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Politics and Economy:
Americans and Debt
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Debating the Bankruptcy Reform Bill

On March 16, 2005, the House Judiciary Committee approved a Senate-passed bill to overhaul bankruptcy laws — the first major change in 27 years. The measure now moves on to the House for a vote in April and is expected to pass and be signed into law. The bill had stalled in previous Congresses because of a controversial amendment preventing abortion protesters from filing for bankruptcy to avoid paying court-ordered fines for violence at clinics. The Senate voted down that amendment last week.

Provisions of the New Bill

One of the most controversial aspects of the bill relates to a new means test to determine who may file under Chapter 7 and Chapter 13. Chapter 7 is a liquidation bankruptcy and includes the cancelation of debts. For individuals, Chapter 7 involves the sale of a debtor's nonexempt property and the distribution of the proceeds to creditors. Chapter 13 is a bankruptcy involving the adjustment of debts for someone with regular income and includes a court-mandated repayment plan for a portion of the debt.

The main provisions of the means test are as follows: People with insufficient assets or income could still file a Chapter 7 bankruptcy, which if approved by a judge, erases debts entirely after certain assets are forfeited. But those with income above the state's median income who can pay at least $6,000 over five years — $100 a month — would be forced into Chapter 13, where a judge would order a repayment plan. Under current law, a bankruptcy judge determines under which chapter of the bankruptcy code a person falls -- whether they have to repay some or all of their debt. Each state's median will be based on U.S. Census numbers but would have to be adjusted for inflation, and how to calculate that adjustment has not yet been defined. The Census Bureau's latest figures show state median incomes range from $55,912 in Maryland and $30,072 in West Virginia. According to THE WASHINGTON POST, "it is estimated that the proposed legislation would force 30,000 to 100,000 additional filers a year into Chapter 13."

The bill also:

  • Imposes new filing requiments on ALL filers.
  • Requires people filing for bankruptcy to pay for credit counseling.
  • Gives top priority to a spouse's claims for child support among creditors' claims on a debtor in bankruptcy.
  • Allow for special accommodations for active-duty service members, low-income veterans and those with serious medical conditions in the new income test for bankruptcy applicants.
  • Restrict the homestead exemption in states to $125,000 unless the person in bankruptcy bought his or her residence at least three years and four months before filing. Florida, Iowa, Kansas, South Dakota and Texas have unlimited homestead exemptions that allow wealthy people to file for bankruptcy and keep their mansions in those states sheltered from creditors. (Source: The Associated Press)

Critics and Champions

Some critics of the proposed reform contend that the bill, in the works for eight years, is out of step with today's climate of credit and debt. They also maintain that the new means test is "one size fits all" and doesn't take into account the myriad of reasons that lead people to seek bankruptcy.

Other critics point to perceived "loopholes" which seem to allow wealthier bankruptcy filers to protect more of their assets. The bill still allows exemptions for certain types of trusts created to shield money from creditors. Bankruptcy attorneys say that the provisions of the bill related to attorney responsibility will raise bankruptcy filing fees and discourage the practice of pro bono bankruptcy aid.

Proponents of the bill say that the great rise in bankruptcies necessitates tightening the rules. They point to people who seem to be "gaming" the system — filing for Chapter 7 when they don't deserve the "fresh start" it promises. The financial services industry says that it is then forced to pass the costs of bad debts on to the rest of the credit using community.

Read more about the debate below and discuss your thoughts on the topic.

"Being pro-debtor is not the same as being pro-consumer. When some people get a free-ride in bankruptcy, the rest of us are forced to pick up the slack. The overwhelming majority of Americans pay their Bills and live up to their financial responsibilities. But it should not be forgotten that those who pay their Bills inevitably have to pay more to make up for those who do not. Bankruptcy losses are a cost of business. Like all other business expenses, when creditors are unable to collect debts because of bankruptcy, some of those losses are inevitably passed on to responsible Americans who live up to their financial obligations."

- Todd J. Zywicki, Visiting Professor of Law, Georgetown University Law Center, Testimony before Senate Judiciary Committee, February 10, 2005

"The means test as written has another, more basic problem: It treats all families alike...If Congress is determined to sort the good debtors from the bad, then it is both morally and economically imperative that they distinguish those who have worked hard and played by the rules from those who have shirked their responsibilities. If Congress is determined to sort the good from the bad, then begin by sorting those who have been laid low by medical debts, those who lost their jobs, those whose breadwinners have been called to active duty and sent to Iraq, those who are caring for elderly parents and sick children from those few who overspend on frivolous purchases."

- Professor Elizabeth Warren Leo Gottlieb Professor of Law Harvard Law School Testimony before Senate Judiciary Committee, February 10, 2005

"Every year, bankrupts wipe $44 billion in debts clean off the books, according to the National Consumer Bankruptcy Coalition in Washington, D.C. The cost of wiping away all this debt usually is passed on to you and other consumers, costing the average American household as much as $550 each year in extra credit costs. Nearly 10% to 20% of bankruptcy filers are taking advantage of the system--racking up debts and then filing bankruptcy to avoid paying them--even when they have the means to do so, according to the coalition."

- Bankruptcy Abusers Hurt Everyone, Amy Manzetti, Credit Union National Association Inc.

"A large body of evidence links the rise in consumer bankruptcies in the last twenty years directly to an increase in consumer debt...Much of this lending boom was fueled by the extension of credit to vulnerable consumers including young people, lower income Americans and minorities and the elderly. Some lenders, such as those offering "predatory mortgage loans, target these borrowers with often deceptive offers that had abusive terms...There is nothing 'balanced' about this bill. It is unfortunate that creditors have used their political might to push through legislation that will limit access to a fresh start in bankruptcy for many who lose a job, get hit with a major illness or suffer other serious financial misfortunes."

- Consumers Union, 2005

Additional sources: "Bankruptcy bill leaves holes; Lawyers say new bill remains open to argument and interpretation," Kathleen Day and Caroline E. Mayer, THE WASHINGTON POST, March 23, 2005; "Debtor's Attorneys See Red in Bankruptcy Bill," Marcia Coyle, NEW JERSEY LAW JOURNAL, March 21, 2005; "Bankruptcy reform appears on its way," Joe Estrella, The Idaho Statesman, March 20, 2005; "Money Managing Your Money Digging a Deeper Hole," Jeff Kosseff and Julie Tripp, THE OREGONIAN, March 20, 2005; "Keeping Some Hiding Places," Albert B. Crenshaw, WASHINGTON POST, March 20, 2005; "Senate Passes Bill To Restrict Bankruptcy Credit Card Business Backed Measure to Collect More Debt," Kathleen Day, THE WASHINGTON POST, March 11, 2005.

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