DAVID BRANCACCIO: NOW on PBS:

New bankruptcy laws are on the way. What do they mean for working Americans?

ELIZABETH WARREN: When someone uses a credit card to buy that fabulous new sweater and when somebody uses a credit card to pay for prescription drugs, they're all treated like abusers, exactly the same.

BRANCACCIO: And that's just the latest example of the middle class squeeze.

ROBERT PARKER: More Americans are taking shorter vacations, getting fewer benefits, retiring with great insecurity, having poorer health care packages.

BRANCACCIO: Economist Richard Parker on paradise lost.

BRANCACCIO: Welcome. The city of Waterbury, Connecticut knows a lot about starting over. This place used to be the center of America's brass industry." In fact, the city's Latin motto translates as "what is more lasting than brass?" Unfortunately, not the brass industry. After a long period of decline Waterbury is struggling to reinvent itself as a commercial center.

Starting over...a clean slate. An American value. People who have hit rock bottom count on America's bankruptcy laws to do just that — for them to get a fresh start in life.

Banks and credit card companies have been pushing major changes in those laws that will likely make starting over tougher for middle class Americans who get in financial trouble. And at the same time, those changes don't touch some of the loopholes that allow the well-off to avoid much of the financial pain of bankruptcy.

Michele Mitchell and producer Kathleen Hughes found our story. And it starts right here in Waterbury.

MICHELE MITCHELL: If there was a family living the American dream, it was the McCormacks. Ron and Sharon had just paid off their home on the outskirts of Waterbury, Connecticut. They'd put their son through college and were saving for their 11-year-old daughter.

They owned a small business — an auto parts manufacturing company. That employed 14 people and had five outlets throughout the state. They weren't rich, but they were comfortable.

Then about four years ago, just as Ron was gearing up to face new competition, he collapsed in his office. Doctors found an aneurism in his brain. Emergency surgery didn't go smoothly. It took Ron months just to re-learn how to walk and talk. Today doctors tell him his brain functions will never return to normal.

RON McCORMACK: But I still have, you know, a short term memory loss. I mean, stuff ten, 15 years ago is no problem. But if you came up to me and gave me a number or said your name, for me to go back to you in five minutes, it doesn't-- it doesn't stick. It doesn't stick.

MICHELE MITCHELL: Ron's illness threw the McCormacks into a financial free-fall. Sharon tried to save the business — even using personal credit to pay business expenses and the medical bills not covered by insurance. They took out a second mortgage on their the house. It wasn't long before the McCormack's business and personal debts piled up to more than a half million dollars. In desperation, they went to a bankruptcy attorney.

SHARON McCORMACK: When we applied for that addition monies Ron had had his surgery. Well, we had- if we had hoped he would gone back 100 percent. And he didn't, Gene. And-- and that was okay too. But, at the time, we took out-- that in earnest and hoped to pay it.

MICHELE MITCHELL: Bankruptcy is the last resort for Americans who find themselves in inescapable financial crisis. Those with creditors pounding at the door and no way to pay.

SHARON McCORMACK: How much money are they looking for?

EUGENE MELCHIONNE: I think it's about $240,000.

SHARON McCORMACK: Don't have it.

MICHELE MITCHELL: Bankruptcy laws were set up to encourage people to take financial risks like starting a business. They allow people in over their heads to liquidate their assets in order pay creditors as much as they can. Once that's done, all the rest of their debts are erased, and the slate is wiped clean. It's called a fresh start.

EUGENE MELCHIONNE: This is a motion that's on for Monday. It's a motion for supplemental judgement.

MICHELE MITCHELL: Bankruptcy attorney Eugene Melchionne has been helping the McCormacks through the process. He sees hundreds of cases like this every year.

EUGENE MELCHIONNE: It's people holding on for as long as they possibly can and then deciding I can't do it anymore. And then they come in. Always, without exception, people who come in to see me are at the end of their rope. They have tried everything else first.

MICHELE MITCHELL: The number of Americans filing for bankruptcy is soaring...1.6 million people applied last year.

What's causing all these bankruptcies? If you listened to the United States Senate discuss the problem last month, it's irresponsible spenders abusing the system.

SENATOR CHUCK GRASSLEY: A system where people are not even asked whether they can pay off their debts obviously contributes to the fraying of the moral fiber of America.

MICHELE MITCHELL: Two weeks ago, the Senate passed a bill aimed at making it harder for people to walk away from their debts.

SENATOR ORRIN HATCH: A means test that requires those who can pay something against their debts rather than every five years go into bankruptcy after running up bills galore?

MICHELE MITCHELL: The bill, which is almost certain to become law, is a big victory for the credit card and banking industries. They've been pushing for changes to the bankruptcy law for nearly a decade. They say that when people don't pay their bills, we all pay them. Many lawmakers agree.

SENATOR CHUCK GRASSLEY: You and I are paying $550 more for goods and services 'cause somebody else isn't paying their debt. If someone can repay, they ought to be repaying. You shouldn't be paying for their lack of personal responsibility.

MICHELE MITCHELL: Senator Chuck Grassley of Iowa sponsored the bill. He says families like the McCormacks, families that face true hardships, will not be affected.

SENATOR CHUCK GRASSLEY: There's two basic principles in this legislation. One, if you're entitled to a fresh start, that's been a principle of bankruptcy for 100 years. We preserve that. But for the first time, we're telling people that if you got the ability to repay some of your debt, you're not gonna get off scott free.

MICHELE MITCHELL: Just how many are abusing the system? Well, the lending industry puts the figure at around 10 percent. The non-profit American Bankruptcy Institute puts the figure at 3 percent. That's closer to what Eugene Melchionne sees on the ground in Waterbury, Connecticut.

EUGENE MELCHIONNE: There are a couple of cases now and then. But I would say they're probably one, two percent of the total case. Not 10 percent.

MICHELE MITCHELL: The red files are bankruptcy.

EUGENE MELCHIONNE: Red. All red. There you go. Red, red, red. None of these are from people spending money to buy a new car or living beyond their means. Typical situations are the medical bills. I see one here. This woman was a nurse who lost her job cause she developed a latex allergy. This one here lost his job. They lost their house. People-- getting divorced. Those are the common causes. We rarely see situations where people get crazy on the credit cards and say, "Okay, that's it. I'm gonna file." They use the credit cards as a crutch. When the income drops they'll go to the credit cards to help buy groceries. Or the prescription drugs like the elderly couple I had.

MICHELE MITCHELL: So if spending spree credit card abuse isn't causing the majority of bankruptcies what is? Harvard law professor Elizabeth Warren has studied the causes of bankruptcy.

ELIZABETH WARREN: A broken health care system is bankrupting middle class America.

MICHELE MITCHELL: Warren recently co-authored a study that found nearly half of all bankruptcies filed are the result of a medical problem.

ELIZABETH WARREN: About three-quarters of a million families each year filing following an illness or accident.

MICHELE MITCHELL: Illnesses like Ron McCormack's and there's something else, the McCormacks share with those families.

ELIZABETH WARREN: Now here's what's really shocking. Three-quarters of those people had health insurance at the onset of the illness that ultimately bankrupted them. So these were people who had jobs, who had played by the rules, who'd done what they thought they were supposed to do. They've gotten health insurance and they discovered a health problem could turn them upside down financially.

SHARON McCORMACK: It was all the co-pays. He was in three different hospitals. It was outpatient therapy for six months. There was no income. There was no money coming in. So, I couldn't-- I-- couldn't meet those payments.

EUGENE MELCHIONNE: I think it was about 20 to $30,000 total of uninsured medical expenses that came out of that whole situation. It was huge.

MICHELE MITCHELL: One of the other things the critics have said is Grassley and the senators are completely out of touch. They don't understand that it's the cost of medical expenses which are bankrupting middle class Americans.

SENATOR CHUCK GRASSLEY: Yeah. Well, I think that that would come from the Warren study, I think. And what I-- what you find is that there's other studies out there, on people that go into bankruptcy. So, you have the Warren study, yes, with the very small pool of people. You have a Department of Justice study, with a very big group of people. You have the Warren study say 50 percent of the people that are in bankruptcy are there because of medical bills. You have the Department of Justice study that says that it's only five percent. And the average person only has $5,000 worth of expenses.

ELIZABETH WARREN: What he's citing is an estimate based on looking at the files and seeing how many medical bills are still medical bills at the moment of filing. Senator Grassley would eliminate from his calculation all the people who put second mortgages on their houses to try to pay for medical bills, all the people who paid for prescription drugs or doctors' visits with credit cards, all the people who depleted their checking accounts or over-drafted or went to pay day lenders to try to make some payment on their medical bills.

MICHELE MITCHELL: Under the new law, no matter where the debt comes from, it is going to be harder and more expensive to file for bankruptcy. Credit card companies more tools to collect what's owed them than they've ever had before. Middle class filers, those above the median income, may find themselves paying off credit card debt even after coming out of bankruptcy.

MICHELE MITCHELL: What was your credit card debt?

SHARON McCORMACK: Probably over 100,000.

EUGENE MELCHIONNE: I think that's about right. That's not counting the installment loans, and mortgages, and other debts that were incurred to keep the business going.

MICHELE MITCHELL: With that kind of debt the McCormacks soon fell into another trap. The higher interest rates the industry charges those who have trouble paying off their bills.

SHARON McCORMACK: Once you fall behind, they don't care, you know? And how could anybody ever pay off even a $5,000 credit card if the interest jumps up into the 20s? Twenty-six percent, 27 percent? You can't.

MICHELE MITCHELL: There are no federal laws limiting how much interest a credit card company can charge. People with good credit usually pay low rates. For those who fall behind, rates often skyrocket. In fact, interest rates have been known to go as high as 30 percent.

MICHELE MITCHELL: Nobody forced them to use credit cards. I mean you write in your book, "Don't use credit cards, use cash." That's common sense. So shouldn't the credit card companies-- don't they have the right to want to get repaid?

ELIZABETH WARREN: They have the right to want to get repaid. But there are two halves to the equation that we have to look at. The first one is the reasons that families are using credit cards. Frankly I see it very differently when someone uses a credit card to buy that fabulous new sweater, and when somebody uses a credit card to pay for prescription drugs. But this bill makes no distinction. They're all treated like abusers, exactly the same.

SENATOR EDWARD KENNEDY: It allows the credit card companies that charge outrageous interest rates, exorbitant fees, and force you into bankruptcy, they still win.

MICHELE MITCHELL: Critics of the bankruptcy bill proposed amendments that would have capped interest rates and protected consumers from predatory lending. They were soundly rejected.

RANDY LIVELY: I think that they just decided to get the job done and they have done it. In the Senate very very admirably, I might add.

MICHELE MITCHELL: Randy Lively is president of the American Financial Services Association, which represents a variety of lending industries that support bankruptcy reform, including credit card companies.

RANDY LIVELY: The real problem is personal accountability and personal responsibility. It's the rare case where there's an external influence that has caused the problem.

MICHELE MITCHELL: I talked to some people who put on their credit cards medical expenses. And then they got into trouble that way.

RANDY LIVELY: Well, you know, I think those are personal choice decisions that individual consumers make. In doing so, though, they should have had some pool of funds available and saved for the event that did come about. So that when they passed through that period of time when they had the cash shortfall, they'd be able to go ahead and pay their responsibility off with a credit card.

MICHELE MITCHELL: The credit card industry didn't make those arguments at last month's Senate hearings on the bill. In fact, no one from the industry testified.

SENATOR RICHARD DURBIN: Where is the credit card industry? I'll betcha in the back rows. Don't hold up your hands. But you're not at the table, and you are the big player and the big push behind this bill for a decade. Ten years you've been begging for this bill to preserve credit card debt through bankruptcy and yet you won't come up and testify?

MICHELE MITCHELL: According to the watchdog group The Center for Responsive Politics, the credit card industry has donated more than 25 million dollars to federal candidates and political parties since 1999, while commercial banks have forked over 76.2 million dollars.

MICHELE MITCHELL: Critics are saying that this legislation is the case study for revisiting campaign finance reform. They say the credit card industry flat out wrote this. And they donate to all these Senators and that's why they got it.

SENATOR CHUCK GRASSLEY: Yeah. Well, if they're so powerful, how come it took eight years to get it passed?

MICHELE MITCHELL: In fact, Congress did pass a nearly identical bill back in 2000. But President Clinton, refused to sign it. President Bush says he's ready to.

Throughout it all there's been a loophole. It lets the wealthy keep millions in special trust funds, even after they declare bankruptcy. It's all enough to make Elizabeth Warren wonder whether we're forgetting why we have a bankruptcy system in the first place.

ELIZABETH WARREN: The notion that we get out there, we take some risks and if we win, we win. But if we lose, it's not all over forever. We don't form a permanent underclass in America. What we do is we give those people a chance to say, "Okay, I tossed the dice. It didn't come up right. But I'm gonna come back again." The creditors know they took that risk with you, and they profit when you win, and they lose when you lose.

MICHELE MITCHELL: The McCormacks are now finding out what happens when you roll the dice and lose. They've been in their house for over 20 years. On this day, their attorney, Eugene Melchionne, goes to court, hoping to convince a judge to let them keep their home.

EUGENE MELCHIONNE: The judgment will enter probably today and if we don't have a miracle in the next three weeks the McCormacks will lose their house.

MICHELE MITCHELL: Sharon and Ron will have to break the news to 11 year old Shannon.

SHARON McCORMACK: She doesn't understand foreclosure. How to tell your 11 and a half year old you might be moving.

MICHELE MITCHELL: The McCormacks are bound to lose almost everything they have, but at least under the current law, their debts will be wiped away, and they'll get that fresh start. But when the new law kicks in, Melchionne says other Americans may tumble down the economic ladder, without the benefit of a safety net to help them back up again.

EUGENE MELCHIONNE: The safety net. Social security, bankruptcy, unemployment, welfare. All of those things are the safety net and little by little we're pulling the threads out of the net until it's just full of holes. And that's what we have here. Is we've got a big hole being developed by passing this bankruptcy bill.

BRANCACCIO: A famous economist once wrote: "The elimination of insecurity in economic life can be a finished business."

That's from THE AFFLUENT SOCIETY the best-known book of John Kenneth Galbraith, who by the 1950s became convinced that economics was on the verge of pulling it off. No economic insecurity, no inequality to speak of. Fast forward to 2005: Where is that vision now?

Harvard economist Richard Parker has been studying the evolving theories of Galbraith and has come out with a biography of Galbraith called: JOHN KENNETH GALBRAITH: HIS LIFE, HIS POLITICS, HIS ECONOMICS.

BRANCACCIO: Richard Parker, Welcome to NOW.

RICHARD PARKER: Thank you very much. Glad to be here.

BRANCACCIO: I saw a statistic that suggested that inequality in America now, income inequality, the gap between rich and poor is the widest now than in 70 years.

RICHARD PARKER: Right.

BRANCACCIO: What does Galbraith make of how it all unraveled?

RICHARD PARKER: He doesn't think it's a failure of economics. He thinks it's a failure of politics and vision. He said that the private sector has done brilliantly now we need to focus on where the real scarcity is. The provision of top quality education, the provision of extensive health care for all. For parks and roads and public services that authentically work, that aren't the roads filled with potholes that I drove on my way to the show this afternoon.

BRANCACCIO: The whole phrase public squalor versus private abundance.

RICHARD PARKER: That's exactly right, exactly right.

BRANCACCIO: Your man Galbraith also believed that this techno- structure ... I would call them kind of the Yuppies of this world ...

RICHARD PARKER: Okay.

BRANCACCIO: The upwardly mobile people who really connected, technically savvy ... with the good jobs.

RICHARD PARKER: Right.

BRANCACCIO: That they would act as a break on these abuses of the market system ... that they would sort of be the overseers.

RICHARD PARKER: Right.

BRANCACCIO: You know what those people ask for now? They ask for lower taxes and that's about it seems.

RICHARD PARKER: Right. His ideal of what he called the new class has not turned out to be nearly as public minded as Galbraith hoped it would. It's also quite clear that everybody in America including the new class has been under extraordinary pressure of various kinds. Insecurity producing pressure that has made us all more inwardly focused because the sense of community is broken. And the last 30 years, in the name of the experiment of the free market we have seen radical stagnation in terms of income for the overwhelming majority of people.

It's also been a 30 years in which it now means two Americans have to be working in each family. More Americans are taking shorter vacations, getting fewer benefits. retiring with greater insecurity, having poorer health care packages.

And it isn't surprising to me, under those circumstances that the courage of the new class isn't what Galbraith had hoped.

BRANCACCIO: Is this is a great quote that present in the book. Galbraith says this in 1952 after Adlai Stevenson, the Democrat, loses.

RICHARD PARKER: Yeah.

BRANCACCIO: He writes back then: "American liberals have made scarcely a new proposal for reform in twenty years. It's not evident that they, the liberals, have had any important new ideas." There are people who think that he could have uttered that in the last couple of months.

RICHARD PARKER: Oh, I think that's probably right. You know, I talk to Galbraith the day after last November's election when President Bush was re-elected. And I said, "Ken, what do you think of this election?" knowing full well that he wasn't terribly happy with the outcome and he paused thought about it a moment and said, "I never thought I'd long for the Reagan Administration."

It's a measure for him of how far this Republican Party has migrated away from Republican traditions. And a measure of the lack of courage at the leadership level of the Democratic Party that America finds itself in the box that it's in.

Remember, starting from his vantage point at the beginning of the twentieth century he, for the first 60, 70 years of that century, saw the nation march forward and upward and bringing its citizens closer together, forging a common country that worked for everyone. In the last 30 years he has seen the country move in a wildly different direction toward greater distrust, distrust of one another, distrust of public institutions.

BRANCACCIO: Richard, how does Galbraith stay optimistic and doesn't get discouraged? I mean, the heyday of a lot of his view of the economy was in the sixties. Yet those experiments didn't work out as intended.

RICHARD PARKER: Galbraith isn't discouraged. He believes that, in fact, we have lived through a difficult period in American life but he believes we're a people who can recover the optimism and the generosity that we have shown throughout so much of his.

But you have to understand something. The conservative version of what happened in the 1960s is that liberalism was triumphant. Galbraith's vision is quite the opposite.

BRANCACCIO: That it was government directing the economy, but it was the wrong kind of government spending.

RICHARD PARKER: Right.

BRANCACCIO: Military.

RICHARD PARKER: Right, it was military spending. And there was a sense of gamesmanship that went with this military this, what Galbraith calls this 'permanent war economy' that we had created. And, we're now going past the half trillion mark again for the Department of Defense. And of course, the budget of the Department of Defense is only part of the cost of the military in the United States.

The legacy of that is what we didn't spend it on. We didn't spend it on education for our young, we didn't spend it on the inner cities, to finally truly get rid of poverty. We didn't spend it on job creation that meant jobs that paid decent wages rather than jobs that were hamburger-flipping jobs without benefits. That money could have been spent on something else, and it wasn't.

Now, the danger of that permanent war economy is that we seem to be back now on the same path with this war on terrorism. The total spending of the DOD, plus homeland security, is gargantuan. And is only going to get bigger.

And represents, if there's a threat to the future of the United States economy, I would suggest that more people ought to be looking there than looking at Social Security at the moment.

BRANCACCIO: Well, Richard Parker, author of JOHN KENNETH GALBRAITH, HIS LIFE, HIS POLITICS, HIS ECONOMICS, thank you very much.

RICHARD PARKER: Thank you, I'm delighted to be here.

BRANCACCIO: Next week, we'll continue our examination of how the burden of economic risk is being shifted from business and government onto the backs of average Americans.

We'll be back on the road - this time in West Virginia, where some retirees are struggling with a broken promise. They suddenly find themselves with fewer health benefits from their former employers.

BASIL CHAPMAN: Never thought of it until I retired. And I really-- I really got a surprise.

BRANCACCIO: And that's it for NOW. I'm David Brancaccio. We'll see you next week.

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