Bankruptcy law: Bankrupting individuals?
KAREN GIBBS: After eight years of consideration and maneuvering, President Bush this week signed a new bankruptcy law that will have significant ramifications for millions of Americans. The new law makes it much tougher for people to write off debt that they cannot pay. One premise behind the law is that those who file for bankruptcy are irresponsible spenders. But is that the whole story? Elizabeth Warren, noted bankruptcy law expert and co-author of "All Your Worth: The Ultimate Lifetime Money Plan" says this bill hurts the most vulnerable, those with serious medical issues.
Well, Elizabeth, what is this bill?
ELIZABETH WARREN: Well, this is a bill that says if you're a multimillionaire, you can still take bankruptcy. If you're a corporation that wants to wipe out your liabilities to the retirees and employees, you can still take bankruptcy.
But if you're just an ordinary working person and you get sick and get hit with big medical bills, if you lose your job, if you have a death in the family, you're presumed to be abusing the system if you file for bankruptcy, and so we've got to have a whole lot of new constraints and new expenses to impose on those families. You know, this is just a case of if you've got good friends in Washington, you can get the kind of laws you need. And it's pretty clear that hardworking American families don't have a lot of friends in Washington right now.
GIBBS: Well, were the guys in Washington watching any of the corporate scandals that have been taking place with the bankruptcies that have been going on?
WARREN: You know, that's what's so troubling about this bill. We have evidence of abuse of the bankruptcy system, big corporations that are headed into bankruptcy in order to knock out liabilities after they have committed significant frauds. We've got CEOs who are bailing out of companies that are bankrupt with $100 million compensation packages. But this bill doesn't lay a finger on them. This is about crushing the 1.5 million families who turn to bankruptcy in the aftermath of job loss, medical problems, and family breakups.
GIBBS: The President said this week that this bill is designed to help those that legitimately need help but then stop those that are trying to commit fraud. How do you answer that?
WARREN: I answer it by saying would that it were so, if only we had truth in advertising in these cases. There's no help for families in this bill. This is a bill that helps those poor, downtrodden credit card companies get more and more money out of families who are in financial trouble. Start to finish, that's all it's about.
GIBBS: So those are the companies that are going to benefit, just the credit card companies?
WARREN: Well, the credit card companies will be the main beneficiaries, but let's not leave out the payday lenders, the mortgage companies who have been doing the big refinances at high rates. Car lenders are going to get a piece of the action here. This is really about all of those companies that lend money to individuals. They'll make the big bucks, and the individuals, the families, are the ones who will have to pay it.
GIBBS: Well, you've done a lot of research about bankruptcy. You're an expert in bankruptcy law. Why are people filing bankruptcy?
WARREN: The reasons right off the top are job loss, medical problems, and family breakup.
GIBBS: One, two, three, just like that.
WARREN: One, two, three, and those three account for more than 90 percent of all bankruptcy filings. That's it. This is about hardworking, middle class families, people who play by the rules, people who went to college, who got a decent job, who bought a house, who had kids, and who got hit hard when a job moved overseas, who got hit hard with a diagnosis of cancer, who got hit hard when a spouse died. Those are the people who end up in bankruptcy.
GIBBS: Well, why is it then that so many hardworking people find the American dream so elusive?
WARREN: You know, part of what's happened is there have been big structural changes in the American economy in the last generation. The cost of housing in inflation-adjusted dollars is up 69 percent, the cost of health insurance up 90 percent. Families today have to get a second car so Mom can get to work. There's an increase of about 60 percent in total costs. Child care, an expense that a family didn't have a generation ago, and let's be fair. The tax burden on the new two-income family, about 38 percent higher than it was a generation ago. By the time they pay for home, health insurance, a second car, child care and taxes, today's two-income family has less money to spend than their one-income parents had a generation ago.
In other words, the reason lots of families are feeling the economic stress is not because they're whooping it off at the Gap, at eating out too much, it's that they're spending it on the basics of a middle class lifestyle. They're trying to buy homes in decent, safe neighborhoods with good schools. They're trying to buy cars that are safe. They're trying to do the things that will let them launch their children into the middle class, and I just have to be frank. The cost of being middle class is quickly moving outside the reach of the median earning family.
GIBBS: You consider dual income families a trap. Why is that?
WARREN: Well, it's a big risk that's going on now. Families with two incomes, Mom and Dad both in the workforce, have budgeted up to both of those incomes. And while that means they get to enjoy a higher standard of living, they have twice the risk that someone will be laid off, twice the risk that somebody will be too sick to go to work, and they have a new risk that one-income families didn't have, and that is a child gets sick or Grandma falls and breaks a hip, the two-income family either has to hire somebody to stay at home or somebody's got to take off work and lose income.
In other words, the two-income family that budgets all the way out to the edge of both of those incomes is facing a lot more risk than either the one-income family that has a reserve worker or the two-income family that treats itself a little more like it has only one full-time employee.
GIBBS: Saving a lot more than what they're doing.
WARREN: Saving more, that's right.
GIBBS: Well, bottom line, we are all responsible for our own financial situation. How does one get their financial house in order?
WARREN: It's really about trying to find a way to get your money in balance. All of spending really just falls into three categories: the things you must have, the things you want, and the savings you should have for the future. If you can figure out how to put your money in those three categories and then get those three categories in balance relative to your income, you can take pretty good care of yourself.
GIBBS: When you look at all of the stimulus that we get in this society, I mean the must-haves and the wants are very, very blurred. Tell me, what is a must have?
WARREN: They're not blurred. They're only blurred if you want them to be blurred. Must haves are the things that keep you warm and dry. That's the rent, the utilities, the car payment. It's the stuff you've got to pay every month no matter what to keep a roof over your head. That's what those are about. The wants are everything else. They're that fabulous pair of red shoes.
GIBBS: Thank you.
WARREN: They're the archery lessons, they're giving the kids piano. They're all the things that give life lots of color. They're things you like and you ought to have in a budget. I think it's a real mistake to think of money in terms of I'm only going to spend money on house and utilities and insurance payments and not spend any money on things I want. If you don't have room in your budget for wants, then there's something wrong with your budget. You don't have room for your life.
GIBBS: But don't we oftentimes buy the house that we know we can't afford but we just want or that beautiful luxury car?
WARREN: People do, and part of what we try to talk about in all your worth is to say, look, you can't use those rationalizations that we know are out there: "Oh, the value of this will just rise over time"; "Why, my Uncle Harry said at a picnic that he's had a 40 percent increase in the value on his house"; yada, yada, yada.
Nope. This is about making those hard decisions about what you really can afford, and then holding yourself to them. If you've got a target, and the target we give families is about 50 percent, you can spend about 50 percent of your take-home pay on your must haves, on the things to keep you warm and dry, then you know about how much house you can afford.
GIBBS: What about these wants then? How much should I portion to wants?
WARREN: The way to do that is move to cash. At the beginning of the month, set aside 30 percent of this month's income in cash. Write yourself a check. Put the cash in your underwear drawer, and then take it out when you want to go shopping, when you need to buy whatever it is you're going to spend on your wants.
If you have an up close and personal relationship with your cash, then it turns out two things happen. The first one is you may decide not to buy some things that you otherwise would have bought. You know, if I've got to peel off six $20 bills rather than just sign a charge slip for that new pair of jeans, I may decide they do not make my rear end look quite as fantastic as I thought they did. So that's part of it.
The other part of it is when you're spending for wants on cash - that's all you're using is cash - you can actually enjoy yourself a lot more while you're spending. You know, you're out having a big day with the kids, you've gone out to dinner. If you've got the cash in your pocket, you know you can afford it.
GIBBS: Well, many of us are already burdened in our future because we're swimming in debt. How do we pay off the debt?
WARREN: Well, the way you have to think about paying off debt is that if you've got your budget right - your must haves at about 50, your wants at about 30 - you've got 20 percent of your income left over, and that's money to pay off those debts, to get them out of your life. Start putting them in that direction. You know I'm real opposed to folks saying "Pay down debt" and not explaining how, where's the money going to come from, or worse yet they say things like "No more lattes." Well, listen, given how much debt most people have, they could cut out lattes until they're 244 years old, and they're still going to have that credit card debt.
So this is about finding a place in your life that's money, first to pay off debt, and here comes the good part. Once those debts are paid off, that same money becomes your savings, so that week after week, month after month, you're putting aside something for tomorrow, not just for retirement, which is a good thing to do, but to make tomorrow better, to pay off your house, maybe to get a little place on the lake, to be able to give money to your church or to be able to work for a charity that you want to work for, the kind of thing that makes dreaming possible. That's what your money ought to be for.
GIBBS: Elizabeth Warren, great advice. Thanks for joining us.
WARREN: Thanks for having me.
Sarbanes-Oxley: Boon or burden?
GEOFF COLVIN: With the trials of Dennis Kozlowski and Richard Scrushy underway, and Bernie Ebbers recently convicted and Ken Lay's trial still ahead, you may not be feeling sorry for corporations. But now some of them are saying, very quietly, that maybe you should be. They say the law intended to prevent future Enrons and WorldComs is in fact a terrible burden that's costing innocent companies billions. Are they right? Is there a better way? Are you as an investor better off?
Michael Farr is a familiar Wall $treet Week with FORTUNE contributor; good to have you back, Michael.
MICHAEL FARR: Thank you, Geoff.
COLVIN: Nell Minow is a founder of the Corporate Library, the innocuously named organization that really holds companies' feet to the fire when they are not serving shareholders.
Nell, the law we're talking about is of course the Sarbanes-Oxley Act passed in 2002, but the final requirements just went into effect in the past few months, and companies are saying that the burden is turning out to be much greater than anyone anticipated. Is Sarbanes-Oxley a sledgehammer for swatting flies?
NELL MINOW: I'm about 80 percent in favor of Sarbanes-Oxley. I will mention that I have a couple of qualms later on, but let me talk about the good news first. One of the big complaints that we get from companies has to do with Section 404.
COLVIN: Which is the section that just went into effect requiring them to attest to the integrity of all their financial reporting.
MINOW: That's right. Now let's be very clear about one thing. They have been required to have internal controls for more than 20 years, and also just by practicality I hope required to have them forever. 404 only requires them to tell us if they're effective or not. There are no new substantive requirements. And somehow this is a shattering obligation. Somehow for the first time they're shocked to find not gambling going on in Casablanca but inefficiencies going on in their internal controls, and they don't want to tell us about it.
So I have no sympathy for them whatsoever. Yes, it's expensive to find out if your internal controls are working, but you know what's really expensive? Not finding out.
COLVIN: Well, it sounds like a pretty strong argument, Michael. What do you think?
FARR: I think that some of the objections that I've been hearing about complying with 404, a lot of corporations don't understand what it means to comply with 404. They know that they've got to have the internal controls, but is it enough to say that we have two people sign our check? Yes, as a matter of fact it is. That's a fine internal control. But the recordkeeping behind it is somewhat ambiguous, and they're confused, particularly smaller companies are confused. This was a code that was largely set up and established to govern big companies, and if you have a $20 million public company, it can be very expensive and confusing
COLVIN: Well, in fact some of the strongest complaints have been coming from these little companies who say we are not set up to do this, and as a percentage of our total business it's extremely expensive. Have they at least do you think gone too far in that regard? Is there something that should be fixed?
FARR: I don't know if it's a matter of going too far. I think maybe it's a matter of not having thought it through as fully as it might have been, particularly for these smaller companies.
I talked with Julia Connolly who's a lawyer at MHI Hospitality. This is a small sort of hotel REIT, very small. She's in charge of Sarbanes-Oxley compliance, and she said, you know, half the committees we're required to have are represented by myself and the CFO. There are a lot of things that work for big companies that don't for small companies, and they're expensive for all companies.
COLVIN: There's an estimate that the cost of complying for all publicly traded companies totals $35 billion, $4.4 million average per enterprise. Nell, whether that's correct of not, it's a large cost, and what a lot of these companies say is, look, the vast majority of us, we're not committing any crimes. We're innocent companies in the first place. Why do we now have to bear all this burden?
MINOW: Once again, they were supposed to have internal controls already. Now we're just testing them. So I'm going to say one more exculpatory thing about Sarbanes-Oxley, and then I'm going to add one complaint to it. The exculpatory thing is that, yes, it is a huge burden, but I think that's just for this year. I think it's going to be like Y2K. There's going to be a big investment this year, and then once the systems are in place, things will sort themselves out.
However, I do think they are justified, the small companies in particular, in one respect, and that is that Section 404 does not require this, but I think that it has turned out to be somewhat of an accountants employment and permanent sinecure act, and I think that the accountants have come into the companies and said, "We're telling you what this requires. We are telling you."
I heard one nightmare story that they wanted to find out whether the IT professionals were changing their passwords every month or not. So, yes, there is a lot of minutiae here that I think is not necessary, and the audit committees are afraid to say no because of course it's the power of the auditors to say whether the audit committee is effective or not.
COLVIN: Well, exactly right, and especially since everyone is terrified of being the company that turns out not to be in compliance with this.
MINOW: Exactly.
COLVIN: They have, as you said, been willing to pay the auditors large sums, very large sums.
MINOW: Yes, and I've heard as much as five and ten times what they paid them last year. So I do have some sympathy for that. And the PCAOB, the Public Company Accounting Oversight Board, is very aware of this issue. Believe me, they have heard the screams of protest, and they are working on trying to straighten that out.
COLVIN: Okay, Michael, what don't you like about Sarbanes-Oxley?
FARR: I guess that it does create something of an unfair burden on all of those that have been honest and good practitioners all the way along. It's sort of like getting punished as one of the siblings for something that one of your brothers or sisters may have done and wasn't even there at the time.
COLVIN: Right, and there's definitely that effect. But one of the arguments in favor of it is, look, it increases the integrity, it increases investor confidence in the integrity of all American companies' financial statements, and that we may not be able to put a dollar value on, but the dollar value is high. Would you agree?
FARR: I would certainly agree. I mean nobody is I don't think ever going to come out and say we don't need greater integrity here.
MINOW: Good. I'm delighted to hear that.
FARR: I mean we're not going to hear that. Everybody wants more integrity. Everybody wants more transparency. I think more of a question that's come up in debate is, are we seeing more form or are we seeing more substance? And I'm not sure exactly what the answer is. I know that the process is headed in the right direction. If you take a look at it from the numbers point of view, yes.
You know former SEC Commissioner J. Carter Beese always used to say that the greater transparency and integrity we have in our markets, the higher premium will be afforded to our markets in our share price. So there is an argument that can be made even though there is greater expense to comply with Sarbanes-Oxley, there will be a greater premium afforded to those companies and to our markets that do. Certainly shareholders are going to bear the cost. We hope that they enjoy the benefit. Better to do this approach I think certainly than endure a WorldCom or an Enron.
COLVIN: Nell, you were saying that there are things you don't like about Sarbanes-Oxley. What are they?
MINOW: Well, first of all, I think also that the forest of good corporate governance does get lost in the trees of compliance and checkboxes, but that is a human problem. That's not a Sarbanes-Oxley problem.
I think what I am primarily concerned about with Sarbanes-Oxley is what is overlooks, and that is because since 1789, corporate governance has been left to the states, and that's why Sarbanes-Oxley kind of nibbles around the edges of problems rather than dealing with them directly.
However, I'm delighted to say that as it always does the market has come to the rescue, and I think that the reforms the market is bringing about with Moody's downgrading a company's debt purely for corporate governance concerns, D&O liability insurers becoming much more sophisticated about the way they look at these issues, and shareholders becoming much more sophisticated, I think that will be much more powerful in the long run than anything Sarbanes-Oxley could do.
COLVIN: Let's go a little bit beyond Sarbanes-Oxley and look at the other enforcement bodies that have taken a big roll here. Eliot Spitzer - some say he's out of control. What do you think?
MINOW: I don't think so at all. He's my hero. I want him to run for President. I think he's just great. I think that there was no one but Eliot Spitzer who could have addressed the issue of the Wall Street analysts, and he did a superb job on that, and I can only dream of what he's going to do next.
COLVIN: He is of course the Attorney General of New York, and we do know that one thing he's going to do next is run for Governor of New York. He has announced that. What do you think? Is he out of control?
FARR: I think that there are a lot of corporate CEOs that will have Run, Eliot, Run on the front bumper of their cars, and happily so. You know, for everybody that doesn't like Spitzer, no one can tell you an issue that he's addressed that's improper. I mean he's nailed it. And not only has he nailed it, it has raised questions about why other people haven't nailed it. Why haven't the other SROs gotten into this? And it seems to be a little embarrassing to them, so much so that I think you begin to have the other worry, which is what are some of these other organizations responsible for oversight and regulation going to do to sort of make up for not being able to keep up with Spitzer? And that could create a problem, a backlash.
COLVIN: If they go too far in order to make appearances look a little better for themselves.
FARR: No question.
COLVIN: So let's talk about one of the other organizations, the most significant one, which is the SEC, under the current chairman, William Donaldson. Some people have said, gee, here's a businessman, lifelong entrepreneur who made himself rich, and now that he's in a regulatory role, he's gone over to the other side, right? He's become too tough on companies. What do you say?
MINOW: Well, you remember who the very first chairman of the SEC was. It was Joseph Kennedy.
COLVIN: It was Joseph Kennedy. That's exactly right.
MINOW: And when they complained to Roosevelt about that appointment, he said it takes a thief to catch a thief. And so I think Donaldson knows exactly where the bodies are buried. This is his last job, and I'm delighted to see him taking a hard line, particularly on the NYSE issues, because he knows that institution inside and out. So I think that's fine.
Sure, it is true, however, that the SEC has felt that they have to do a little catch up with Spitzer, and there have been individual cases where I think perhaps they've come down too hard. But right now my biggest complaint with the SEC is that I think they're being too tough on shareholder proposals. I think they need to be reminded that they, that over the door is does say "The Investors' Advocate."
COLVIN: Yeah, people may not realize that if you want to put a proposal on the proxy statement of a company, it has to be approved by the SEC before it can appear there, and they have not been letting a lot of them go through.
COLVIN: Bottom line, are investors better off?
FARR: Yes, investors are better off from this trend. I think there's no question investors are better off. In the short-term, I think it's going to affect their pocketbooks in a negative way. The pendulum will swing too far. It will be too expensive. They will pay for it. Long-term, this added clarity, this added integrity will benefit all of us. We have the world's greatest market. We have the most liquid market in the world. And we need to do things like this. Short-term, it's painful.
COLVIN: Any quibble with that, Nell?
MINOW: I think that's exactly right, and I think that things will calm down. The PCAOB will tell people that they don't have to count every key to the men's washroom when they're checking their internal controls, and it will be just fine.
COLVIN: Nell Minow, Michael Farr, thanks for your views.
FARR: Thank you.
MINOW: Thank you.
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