Sign in
Become a MarketWatch member today
David Weidner's Writing on the Wall
April 6, 2010, 12:01 a.m. EDT · Recommend (13) · Post:
View all David Weidner's Writing on the Wall "º
"¹ Previous Column
Is your bank the next Lehman?
First Take "º
Steep trader pay on Wall Street is no surprise
By David Weidner, MarketWatch
NEW YORK (MarketWatch) -- For those who underestimate the power of the banking lobby as financial "reform" weaves its way through Washington, one need only look back five years ago to see how influential banks are at pressing their agenda.
In 2005, Congress yielded to an eight-year, $100 million campaign by banks to change personal bankruptcy law. In effect, the Bankruptcy Abuse and Consumer Protection Act made it harder for individuals to wipe away their debts under Chapter 7 of the U.S. Bankruptcy Code. More had to file under Chapter 13.
Reuters Former U.S. President George W. Bush
The bill was signed into law by President George Bush despite protests of consumer protection groups, economists and legal experts. President Bill Clinton actually was presented an earlier version of the bill first, but he vetoed it.
Under the law, it became hard to file any type of bankruptcy. There were new reporting requirements, more fees, mandatory credit counseling and new burdens on bankruptcy attorneys. But the real meat of the act was the higher threshold for Chapter 7 cases.
Chapter 13 was preferable to the banks because it doesn't wipe away debt. Individuals still had to pay down some of their credit cards and loans. The stinging effects of this change have become abundantly clear as unemployment hovers near 10% and Americans are swamped with debt.
At first, the new law seemed to slow the rash of filings. Only 597,965 personal bankruptcies were made in the first year after the law passed. But as the economy turned, filings rose, to 822,590 in 2007, 1.074 million in 2008 and 1.413 million last year, according to the American Bankruptcy Institute. See ABI's quarterly statistics.
The new law not only didn't stem the tide of bankruptcy filings, it only temporarily slowed the pace of filings under Chapter 7. Filings under that part of the bankruptcy code actually rose to 71% last year, up from 59% in 2006, or to about the same level of Chapter 7 filings before the 2005 law was enacted.
Here's why the rash of Chapter 7 filings is alarming: under the 2005 law, only debtors with incomes under their state's median income qualify. Debtors who make more than the median income can qualify too, if they pass an onerous "means test."
In other words, the economy has taken such a hard toll on poorest Americans, their debts have become so deep, they're easily able to qualify for Chapter 7, even though banks were able to create higher hurdles for that more drastic step.
The fallout from the reform doesn't end there. A study by the New York Federal Reserve Bank in November found that the new bankruptcy law actually fueled the financial crisis by precipitating subprime mortgage defaults by as much as 128,000 a year.
Under the old bankruptcy law, "over-indebted mortgagors could free up income to pay the mortgage by filing bankruptcy and having their unsecured debts discharged," the report stated. The reform "blocks that maneuver for better-off filers by way of a means test."
On the surface, all of this sounds like bad news for the banks. Bankruptcy brings credit card defaults and foreclosure -- both big losses for banks. But, in reality, banks benefited from the change in bankruptcy law by limiting losses and accelerating the credit cycle.
First, banks swamped consumers with easy credit. They offered unlimited credit cards, and jumbo mortgages to borrowers with little or no documentation. Then, the banks piled on home equity lines and refinancing. Throughout the process they took thousands of dollars in fees along the way.
When the borrower filed for bankruptcy, the new law gave banks power to go after debtors. If they filed Chapter 13, banks could expect some portion of the credit card debt, for instance, to be repaid in 60 months.
But that's the worst case. Some bankruptcy attorneys, including Warren Graham, writing on Cornerattorney.com, believe many borrowers could be avoiding bankruptcy by defaulting on their credit cards and funneling cash into mortgage payments. See Graham's piece on CornerAttorney.com.
Given how most mortgage payments are front-loaded with interest, a bank would probably take this trade. After all, banks can garnish wages without bankruptcy, a trend that's been growing nationally during the recession, according to a recent report in The New York Times. See New York Times story.
Ultimately, banks probably would like another shot at bankruptcy reform. They'd undoubtedly like to squeeze more middle-income Americans into Chapter 13. The 2005 effort has had mixed results, it's made matters worse for many borrowers, but it's helped the industry recoup its losses and scare people into trying to keep up, even when the odds are against them.
Though the ability to wipe away debts may seem unfair to us mopes who live within our means, it's vital to our society. Filing for bankruptcy has always been an American institution. As a nation, we value the right to start over. If you lose your job or endure another kind of tragedy -- loss of a breadwinner, or unexpected health problems -- you can bet your feelings about bankruptcy would change too.
And don't we deserve the same help we've given the biggest credit card issuers? Banks such as J.P. Morgan Chase & Co. /quotes/comstock/13*!jpm/quotes/nls/jpm (JPM 45.87, +0.53, +1.17%) , Bank of America Corp. /quotes/comstock/13*!bac/quotes/nls/bac (BAC 18.39, +0.26, +1.43%) and Citigroup Inc. /quotes/comstock/13*!c/quotes/nls/c (C 4.30, +0.04, +0.93%) took billions in taxpayer money to stave off their own potential bankruptcies. It was their second chance.
The proposed Consumer Protection Agency would put a dent in the banks' effort to keep the cycle running. Educated consumers would be less likely to saddle themselves with bank debt that must be repaid in or out of bankruptcy.
Unlike banks, consumers don't have eight-year, $100 million lobbying campaigns to fight for their interests. They have to hope Washington isn't bankrupt of common sense and realizes its debts are to the people.
David Weidner covers Wall Street for MarketWatch.
David Weidner is the Wall Street columnist for MarketWatch. He formerly covered M&A and financial services at The Daily Deal, American Banker and Dow Jones. He writes the Writing on the Wall column which appears Tuesday on MarketWatch and Thursdays on WSJ.com. He also is a regular contributor to the News Hub.
Revelations that Wall Street traders gorged on fat compensation, beating their respective chief executives, is certain to fuel the simmering consternation directed at the financial industry, writes David Weidner.
10:46 a.m. Today10:46 a.m. April 6, 2010 | Comments: 11
- JRK | 11:40 p.m. April 5, 2010
"RT @gbussmann: Apple's iPhone 4.0 OS to be revealed Thursday http://bit.ly/9Renky" 12:50 p.m. EDT, April 6, 2010 from davidweidner
"How bankruptcy "reform" failed. http://bit.ly/bm1ivY" 6:02 a.m. EDT, April 6, 2010 from davidweidner
"David Weidner's Writing on the Wall: Bailed-out banks feast on bankrupt customers: For those who underestimate the... http://bit.ly/aCeU9o" 11:58 p.m. EDT, April 5, 2010 from davidweidner
"Just. Doesn't. Get. It. RT @ProPublica Geithner's Letter Shows Opposition to Fixed Capital Requirements In Reform Bill: http://bit.ly/99pG1Y" 3:10 p.m. EDT, April 2, 2010 from davidweidner
"The markets don't seem to be moving on the jobs report. Both the Dow and S&P 500 are flat." 11:16 a.m. EDT, April 2, 2010 from davidweidner
Writing on the Wall
Bailed-out banks feast on bankrupt customers
Behavioral Economics
Mighty America's 5 stages of rapid decline
Read Full Article »