreover, public attitudes concerning the use of credit have
undergone immense change. Certainly the use of credit by a steadily-
growing segment of our population means the incidence of consumer
bankruptcy will likely rise in some parallel relationship. But making
consumer and other forms of credit more broadly available to the
general public, and particularly to discrete segments of our population
previously denied credit, does not represent irresponsible, imprudent,
or predatory lending. Legislation of the past twenty-five years has
evidenced the desire of Congress that all segments of the public be
served fairly and adequately. Restrictive legislation will cause denial
of credit to those otherwise creditworthy borrowers who most benefit
from the flexibility consumer credit provides. For example, the rate of
bankruptcy filing in Memphis, TN is 33% higher than the national
average. For credit cards to be the sole link to bankruptcy, resident
of Memphis would have to have 33% more credit than the national
average--and that simply is not the case.
Holding needs-based reform of our consumer bankruptcy system
hostage to a debate over whether all consumer lenders behave prudently
and responsibly simply misunderstands the purpose and the methodology
of the proposed reforms. Needs-based limitations on bankruptcy relief
will not bail our bad loans. Where basic cashflow analysis demonstrates
no reasonable capacity to repay the bankruptcy system will continue to
discharge the debtors and the lenders will continue to bear the full
responsibility for a bad loan. But, where repayment capacity exists to
some considerable degree (25 percent OR $5,000, seems fair), then our
Federal bankruptcy system should not randomly ignore and undermine
sound credit underwriting practice. Bankruptcy system discharge policy
cannot be at odds with consumer credit underwriting if we want our
national economy optimally served by the lending industry.
Question 2.
Our concerns are for the trends of behavior and practice and the
long-term impact on future outcomes. Throughout the consumer lending
industry (including retailers) we are encountering growing numbers of
cases where customers with no history of repayment problems file for
bankruptcy relief without notice.
Ernst & Young, using a nationally-valid database of 1997 bankruptcy
petition data and the income-expense guidelines of H.R. 833 and S. 625,
concluded that 10 percent of all filers had incomes at or above the
national median family income and could have repaid a significant
portion of their unsecured obligations. This amounts to roughly 100,000
filers. In our information-driven society of today, it would be naive
for us to conclude that the bankruptcy system's treatment of 100,000
debtors or more annually is going unnoticed by the remainder of our
national society. Clearly if we establish no reasonable standards for
bankruptcy relief, if our courts ignore capacity to repay--a treatment
at odds with rational loan underwriting--we should expect growing
numbers to avail themselves of such relief. At some point that upward
trending development must be accounted for by lenders--probably first
by pricing and/or diminished service, but ultimately by more
restrictive availability. To protect against that future dilemma by
directing the Federal bankruptcy system to adopt orderly procedures
employing objective standards for determining the nature and extent of
relief granted petitioner would seem to be both reasonable and
responsible.
senator feingold's questions
Question 1.
Note: Since bankruptcy losses were not available for 1980, 1989 was
used for comparison purpose.
1 (A) Ending outstanding for calendar year 1989 and 1990 were
$5.1 billion and $48.7 billion, respectively, and average
outstanding for 1989 and 1998 were $4.5 billion and $45.3
billion, respectively.
1 (B) In 1998, non-bankruptcy losses were $1.1 billion as
compared to 1989 non-bankruptcy losses of $46 million.
1 (C) MBNA's bankruptcy losses as a percent of credit card
debt outstanding in 1989 and 1998 were 1.02% and 2.61%.
1 (D)
------------------------------------------------------------------------
1980 1998
------------------------------------------------------------------------
A. Average Balance per Active $1,058 $2,339
Account
(1998 Dollars)
B. n.a. 2.9% of outstandings
C. n.a. 2.9% of outstandings
------------------------------------------------------------------------
Question 2 A.
The Federal bankruptcy system does not maintain an annual
accounting of the aggregate amount of consumer debt discharged. The
WEFA Group, a highly regarded national economic consulting firm, used
established econometric and evaluating methods to produce it loss
estimate from bankruptcy petition data. Two other outstanding economic
research organizations, SMR Research and Ernst & Young, conducting
independent studies using different data bases, produced conclusions of
aggregate consumer bankruptcy debt and losses comparable to WEFA's
results.
GAO did not characterize WEFA's figures as ``unreliable''. With
respect to the GAO's comments on the WEFA study, I respectfully
recommend a careful review of WEFA's response, dated April 29, 1998.
Acknowledging that all bankruptcy studies to date have used unaudited
petitioner data (since neither the courts nor the U.S. trustees conduct
audits), I believe WEFA carried out its evaluation with great
professional integrity and utilized established methodologies in
arriving at its quantitative conclusions.
Question 2 B.
While I did not use a $550 per household average for 1999, the
estimate of projected losses for this year in a general magnitude of
$50 billion does not seem unreasonable.
Questions 2 C and 2 D.
My understanding of the WEFA, Ernst & Young, and SMR loss estimates
is that each endeavored to calculate aggregate losses arising from
discharge. If my understanding is correct, the estimates do not take
account of reaffirmations, non-discharged obligations, and ``failed
plans'' in Chapter 13, which means that the estimates are conservative.
Keep in mind that most filers choose Chapter 7 and unsecured
lenders typically collect nothing in a Chapter 7 filings. In 1997,
according to Ernst & Young, using the only statistically valid
bankruptcy petition database in existence, total unsecured debt in
Chapter 7 approached $35 billion.
Question 2 E.
The estimate o floss does not include so-called contract charge-
offs that occur outside of the bankruptcy process and which are largely
governed by the financial regulatory agencies' guidelines.
Question 3.
In fact, the intensified competition within the bankcard industry
over the last few years has materially influenced pricing and product
content. Interest rates are down some 200 basis points, annual fees are
essentially non-existent, and product enhancement (rewards, discounts,
24-hour customer service) continues to expand.
Among traditional bank loan products, funding cost are least
influential for pricing purposes in unsecured bankcard lending. Among
the large issuers, funding costs are typically 40 percent or less of
total expenses. The remaining 60 to 70 percent is comprised of
servicing, general administration, marketing, and loan losses.
Currently in our expense base, funding and loan losses each represent
about one-third. Over traditional economic cycles, there is usually a
strong reciprocal dynamic relationship between funding costs and loss-
related cost:--when one factor is up the other is down. This offsetting
relationship makes it hard to predict pricing practice based on the
level of market interest rates.
While I'm reluctant to be highly specific in publicly sharing
proprietary data, I will state that the percentage of our annual credit
losses attributable to bankruptcy discharges has risen very
substantially in the last few years. Moreover, as I indicated in my
testimony at the Senate-House hearing, a majority of our bankruptcy
charge-offs occur in accounts that have been with us for three or more
years. These are accounts that were carefully underwritten at their
inception and for which we have extensive experience data for account
administration.
Since the increase in bankruptcy has driven loss rates to
unprecedented levels. MBNA has implemented strategies which increase
APRs on accounts bases on risk. This strategy, while necessary to
maintain profitability, has resulted in customers receiving APRs of at
least 23.9% in some circumstances. Previously, APR increases on the
portfolio were typically associated with changes in cost of funds.
Question 4.
Of course bankruptcy-related losses (like other losses) impact the
behavior of individual lending institutions. Because the aggregate
volume of consumer credit in our national economy has grown since 1980,
it does not follow that this result was unaffected by the bankruptcy
losses sustained over this two-decade period. The varying experience of
individual institutions and the multiplicity of other economic,
regulatory, technological, cultural, and other factors which have
shaped lending decisions make it impossible to isolate the precise
impact of bankruptcy losses. But have no doubt that all major cost
components directly influence each lender's decisions on the key
considerations of price, availability, product content, service, and
marketing.
Restriction of credit is one way to maintain profitability in the
face of rising losses. MBNA Has not yet restricted credit, because we
have been able to offset higher losses through more targeted pricing
strategies. However, deteriorating credit quality of applicants has led
to lower approval rates. If losses continue to increase, ti will be
difficult to maintain profitability by increasing the interest rate
charged to the consumer. If revenue cannot be increased through
repricing, restriction of credit would be necessary to reduce losses.
Question 5 A.
MBNA doe s not approve credit for recent bankrupts. In select
circumstances, MBNA may approve credit for a former bankrupt, if we are
able to establish that the consumer has resolved the situation that led
to the bankruptcy and has also established a track record of repayment
with other creditors.
Question 5 B.
Most major bankcard issuers evaluate applications based on an
overall risk profile that is designed to yield loss rates that track at
or below the industry average. Because most former bankrupts would not
fit this profile, they would be declined for an account if they
responded to a mass-market solicitation. However, some issuers do
target riskier prospects and compensate for the increased risk through
security deposits, higher interest rates, and fees. Certainly if the
concept of ``fresh start'' has practical meaning, it is to be expected
that many individuals and households will need access to credit and the
opportunity to rebuild their credit records through responsible
management of their financial affairs.
Question 6.
6(A) In 1998, MBNA challenged the dischargeability of the debtor's
debt on less than 1% of the total Chapter 7 petitions filed, almost all
of the basis of fraud.
6(B) Of the cases where dischargeability was challenged, 6% (of the
1% described above) were litigated. However, response is still pending
on 71%, so the litigation percentage could potentially increase.
6(C) 93% of debtors either admitted non-dischargeability or
reaffirmed their debt. This is the case because MBNA rarely challenges
any petition except for fraud. When confronted with their attempt to
propitiate a fraud on the court, the overwhelming majority decide to
choose another option, i.e., repayment.
Question 7.
Over the past thirty years there has been a tremendous broadening
of the availability of consumer credit within our national society.
Federally mandated statutory and regulatory policy has been a powerful
force in support of this development. This so-called democratization of
credit availability is strongly favored by the public. There has been
corresponding cultural change in terms of public acceptance of credit
use. Lenders have responded to these dynamics of public policy and
public attitudes. To state the obvious, if many more individuals and
many more households have access to credit (which they do), it follows
that within that expanded population of credit users there will be, at
least, a normal incidence of bankruptcies, which will increase the
absolute numbers overall. Lenders share in the responsibility for that
increase to the extent that underwriting makes bad choices and
individuals cannot meet their credit obligations. In that circumstance
lenders bear the loss, as they properly should. Losses stemming from a
debtor's cashflow incapacity to pay are the assumed risks of consumer
lending. Proposed bankruptcy reform initiatives are not designed to and
WILL NOT provide relief to institution for losses which are the result
of underwriting errors.
Solicitations, by mail or telephone, or credit card offerings are
modes of marketing; no different in content or purpose than advertising
in newspapers or on radio, TV, and the Internet. The volume of
solicitations is a direct reflection of the intensity of the
competition that exists within this sector of the financial services
industry. While direct-mail solicitations may prove irritating to some,
they certainly pose no threat to our economic health, and these
solicitations bear no more responsibility for the frequency of
bankruptcy than automobile advertising does for traffic deaths.
Question 8 A.
Yes, and when we're wrong, we should (and will, even under proposed
legislation) bear the resulting losses. But when our underwriting has
correctly predicted ability to repay, as demonstrated by the
petitioner's own bankruptcy petition calculations, the bankruptcy
system should not discharge the obligation. If this practice continues,
new assumptions will need to be built into our underwriting that will
restrict credit to creditworthy consumers, with predictable
consequences not only for many thousands of consumers, but also for the
U.S. economy.
In terms of all of those who look to us for responsible behavior
(customers, shareholders, employees, and regulators), we have no higher
obligation than to make our best efforts in underwriting credit
extensions, which entails identifying individuals who will use credit
prudently and who will fulfill their contractual repayment obligations.
While technology is expanding and improving our underwriting
capabilities, it is in no sense a perfect science. In our own
procedures we continue to place heavy reliance on the direct review of
credit applications by experienced underwriters.
Question 8 B.
An overwhelming majority of those who file for bankruptcy--almost
75%--have a serious disruption in income in the year prior to filing.
As a result, a large number of filers who were prudently granted
credit--and who prudently used credit--turn to credit cards in an
economic crisis, in an effort to maintain a lifestyle or to get back on
their feet. Most are successful, with credit cards providing
assistance. Those who are not successful show up in bankruptcy court
with higher than average credit card debts. To the extent that they
cannot repay their debts, they should be entitled to a discharge.
In consumer credit underwriting there is a mutual dependency of all
credit grantors on knowledge of the activities of other grantors. We
look to credit reporting agencies for information concerning the credit
history of individual applicants. These national agencies are making
great strides in perfecting the accuracy, currency, and
comprehensiveness of their data. Nonetheless, these systems, which are
likewise dependent upon periodic inputs from hundreds of thousands of
entities, are not an absolute guarantee of accurate and up-to-date
information. As a practical matter, there are simply too many variables
to achieve systems that are error-free. Lack of currently reliable
information is certainly one factor in the multiple card cases. Low-
limit cards to individuals with limited credit history is another
factor. And although we wish it were otherwise, consumer lending still
suffers from some isolated cases of mediocre underwriting. However,
given that as an industry 96% of our accounts meet their contractual
obligations, I personally take great pride in the professionalism and
responsibility of the American bankcard industry.
Question 9 A.
This quoted observation is not directed at the bankruptcy system's
current lack of standards and systematized procedures for determining
the relief needed by petitioners. It refers to the fact that the system
does not provide training in the fundamentals of household financial
management for individuals who have been through bankruptcy. We applaud
the fact that last year's conference report, as well as legislation
introduced this year, authorize pilot programs for this purpose. We in
the financial services industry are working at consumer education, and
we will continue to expand and improve those efforts.
Question 9 B.
We believe that the new disclosure requirements relating to the use
of minimum payments contained in the Conference Report on H.R. 3150
would do an effective job of alerting consumers to the financial
disadvantages of using minimum payments as the principal means of
repaying indebtedness. However, for those who believe more detail is
necessary, the Conference Report directs the Federal Reserve Board to
make a detailed study, to report its findings to the Congress, and to
promulgate such additional disclosures as it deems beneficial. Thirty
years of experience under the Truth In Lending Act has richly
demonstrated the wisdom of using the Federal Reserve as the fact-
finding instrument in the development of comprehensible disclosures
that can be provided in a cost-effective manner.
Question 10 A.
Organizing the procedures of the Federal bankruptcy system to
receive and review petitioner income and expense data and to apply the
statutory expense guidelines represents a very straightforward
information systems project involving routine systems applications.
Once that systems structure is installed, its operation should prove
both time and cost efficient to the entire process. Clearly it will be
more orderly, efficient, auditable (and thus accountable) than existing
arrangements.
Question 10 B.
If to repay 20% of a petitioner's outstanding unsecured debts over
a five-year period required the petitioner to make monthly payments
which were ``overwhelming as compared to her disposable income'', it is
highly improbable that such a petitioner will be impacted by the needs-
based test. The provisions have been crafted to protect against the
very outcome suggested in this question. While it may be possible to
construct a hypothetical example of a debtor with income at the poverty
level being required to make repayment, in practice such a debtor will
be unaffected by the needs-based reforms.
Question 10 C.
The IRS expense categories appear to cover most, if not all, of the
expenses you inquired about. Specifically, the ``other necessary
expense'' categories identified by the IRS cover health care, child
care, and dependent care for the elderly invalid or handicapped. Thus,
an elderly person filing under Chapter 7 would not need permission to
include such expenses, but would be granted such expenses
automatically.
Question 11 A.
My understanding is that there was technical mistake in H.R. 3150
which might have produced the result you suggest. However, I'm advised
that error was corrected in the text of the Conference Report. In the
unlikely circumstance that a required monthly repayment was too small
to justify the administrative fee of the Chapter 13 trustee, that can
be cured with some type of de minimus rule.
Question 11 B.
It is my understanding that trustees apply an approved overhead
percentage to the administration of their entire caseload, rather than
a monthly dollar amount. Accordingly, the larger repayment plans do and
will continue to subsidize the administration of smaller plans.
Question 12.
Yes, I disagree with Ms. Miller's view. The Ernst & Young study of
last year and its recent update (responding to legislative changes)
demonstrate that there is a small but significant percentage of filers
who have debt repayment capacity and should be obtaining their
bankruptcy relief in Chapter 13.
Question 13 A.
The 16% figure was presented in the 1997 study of Professors
Michael Staten and John Barron, published by the Credit Research
Center, affiliated with Georgetown University.
Question 13 B.
The 16% figure includes only bankcard debt, which is all unsecured.
Question 13 C.
The Staten-Barron study estimated all credit card debt (including
bankcard debt) in the total credit obligations of Chapter 7 and Chapter
13 debtors to be 28% of the total.
Question 14.
Since bankcard debt represents roughly one-sixth of the total
credit indebted ness of debtors in Chapter 7 and Chapter 13 (according
to estimates of Staten and Barron), it is a little difficult for me to
understand how bankcard debt becomes a ``disproportionate'' part of the
overall debt problems of these petitioners.
Question 15 A.
According to the study conducted by Ernst & Young, it concluded
that for 1997, under the needs-based system in last year's Conference
Report, debtors could have repaid some $3 billion over five years.
Question 15 B.
In 1998, contractual losses were $1.1 billion.
Question 15 C.
Most charged-off loans are sold at discount to firms that
specialize in the collection of defaulted obligations.
For accounts in delinquency, MBNA utilizes telephone calls,
statement messages, and direct mail to open communications with
delinquent customers. Once a customer is contracted, a variety of
payment options are available, for example, electronic debiting of
customer deposit accounts, fixed payment options, reduced interest (in
conjunction with CCCS referrals), and offers of settlement for less
than the full amount of principal.
Question 16.
No! Both the House and Senate bills in the 106th Congress include
many provisions that have the potential for significantly improving our
bankruptcy system, and, hopefully, over time creating conditions in
which consumers who suffer life events producing financial disruption
will look to credit counseling and other alternatives short of
bankruptcy. It would be unfortunate not to begin putting in place all
of these reforms, many of which will be most effective when working as
part of an integrated whole.
Question 17.
My own prioritizing would be as follows : (1) custodial parents,
(2) obligations to governmental entities, (3) secured creditors, (4)
unsecured creditors including card issuers.
Question 18.
The two debts should not and are not treated the same under either
current law or proposed reform. Non-dischargeability in such cases is
only a presumption which may be overcome by demonstrating a legitimate
reason for obtaining the credit. I am not aware of any court which
would not view the purchase of food and fuel as legitimate. By the same
token, I would hold that the law would not condone the obtaining of
credit without an intent to repay for luxury good and services or
frivolous activity such as gambling.
On a purely personal basis, the mother's case is clearly the most
appealing. In fashioning public laws and implementing regulations one
must, of course, be attentive to the practical problems of enforcement
and the associate requirements of proof. With cash advances, money
being fungible, it is difficult (perhaps impossible) to determine the
precise use of any particular cash advance. Therefore, for cash
advances the practical approach is to establish limits on discharge
based on timing and amount. I believe this is the approach in existing
law.
Question 19.
I find the premise for this question troubling. I hope there is no
intention to place bankruptcy reform in a partisan political context.
All of us who have worked in support of these legislative reforms have
been pleased by the support, cooperation and encouragement we have
received on both sides of the political aisle. It has been particularly
pleasing to note that in this Congress both the House and Senate bills
have had as their original co-sponsors prominent and respected Members
of Congress from both political parties.
Question 20.
Last year's Conference Report includes a number of new creditor
obligations. Even though some are not necessarily relevant to consumer
bankruptcy, it does seem to me that a sound balance was achieved, which
I accept as fair and necessary.
__________
Judge Carol J. Kenner's Responses
U.S. Bankruptcy Court,
District of Massachusetts,
Boston, MA, March 23, 1999.
Hon. Henry J. Hyde, Chairman,
Committee on the Judiciary,
House of Representatives, Washington, DC.
Re: Followup Questions to the Senate and House Joint Hearing on
Bankruptcy Reform
Dear Chairman Hyde: Thank you for forwarding to me the followup
questions of Senators Torricelli and Grassley. Their questions and my
answers are as follows:
senator torricelli:
1. Senator Torricelli first asked whether, based on my experience,
Congress's intention of providing meaningful debt relief in Chapter 7
for honest, hard-working, middle class American families was best
served by the current policy of not requiring bankruptcy courts to
review reaffirmation agreements (except where the agreement is not
accompanied by a statement from the debtor's attorney) or by the
earlier policy, contained in the Bankruptcy Code as it existed in 1983,
mandating court review of all reaffirmation agreements.
Based on my experience, I believe that Congress's intention is
better served by the earlier version of the law, which required court
review of every reaffirmation agreement. This is the only means by
which raffirmation agreements can uniformly get the independent review
that the Bankrtupcy Code now attempts to obtain (in most instances)
from the debtor's attorney, with extremely mixed results. The
importance of independent review may be heightened if additional
provisions are added to the Bankruptcy Code that increase the leverage
of some creditors to obtain reaffirmation agreements. (See response to
Question 2.)
2. Senator Torricelli's next question was this: in view of my
testimony--that some debtors reaffirm debts after being accused by
credit card companies of having committed acts that make those debts
nondischargeable, whether or not they are guilty, because they cannot
afford to defend themselves in a court proceeding--what will be the
effect of adding more execeptions to discharge that make it 3easier for
credit card companies to argue that their debts are nondischargeable?
The likely effect would be to increase the leverage of credit card
companies to obtain reaffirmations agreements, even from honest
debtors. Credit card companies presently rely heavily on the ecxception
from discharge for fraud and misrepresentation, 11 U.S.C. section 523
(a)(2)(A). Their complaints typically allege that the debtor incurred
credit card debt without truly intending to repy the debt: a fraudulent
misrepresentation of intent to repay. These cases almost always boil
down to subjective judgments of intent, made on the basis of
circumstantial evidence: we rarely have direct evidence of what the
debtor was thinking when he or she incurred debt. Because the
applicability of the exception turns on a judgment call, (1) the
creditor can plausibly allege that exception applies without carefully
looking into the cirmsumstances of the case, (2) resolution of the
complaint is more costly because it requires litigating a disput of
fact, and (3) even the honest debtor cannot be certain that the Court
will ultimately read the circumstantial evident in the Debtor's favor.
Thus, the uncertainty of the standard gives the creditor easy leverage
over honest and dishonest debtors alike, leading many honest debtors to
concede nondischargeability or to reaffirm the debt. The proposed
amendment to section 523 (a)(2), set forth in section 310 of S. 625,
would expand the presumption of nondischargeability for certain credit
card debts. The presumption would further strengthen the hand of credit
card companies.
3. Senator Torricelli's final question is whether I would agree
with the suggestion that the recent successful prosecution of certain
consumer creditors for widespread illegal reeaffirmation practices
demonstrates that ``the system works,'' such that review of the
reaffirmation process is not necessary.
I disagree with this position for reasons I set forth in response
to Senator Grassley's first question below.
senator grassley:
1. Senator Grassley's first question concerns the problem of
debtors being coerced into reaffirmation agreements by abusive or
deceptive creditor practices: given the laws and harshsanctions that
are already in place for dealing with such conduct, why shouldn't we
conclude that what we need is betyter encofrcement of existing laws,
not new laws?
Senator Grassley's concern about the probelm of illegal practices
is valid. His empahisis on enforcement of existing laws is also well-
warranted. My own experience with illegal creditor practices, however,
is limited to the recent Sears case, to which the Senator's question
makes reference; and, as a matter of judicial ethics, I am not at
liberty to comment upon that case. Nonetheless, I can and would like to
clarify that the subject of my tesitmony before the joint committees
did not concern conduct that is illegal. Rather, my concern was and is
with tactics that, though they fall within the bounds of the current
law, nonetheless may intimidate debtors into uniformed and ill-
considered decisions to reaffirm.
The Bankruptcy Code deals with the problem by mandating a third-
party review to protect debtors from the imprudent decisions they make,
often (but not always) under pressure from overbearing creditors. As I
explained in my intiial statement, because this review is most often
performed by the debtors' counsel, who have something of a conflict of
interest when asked to be independent judges of what their clients
propose, ti oftem doesn't result in a meaingurl review at all. Out of
loyalty to their client, many attorneys simply facilictate the client's
decision to reaffirm by providing the necessary declaration.
In essence, this is a case where the policy--the requirement of an
independent review--is correct but the enforcement inadequate. To
provide the necessary enforcement, the Code should be changed to
require that a mandatory, non-waivable review be performed by the
bankruptcy judge in every instance.
2. Senator Grassley's last question concerns the effect on the
Bankruptcy Court's workload of my proposal for court review of all
reaffirmation agreements. He asks (1) whether I have considered how my
proposal would affect the staffing formula used by the Judicial
Conference to determine whether to request the creation of additional
bankruptcy judgeships and (2) whether I have run my proposals by the
relevant committees of the Judicial Conference.
I have not considered how the proposals would affect the staffing
formula, whether independently or in the context of the other
amendments in H.R. 833. Nor have I run my proposal by any committee of
the Judicial Conference. The increase in the workload would vary from
judge to judge and would depend on the procedures and mechanisms
developed--in the Code and Bankruptcy Rules, in the local rules of the
various districts, and by individual judges--to facilitate the review.
I believe the additional work that would be required to carry the
proposal into effect is well-justified by the need to ensure to debtors
the full benefit of their discharge. The additional work can be
minimized by a requirement (along the lines of those in the Truth in
Lending Act) that reaffirmation agreements clearly state to debtors the
full cost over time, in principal and finance charges, of their
reaffirmation, so that debtors and the court can more readily balance
the costs and benefits of each agreement.
If I can be of any further assistance, please do not hesitate to
contact me.
Sincerely,
Carol J. Kenner,
U.S. Bankruptcy Court,
District of Massachusetts.
__________
Larry Nuss' Responses
Credit Union National
Association, Inc.,
Washington, DC, March 30, 1999.
Hon. Henry J. Hyde, Chairman,
Committee on the Judiciary,
House of Representatives, Washington, DC.
Dear Chairman Hyde: I am responding on behalf of Larry Nuss of the
Cedar Fall Community Credit Union, who appeared before the Joint
Hearing of the House Subcommittee on Commercial and Administrative Law
and the Senate Subcommittee on Administrative Oversight and the Courts
to testify on bankruptcy reform on March 11. I wish to extend our
thanks for agreeing to keep the hearing record open an additional week
to provide the opportunity to answer the additional questions provided
to Mr. Nuss. His answers, as the witness for the Credit Union National
Association (CUNA), are attached.
Sincerely,
Gary J. Kohn, Vice President &
Senior Legislative Counsel.
Enclosure
answers to senator torricelli's followup questions:
Does it bother you that the lending practices of large for profit
lenders are increasing your losses? Do you think you deserve better
treatment in bankruptcy because you at least are trying to lend only to
those people who are more likely to be able to repay?
In most case situations where our member files for bankruptcy
relief, we find that the member has taken on more credit than they are
able to repay on a systematic regular basis. We will attempt to work
out a repayment schedule that will assist the member in making regular
payments on their debt. We will analyze the annual percentage rates to
determine what debt we can consolidate in order to reduce the member's
total finance charge. If the member has equity in a home we will
counsel the member emphasizing that they are pledging their home to
consolidate debt before finalizing a consolidation loan. In many cases
we are able to reduce their interest rate to half of the rate they are
paying on unsecured debt. We also determine if they have equity in an
automobile and consolidate debt into the auto loan, again reminding
them that an auto will require replacement some time in the future.
When we are able to consolidate members' debt, we request that they not
respond to any other offers that they may receive in the mail or by
telephone. Our philosophy is to evaluate each member's request on its
own merits. A member must request an increase in secured and unsecured
debt. We do no automatically increase a members line-of-credit like so
many creditors practice. We feel that members have a tendency to
reaffirm with the credit union because of our member-owned cooperative
structure. They also recognize that they will continue to have a need
for financial services. For many years our credit union has maintained
a low net charge-off ratio in spite of a delinquency ratio that was
above peer group comparisons, we feel these ratios exemplify the fact
that we attempt to ``work out'' a satisfactory repayment of debt that
not only helps the credit union but also restores the self-esteem most
members have and we think this is very important for the members, if
the credit union did not receive reaffirmations, it would have a major
impact upon the credit union's capital structure.
answers to senator grassley's followup questions:
How much has the Cedar Falls Community Credit Union lost due to
bankruptcy filings?
Percentage of total
Amount charge-offs
1998: $34,813 = 51.8%
1997: $40,237 = 38.5%
1996: $39,353 = 58.6%
1995: $19,848 = 35.0%
Could you comment on how many Chapter 7 cases you encounter versus
the number of Chapter 13 cases you encounter?
Number of filings
Chapter 7 Chapter 13
1998: 18 1 converted to Chapter 7
1997: 24 2
1996: 21 4
1995: 17 0
senator russ feingold's followup questions and answers:
1. You report in your testimony that National Credit Union
Administration data show that credit unions had approximately 253,000
members file for bankruptcy in 1998, an increase over the 250,000
filings in 1997.
A) What was the total number of members in the credit unions
that were the subject of the NCUA statistic in 1998 and 1997,
and the percentage of credit union accounts in bankruptcy in
those two years?
Before answering the question, let me first correct the
record. The testimony indicated that the number of member
bankruptcy filings were according to the NCUA. These estimates
are, in fact, from CUNA's own research department. The estimate
is, however, based on NCUA data, but because privately insured
credit unions do not report to the NCUA, the agency's data is
incomplete.
In 1998, CUNA estimates that the total number of credit union
member was 76.1 million, while in 1997 the estimate is 73.5
million. We do not have statistics for the percentage of credit
union accounts in bankruptcy. We do know that the dollar amount
of loan balances subject to bankruptcy, as a percent of total
balances was 0.40 percent in 1998 and 0.48 percent in 1997.
B) Unless credit union membership declined significantly in
1998, a 3,000 increase in credit union member bankruptcy
filings in 1998 (just over a 1% increase from the previous
year) is probably far below the nationwide filing rate
increase. Do you attribute this lower increase to self-
correction in lending and/or the high standard of care
generally used by credit unions when lending to their members?
The credit union percent increase in bankruptcy filings is
lower than the national percent increase. The lower rate of
credit union increase could be attributable to many things. For
instance, compared to national averages, credit union
households are more likely to be two-income households and thus
may be less exposed to shocks related to job loss, etc.
Likewise, credit union field of membership policies may keep
increase in check. Also, in 1997, the growth rate in revolving
credit nationally was 5.5 percent. In contrast, the growth rate
in credit union personal unsecured loans was -3.5 percent and
+1.6 percent for credit card balances. There is a strong
correlation, as indicated in other testimony, between growth in
unsecured credit and bankruptcy filings. The slower growth in
credit union unsecured credit may have something to do with
stricter underwriting, but it is difficult to substantiate.
2. You report that the Credit Union National Association estimates
that almost half of all credit union losses in 1998 were bankruptcy-
related and that those losses reached $684 million.
A) Does this mean that the bankruptcy losses are $684 million
or the total losses are $684 million?
The $684 million figure is for bankruptcy losses, not total
losses. The calculation is based on the following: dollar
amount of total loans (CUNA estimate) x net chargeoffs as a
percent of total loans (preliminary call report data from NCUA)
x percent of net chargeoffs due to bankruptcy (preliminary
call report data from NCUA). That is: $254.2 billion x .0057
x .472 = $684 million.
B) To enable us to determine the overall credit union default
rate and bankruptcy default rate, what was the aggregate loan
portfolio of all credit unions included in these statistics?
As of year-end 1998, total loans were $254 billion, while
total loans at year-end 1997 were $238 billion.
3. According to your testimony, your credit union currently has
8,300 members. In 1998, 18 of your members (approximately .02%) filed
for bankruptcy. The filing rate among your membership is far lower than
the national filing rate. Although the national nonbankruptcy filing
rate has increased substantially since 1995, your filing rate in 1998
(approximately .02%) is the same as in 1995 (assuming you had 8,300
members then as well).
A) To verify that your filing rate was approximately the same
in 1995 as it is in 1998, how many members did you have in
1995?
Our credit union had 6.031 members on December 31, 1995. On
December 1, 1995, we had a single employee group credit union
merge with Cedar Falls Community Credit Union with the merging
credit union increasing our membership total by 840 members.
The merging credit unions's sponsor had announced that they
were going to be closing their Waterloo manufacturing site and
moving their members would be better served by merging with
another area credit union rather than attempting to convert to
a community charter on their own.
B) Do you think that if other lenders were as careful as you
are, that the market would fix the current ``bankruptcy
crisis'' without the proposed government intervention?
Probably not. We are concerned that conservative lending
practices may not the entire answer to increasing bankruptcy
filings. While credit union growth in bankruptcy filings was
slower than the growth observed nationally, the level of
bankruptcy filings amongst credit union members remains near
all time highs. Over the past 10 years, total borrower-
bankruptcies at credit unions have increased 82 percent. In
that same period, credit union membership increased by only 26
percent. But the nation has experienced a positive economy for
an extended period of time and what will be the rate of filings
may very likely increase further. Credit unions may be more
``careful'' lenders than others, but many factors contribute to
the growth in credit union borrower-bankruptcies, and more
often than not they are factors out of credit union's control.
Certainly, increased consumer financial education could be a
great help; thus CUNA's increased efforts in this area.
C) Although your filing rate is nearly identical in 1998 to
your 1995 rate (assuming that the number of members has not
changed substantially), your losses appear to have increased
from $19,848 in 1995 to $34,813 in 1998. If you adjusted your
numbers for inflation and reported your 1995 losses in 1998
dollars, how would your losses compare in those two years? If
there still is a substantial difference, what accounts for that
difference in losses?
In comparing the 1995 loss total to 1998 losses after
allowing for inflationary adjustments, the loss comparison
would seem to indicate an increase in the amount being charged-
off. If some of the members filing for bankruptcy under Chapter
7 did not reaffirm their debt, the losses would be
substantially increased. For those members that filed Chapter
7, the ease of avoiding debt contributed to the increase in
adjusted charge-offs.
4. The losses in dollars that you experienced in 1998 that you have
attributed to bankruptcy are only .014% of your loan portfolio. Does
this extremely low dollar loss rate, along with your low filing rate,
provide further evidence that bankruptcy losses can be contained by the
market without unduly restricting credit availability overall?
The bankruptcy ratio experienced in 1998 and the low
percentage to our entire loan portfolio is indicative of a
conservative lending philosophy established by our Board of
Directors and lending staff.
5. You testified that reaffirmation agreements have been a
significant factor in reducing your losses.
A) How many of your bankrupt members reaffirmed one or more
debts to your credit union in 1997 and 1998?
We had nine member reaffirm in 1997 and another ten
reaffirmed debt in 1998.
B) What proportion of those reaffirmations was for partially
secured car loans?
1997--Six reaffirmed auto loans
1998--Eight reaffirmed auto loans
1997--Two reaffirmed a combination of auto and unsecured
1998--Two affirmed a combination of auto and other
One did not reaffirm but continued to repay on an auto
C) What proportion was for credit cards or other unsecured
debts?
1997--Two reaffirmed a credit card
1998--One reaffirmed a credit card
D) What was the total dollar amount of debt that your members
reaffirmed in 1997 and 1998?
1997--$121,581.83
1998--$70,114.60
6. Your testimony indicates that you believe that your
reaffirmation agreements confer a benefit on the debtors who reaffirm
those debts. As you know, you may be one of several lenders asking a
debtor to reaffirm her debts, and it may be financially infeasible for
that debtor to honor all of those commitments. Reaffirmation of other
debts may interfere with the debtor's ability to repay your credit
union, and other lenders might use more aggressive collection practices
and higher fees to encourage the debtor to pay them first.
A) If debtors were not allowed to reaffirm any unsecured debt,
would most of your members continue to pay you voluntarily?
A very small percentage of member filing for bankruptcy do
not complete a reaffirmation agreement but continue to pay. Our
current policy regarding members causing a loss to the credit
union simply states that the only service allowed is a basic
share account allowing the member deposits and withdrawals.
They are no permitted to have any other services being provided
to the general membership but they can attend and vote at
regular membership meetings. A reaffirmation agreement is
identified as a commitment to repay which allows the credit
union to extend other services to the member that has not yet
cause a loss to the credit union and its membership. The lack
of formal reaffirmation agreements would tend to lesson the
debtors' commitment to repay some or all of the unsecured debt.
Voluntary payment is fine, but we no recourse if they stop
paying except to go after the collateral. We are prohibited
from getting any deficiencies, otherwise known as a ride-
through.
B) Do you believe that the benefits your members receive from
reaffirming debts to you would make them more likely to pay you
than some of their other creditors?
Again, the ability to have access to other financial services
is a viable option many members feel is important. In addition,
most members realize the commitment the credit union has to
helping the member rebuild their credit status is recognized as
a member benefit.
C) Would you support court review of reaffirmation agreements
if it did not necessarily require a hearing and could be done
inexpensively?
We would like to review any proposed structure of a court
review of affirmation agreements but it is possible a viable
program could be instituted. The caseload of the bankruptcy
court system would be a challenge to this concept but we would
be receptive to pursing the idea.
D) Do you believe that reaffirmation agreements should
clearly state the terms of the agreement so that debtors can
understand the financial consequences of the reaffirmation,
similar to the Truth in Lending Act requirements? If not, why
not?
When we discuss loans with our members we currently review
all terms of the loan as required by the Truth-In-Lending Act.
We certainly feel that debtors should get good information
about their legal obligations and protections. But just as
importantly, we feel that financial education and the
understanding of finance is lacking. Education and counseling
should be key factors to be considered when helping debtors
understand the financial consequences to reaffirmation.
7. You testified that you support needs based bankruptcy, in part
because you believe that more of your members could repay some of their
debt in Chapter 13. However, the national statistics on Chapter 13 plan
completion are low, and many do not distribute much, if any, payments
to unsecured creditors.
A) Of the Chapter 13 cases your members have filed since
1995, how many were completed or still in payment?
Two Chapter 13's remain in payment.
B) How many dollars of unsecured debt have been collected
from in the Chapter 13 cases of your members since 1995?
$8,854.49 of a total of $27, 479.71.
C) If one of your members files for bankruptcy, are you
better off financially if the member files for Chapter 7 and
reaffirms her debt to you in full rather than filing for
Chapter 13 and paying all of her debts pro rata over several
years?
The Chapter 13 experience has been with secured loans in
almost all cases. One member remained in Chapter 13 for several
months with the case being terminated. We were unable to
consolidate the member's loans at the credit union and assist
them in purchasing a more reliable auto for family usage.
Another member converted a Chapter 13 to Chapter 7 but
reaffirmed with us. The loan has since been charged-off due to
the termination of her employment. Two Chapter 13 filings have
continued to pay full loan payments via payroll deduction and a
third has continued to pay contracted payments directly to the
credit union. Another Chapter 13 was charged-off because the
member moved to Texas and we have never received a payment on
the contracted loan. Based upon our experience, a Chapter 13
filing in cases where the member has the ability to pay at
lease some of the debt is more beneficial to the overall
membership than simply charging the balance against the
reserves.
8. Most discussions have focused on the importance of the means
test, which was the subject of the panel on March 11. However, as Gary
Klein pointed out at the hearing at which you testified, the bankruptcy
bill spans 300 pages and contains hundreds of amendments affecting
consumer bankruptcy that have received little or no attention. Would
you be willing to accept a means testing amendment and forgo the
remainder of the other significant consumer bankruptcy amendments, such
as the various provisions expanding the nondischargeability of credit
card and retail charge card debt and the provisions inflating the value
of nominally secured debt?
Means testing is an important cornerstone of reform. Without
knowing specifically what all the ``significant consumer bankruptcy''
amendments are, we are unable to comment on this proposal.
9. In recognition of the lower loss rates and sometimes more
responsible consumer lending practices of credit unions, should there
be special provisions in this legislation that apply only to credit
unions? Should credit unions be treated differently with respect to
reaffirmation?
Credit unions shouldn't be prevented from obtaining reaffirmations,
since there is no indication that they have any problems in that area.
Our members, as consumers, should retain the right to choose which
debts, or whether, to reaffirm.
10. Do you believe there are any creditor abuses in the bankruptcy
system that should be addressed in bankruptcy reform legislation? If
so, what are they?
We are aware of the illegal practices in reaffirmations in the
Sears and other cases. As mentioned in my testimony, they were punished
under the current code and the size of the penalty should act as a
deterrent for future abuses.
__________
Gary Klein's Response to Senator Torricelli's Followup Questions
Question: We have been told in the past that there is a difference
between provisions that are ``debtor friendly'' and those that are
``consumer friendly''. For example, some people have argued that
provisions protecting the fresh start for honest families work hardship
on other consumers who never file for bankruptcy. And, on the flip
side, we have been told that by restricting debtors' rights, we will
make the price of credit, goods and services cheaper for nonbankrupt
consumers. As an advocate of both debtors and of consumers, can you
comment on whether this distinction is real? Are the interests of
bankrupt debtors and middle class consumers conflicting?
Response: No. Organizations that represent consumers [National
Consumer Law Center, Consumer's Union, and Consumer Federation of
America] \1\ unanimously believe that proposed bankruptcy legislation
is among the worst bills for consumers offered in the past 20 years.
Only the credit industry call this bill ``consumer friendly''.
---------------------------------------------------------------------------
\1\ Representatives of each organization have reviewed and agree
with this response.
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explanation:
Bankruptcy cannot appropriately be blamed for credit industry losses
that are passed on to consumers. All parties concede that the
vast majority of debts written off after bankruptcy couldn't
have been cost-effectively collected if bankruptcy had no
intervened. ``Bankruptcy losses'' are really just ``bad loan''
losses. The problem for consumers is that the credit industry
is too aggressively marketing loans to consumers that can't
afford to pay their balance in full each month. The industry
does this because, in the aggregate, those loans are
profitable.
The banking industry has claimed that it is losing 40 billion
dollars each year to the bankruptcy system and that it is passing those
costs on to consumers at the rate of $400 per family. The unpublished
credit industry-funded report which served as the basis for this claim
has been criticized by the GAO for lack of analytical rigor.\2\
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\2\ GAO/GGD-98-116R ``The Financial Costs of Personal Bankruptcy''
Letter from Associate Director Richard Stana to the Honorable Martin T.
Meehan.
---------------------------------------------------------------------------
Families may be discharging debt in bankruptcy, but all of the
relevant empirical work, including the creditors' own studies, agrees
that the debtors involved can not afford to repay those debts. Most
recently, a study released by the American Bankruptcy Institute showed
that only 3% of chapter 7 debtors can afford to pay back their
debts.\3\ A recent Ernst & Young study (funded by Visa) concludes that
bankruptcy debtors can afford to pay back 10 billion dollars in debt,
but they reached that conclusion only by including secured debt, non-
dischargeable debt, and reaffirmed debt which is not discharged in
bankruptcy and which must be repaid by chapter 7 debtors in any event.
---------------------------------------------------------------------------
\3\ Culhane and White, ``Means Testing for Chapter 7 Debtors:
Repayment Capacity Untapped?'' (American Bankruptcy Institute, 1998).
---------------------------------------------------------------------------
In reality, the lending community is scapegoating the bankruptcy
system for losses associated with its bad loans. If no bankruptcy
system existed, it would likely cost the credit industry two dollars in
collection costs for every additional dollar generated from the
overwhelmed consumers that that now get relief in bankruptcy. The
bankruptcy bill is, in part, an attempt to pass these collection costs
on to taxpayers.
The problem could be fixed if lenders were more closely attentive
to underwriting. Industry consultants estimate that credit card
companies could cut their bankruptcy losses by more than 50% if they
would institute minimal credit screening.\4\ They choose not to make
that effort because high-rate credit card lenders profit, in the
aggregate, by finding borrowers that cannot afford to pay their
balances in full each month. Since most of that debt is repaid at high
rates, the industry profits despite increasing defaults and the
attendant hardship to families.
---------------------------------------------------------------------------
\4\ George M. Salem and Aaron C. Clark, GKM Banking Industry
Report, Bank Credit Cards: Loan Loss Risks are Growing, p. 25 (June 11,
1996).
---------------------------------------------------------------------------
There is no reason to think that any savings to lenders which would
result from tightening the bankruptcy laws would be passed on
to consumers.
There is no evidence that lenders would reduce rates on unsecured
consumer lending if they could avoid bankruptcy losses. Between 1980
and 1992, the federal funds rate at which banks borrow fell from 13.4%
to 3.5%. Nevertheless, credit card interest rates actually rose.\5\ How
likely is it that savings realized from changes in the bankruptcy law,
if any, would be passed on to consumers rather than investors? Bruce
Hammond, Chief Operating Officer of MBNA Corporation conceded this
point at the joint hearing in which I participated.
---------------------------------------------------------------------------
\5\ Medoff and Harless, The Indebted Society, at pp. 12-13 (Little,
Brown & Co. 1996).
---------------------------------------------------------------------------
There is evidence that excessive tightening of the bankruptcy laws
would actually increase credit card defaults and credit card
losses, because lenders would be able to make more loans to
risky borrowers.
Ausubel, ``Credit Card Defaults, Credit Card Profits and
Bankruptcy'', 71 Am. Bankr. L.J. 250 (1997). This work, by a University
of Maryland economist, analyzes credit card lending trends and
concludes that credit card interest rates cannot be explained by market
forces. In addition, Professor Ausubel concludes that pressures related
to risk are important to prevent lenders from making more unwise
consumer loans leading to more defaults rather than less.
Non-bankrupt consumers benefit from having a viable, effective and
cost-efficient bankruptcy system in case something goes wrong
in their lives.
Every American is vulnerable to financial problems related to job
loss, illness, death of a bread winner and a myriad of other
circumstances beyond their control. Even former Treasury Secretary John
Connally was forced by circumstances to file bankruptcy.
The fundamental reality is that the bankruptcy system serves as
insurance when unexpected financial problems strike. Although there is
no proof of a connection between the bankruptcy law and interest rates,
(and some proof to the contrary), even if there were proof, American
consumers can and should be willing to pay a small premium for the
safety valve inherent in a court system designed to help them during
times of financial distress.
what would make these bankruptcy bills more consumer friendly?
Do not increase opportunities for creditors to pursue litigation
against indigent debtors in bankruptcy and avoid new
requirements that would raise the costs and burdens of filing.
There is no dispute that debtors that can afford to pay back their
creditors should be made to do so. However, the means test provision is
only one of 70 provisions that would affect consumer bankruptcy. The
net result of the means test and these other provisions is that they
would greatly increase the cost of bankruptcy and reduce its
effectiveness.
If the proposed legislation passes, only relatively well-off
debtors will be able to afford relief in the bankruptcy system. They
can hire expensive lawyers to navigate the new minefields. Most non-
wealthy families will be unable to afford the system. Those few that
can will be vulnerable to new creditor-initiated litigation that they
cannot afford to defend.
Create a balanced bill which includes new consumer protections designed
to help consumers avoid over-extension on debt and bankruptcy.
Credit card marketers go to great lengths to encourage people to
generate big balances on their cards so that they pay more interest.
Most even punish consumers facing legitimate financial problems by
charging punitive late fees and by automatically doubling interest
rates upon default.
Any fair and balanced bankruptcy bill must include provisions
designed to give consumer adequate information about the consequences
of taking on on more debt. Some example of important protection are:
Linformation sufficient for consumers to understand
how long and how much it would cost to pay off a credit card
loan by making only minimum payments;
Linformation about the risk of repossession associated
with credit card security interests;
La clear picture of what it means to accept a credit
card carrying an artificially low ``teaser rate'';
Lbetter information for bankruptcy debtors about the
costs and risks associated with reaffirming a debt in
bankruptcy;
Lprotections for debtors forced into bankruptcy by
high rate mortgage loans that violate federal law;
Lprotections/incentives for consumers that are
responsible and pay their balances in full every month;
Lsanction for overly aggressive collection efforts
which force people into bankruptcy (e.g. refusal to agree to a
reasonable debt management plan, or threatening to take an
action which is not legally permissible);
Lbetter education when bankruptcy is filed to teach
people how to understand and manage credit; and
La provision which insures that any profits generated
by tightening the bankruptcy laws is passed on to consumers.
Including these provisions in the bill would not just benefit
consumers. Honest and reasonable creditors that act responsibly in the
market place would also benefit, because more money would be available
for consumers to repay their debts.
Thank you for the opportunity to respond on behalf of consumers to
this important question.
__________
Edith H. Jones' Responses
U.S. States Court of Appeals,
Fifth Circuit,
Houston, TX, March 22, 1999.
Hon. Henry J. Hyde, Chairman,
Committee on the Judiciary,
House of Representatives, Washington, DC.
Re: Joint Hearing of the House Subcommittee on Commercial and
Administrative Law and the Senate Subcommittee on Administrative
Oversight and the Courts on Bankruptcy Reform, March 11, 1999
Dear Congressman Hyde: Attached you will find my answers to
questions submitted in writing as a followup to the March 11 hearing on
bankruptcy reform. Thank you for giving me the opportunity to respond
to these questions.
Very Truly Yours,
Edith H. Jones
cc: Honorable George W. Gekas
followup questions from senator chuck grassley:
1. You are a Federal Appeals Court judge who hears bankruptcy
appeals. Do you think a bright-line rule with respect to means-testing
helps judges make clear and consistent decisions?
Yes. Whenever clear standards are embedded in the law, the law is
more easily applied by the court and more easily followed by the
citizens. The desirability of uniformity cannot be over-emphasized.
When the 1978 Bankruptcy Code was written, only approximately
300,000 bankruptcies were filed annually. The Code conferred enormous
discretion on bankruptcy judges with the thought that they could use
that discretion to accomplish justice in each individual case, both to
enhance the fresh start and to curb abuse. Virtually open access to
bankruptcy relief was provided by the Code.
As Congress is aware, the number of consumer bankruptcy filings has
more than quadrupled in the last 20 years. Any thought of tailoring
justice to the individual case is now a mirage. Cases are routinely
processed en masse in the courts, and most debtors never even see a
judge. The participants in the mass bankruptcy system--debtor's
lawyers, Chapter 7 and Chapter 13 trustees, U.S. Trustees, and judges--
have neither the time, the resources, or the incentives thoroughly to
police the system. For creditors, the costs of rooting out and curbing
abuse and fraud through a litigation-oriented system are prohibitive. I
hasten to add that I am not castigating any of the participants in the
bankruptcy system, but I must observe how the sheer volume of filings
has undermined the original ideal of dispensing individualized justice.
The only practical, fair way to run a system as large as the
current one is by means of objective standards that define when a
debtor should be required to repay some debts in exchange for receiving
a discharge and fresh start. Congress, as the people'' representatives,
is best situated to articulate uniform standards.
2. During your tenure on the Bankruptcy Review Commission, did you
propose a means-testing provision?
In a dissent to the Commission Report, Commissioners Shepard and I
proposed five different means-testing provisions, several of whose
features resemble H.R. 833.\1\ This and other dissents explain that the
Commission's process with respect to consumer bankruptcy, flawed from
the outset, prevented serious consideration of most meaningful reforms
to counter abuse and fraud.\2\ Means-testing in particular never had a
hearing in the Commission.
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\1\ See Additional Dissent of Commissioners Jones and Shepard from
[NBRC] Recommendations for Reform of Consumer Bankruptcy Law.
\2\ Recommendation for Reform of Consumer Bankruptcy Laws by Four
Dissenting Commissioners; Dissent from the Process of Writing the NBRC
Report by Commissioners Gose, Jones and Shepard.
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Since the Commission completed its tenure, however, the argument
for means-testing has become increasingly compelling for two reasons.
First, the number of personal bankruptcies continues to increase and
remains at an incredibly high level. Second, more empirical studies are
confirming the seminal work of Professors Barron and Staten; the
studies all demonstrate that tens of thousands of well-off, employed
people have filed bankruptcy despite their ability to repay (in total)
billions of dollars to creditors. See, e.g., the new Ernst & Young
study based on 1997 bankruptcy petitions; See also, Jones and Zywicki,
It's Time for Means-Testing, 1999 B.Y.U.L.J.1 (attached to my testimony
for this hearing). Such freeloading is an affront to the hardworking,
lower-income citizens who bear the cost of bankruptcy losses, and it is
fundamentally inconsistent with the means-testing rationale behind
nearly all of the other programs in our government's social safety net.
followup questions from senator torricelli:
A. You have commended Congress for rejecting findings of the
National Bankruptcy Review Commission, of which you were a member.
However, 7 out of 9 Commissioners chose not to recommend to Congress
that it consider a formal means testing system. Now we have heard that
the only recent independent study on this subject, sponsored by the
American Bankruptcy Institute, found that even if we did turn the
system upside down, only a small portion of chapter 7 debtors could pay
even 20% of their debts. In addition, we have a witness here who often
represents unsecured creditors and who is telling us that she thinks
the means test does not work. In light of these factors, why should we
move to a formulaic means testing system?
The reasons why we should move to a formulaic means-testing system,
of the sort proposed by H.R. 833, are fully stated in the testimony I
submitted previously for this hearing as well as the testimony of
Professor Todd Zywicki for the same hearing. Rather than burden the
record further, I refer you to those sets of remarks.
I must, however, respectfully disagree that the ``factors'' to
which you refer counsel against means-testing. First, it is incorrect
that ``7 out of 9 Commissioners chose not to recommend to Congress'' a
formal means-testing system. As my previous answer to Senator Grassley
notes, the Commission never formally considered and debated means-
testing. Had it been given a fair hearing, I don't know what the
Commission would have concluded.
Second, I respectfully disagree that the only recent
``independent'' study on means-testing is that sponsored by the
American Bankruptcy Institute. Although I respect ABI, its membership
consist of professionals who make their living from the bankruptcy
system. If the mere source of a study constitutes bias, then surely ABI
is not less immune to the charge than the creditor groups which have
sponsored studies of other researchers.
But to challenged ABI or the professors who conducted the ABI study
on such a basis is as unfair to them as it is to the creditor groups
and the studies conducted by Ernst & Young, The WEFA Group, and
Professors Barron & Staten. In our recent article on means-testing,
Professor Zywicki and I analyze all of these studies and conclude that
they reflect a significant ability on the part of high income-earning
Chapter 7 debtors to repay unsecured, non-priority debt. Please see our
article, attached to my testimony, at pp. 10-24.
Third, I respectfully disagree with the witness who thinks that the
means-test does not work. No matter what the lawyers for unsecured
creditors say about means-testing, it can be hardly doubted that the
creditors themselves favor it. Significant advocates of H.R.833 include
child support enforcement agencies, the National Governors'
Association, and every major creditor group.
Further, Professor Zywicki's and my article deals at length with
objections that have been made to means-testing. In brief, such
objections overlook several points. First, means-testing is easily
amenable to information procession software. Second, if means-testing
imposed more costs on trustees, the costs could be recovered by such
devices as increasing filing fees for means-test-eligible debtors.
Third, while there may be initial legal uncertainty surrounding some
facets of a means test, the same is true whenever any change occurs in
the law. The initial court decisions will resolve such uncertainties.
B. Supporting the concept of needs based bankruptcy is one thing;
supporting the details of this bill's means testing approach is
another. Even if you support a ``means based'' system in theory, aren't
you concerned by the logistical problems that have been identified
regarding this means test by the Commercial Law League, trustees,
judges, and the National Bankruptcy Conference?
As you observe, interest groups in the bankruptcy community have
opposed means-testing as embodied in H.R. 833. In my experience,
however, these same interest groups have opposed any type of means-
testing in any form. While saying they are opposed to the details of
specific proposals, their opposition is more to the details of specific
proposals, their opposition is more philosophically rooted. These
groups tend to believe that bankruptcy should operate on an open-door
policy, where anyone--no matter how well off--can avail himself of the
process without having to justify his need for relief. These groups
also tend to deny the power of the growing evidence that shows many
well-off income-earning individuals file bankruptcy notwithstanding
their ability to repay some debt.
When forced to confront the problem of debtors who are able to
repay some of their debts, these interest groups advocate giving the
bankruptcy judges discretion to week out undeserving cases. The judges
have had this discretion for 20 years, and it has obviously not worked!
The number of cases had exploded, while the integrity of the system has
declined.
The H.R. 833 proposal is about as fair as can be devised given its
modest application, its reliance on established national guidelines for
living standards, and an ``exceptional circumstances'' exclusion.
Further logistical simplicity could be achieved, however, by going back
to last year's ``up-front'' test contained in H.R. 3150. That proposal
imposed less of a burden on Chapter 7 trustee, who, under H.R. 833,
will probably have to litigate more cases under a section 707(b) test.
Nevertheless, critics underestimate the clarity that will be achieved
from having uniform national standards in this area. I am confident
that, just as accountants and CPAs adjust to far mor complex
modifications of our federal tax laws, so the bankruptcy community
participants can adjust to this modest means test.
C. As a judge, do you think it is appropriate to make debtors'
lawyers personally and financially responsible if their clients are
found to have filed under the wrong chapter?
I believe you are referring to Sec. 101(b) (3) of H.R. 833, which
imposes on debtors' lawyers (1) a responsibility similar to that in
Fed. R. Civ. Proc. 11 for certifying the debtor's filings at court and
(2) a provision for fee-shifting in cases where the means-test is
egregiously evaded. I do not see why debtors' lawyers should be immune
from the potential liability that any lawyer faces when filing a
pleading in federal court: if the lawyer has no reasonable basis for
believing in the accuracy of the pleading, he may be subject to
sanctions. Such a device is necessary to maintain the integrity of
conduct in federal courts and to avoid drowning our meritorious claims
with those that have no real foundation. Further, all lawyers have an
ethical responsibility to deal fairly with the court and with their
opponents. Why should bankruptcy be any different?
The fee-shifting provision is written in language similar to that
of numerous federal statutes, which provide for an award of fees if the
litigant's position was not ``substantially justified.'' The provision
is discretionary, not mandatory. This provision is matched by an equal
and opposite provision for fee-shifting if a motion to require
conversion under the means-test is itself not ``substantially
justified.''
Scandalously, the entire bankruptcy community acknowledges that
debtors' schedules and statements of affairs, which list their income
and assets as well as liabilities, are neither accurate nor
trustworthy. This is true although the documents are filed under
penalty of perjury, and competent counsel should be advising their
clients about the risks of filing inaccurate papers. Unfortunately,
debtors' lawyers, whose offices often mass-process bankruptcy
petitions, see no to be fulfilling their ethical responsibilities.
Strong medicine like that in this bill is necessary to enhance the
integrity of documents filed in bankruptcy court. No one has proposed
any better device.
D. Even if we make it less ``easy'' to file for bankruptcy so that
the filing rate goes down, it seems to me that we have looked at only
one half of the problem because some people are going to default on
their obligations whether or not they ``discharge'' their debts in
bankruptcy. Can you comment on this? Do you think that more needs to be
done to help prevent people from incurring so much debt in the first
place?
This questions seems to indicate that no matter what changes are
made to bankruptcy law, some people will default on their obligations,
and maybe their defaults are due to excessive levels of personal debt.
I agree that bankruptcy reform addresses one major problem--abuse of
the bankruptcy laws. Insofar as law serves a teaching function for
society, of course, tightening up the bankruptcy laws sends a message
to society at large that it is better to keep contracts than to break
them--especially if you are able to repay. I don't think we can
quantify this teaching function of the law, however.
Whether ``incurring so much debt'' is a social problem or not is a
question beyond bankruptcy law and within the special capability of
Congress. Logically, those who are afraid that people are incurring too
much debt ought to be just as concerned about the non-bankrupt who is
hard pressed by obligations as they are about the welfare of the
bankrupt individual. If Congress thinks interest rates are too high, it
can re-impose usury ceilings. If it thinks credit practices are too
lax, it can institute additional truth-in-lending or credit controls.
Congress should undertake such measures after full public debate,
however, rather than indirectly through manipulation of bankruptcy
laws. Such a debate would pit those who paternalistically fear consumer
credit against those who believe that the wise use of ``democratized''
consumer credit, home loans and student loans has contributed
enormously to increased personal welfare and our economic prosperity.
E. Using conservative economic theories, some researchers believe
that restricting bankruptcy laws will increase defaults and ultimately
increase bankruptcy filings. Do you disagree with those conservative
economists?
This is a difficult question to answer for two reasons. First, I am
unfamiliar with those ``conservative economists'' to whom the question
refers. Second, the observation that ``restricting bankruptcy laws will
increase defaults and ultimately increase bankruptcy filings'' is
flatly inconsistent with the previous question, which assumed that
bankruptcy filing rates will go down if access to bankruptcy
restricted.
On one level, I guess these contradictory assumptions symbolize
that no one knows what will happen to bankruptcy filings if this reform
bill is passed. The case for reform does not, however, depend on how it
will affect the number of filings. Reform is justified to prevent
patent abuses that are now occurring, such as misuse of bankruptcy by
ex-husbands trying to avoid their marital obligations. Reform is
justified to prevent people from ``loading up'' on consumer purchases
just before filing bankruptcies to discourage them for from incurring
new secured debt just before for filing Chapter 13; to prevent them
from filing multiple bankruptcies; and to prevent other inarguable
abuses. Reform is also justified to incorporate an ability-to-repay
test into bankruptcy, at least for those Americans who are above the
median family income and who are truly able to repay. If these abuses
of the bankruptcy law and courts are rectified, it does not matter to
me whether the filing rate goes up or down, because the public can be
more confident that the law is being properly used to protect honest
but unfortunate debtors.
followup question from senator kohl:
The National Bankruptcy Review Commission, which you served on,
recommended a $100,000 cap on homestead exemptions. I have introduced
legislation that would establish such a cap. We have heard from some of
the states with unlimited homestead exemptions that a $100,000 cap
would unfairly infringe on states' rights. Cap supporters argue that
debtors are using federal courts and federal laws to get bankruptcy
relief, and it is fair to make them subject to federal limits in order
curb egregious abuses, like the recent example of long-time Florida
resident Burt Reynolds who wrote off over $8 million in debt through
bankruptcy while still holding onto his $2.5 million estate. Do you
agree with this recommendation of the NBRC? Please explain your
response, including your reaction to arguments from both sides.
In principle, I do not oppose a $100,000 cap on homestead
exemptions, particularly if it were indexed to account for inflation.
I agree with cap supporters that debtors have used liberal
homestead laws, like that of my home state Texas, to shelter large
amounts of wealth from their creditors. It is also true, however, that
states have been firmly attached to requiring federal recognition of
their exemption laws, including their homestead laws, in the federal
bankruptcy courts.
The question is how to prevent abuse of bankruptcy Section 126 of
H.R. 833 would discourage a great deal of abuse by lengthening the
residency required before a debtor can take advantage of a state's
exemptions. Thus, a debtor would have to live in Texas for two years
(rather than the current three months) in order to avail himself of
Texas homestead protection. A more general reform would limit transfers
of real or personal property from non-exempt to exempt status shortly
before filing bankruptcy. In short, while I personally do no object to
$100,000 cap, other kinds of limitations can reach the same goal.
__________
Judith Greenstone Miller's Responses
Commercial Law League
of America,
Chicago, IL, March 22, 1999.
Hon. Henry J. Hyde, Chairman,
Committee on the Judiciary,
House of Representatives, Washington, DC.
Dear Chairman Hyde: I understand that since the Joint Hearing of
the House Subcommittee on Commercial and Administrative Law and the
Senate Subcommittee on Administrative Oversight and the Courts on
Bankruptcy Reform held on March 11, 1999 (the ``Joint Hearing''),
additional written questions have been submitted for inclusion in the
record. The Commercial Law League of American (the ``League''), its
Bankruptcy and Insolvency Section (``B&I'') and its Legislative
Committee appreciate the opportunity to have appeared and testified at
the Joint Hearing about the Bankruptcy Reform Act of 1999, H.R. 833
(the ``Bill'').
The League, founded in 1895, is the nation's oldest organization of
attorneys and other experts in credit and finance actively engaged in
the fields of commercial law, bankruptcy and reorganization. Its
membership exceeds 4,600 individuals. The League has long been
associated with the representation of creditor interests, while at the
same time seeking fair, equitable and efficient administration of
bankruptcy cases for all parties involved.
The B&I is made up of approximately 1,600 bankruptcy attorneys and
bankruptcy judges from virtually every state in the United States. Its
members include practioners with both small and large practices, who
represent divergent interests in bankruptcy cases. The League has
testified on numerous occasions before Congress as experts in the
bankruptcy and reorganization fields.
The League supports changes to the Bankruptcy Code (the ``Code'')
to limit abuses by debtors and creditors. Any proposed change will have
consequences on the system. It is the goals of the League to be a
resource for Congress and to help Congress carefully consider the
practical implications of each change in order to maintain and preserve
the delicate balance between debtors' rights and creditors' remedies
and to foster and effectuate fair treatment for all parties involved in
the process. With that in mind, the League is pleased to respond to the
two written followup questions submitted by Senator Torricelli.
Question 1:
Some people have argued that individuals and groups voicing
opposition or concerns about the bill are simply trying to block reform
and believe that b buses should not be addressed. If this is the case,
why is a creditor oriented group like the Commercial Law League of
American voicing objections about the bill?
Response:
There are those who are opposed to any change in the Code. On the
other hand, many pursue specific agendas. Some feel that there should
be no limits on relief for a debtor or remedies by a creditor. As
indicated about, the League views itself as a resource to Congress to
offer a practical, balanced analysis to proposed legislation. The
League believes that it should do all it can to support Congressional
efforts to maintain a Code which provides fair treatment to all
participants in the system. While this position is sometimes not
politically popular because it may not fall on the side of an issue
favored by a proponent, nevertheless, it is a consistent position taken
by the League. The fact that members of the League represent all types
of creditors, as well as debtors, frees the organization from the need
to advocate the interests of any particular creditor group or to pursue
any specific agenda.
The League has consistently articulated in its written position
papers and statements and its testimony before Congress the need for
reform to address and remedy abuses by debtors and creditors in order
to improve the bankruptcy system. Although the Bill proposes many
favorable changes to the Code that the League has endorsed, the Bill
also proposes several modifications, which, if adopted, will negatively
impact creditors, as well as other participants involved in the
bankruptcy process. For example, the anti-strip down provisions of the
Bill that seek to amend Section 506(a) of the Code, see e.g., Sections
124 and 125, required a debtor to repay a secured creditor based on the
full amount of the debt even though the value of the property securing
the debt may be significantly less than the amount of the outstanding
indebtedness. Under applicable state law, if the secured creditors
foreclosed on the loan in order to recover their collateral, the
creditors would not receive in excess of the fair market value
attributable to the property, and then be left with an unsecured
deficiency claim against the debtor. Why should the procedure be any
different under the Code? Why does Congress believe it necessary to
alter Section 506(a) of the Code, particularly when the result will be
that less funds will be available to pay unsecured creditors of the
estate and the ability of a debtor to formulate and successfully emerge
from a Chapter 13 repayment plan will be significantly compromised?
Another provision of the Bill, Section 205, seeks to extend the
time for assumption or rejection of unexpired executory contracts of
nonresidential real property from 60 days to 180 days. The only way
that this time period may be extended is upon consent of the lessor.
The League opposed this provision because it tips the delicate balance
contained in the Code by placing landlords of nonresidential real
property in the position of forcing assumption or rejection within the
earlier of 180 days after the entry of the order for relief or the date
of entry of the order confirming a plan. As long as landlords are
receiving rental payments consistent with Section 365(d)(3), there is
no reason to create an arbitrary, inflexible and unrealistic deadline,
which will inure to the detriment of the debtor and its unsecured
creditors. The debtor is likely to prematurely assume a lease in order
to facilitate a reorganization, and thereby create a large
administrative expense for the estate if subsequently it is unable to
successfully reorganize. On the other hand, this proposed modification
to Section 365 of the Code may force a debtor to prematurely reject a
lease necessary and essential to facilitate a reorganization to negate
the potential prospective administrative hit from failing to confirm a
plan. In addition, the only way that the time period may be extended is
upon motion of the lessor; the court would no longer have any
discretion to determine whether justification existed to extend the
time period or whether an extension was in the best interest of
creditors and the estate. This provision gives too much bargaining
power to the lessor, is likely to result in the extraction of
additional benefits or concessions by the lessors, and impacts the
debtor's ability to successfully reorganize, particularly in cases
involving multiple shopping center locations. For example, take a
debtor with multiple retail locations in shopping centers, who files
bankruptcy in March. Under the proposal, the debtor will be forced to
make a decision to assume or reject prior to the Christmas season, when
sales at that time are so crucial in assessing the likelihood of its
reorganization and new business plan.
The League believed that this section of the Code, as currently
drafted, appears to be working well, and is not in need of revision.
If, however, Congress nevertheless believed that landlords are not
adequately protected by the current safeguards contained in the Code
(e.g., requirement that debtors timely pay postpetition rental charges,
administrative priority treatment for nonpayment of postpetition rental
charges, 60-day period to assume or reject that can be extended upon
showing of ``cause''), the League suggested that Congress may wish to
consider bolstering the current Code provisions to provide a better
remedy for lessors when debtors fail to perform their obligations under
lease postpetition. However, as long as lessors are receiving what they
are entitled to under a lease, they are receiving the benefit of their
bargain and should not be able to tip the delicate balance by
suggesting that Congress establish a rigid and inflexible period by
which assumption or rejection takes place, particularly when that
decision ultimately affects the potential distribution made to
unsecured debtors under a plan.
The two examples cited above clearly evidence that the League is
not attempting to block reform, but rather analyze the impact from
implementation of such changes. It is important as part of the
legislative process to focus on the result of such changes--in both of
these instances, unsecured creditors and the debtor will be adversely
impacted at the expense of secured creditors and commercial retail
lessors. The League has always opposed special interest legislation
that has no special policy justification--both of these examples
represent special interest legislating that will negatively impact the
delicate balance between debtors' right and creditors' remedies
inherent within the Code. Remedying one perceived abuse does not
improve the bankruptcy system if the result of such curative actions is
merely to create another potential abuse.
Question 2:
You seem to have some serious concerns about the means test in this
bill and its ability to identify debtors who can pay back their
unsecured debts. As a representative of many unsecured creditors, your
opinion on this is obviously significant. Are you saying that unsecured
creditors are unlikely to benefit from this means test? If so, how
should we fix this problem?
Response 2:
The League has expressed concerns about various provisions of the
Bill and made suggestions on many changes that it feels would improve
the Bill and would remedy and limit abuses by debtors and creditors.
The means test as proposed has numerous problems and is not likely to
improve the recovery to unsecured creditors. It is also likely to be
the subject of creative avoidance efforts by counsel for debtors.
Because individuals with secured debt are allowed deductions for such
obligations prior to calculating available disposable net income, a
debtor with too much income could trade in an old car for a new one, or
take a second loan on a house, deduct the payments from the means
formula, and thereby become eligible for Chapter 7 relief. If they do
not meet the means test, and thus forced into Chapter 13, the result
may very well be zero percent or small percentage Chapter 13 repayment
plans. The means test also operates to the exclusion of the trustee's
significant avoidance powers. The schedules may reveal a significant
avoidance action (e.g., preferences or fraudulent conveyances), which
if recovered could result in a distribution to unsecured creditors in
excess of what they would receive upon application of the means test.
However, under the means test, as proposed, if a debtor does not
qualify for Chapter 7 treatment and the debtor does not elect to
convert the case, the trustee does not have the ability to seek
recovery through the avoidance action, a remedy that would clearly
benefit unsecured creditors over dismissal of the proceeding.
The League believes that debtors who have the ability to repay
their debts should be compelled to undertake such action. The League,
however, believes and has suggested that the best way to achieve that
goal is by amending Section 707(b) to empower the Court on the motion
of any party in interest to consider a debtor's means as a nonexclusive
factor in dismissal or conversion--such a change is more likely to
benefit the creditors than the mandatory tested currently set forth in
the Bill. The Court is in the position to identify abuse and fashion
relief appropriate to the circumstances. Under the current Doe, the
courts do not have the authority to affirmatively look for abuse or
fashion an appropriate remedy except in the most egregious
circumstances. Adoption of a ``totality of circumstances'' test, in
conjunction with a discretionary means test, would accomplish the goal
for which Congress has proposed the means test, provide a guide for
defining abuse by the courts, and represent a major change and a
vehicle by which abuse could be addressed and remedied.
The League would be pleased to comment on any additional concerns
or queries regarding the pending Bill or other matters of concern to
your office.
Very truly yours,
Judith Greenstone Miller,
Co-Chair, Legislative Committee,
on behalf of the Commercial Law League of
America and its Bankruptcy & Insolvency Section
cc: Hon. George W. Gekas (Hand Delivered)
Hon.Robert J. Torricelli (Hand Delivered)
Louis A. LeLaurin III, President of the League
Mary K. Whitmer, Chair of the B&I Section
Jay L. Welford, Co-Chair, Legislative Committee
Max G. Moses, Executive Vice President
__________
Professor Todd Zywicki's Responses
responses to followup questions from senator chuck grassley
Question 1. You mentioned that means-testing would affect a maximum
of all bankruptcy filers, do you know what percentage of filers are
reported to be repeat users of their ``fresh start'', and can you
comment on what this number suggests about the current remedies in the
consumer bankruptcy system?
The absolute number of repeat bankruptcy filers is difficult to
ascertain with certainty. One study in the early 1980s found a repeat
filing rate of about eight percent. Professor Lynn LoPucki has
observed, ``The rate is probably higher today.'' But these figures
almost certainly understate the overall number of ``functional repeat
filings,'' the most common of which is the practice of conveying a
``fractional'' interest in one's house to a relative or other cohort,
who then files bankruptcy so as to bring the automatic stay back into
effect. In some cases, debtors have conveyed as little as a 1/32
interest to a relative or friend who then files bankruptcy so as to
prevent foreclosure. There are even some businesses that have been
established to conduct this activity.
A number of reforms may be appropriate to prevent abusive repeat
filings by bankruptcy debtors. Perhaps the most important reform would
be the development of a national bankruptcy filing registry to deep
track of filers and to prevent multiple and sometimes even
contemporaneous filings. Because most repeat filings are animated by an
attempt to delay and thwart house foreclosures, certain reforms
designed to create in rem rights in property (as suggested by the
National Bankruptcy Review Commission) and to expedite relief from the
automatic stay for repeat filers are also appropriate. Stricter
limitations on access to bankruptcy relief, such as a flat limit on the
number of times a debtor could file bankruptcy in a given period, would
also be appropriate. Finally, to prohibit the ``fractional interest''
problem, the automatic stay should be inapplicable for anyone who had
filed within 180 days, or who are spouses, co-owners, or co-lessees of
a person who filed in the previous 180 days.
Question 2. How will means-testing improve the consistency and
objectivity in the application of the bankruptcy code?
One of the most important justifications for means-testing would be
to increase the consistency, objectivity, and uniformity of the
Bankruptcy Code. Article I, Sec. 8 of the United States Constitutions
gives Congress the power to establish ``uniform Laws on the subject of
Bankruptcies throughout the United States'' (emphasis added). Current
law regulating eligibility for Chapter 7 of high-income debtors who can
repay substantial portion of their debts is anything but uniform. Under
current law, judges are to police abuse through the ``substantial
abuse'' provision of Sec. 707(b). The attempt to develop coherent,
fair, and rational standards under Sec. 707(b) has proven itself to be
a failure. This chaos has resulted in both real and perceived
unfairness in the treatment of debtors from district to district and
courtroom to courtroom. The confusion spawned by Sec. 707(b) is
summarized in In re Attanasio, 218 B.R. 180 (Bankr. N.D. Ala. 1998).
Attanasio surveys hundreds of cases drawn from bankruptcy, district,
and circuit courts throughout the country. As the discussion reveals,
there is very little agreement in the legal definition of what
constitutes ``substantial abuse'' and even less agreement on how the
facts should be weighed in determining whether substantial abuse
exists. Finally, there is a great degree of nonuniformity and
unpredictability in predicting when a substantial abuse challenged will
be brought under Sec. 707(b). This uncertainty and nonuniformity
undermines public support for the bankruptcy system and makes it
difficult to prevent abuse.
Means-testing will streamline the system and limit the issues in a
given case to narrow and discrete inquiries. By providing a rule of
decision tying the applicability of means-testing to objective
standards, it will eliminate the uncertainty and regional variations
that plague the current system. It will insure that all high-income
debtors are treated alike, thereby increasing uniformity and public
confidence in the bankruptcy system.
responses to followup questions from senator torricelli
Question 1. The means test in this bill relies heavily on the IRS
collection allowances. We have heard lots of concerns about these
allowances, even from those who take no position on the bill generally.
One problem is the ``other necessary expense'' category. Since it
clearly was not designed for this purpose, the items that fall into the
category are totally discretionary with the IRS and are approved on a
case by case basis (see IRS regulations 5323.434). Thus, we have no
guarantee that these expenses may be deducted from the means testing
formula. This is not simply a minor inconvenience; families in
bankruptcy will need to use this category for such things as health
care, child care, disability insurance, union dues, and court-ordered
payments (such as support), because the IRS collection allowances do
not cover these critical expenses anywhere else. How is this supposed
to work?
Section 102 of H.R. 833 approves such expenditures by the debtor so
long as they are actual necessary expenses. If they are actual
necessary expenses, there would be no need for the debtor to prove that
they are ``other necessary expense'' for purposes of the applicable IRS
regulations. Unlike the IRS regulations, the debtor would be entitled
to subtract these actual expenses without a case-by-case justification.
All that is required is that they be actual expense.
Question 2. The means test in this bill requires a trustee to do a
complete ability to pay analysis under the means test in every single
chapter 7 consumer case at the very beginning of the case, 10 days
before the 341 meeting, before the trustee has even met any of the
debtors. People who actually work in the bankruptcy system say that
this simply is not feasible. In addition, the trustees would not even
be compensated for this extraordinary expenditure of time. Don't you
think that there are serious feasibility requirements with the means
test?
These concerns are not well-founded. The crucial information would
be available directly from the debtor's bankruptcy schedules and forms.
For instance, the trustee is required to bring a conversion motion only
if the debtor's income exceeds the national median, in addition to
meeting the other ability-to-pay criteria. Thus, in the approximately
80% of cases where the debtor's income is less than the median national
income, means-testing will impose no additional duties over present
law. Moreover, the Act also specifically provides that the applicable
bankruptcy forms should be revised to conform to the means-testing
requirements, thereby making it easier for the trustee to determine the
applicability of means-testing. This is merely a change in the format
of the income and expense forms the debtor already is required to fill-
out under current law. Thus, means-testing should add little, if any,
administrative burdens to the trustee's duties. Thus, it is doubtful
that means-testing would be any less feasible than current law.
Question 3. As a law professor who has studied the bankruptcy
system, do you believe that it is appropriate to give lawyers a
financial disincentive to file chapter 7s for their clients if they
believe that doing so is in the best interest of their clients? Are you
concerned that creating such financial disincentives for lawyers to act
in their clients' best interests will run afoul of other ethical
requirements?
It is not fully clear to me what ``financial disincentive to file
chapter 7s'' is referenced in this question. I will assume that the
question refers to the provisions what would require the debtor's
counsel to reimburse the trustee for all reasonable costs and
attorney's fees if the debtor's filing was not ``substantially
justified'' and provisions for enforcing Rule 9011. If that is the
case, it seems strange to refer to these ethical requirements as a
``financial disincentive.'' Clearly these rules provide a financial
disincentive for a debtor's attorney to file frivolous chapter 7 cases
and to file cases where the debtor's lawyer fails to perform even a
modicum of investigation into the debtor's financial affairs. Rule 9011
also gives a debtor's lawyer a financial disincentive to engage in
fraudulent or other inappropriate activity, even if it is the client's
best interests. The requirements of the proposed legislation require
the debtor's lawyer to balance his ethical obligations to the debtor
with his ethical obligations to the court and his fiduciary obligations
to creditors. All lawyers balance these competing ethical obligations
every day, and it is not clear why bankruptcy lawyers should be
relieved of this obligation, or why it is useful to refer to ethical
obligations as ``financial disincentives to file chapter 7s'' as
opposed to ``financial incentives to ensure that chapter 7 filings are
made in good-faith and after reasonable investigation by the debtor's
counsel.''
responses to followup questions from senator russ feingold
Question 1. You testified that ``studies repeatedly conclude that
those affected by means-testing could pay approximately 60%-70% of
their unsecured debts if they filed under Chapter 13, which amounts to
a total of over $4 billion.'' Do you have a source for this $4 billion
number, other than the report of the WEFA Group study that did not
provide sufficient information for the General Accounting Office to be
able to assess the reliability of the data, the reasonableness of the
report's assumptions, and the accuracy of the report's estimates of
creditor losses and the bankruptcy system's costs in 1997? See ``The
Financial Costs of Personal Bankruptcy'' Letter from Associate Director
Richard Stana to the Honorable Martin T. Meehan, GAO/GGD-98-116R.
$4 billion is an approximation that comes from a analysis of
several studies that report similar conclusions. In addition to the
WEFA study, the Ernst & Young study of nationwide sample of petitions
drawn from 1997 filings concluded that those affected by means-testing
would have had the ability to repay 64% of their unsecured nonpriority
debts, which represented over $4 billion. See Tom Neubig & Fritz
Scheuren, Ernst & Young, Chapter 7 Bankruptcy Petitioners' Ability to
Repay: The National Perspective, 1997 (March 1998). That report further
concludes that ``the WEFA estimates may have understated the amount of
debt in the system, and consequently, may have underestimated the
financial costs of the personal bankruptcy system.'' While other
studies do not directly state the amount of money that would be
captured by means-testing, it is a matter of simple mathematics to
calculate the amount recoverable as a result of means-testing. These
earlier conclusions were based on the provisions of last session's
House bill, H.R. 3150. I am not aware of any studies of sufficient
scope and credibility that would cast doubt on the conclusions drawn
from a meta-analysis of these several studies.
Subsequent to my testimony, Ernst & Young released a new study that
applies the provisions of the current bill H.R. 833 and revises its
conclusions to conclude that those affected by the means-testing
provisions of H.R. 833 would be able to repay $3 billion of their
unsecured nonpriority debts over five years.
Upon reviewing these various studies, the Government Accounting
Office concluded that the studies of the Credit Research Center and
Ernst & Young ``[b]oth . . . represent a useful first step in
addressing a major public policy issue--whether some proportion of
those debtors who file for personal bankruptcy under chapter 7 of the
bankruptcy code have sufficient income, after expenses, to pay a
`substantial' portion of their outstanding debts.'' The GAO also notes
that actual number of chapter 7 debtors who could repay at least a
portion of their nonhousing debt ``could be more or less than the
estimates of these two studies. Similarly, the amount of debt these
debtors could potentially repay could also be more or less than the
reports estimated'' (emphasis added). Thus, according to the GAO, the
studies may underestimate the total number of filers who could repay a
substantial amount of their debt. Given that the authors of those
reports deliberately made conservative estimates of repayment ability,
it is more likely that they understate rather than overstate their
results. Not only that, but GAO's reasons for suggesting that the
findings of repayments ability are overstated is implausible on its
face. For further discussion of the problems with GAO's assumptions,
see Edith H. Jones and Todd J. Zywicki, It's Time for Means-Testing,
1999 BYU L. L. Rev. at n.67.
Question 2. You testified that ``95% of Chapter 7 bankruptcy
filings make no distribution at all to unsecured creditors, and those
that do rarely pay out more than a trivial amount'' and went onto
suggest that creditors receive a much larger payout in chapter 13
cases. However, VISA U.S.A. studies the Creighton University
reaffirmation study indicate that a substantial portion of chapter 7
debtors reaffirm their debts and thus continue to pay one or more of
their unsecured debts, notwithstanding the fact that they have no
nonexempt property to be liquidated in the course of the bankruptcy
case. The chapter 13 plan completion rate is low, and many times plans
are terminated before payments to unsecured creditors are commenced.
Moreover, some plans are 0% plans and never intend to pay unsecured
creditors at all.
Question (A) Do these factors affect your comparison of the
benefits of the two chapters?
As an initi matter, it is not clear to me why reaffirmed debt
should be considered a ``distribution'' to unsecured creditors. It
would seem more sensible to think of amounts paid due reaffirmations as
exactly that, rather than as distribution in the chapter 7 case, which
would relate to payments made on claims through the chapter 7 case.
Otherwise, the overall chapter 13 failure rate and the existence of
0% plans does not alter the conclusion that in general chapter 13 pays
larger distributions to creditors than chapter 7 cases. It's a matter
of common sense. In chapter 7, neither high-income nor low-income
debtors make significant distributions to creditors. In chapter 13, by
contrast, high-income debtors will make distributions even if low-
income debtors do not. Ceteris paribus, larger amounts will be
distributed in chapter 13 because the distribution as a result of high-
income filers being forced to pay will be larger than the amounts these
debtors would distribute in chapter 7. It follows that by forcing high-
income debtors to file chapter 13, means-testing will target exactly
the class of debtors from which these larger payouts are available.
The overall chapter 13 failure rate is irrelevant to a comparison
of the benefits of the two chapters as they relate to those covered by
means-testing, namely high-income debtors who have the ability to repay
a substantial portion of their debts without significant economic or
other hardship. Debtors currently file chapter 13 for a variety of
reasons, most of which have nothing to do with their ability to repay
in chapter 13. For instance, debtors often use chapter 13 to take
advantage of the automatic stay and to repay mortgage arrearages. Once
they do, the case is dismissed and the case is listed as a ``failure,''
even though there was not anticipation from the beginning that the plan
would be completed. Other cases involve low-income or debtors with
irregular income-earning patterns who mistakenly or ill-advisedly file
chapter 13. It is unclear how many chapter 13 filers fit the profile of
those subject to means-testing; high-income debtors with regular
employment who are forced in chapter 13 specifically because of their
ability to pay a substantial portion of their debts, and not for the
various other reasons that often lead people to file chapter 13.
Question (B) Do you have any data to make a more complete
comparison between the payouts from chapter 7 and chapter 13 debtors?
The basic conclusion that distributions to creditors in chapter 7
are small is well-established. See Michelle J. White, Personal
Bankruptcy Under the 1978 Bankruptcy Code: An Economic Analysis, 63
Ind. L. J. 1 (1987); Michael J. Herbert & Dominic E. Pacitti, Down and
Out in Richmond, Virginia: The Distribution of Assets in Chapter 7
Bankruptcy Proceedings Closed in 1984-87, 22 U. Rich. L. Rev. 303
(1988); Note, A Reformed Economic Model of Consumer Bankruptcy, 109
Harv. L. Rev. 1338 (1996) (discussing several studies of distributions
made in chapter 7 cases). Several studies in the past year or so have
identified the substantial recoveries available as a result of forcing
high-income debtors to file under chapter 13 rather than chapter 7.
Question 3. You testified that the reach of means-testing is small
in terms of the number of filers impacted but that its impact would be
large in terms of the amount of money collected. In light of this view,
do you believe that it is necessary or efficient to review all cases
for ability to pay under the means test, even cases of debtors with
income below the poverty level, as section 102 of H.R. 833 currently
requires?
This question appear to be based on confusion regarding the
provision of section 102 of H.R. 833. Section 102(b)(2) of H.R. 833
requires the trustee to bring a motion to dismiss or convert only if
the debtor's income is above the national median income and the other
means-testing criteria are met. If the debtor's income is below the
national median income, then means-testing is irrelevant and the
trustee would not be required to review for ability to pay under the
means test.
Question 4. Your testimony suggests that a means test should
identify those debtors with high incomes who could repay creditors,
such as the doctor in the case of In re Kornfield, 164 F.3d 778 (2d
Cir. 1999). Your testimony also suggests that although the current
system has been successful in denying relief to debtors such as Dr.
Kornfield, current law permits those debtors to continue to contest the
denial of relief by filing and litigating appeals. You probably would
get little or no argument from debtor advocates that individuals like
Dr. Kornfield may not be deserving of chapter 7 relief. However, some
observers have questioned whether the means test in H.R. 833 will
actually be able to catch someone like Dr. Kornfield; after all, an
individual with his sophistication and legal resources will be able to
inflate and shape his debts and expenses to escape the means test.
I have not suggested that anyone should be ``denied [bankruptcy]
relief.'' I have argued that bankruptcy relief should be conditioned in
some cases on the repayment of one's debts to the best of one's
ability, and that one such case is that of a high-income debtor who can
repay a substantial portion of his debts with no significant financial
or other hardship. H.R. 833 would not deny relief to any debtor,
although it would limit access to chapter 7 by some debtors, and would
force them to seek relief under chapter 13 instead of chapter 7.
The current system has not been successful in systematically
preventing abuse by debtors such as Dr. Kornfield. In Dr. Kornfield's
particular case, the system worked to dismiss his case for substantial
abuse, but only after great delay, expense, and litigation. This should
not be read as an endorsement of the current system of policing abuse
under Sec. 707(b), a system that is racked with nonuniformity,
uncertainty, and real and perceived unfairness.
Question (A). Do you agree that the means test in H.R. 833 provides
leeway for wealthy and savvy individuals, the Dr. Kornfields of the
world, to escape the means test?
Clearly, some wealthy and savvy individuals will attempt to escape
the means-test, just as they do under current law. Means-testing is not
a panacea that will prevent all bankruptcy abuse by high-income
debtors. But by replacing the wide-ranging discretionary standard of
current Sec. 707(b) with a more objective rule of decision, means-
testing will certainly reduce the leeway for wealthy and savvy
individuals to abuse the bankruptcy system. Thus, means-testing should
not be expected to completely eliminate bankruptcy abuse, but it should
significantly decrease it.
Moreover, even if a strategic debtor is able to evade the means-
test, the benefit would be small; i.e., he would just get to file under
chapter 7 rather than 13. Thus, ``benefit'' would be to put him right
back where he is under current law, in chapter 7. Means-testing might
be rendered irrelevant by bankruptcy planning, but it would not make
matters worse. This question apparently does not take account of H.R.
833, section 102(3)(B) which supplements the means-test with
discretionary power to find abuse when the ``totality of
circumstances'' requires. A strategic attempt to shape assets and
liabilities in a manner designed to evade the means-test would plainly
constitute abuse under this ``totality of circumstances'' test and the
traditional Sec. 707(b) standards. This question also ignores the fact
that if the debtor did succeed in getting himself into chapter 7 under
such circumstances, he would still have to contend with the traditional
nondischargeability objections associated with ``loading-up'' on debt,
such as fraud and certain expenditures on luxury goods. Similarly, if
he increased his secured debt in an attempt to evade discharge, he
would be bound to the higher secured debt in chapter 7, so the strategy
would be largely self-defeating.
Question (B). How would H.R. 833 prevent Dr. Kornfield from taking
several appeals as he did under current law? After all, with his legal
resources, he could contest the ``other necessary expense'' category of
the IRS collection allowances, which are determined on a case by case
basis, and he could contest any determination of whether he had
``extraordinary expenses.''
H.R. 833 would not prevent Dr. Kornfield from taking several
appeals. But it would significantly reduce the incentive for Dr.
Kornfield to take appeals, as the legal rule would be far more well-
defined than the murky discretionary standard of the current law. Thus,
the results of the appeals process would be much more predictable and
uniform, thereby eliminating much of the incentive for appeal. H.R. 833
would also reduce the costs associated with reviewing cases on appeal.
As the question itself suggests, the issues raised by means-testing
would be much more narrowly defined than under current law, and thus
the factual inquiry would also be much more narrowly tailored and
predictable than under current law. Unless the debtor could fit his
desired expenses within one of the enumerated categories, he will be
unable to prevail. Again, this is an improvement over the rule-less
unlimited discretion of the current regime where almost anything goes
in an evidentiary hearing. Finally, the question suggests that the IRS
approach of determining and reviewing ``other necessary expenses'' on a
case-by-case basis would also be the practice in bankruptcy. This does
not appear to be the case with H.R. 833, as H.R. 833 only requires that
the expenses be actual necessary expenses, it does not require them to
be proven as ``other necessary expense'' as the IRS would require.
Question 5. You testified that the 1978 Code significantly reduced
the economic costs and increased the economic benefits of filing
bankruptcy. However, the Code was tightened with amendments proposed by
the credit industry in 1984, only to be followed by a sharp increase in
filings notwithstanding decreased debt relief. How do you explain this
trend?
Multiple scientifically-controlled studies have concluded that the
1978 Code reduced the economic costs and increased the economic
benefits of filing bankruptcy, and that the result was an increase in
bankruptcy filing rates. I am not aware of any scientifically-
controlled studies that have concluded that the 1984 amendments led to
increased bankruptcy filing rates. Correlation is not causation; a
``trend'' by itself proves nothing at all. It is impossible to draw any
conclusion about the effects of the 1984 amendments unless we can
establish with reasonable certainty what the filing rate would have
been absent the 1984 amendments. For instance, filing rates may have
increased absent the 1984 amendments for completely unrelated reasons,
and the 1984 amendments may have caused this rate of increase to be
lower that it would have been absent the 1984 amendments. I am aware of
no credible study that has attempted to isolate the effects of the 1984
amendments on bankruptcy filing rates.
Question 6. You testified that economist Michelle White estimates
that 15%-20% of American households would financially benefit from
filing bankruptcy, especially if they engaged in some planning prior to
filing. Since a far smaller percentage of American households file for
chapter 7 bankruptcy, doesn't this mean that bankruptcy still carries
stigma sufficient to deter the vast majority of families who would
benefit from filing?
Yes, absolutely. And well it should, as trust, promise-keeping, and
reciprocity provide the foundations of a free economy and healthy civil
society. Thus, a desire to keep promises and reciprocate are embedded
in our consciousness and moral principles. We feel shame when we break
promises and it is appropriate that there is a stigma associated with
such an act, as it is a moral; as well as a legal and economic act. And
it is almost certainly the case that the residual effect of these
principles explains why so few people file bankruptcy even when it is
to their financial benefit.
But shame and stigma operate at the margin to constrain
individuals, they are not absolute concepts. If the economic benefits
of filing rise high enough, some people will consider filing bankruptcy
who might not have done so previously. Similarly, if the social
disapproval associated with bankruptcy falls, some people will consider
filing who would not have filed when social approval was greater. Thus,
it should not be surprising that a recent study concludes that the
constraining effect of filing bankruptcy traditionally has been largest
for the very high-income filers who can capture the greatest economic
benefit from filing bankruptcy.
Given this, it is not clear why the ``vast majority'' is the
appropriate benchmark for determining the residual effect of stigma on
restraining bankruptcy filings. Given the corrosive effect of
opportunistic bankruptcy filings and the opportunistic promise-breaking
that such filings represent on the economy and on civil society
generally, it is not clear why we would tolerate more than the absolute
minimum of such opportunistic behavior in society and in the economy.
Question 7. Your testimony indicates that you believe that
individual who borrow money or purchases an item should be required to
repay it. Drawing the analogy between bankruptcy and shoplifting, you
state that ``you shouldn't take it if you aren't going to pay for it.''
This paragraph reflects a fundamental confusion about my testimony.
My analogy is between unnecessary bankruptcy losses and shoplifting. I
will repeat the relevant passage from my Statement of March 11, 1998
(page 5): ``Who are the beneficiaries of means-testing? We all are. To
see why, consider that although few of us actually own retail shopping
stores, all of us oppose shoplifting and believe that it should be
forbidden. The reason why we support laws against shoplifting are
analogous to the justification for means-testing.'' The analogy is
clearly between shoplifting and means-testing, not shoplifting and
bankruptcy generally.
Question (A). If this is the case, do you think that Congress is
wrong to provide a discharge in bankruptcy at all?
That is not the case. I am not opposed to a discharge. I am in
favor of placing a condition of repayment to the best of one's ability
for high-income debtors who can repay a substantial portion of their
debts with no significant financial or other hardship.
Question (B). Should society recognize that changed economic
circumstances caused, for example, by illness, disability, divorce, or
loss of employment might make it impossible for consumers to satisfy
debts they had every intention of paying when they incurred them?
Yes.
Question (C). Are you concerned that the lack of a bankruptcy
safety valve will hamper entrepreneurs, who currently comprise one in
five consumer bankruptcy filings, from engaging in the appropriate
level of risk-taking activity?
I am unfamiliar with the claim that one in five consumer bankruptcy
filing are failed entrepreneurs, and am very skeptical about that
number. Clearly self-characterizations in interviews be self-proclaimed
entrepreneurs would not provide a suitable basis for the conclusion.
More fundamentally, I am confused as to the premise of the question.
Eliminating a bankruptcy safety valve would undoubtedly reduce risk-
taking, just as eliminating limited liability for corporations would
reduce risk-taking. I am not aware of any efforts to eliminate
bankruptcy generally, nor am I aware of any efforts to eliminate the
discharge or the fresh start. Thus, I am somewhat confused as to the
premise and purpose of the question.
Question 8: You state in your testimony that ``a borrower's
willingness to take on debt clearly will be related to the ease with
which he can later discharge those debt obligations if he chooses to do
so.'' This statement assumes that consumers incur obligations with the
understanding of their true costs. Some economists believe that many
consumers systematically underestimate the extent of their borrowing
and the cost of repayment and therefore make sub-optimal borrowing
decisions. If this is the case, changing the bankruptcy law will not
affect the borrowing decisions of many consumers. To enable consumers
to make more rational borrowing decisions that will be less likely to
lead them into financial distress, particularly if the bankruptcy laws
are going to be tightened and consumer credit remains freely flowing,
do you believe that open end credit should be accompanied by additional
disclosures that reveal to the potential borrower the actual costs of
credit?
The assumption of this question appears to be the complete opposite
of that in question 7. In question 7 it was assumed that if bankruptcy
relief was restricted, then individuals would take fewer risks for fear
of incurring nondischargeable losses. This question appears to assume
that a borrower's willingness to incur debt and risk losses will be
unaffected by its dischargeability in bankruptcy. Despite these changes
in the factual predicate of the question, my answer remains the same;
the willingness of individuals to incur debt will to some extent be a
function of their ability to discharge that debt in bankruptcy.
The belief among ``some economists'' that individuals
systematically underestimate the extent of their borrowing and
repayment obligations has been proven incorrect in recent years. The
premise for this view seems to be rooted in the dubious and outdated
research of economist Lawrence Ausbel's in his 1991 article in the
American Economic Review. Virtually every element of Ausbel's research
has been shown to be flawed, dated, or both. The basic methodology used
to collect the data that underlies the so-called ``underestimation
hypothesis'' has been criticized. See Thomas F. Cargill & Jeanne
Wendel, Bank Credit Cards: Consumer Irrationality versus Market Forces,
30 J. Consumer Aff. 373, 375-77 (1996). For instance, Ausubel
dramatically overstates the number of consumers who revolve balances
from month-to-month. The Survey of Consumer Finances indicates that
approximately 68% of households report that they nearly always pay
their credit card balances in full. Even where Ausubel's methodology
for collecting data passes muster, the conclusion of chronic
underestimation by consumers is simply not a plausible conclusion to
draw from the data he collects. See Dagobert L. Brito & Peter R.
Hartley, Consumer Rationality and Credit Cards, 103 J. Pol. Econ. 400
(1995). For instance, Ausubel makes no attempt to distinguish so-called
``irrational'' credit revolving from ``rational'' use of credit cards
to finance short-term swings in consumption or as an attractive form of
short-term borrowing (compared to alternative sources of low-
transaction cost short-term borrowing). I am not aware of any effort on
Ausubel's part to respond to the criticisms of his research that have
been launched by Cargill & Wendel or Brito & Hartley. I have personally
contacted him to see if he intends to respond, but I have received no
response. In short, at the current time, there is little reason to
believe that the underestimation hypothesis has any validity
whatsoever.
Moreover, the proposition begs common sense. Short-term consumer
credit seems like an unusual scenario for the underestimation
hypothesis to arise, when compared to more plausible situations. For
instance, student loans and mortgages would seem to raise the
underestimation hypothesis more powerfully, as both forms of credit are
for much longer repayment terms, sometimes as much as 15-30 years.
Similarly, yearly tax obligations are also much larger than consumer
debt burdens, yet we force individuals to anticipate their tax
obligations and pay them. In all of these situations the complexity and
size of the obligations, combined with the length of time for repayment
suggests that the underestimation hypothesis would seem to be far more
troublesome than on monthly consumer credit payments.
Given that the underestimation hypothesis has little theoretical or
empirical support, it is not clear what difference additional
disclosures would make. Consumers appear to be well-aware of how much
debt they are incurring and know exactly where they are spending it. If
individuals are capable of anticipating and paying their student loans,
mortgages and taxes they certainly are able to anticipate their monthly
credit card bill. Credible empirical studies confirm this.
Question 9. You testified that consumer credit is not to blame for
the bankruptcy filing rate. The credit industry witnesses agreed with
you, noting that credit card debt is only 3.7 percent of consumer
credit overall and bank card debt (presumably a subset of all card
debt) is only 16% of all debt (including secured debt) in bankruptcy.
However, don't these numbers alone indicate that the individuals and
families who ultimately resort to bankruptcy have inordinately high
credit card debts as compared to the population as a whole?
I am not sure what the term ``inordinately high'' means. I have a
Master's degree in economics and have studies statistics and
econometrics, and I am familiar with the term ``statistically
significant'' which is a term that suggest certain statistical
safeguards designed to make sure that the results of such a comparison
have meaning. Given that the comparison stated does not appear to be
the result of a study designed to elucidate ``statistical
significance,'' I am wary of drawing any conclusion one way or the
other from this data.
Even if the data established that those in bankruptcy have higher
credit card debts than those who are not, its not clear what that would
prove. If it were true that credit card debt is correlated with
bankruptcy filings, this would not prove that excessive credit card
debt caused bankruptcy filings. For instance, high credit card debt
might simply reflect reckless and irresponsible spending, in which case
the spending would be a more plausible cause of bankruptcy than the
credit cards. Obviously no conclusion could be drawn about the causal
role of consumer debt in bankruptcy without adjusting for overall
levels of home debt and multiple other factors. The theory is also
lacking in a persuasive causal link between changes in the absolute
level of credit card debt, as opposed to current debt levels that
account for such variable and changes in the interest rate.
Question 10. You testified that ``the credit card industry has
revealed itself to be ferociously competitive.''
Question (A). If that is the case, why have average interest rates
on credit card hardly varied over the past 2 decades since the industry
was functionally deregulated by the Marquette Supreme Court case, even
though the cost of funds declined dramatically in this period?
As an initial matter, it is unclear to me what the term ``hardly
varied'' means. Does it include very low ``teaser'' rates that many
cardholders avail themselves of when they change cards? Without more
information as to what that term means, it is difficult for me to even
conclude that the factual predicate to the question is correct.
This question reflects several misunderstandings about the nature
of the credit card market. As an initial matter, it is hard to imagine
a market more competitive than the credit card market, which as of a
recent count had 6,000 card issuers and millions of customers. The
intense competition between card issuers to attract clients is probably
best-evidenced by the massive volume of direct mail that card issuers
send each year in an attempt to induce cardholders to shift from one
card to another. As Brito and Hartley write, ``Several authors . . .
have argued that even though the market for bank credit cards is
unregulated, has thousands of independent firms, many of them recent
entrants, and has millions of consumers, it nevertheless appears to be
noncompetitive.'' Indeed, the intense competition in the 1990s due to
the entry of new issuers such as AT&T, Household and First USA,
generated a precipitous loss of market share for the incumbent card
issuers such as Bank of America, Chase, and others. Consider the
following discussion from Credit Card Management magazine: ``Issuers
need look back no further than the onset of the 1990s for a textbook
case of such an occurrence. At the time, money center banks were the
dominant issuers, thanks to the resources brought on by their size.
Despite their power, they have become lethargic, charging interest
rates of 18.9% or 19.8% and $20 annual fees for plain-vanilla cards.
When the speciality card issuers, such as Household, AT&T, and First
USA, began shaking up the business with contrarian marketing strategies
that eliminated annual fees, slashed interest rates, and offered
cardholders rich rewards for using their cards, the money centers were
not creative enough to counter the assault on their domain.'' Thus, it
is evident from the basic market structure of the industry that the
credit card market is highly competitive.
Looking to changes in interest rates is not a sensible way to try
to gauge the competitiveness of the market. Card issuers have added
many benefits to their cards in the past decade, ranging from the
spread of ``affinity'' cards, to co-branded cards that give frequent
flyer miles, to cash back bonuses in some cases. Looking only at
interest rates and ignoring the benefits that have arisen would be
comparable to saying that the automobile industry is noncompetitive
because sometimes automobile manufacturers improve the quality of their
product rather than simply cutting the price. Such a conclusion would
obviously be incorrect when applied to cars, and it is equally
incorrect when applied to credit cards. Looking only at interest rates
is also problematic in that ignore the serious adverse selection
problems that would accompany a ``low interest rate'' marketing
strategy; thus, issuers might be expected to increase benefits and
decrease other fees rather than reducing interest rates in response to
a fall in the cost of funds rate.
The question also overstates the role of the Marquette decision in
the development of the credit card market. Usery regulations have been
on the books throughout world history, and they have been easily
circumvented throughout world history. The American experience is no
different. Prior to Marquette, credit card issuers charged annual fees
of $20 or $30 that were implicit compensation for the interest caps
placed on credit cards. Of course, all customers were forced to pay
this fee, even those who paid their bills every month. Similarly,
retailers such as Sears were able to ``hide'' their interest rate
losses in the prices of the goods they sold. The effect of the
Marquette decision simply converted these hidden interest charges into
more direct charges and allowed card issuers to target interest fees
toward those who revolved balances rather than imposing them on
everyone in the form of an annual fee. Focusing on interest rates
ignores the reality that the almost complete elimination of annual fees
during the past decade was really a de facto fall in the interest rate
on credit cards.
There are other problems with looking at interest rates a proxy for
competition in the credit card market. Because the vast majority of
users are convenience users who pay their bills each month, they have
little concern about credit card interest rates and would be willing to
sacrifice the benefit of a lower interest rate in exchange for the
elimination of an annual fee or the addition of an ancillary benefit
such as frequent flyer miles. Thus, offering these benefits rather than
an interest drop reflects competition. Focusing on the relationship
between cost of funds and credit card interest rates is also misguided
because it fails to account for the large ``fixed costs'' associated
with credit cards, such as its much higher transaction costs due to the
nature of credit cards as relatively small credit transactions. Finally
focusing on interest rates reflects a fundamental misunderstanding of
the consumer ``demand'' side of credit card transactions. I refer you
to my article with Judge Jones for a further explanation of these
issues, see Edith H. Jones and Todd J. Zywicki, It's Time for Means-
Testing, 1999 BYU L. Rev.
Question (B). Why have profits in the consumer credit consistently
exceeded profits for all other lending activities?
This question is based on an incorrect factual predicate. Through
the 1980s, returns for commercial credit were larger than for other
sectors of banking activity. This was partly because returns to other
sectors were artificially low due to passing problems such as a foreign
debt crisis, energy sector borrowers, and commercial real estate
markets, all of which struggled during the 1980s and early 1990s. It
was also partly because the early issuers into the bank card market
during the 1980s made unusually large profits that are typical in any
major transitional period in an industry.
As applied in recent years, however, the question is simply
incorrect in its factual predicate. In recent years, profit returns for
consumer credit have been comparable to other sectors of the banking
industry. Moreover, risk-adjusted profits are significantly lower, as
credit card loans are riskier than other forms of credit; as a result,
issuers maintain significantly higher average equity to asset and loan
loss reserves to total loan ratios than for other operations. Finally,
studies that purport to show disproportionate returns to consumer
credit operations usually draw on an artificially limited sample of
issuers that tends to ignore those issuers who have been losing money
during this period. Thus, while it is true that until the early 1990s,
consumer credit operations may have been higher than other sectors,
since then those supranormal returns consumer credit operations is a
myth.
Question 12. As further support for the proposition that the time
has come for means testing, you testified: ``Access to credit cards are
especially important for low-income borrowers, as they lack the options
of more wealthy borrowers.'' However, the means testing provision is
one of dozens of changes to the consumer bankruptcy system in the
pending legislation. Some of the provisions in the bill will decrease
the amount of the debtor's income available for payment of unsecured
debt in chapter 13, and in fact may further suppress the chapter 13
plan completion rate. How will these provisions affect the cost of
unsecured credit and its availability for low income borrowers?
To the extent that means-testing reduces the financial losses
associated with bankruptcy, ti will also reduce the overall
``bankruptcy tax'' paid by all Americans. Lower-income borrowers will
benefit as well as everyone else.
Question 13. As a professor who has argued vigorously in favor of
retaining disinterestedness requirements on chapter 11 debtors' lawyers
to ensure that they act in their clients' best interests, do you
believe it is appropriate for the bill to impose financial
disincentives on lawyers to help their debtor clients file for chapter
7 if those lawyers believe that the debtor is an eligible candidate for
chapter 7 and that it is in the best interest of the debtor to seek
that relief?
It is not fully clear to me what ``financial disincentive to file
chapter 7s'' is referenced in this question. I will assume that the
question refers to the provisions that would require the debtor's
counsel to reimburse the trustee for all reasonable costs and
attorney's fees if the debtor's filing was not ``substantially
justified'' and provisions for enforcing Rule 9011. If that is the
case, it seems strange to refer to these ethical requirements as a
``financial disincentive.'' Clearly these rules provide a financial
disincentive for a debtor's attorney to file frivolous chapter 7 cases
and to file cases where the debtor's lawyer fails to perform even a
modicum of investigation into the debtor's financial affairs. Rule 9011
also gives a debtor's lawyer a financial disincentive to engage in
fraudulent or other inappropriate activity, even if it is the client's
best interests. The requirements of the proposed legislation require
the debtor's lawyer to balance his ethical obligations to the debtor
with his ethical obligations to the court and his fiduciary obligations
to creditors. All lawyers balance these competing ethical obligations
every day, and it is not clear why bankruptcy lawyers should be
relieved of this obligation, or why it is useful to refer to ethical
obligations as ``financial disincentives to file chapter 7s'' as
opposed to ``financial incentives to ensure that chapter 7 filings are
made in good-faith and after reasonable investigation by the debtor's
counsel.''
Question 14. As a professor who has studied the bankruptcy system
closely, do you see any creditor abuses in the system that should be
addressed in bankruptcy reform legislation? If so, what are they?
To the extent there are creditor abuses in the system, they appear
to have already been addressed or are addressed in H.R. 833. For
instance, creditors who file false claims are already subject to
punishment as are those who act illegally with respect to
reaffirmations, as well-evidenced by the Sears case. Creditors are
already subject to fee shifting for improper objections to discharge.
There are additional debtor protections in the pending legislation. To
the extent that creditors make ill-advised extension of credit to
unworthy borrowers, the market will punish them through higher losses
than their competitors. Finally, creditors that engage in abusive
credit practices or overreach with their customers will find themselves
disciplined through their customers switching to other credit issuers,
different forms of credit, or substituting to non-credit alternatives,
such as checks and cash.
__________
Professor Elizabeth Warren's Responses
Harvard Law School,
Cambridge, MA, March 26, 1999.
Hon. Henry J. Hyde, Chairman,
Committee on the Judiciary,
House of Representatives, Washington, DC.
Dear Congressman Hyde: Thank you for providing me with the
opportunity to appear before the Joint Hearing of the House
Subcommittee on Commercial and Administrative Law and the Senate
Subcommittee on Administrative Oversight and the Courts on Bankruptcy
Reform on March 11, 1999.
Attached is my response to the questions posed by Senator
Torricelli as followup questions to the Joint Hearing.
If there is any way in which I can be of further assistance, please
let me know.
Very truly yours,
Elizabeth Warren,
Leo Gottlieb Professor of Law.
responses to senator torricelli's followup questions
Effects on Women and Children
During 1997, an estimated 300,000 bankruptcy cases involved child
support and alimony orders.\1\ In about half of these case, women were
creditors trying to collect alimony and child support from their
bankrupt ex-husbands and others. In about half, women filed for
bankruptcies themselves as they tried to stabilize their post-divorce
economic condition. In the past five years, well over a million women
collecting alimony and child support have been involved in bankruptcy
cases.
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\1\ The reported data are from Health and Human Services (support
data) and the Consumer Bankruptcy Project, Phase II (bankruptcy data).
Principal researchers for the bankruptcy data are Dr. Teresa Sullivan,
Vice-President of the University of Texas, Professor Jay Westbrook,
Benno Schmidt Chair in Business Law, University of Texas, and Elizabeth
Warren, Leo Gottlieb Professor of Law, Harvard Law School. These
estimates are based on data collected in 1991 in sixteen judicial
districts around the country. For more details about the study, see
Sullivan, Warren and Westbrook, Consumer Debtors Ten Years Later: A
Financial Comparison of Consumer Bankrupts 1981-91, 68 American
Bankruptcy Law Journal 121 (1994). For a more detailed discussion of
the divorce data see Sullivan, Warren, Westbrook, Bankruptcy and the
Family, 21 Marriage and Family Rev. 193 (Haworth Press 1995). The data
reported here will be discussed in fuller detain in Sullivan, Warren
and Westbrook, The Fragile Middle Class (Yale University Press
forthcoming 1999).
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Current law helps support recipients collect their debts after
bankruptcy. It makes alimony and support obligations nondischargeable
and provides a discharge of most other debts as long as they were not
incurred fraudulently. The support provider emerges from bankruptcy
economically stabilized and more easily able to meet ongoing support
obligations and make up prebankruptcy support obligations. The pending
legislation, largely supported by the credit card companies, makes more
credit card debt nondischargeable and creates greater leverage for
reaffirmation of unsecured and nominally secured debt (e.g., retailer
charge cards). There are only a limited number of dollars available for
collection from ex-partners. These women face stiffer competition from
credit card issuers who are trying to collect from the same people,
whether or not the support recipients can rely on government agencies
to help them enforce their rights.
In addition, may divorced women file for bankruptcy themselves to
deal with crushing debts. These debts may have been incurred only by
the ex-husband but are legal obligations of the ex-wife as well.
Provisions making more debt nondischargeable and making bankruptcy less
accessible will hurt every one of these women who turns to bankruptcy
for some economic stability and relief from debts she did not incur.
Reaffirmations
Debtors should be free to repay debts if they so choose, whether or
not those debts have been discharged, and they are free to do so under
current bankruptcy law. However, the system currently permits debtors
to bind themselves to repay those debts through reaffirmation
agreements. Many reaffirmation agreements, even technically legal one,
are the product of creditor coercion, are not voluntary, and are
inconsistent with the purpose of chapter 7 debt relief. Currently, the
law relies on attorney affidavits as evidence that debtors understand
their rights and that the reaffirmation does not impose an undue
hardship on the debtor and his family. The attorney affidavit approach
has, for the most part, been a failure.
I attach letters from the Sears case, which are a matter of public
record. These reaffirmations were illegal because Sears failed to file
the agreements with the court. The tactics used to obtain these
``voluntary'' agreements that these debtors describe are not at issue.
Every day, ``legal'' and ``voluntary'' reaffirmation agreements are
filed with the court that will impose an undue hardship on the debtor
and his family after bankruptcy.
It is easy to understand why a creditor wants the debtor to be
legally bound to pay debts after bankruptcy, and why an emotionally and
financially vulnerable debtor is convinced to comply. Given the
dynamics of the situation, self-policing has not worked.
Pending bankruptcy legislation makes a bad situation worse. It is
filled with provisions that give creditors additional leverage to
pressure debtors to reaffirm debts and to increase the size of the
reaffirmations to include more fees and charges. At the same time, it
is devoid of provisions to offers meaningful protection for debtors
pressed to make reaffirmations of unsecured and nominally secured
debts.
The Effects of Credit Cards on Personal Failure
The basic link between consumer debt (primarily short-term, high
interest credit card debt) and bankruptcy has been demonstrated again
and again. Studies by an economist at the Congressional Budget Office,
the Federal Deposit Insurance Corporation, and independent economists
link the rise in consumer bankruptcies directly to the rise in consumer
debt.\2\ The growth of credit card loans has been faster than any other
type of consumer loans since 1993. Credit card debt doubled in just
four years: The amount of credit card loans outstanding at the end of
1997 was $422 billion, twice as must as the amount in 1993.\3\ The
credit industry's own statistics support the hypothesis that people in
bankruptcy have credit card debts substantially higher than the
population at large. An MBNA representative testified on March 11, 1999
that bankcard debt alone is 16%of all debt in bankruptcy, including
secured debt such as home mortgages. Assuming that this number is
accurate, it is far higher than the percentage of credit card debt
among total consumer credit outstanding--suggesting that credit card
debt is an important trigger for bankruptcy.
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\2\ Diane Ellis, Division of Insurance, FDIC, The Effect of
Consumer Interest Rate Deregulation on Credit Card Volumes, Charge-
offs, and the Personal Bankruptcy Rate, Bank Trends 98-05 (March 1998);
Lawrence Ausubel, Credit Card Default, Credit Card Profits, and
Bankruptcy, 71 Am. Bankr. L.J. 249 (1997); Statement of Kim Kowalewski,
Chief, Financial and General Macroeconomic Analysis Unit, Congressional
Budge Office, before the Subcommittee on Administrative Oversight and
the Courts, Committee on the Judiciary, United States Senate, p. 4
(April 1997); Jagdeep S. Bhandari & Lawrence Weiss, The Increasing
Bankruptcy Filing Rate: A Historical Analysis, 67 Am. Bankr. L.J. 1
(1993).
\3\ OCC Advisory Letter 96-7, September 26, 1996, (96-7.txt at
www.occ.treas.gov); FDIC Quarterly Banking Profile Graph Book, Fourth
Quarter 1997.
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Credit card usage has grown fastest in recent years among families
with the lowest incomes. Since the early 1990s, Americans with incomes
below the poverty level nearly doubled their credit card usage, and
those in the $10,000-25,000 income bracket come in a close second in
the rise in debt. The result is not surprising : 27% of the under-
$10,000 families have consumer debt this is more than 40% of their
income. Nearly one in ten has at least one debt that is more than sixty
days past due.\4\
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\4\ Federal Reserve Bulletin, Family Finances in the U.S.: Recent
Evidence from the Survey of Consumer Finances, Table 14, Aggregate and
median ratios of debt payments to family incomes, and shares of debtors
with ratios above 40 percent and those with any payment sixty days or
more past due, by selected family characteristics, 1989, 1992, and
1995; Peter Yoo, Charging up a Mountain of Debt: Accounting for the
Growth of Credit Card Debt, Review: Federal Reserve Bank of St. Louis,
p. 4 (March/April 1997); David Wyss, DRI/McGraw-Hill, ``Surveillance
Programs & Performance'' p. 8 (April 15, 1997).
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Subprime lending targets borrowers with poor credit records. Such
lending has become the fastest growing, most profitable subset of
consumer lending. Although losses are substantial, interest rates of 18
to 40% on credit card debt make this lending lucrative. In the subprime
automobile finance market, by charging interest rates of 15% to 25% on
secured car loans, several lenders have reported profit margins ranging
from 23% to 41%.\5\
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\5\ Dow Jones & Company, Inc. Capital Markets Report (Oct. 7, 1997)
(noting an increase from $80 billion in subprime loans in 1992 to $150
billion in 1996); Robyn Meredith, Will Ford Become the New Rep Man?,
N.Y. Times, A1 (Dec. 15, 1996); Life After Mercury: How to Pick a
`Safe' Used-Car Lender, Financial World, 40 (May 20, 1997).
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As card issuers target ever more vulnerable families, more people
file for bankruptcy. Their path to bankruptcy is generally more complex
than simply overspending on credit; when families' saving are being
consumed by credit card debt, they are less able to withstand economic
difficulties. A temporary job los, an uninsured medical bill, a divorce
create financial stress; for the family already loaded with debt, the
burden becomes unbearable.
Identifying the ling between debt and bankruptcy is not intended to
impart ``blame,'' but rather to show that lowering the bankruptcy
filing rate and default rate, if these are Congress' goals, will not be
accomplished by changing the bankruptcy laws. As long as the consumer
credit industry continues to distribute large amount of credit to the
most vulnerable sectors of the population and opposes requirements to
disclose the true cost of open end credit, the bankruptcy filing rate
and the default rate are not likely to decline.
Unintended Effects
The means test in H.R. 833 is designed to channel more high income
debtors toward chapter 13 if they can pay a portion of their debts.
This alone sounds relatively harmless, but is problematic for at least
two reason. First, the means test not only screens all debtors, but it
favors higher income debtors by giving them larger expense and debt
allowances, particularly if they have bought a new car on the eve of
bankruptcy. Thus, the means test in operation does not live up to its
image. Second, the bill decreases the likelihood that a debtor will be
able to repay creditors and discharge debts through a chapter 13 plan.
For example, debtors would be required to make ``adequate protection''
payments to lessors and secured creditors at the same time they are
paying all of their disposable income to the trustee; a debtor cannot
make the same payments twice, and will have to surrender the property
that he was trying to save through chapter 13. More debts would be
considered ``priority'' debts and thus must be paid in full in the 5
year plan as a condition of confirmation, regardless of the size of
those debts. Credit card debts would survive a five year repayment plan
if declared nondischargeable, thus debtors would expend resources
litigating nondischargeability that otherwise could be used to pay
creditors. New treatment of undersecured debts would consume most
debtors' disposable income and leave little or nothing for unsecured
creditors. Making matters more complicated, the managers' amendment to
H.R. 833 requires that chapter 13 payments be structured like the means
test, even though the means test may still fail to take account of
chapter 13 trustees' fees and back payments on secured debt. One is not
even eligible for chapter 13 repayment plans unless she attempted
consumer credit counseling within 90 days before filing.
There are two explanations for the conflicting messages in this
bill. One is that the bill is at war with itself due to inadvertence.
The second explanation is that this bill is not designed to increase
distributions in chapter 13 but rather to make bankruptcy unworkable
and altogether too expensive to be used by overburdened middle class
American families. If that is the goal, it should be stated and
accomplished directly rather than through this expensive piecemeal
approach.
Other consequences, perhaps unintended, go far beyond the limits of
the bankruptcy system. For example, some economists predict that making
the consumer bankruptcy system more restrictive will increase risky
lending and produce more defaults. In addition, one cannot
underestimate the effect of business bankruptcy amendments. Many of the
business provisions, such as those imposing absolute time limitations
where there were once none, will have a tremendous effect on the out of
court negotiations among various parties who bargained in contemplation
of a different set of legal rules.
Stigma
The consumer credit industry and others have blamed declining
stigma for consumer failures for more than sixty years. In 1933, for
example, it was the ``ease of the bankruptcy laws'' that attracted
debtors who could pay said those who urged tightening the laws.\6\
Those who want to blame rising bankruptcy filings on a lack of stigma
ask us to believe the worst about middle class families in deep
financial trouble.
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\6\ Victor Sadd & Robert T. Williams, Causes of Bankruptcy Among
Consumers p. 5, 8, 11 (Washington GPO 1933).
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If declining stigma were the reason for the increase in bankruptcy
filings, we would expect the average family in bankruptcy to have an
increasingly high income; more families in less trouble would say,
``Why struggle so hard? Bankruptcy is an easy answer.'' However, the
economic profile of debtors is not consistent with this theory. The
median income of the debtors who have filed for Chapter 7 has been
declining.\7\ In inflation adjusted dollars, the average family in
Chapter 7 in 1981 had an income of $23,254. By 1997, the average family
in Chapter 7 had an income of $17, 652. Moreover, their debt-to-income
ratios have worsened, not improved. If bankruptcy were easy, why
wouldn't it be attractive to people in better shape--rather than being
something people evidently avoid more now than ever before?
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\7\ Elizabeth Warren, The Bankruptcy Crisis, 73 Ind. L.J. 1079
(Harris Lecture) (1998).
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The data are collected in the table reproduced and attached to this
answer.
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