Upcoming Public Events for Unjust Debts

More upcoming events open to the public - in person and virtual - for the new book Unjust Debts, including tonight in Washington DC. Join the conversation!

• Monday July 8, 7pm ET: Politics & Prose, with Vicki Shabo, Senior Fellow at New America
• Wednesday, July 17, 3pm ET VIRTUAL: Roosevelt Institute, with think tank director Hannah Kroch-Blegley
• Thursday, July 18, 5:30 PM: Fletcher Free Library, Burlington VT, with Vermont State Treasurer Mike Pieciak
• Sunday, July 21, 10:30 AM: Temple Beth Shalom, Brigantine NJ (contact me for registration information). 
• Friday August 16, 12pm PT/3pm ET VIRTUAL: Berkeley Judicial Institute/Berkeley Civil Justice Research Initiative, with Professor Abbye Atkinson

 

Unjust Debts on the Road

First, thanks to Bob Lawless for his post about my new book. It has been great to engage with people about Unjust Debts so far, and especially appreciated the book making a new Financial Times best books list (links to that and other coverage here). Wanted to note a few upcoming book events for Credit Slips readers:

• June 27 (TONIGHT): Greenlight Bookstore, Brooklyn NY, in conversation with Zephyr Teachout. Information and RSVP here. 
• July 1 (VIRTUAL): Commonwealth Club World Affairs, in conversation with Senator Elizabeth Warren. Information and registration here. 
• July 8: Politics & Prose, Washington DC, in conversation with Vicki Shabo. Information here. 

Bankruptcy on Last Week Tonight with John Oliver

The consumer bankruptcy system has made it to late-night television! The main segment on Last Week Tonight with John Oliver this week focused on bankruptcy. As described: "John Oliver details why people file for bankruptcy, how needlessly difficult the process can be, and the ways we can better serve people struggling with debt." Twenty minutes about consumer bankruptcy!

Per usual, it's a well-researched, understandable, and fast-moving segment, with dashes of dark humor. My favorite references Julianne Moore's character in Magnolia. To the well-research part: It is supported by a host of papers about consumer bankruptcy, including the work of several current and former Slipsters. Among them is Portraits of Bankruptcy Filers (forthcoming Georgia Law Review), the most recent article based on Consumer Bankruptcy Project (CBP) data, co-authored with Slipster Bob Lawless and former Slipster Debb Thorne. In Portraits, we rely on data from 2013 to 2019 to describe who is using the bankruptcy system, providing the first comprehensive overview of bankruptcy filers in thirty years.   

Also referenced are Life in the Sweatbox, former Slipster Angela Littwin's The Do-It Yourself Mirage: Complexity in the Bankruptcy System, Slipster Bob Lawless, Jean Braucher, and Dov Cohen's Race, Attorney Influence, and Bankruptcy Chapter Choice, and the ABI Commission on Consumer Bankruptcy's report. The segment closes by highlighting the Consumer Bankruptcy Reform Act of 2020 (and includes a bonus at the end, which you'll have to watch to find out what that's about).

What's in a Word: New Immigration Public Charge Rule and "Bankruptcy"?

I was surprised to find that the explosive new US immigration "public charge" rule has some interesting bankruptcy angles. The rule is a thinly veiled attempt to reduce immigration to the US by non-wealthy individuals (i.e., the vast majority of applicants) by expanding the legal basis for "inadmissibility" based on the likelihood that the immigrant might at some point become a "public charge" drain on the US public welfare system (such as it is). The indirect bankruptcy angle is how similar this is to the BAPCPA means testing fiasco of 2005. Want to reduce access to a public benefit on the pretextual basis that it's being "abused"? Simply ramp up the formalistic application requirements! The new rule imposes a ridiculous and substantial paperwork burden on immigrants to demonstrate that they're not "inadmissible" as potential public charges, requiring completion of a means-test like questionnaire (with often only vaguely relevant questions) supported by a thick sheaf of evidence. The direct bankruptcy angle is ... one of the questions is about bankruptcy! Item 14 (!) asks "Have you EVER filed for bankruptcy, either in the United States or in a foreign country?" (emphasis in original). The thing that struck me about this question is that, of the small but growing number of non-Anglo "foreign countries" that have a system for providing debt relief to individuals, few call this system "bankruptcy." That word is reserved for business cases, creditor-initiated cases, a traditional liquidation not involving a multi-year payment plan, or some other distinction. Individual debt-relief procedures are often intentionally called something other than bankruptcy to signal these differences, reduce the stigma of seeking relief, and emphasize the rehabilitative function of the procedure. The public charge form (and instructions) betray no familiarity with this reality, even in the context of a follow-up question, "Type of Bankruptcy," with check-boxes for "Chapter 7," "Chapter 11," and "Chapter 13." Chauvinism, anyone? I guess I should be relieved that the ignorance of the drafters of this silly and odious new rule might have undermined the "bankruptcy" question, but that leaves honest immigration attorneys in a bit of a bind: do I prompt my client to answer "yes" and explain that her country doesn't have three "Chapters" or even "bankruptcy," but that her gjeldsordning procedure was the functional equivalent? Oh, I forgot--immigration from Norway is actually encouraged!

Consumer Bankruptcy, Done Correctly, To Help Struggling Americans

Today, Senator Elizabeth Warren unveiled her new plan to reform the consumer bankruptcy system. The plan is simple, yet elegant. It is based on actual data and research (including some of my own with Consumer Bankruptcy Project co-investigators Slipster Bob Lawless, former Slipster, now Congresswoman Katie Porter, and former Slipster Debb Thorne). Most importantly, I believe it will make the consumer bankruptcy system work for American families. And, as a bonus, it will tackle the bad behavior that big banks and corporations currently engage in once people file, like trying to collect already discharged debts, and some non-bankruptcy financial issues, such as "zombie" mortgages.

In short, the plan provides for one chapter that everyone files, combined with a menu of options to respond to each families' particular needs. It undoes some of the most detrimental amendments that came with the 2005 bankruptcy law, including the means test. In doing so, it sets new, undoubtedly more effective rules for the discharge of student loan debt, for modification of home mortgages, and for keeping cars. It also undoes "smaller" amendments that likely went unnoticed, but may have deleterious effects on people's lives. Warren's plan gets rid of the current prohibition on continuing to pay union dues, the payment of which may be critical to allowing people who file bankruptcy to keep their jobs and keep on their feet. Similarly, the plan eliminates problems debtors face paying rent during their bankruptcy cases, which can lead to eviction.

One chapter that everyone files means that the continued racial disparities in chapter choice my co-authors and I have documented will disappear. No means test, combined with less documentation, as provided by Warren's plan, means that the most time-consuming attorney tasks will go away. Attorney's fees should decrease. Warren's plan also provides for the payment of fees over time. People will not have to put off filing for bankruptcy for years while they struggle in the "sweatbox." Costly "no money down" bankruptcy options should disappear. People will have the chance to enter the bankruptcy system in time to save what little they have, which research has shown is key to people surviving and thriving post-bankruptcy.

Driven to Bankruptcy — New Research from the Consumer Bankruptcy Project

In America, people drive — to work, to the doctor, to the grocery store, to their kids' daycare, to see their aging parents. Research shows that car ownership increases the probability of employment and number of hours worked; households without cars have lower incomes and are more likely to be in poverty. In short, cars are essential. Household financial distress can threaten people's cars, and with them, the day-to-day stability that car ownership brings. People thus may file bankruptcy, in part, to save their cars.

Although there is a substantial literature on financial distress and home ownership, the literature on car ownership, financial distress, and bankruptcy is thin. In Driven to Bankruptcy (available via SSRN, forthcoming in the Wake Forest Law Review), Slipster Bob Lawless, past Slipster Debb Thorne, and I document what happens to car owners and their car loans when they enter bankruptcy.

In brief, we find that people who file bankruptcy own automobiles at the same rate as the general population. This means that over the last ten years, 15.1 million people filed for bankruptcy owning 16.4 million cars. The majority of these cars, particularly a household's most valuable car, entered bankruptcy encumbered with a hefty loan. And most debtors want to keep their cars, particularly their most valuable and second most valuable cars.

Consumer Bankruptcy Reform ... and American Xenophobia?

I hope I'm not stepping on Bob's toes in announcing the public release of the long-awaited report of the ABI Commission on Consumer Bankruptcy. The Commission, with Credit Slips' own inimitable Bob Lawless as its reporter, was formed in December 2016 to explore revisions to the US consumer bankruptcy system that would improve the operation of its existing structure; that is, evolution, not revolution. With this explicitly limited charge, one would not necessarily expect to find much high-level discussion of how the US approach squares with or fits within the many recent global developments in consumer insolvency relief, and one would expect to see a concentration on local solutions for local stumbling blocks.

That being said ... and in no way to detract from the monumental amount and truly impressive nature of the work the Commission has done here ... one might have expected to see a bit of discussion, if not even a touch of inspiration, from comparative sources. In 1970, the Bankruptcy Commission rejected any consideration of foreign developments in consumer bankruptcy, in part because there were few such developments, and in part because so little was known about the operation of non-US bankruptcy law at the time (for those younger than I, note that neither home computers nor the public Internet existed in 1970 ...). Nearly 50 years later, we now have at our fingertips a mountain of comparative data and analysis on the development, operation, and revision of consumer insolvency systems around the world, much of it reported in English specifically to make it widely available to law reformers like the ABI Commission. Again, one would not have expected this comparative material to occupy center stage in a reform of largely US problems in the uniquely US consumer bankruptcy system. But in a bit part here and there, some comparative observations might have supported the Commission's already compelling recommendations.

File This Under Calling BS on Bankruptcy Fearmongering

As anyone familiar with bankruptcy would have predicted, the dire predictions of disaster for municipalities seeking bankruptcy protection have proven to be ... let's just say exaggerated. Bloomberg is out with a notable story this morning on Jefferson County's healthy return to the bond market, carrying an investment-grade rating of AA-  within five years of emerging from municipal bankruptcy. This squares with similar accounts of consumers rehabilitating their credit within two to four years of a chapter 7 liquidation-and-discharge (see, for example, here and here). Let's all file this in our "lying liars and their bankruptcy impact lies" file and be prepared to continue to counter this, among the many, many other, bankruptcy scare myths to be debunked.

Glass-Steagall: It's the Politics, Stupid!

It was like eight nights of Chanukkah in one for me watching the Democratic debate last night. There was a Glass-Steagall lovefest going on. But here's the thing:  no one seems to get why Glass-Steagall was important or the connection between Glass-Steagal and the financial crisis. The importance of Glass-Steagall was not as a financial firewall between speculative investment activities and safe deposits. It was as a political Berlin Wall keeping the different sectors of the financial industry from uniting in their lobbying efforts and disturbing the peace of the nation.

Until and unless we realize that the importance of Glass-Steagall was political, we're going to continue wasting our time debating insufficient half-measures of financial regulation like the Volcker Rule, which has the financial, but not the political benefits of Glass-Steagall. More critically, we're going to pass regulations like the Volcker Rule and then wonder slack-jawed why they don't work, as the financial industry undermines them through the regulatory implementation and legislative amendments. Financial regulation is just not that complex technically, even if if has a lot of technical rules (it's the capital, stupid!). The problem we face is not technical, but political.

All Late-Filed Taxes Now Nondischargeable?!

Sometimes a tax return is not a tax return. As a result, bankruptcy is becoming a less effective response to back tax woes in the US. Yesterday, the 1st Circuit joined the 5th and 10th in holding that old income tax debts are nondischargeable if the taxpayer-debtor filed the related tax returns late. This is the latest negative impact of BAPCPA and an oddly worded statute with an even odder citation.

Section 523(a)(1)(A) of the Bankruptcy Code has long made nondischargeable recent income tax debts, for taxes for which the return was due within three years before the bankruptcy filing. But older tax debts might also survive the discharge thanks to section 523(A)(1)(B)(i). That section renders taxes nondischargeable if the taxpayer-debtor failed to file a return. Not surprising. What is surprising is a recent revision and its expansive interpretation, which have created a vast new category of nondischargeable tax debts.

Have Retail Reorgs Gone the Way of the Dodo?

In the past two months, four retailers have filed bankruptcy cases. RadioShack is rumored to be preparing a chapter 11 filing, and other retailers certainly appear to be struggling (see Stephen Lubben’s post here). But if you were counseling any of these retailers, would you recommend a chapter 11 filing? Okay, put aside the professional fees you might earn—would filing really be in the best interests of your retail client? (For a discussion of fees and costs in chapter 11, see Part IV.A.8 of the ABI Commission Report.)

Consider this: from 2006-2013, the number of retailers liquidating in chapter 11 increased significantly. Although no data are perfect, the various data we have on chapter 11 filings are quite telling. For example, according to the UCLA-LoPucki Bankruptcy Research database, during 2006-2013, 41.2% of large public retailers (excluding eating and drinking places) emerged from chapter 11 and 58.8% liquidated while, during 1980-2005, 60.5% of large public retailers emerged from chapter 11 and only 39.5% liquidated. Likewise, a quick look at the New Generations Public and Major Private Companies database suggests a similar trend for 2006-2013: approximately 62% of retail cases in the database ended in a liquidation (36 of 58). A chapter 11 filing has, quite literally, become a “bet the company” decision for retailers.

"Don't give me so much that you've given me nothing" - Remembering M. Caldwell Butler's Contribution to Bankruptcy Law

Former Virginia Congressman M. Caldwell Butler died last week. He is widely known for his role in the Nixon impeachment proceedings, his efforts to limit extensions of the Voting Rights Act, and his support for ensuring legal representation for low-income individuals. But Congressman Butler is also a major figure in the history of bankruptcy law. He was a principal co-sponsor of the Bankruptcy Reform Act of 1978 that serves as the foundation of the modern bankruptcy system. Professor and lawyer Kenneth N. Klee worked closely with Congressman Butler on the House Judiciary Committee in the 1970s. I asked Professor Klee to share a few words of remembrance with us, which I repeat in their entirety here:

I first met M. Caldwell Butler in 1975 when he became the Ranking Minority Member of the Subcommittee on Civil and Constitutional Rights of the House Judiciary Committee. Caldwell was most interested in the Voting Rights Act legislation and finding a way for the South to get out from under the Act. In his view, Washington was improperly interfering with the sovereignty of the southern states based on predicate acts that had long since ceased to serve as a basis for federal control. He asked me to draft a series of amendments that would permit the South to extricate itself from the Voting Rights Act. The requirements to regain sovereignty were quite demanding, to the point that the amendments became known as the "impossible bailout."  Nevertheless, the amendments did not come close to passing. It was evident that there were no circumstances under which the majority in Congress wanted to let the southern states out from the Voting Rights Act.

Caldwell assumed his responsibilities over bankruptcy legislation with diligence and good cheer. His fabulous sense of humor carried us through many long markup sessions during which the members of the Subcommittee read the bankruptcy legislation line by line. He had a sharp legal mind and deep curiosity. He also was very practical and to the point. He was fond of telling me "don't give me so much that you've given me nothing."

It was a privilege and honor to work with him. The bankruptcy community should join in paying him tribute.

                        -- Ken Klee

Congressman Butler made another round of contributions to bankruptcy reform in the 1990s. The fact that they are not all reflected in today's Bankruptcy Code makes this story more pressing, not less. Well over a decade after he had returned to the practice of law in Virginia, Congressman Butler was appointed to the National Bankruptcy Review Commission, for which I was a staff attorney. Expressing satisfaction with the 1978 Code, the House Judiciary Committee directed this Bankruptcy Commission to focus, for two years, on "reviewing, improving, and updating the Code in ways which do not disturb the fundamental tenets of current law."  Not one to leave the heavy lifting to others, even in a pro bono post, Congressman Butler stepped up to the challenge of forging a compromise, among those with diverging politics and views, to improve the consumer bankruptcy system.

The "New" New Legislation on Student Loans and Bankruptcy

Senator Harkin's discussion draft of the Higher Education Affordability Act (described here) is expected to include a provision restoring bankruptcy relief from private for-profit student loans. A few years ago, I offered justifications for that move here. Prof. Scott Pryor agrees.

But wait, there's more. S.2471, The Medical Bankruptcy Fairness Act of 2014, introduced by Senator Sheldon Whitehouse, co-sponsored by Senator Elizabeth Warren. Section 6 would offer relief from student loans for some bankruptcy filers. Take a look. 

Abstract image courtesy of Shutterstock

 

Just Punch My Bankruptcy Ticket

That's the title of Denver Law Professor Michael Sousa's new article exploring debtors' evaluations of the pre-filing credit counseling course and the post-filing financial management course mandated by BAPCPA. The data for the article came from in-depth interviews that Sousa conducted with 58 individuals from Colorado who filed under Chapter 7 between 2006 and 2010. Bob Lawless previously posted about another article Sousa wrote based on the interviews that discusses debtors' perceptions of bankruptcy stigma. Like Sousa's previous article, this paper carefully presents the interviews for what they are and what they can reveal about debtors' interactions with these two components of the bankruptcy process.

Sousa's findings generally confirm the limited prior research about the two courses. In fact, they may paint an even grimmer picture of the courses' usefulness. None of the debtors thought the credit counseling to be of any help, and only 2 couples (4 of the 58 debtors, or 7%) thought they had learned anything useful from the financial management course. Indeed, and one of Sousa's more interesting findings, what some debtors took from the credit counseling course contravenes Congress's aim for the course to inform debtors of all their options and thereby convince some debtors to settle their debts outside of bankruptcy. Debtors instead said the course affirmed their decision to file because it showed them how bad their situation was and provided them some psychological comfort in accepting that bankruptcy was the last remaining option.

Suffolk/NCLC Student Loans Symposium

I had the pleasure of participating in this weekend's very successful Research Symposium on Student Loans organized by Kathleen Engel of Suffolk Law School and Deanne Loonin of the National Consumer Law Center (NCLC) (NCLC, by the way, is looking to hire three attorneys!). In this post I want to mention some of the highlights.

The symposium was not your typical academic conference. Although almost 20 papers were presented during the two days, a number of participants were from industry and nonprofits. Participants also heard from an NCLC client who had actually dealt with student loan issues and come out the other side. This was, as one speaker mentioned, the conference some of us had been waiting for. 

The speakers also included former Slips regular and now senior Massachusetts Senator Elizabeth Warren (pictured at the event). The Senator focused her remarks on her proposal to allow refinancing of student loans (federal and private) at the interest rates Congress approved last summer (3.86% for undergraduate loans and 5.41% for grad unsubsidized loans). She noted that this is just a small step on the road to fixing the problems with the student loan system but since Congress not too long voted to lower future students' interest rates agreeing that they were too high she is hoping this proposal might actually have some political legs.  

Update -- The Sixth Circuit Rules IRAs Are Exempt

A few weeks ago, I posted about an apparent movement to challenge the bankruptcy-exempt status of IRAs based on boilerplate language commonly found in the account agreements of many of the nation's largest brokerages. The legal argument rested on hyper-technical interpretations of the Bankruptcy Code and the account agreements, but nonetheless several lower courts had ruled that debtors could lose their IRAs to the bankruptcy trustee.

The Sixth Circuit heard oral arguments on the case last Thursday and issued an opinion yesterday. The court rejected the bankruptcy trustee's arguments and ruled the IRAs remained exempt despite language that hypothetically could have led to the brokerage having a lien on the account. And, yes, for you keeping score at home that is four days total, including a weekend, from oral argument to published opinion.

Non-exempt Exempt IRAs and Undercompensated Chapter 7 Trustees

Some chapter 7 trustees have found a problem that could affect thousands of IRAs, leading to the first post in a  two-post series on unintended consequences. A better reading of the law is that these IRAs should remain exempt from the bankruptcy process. Cases are wending their way through the court system, and until the courts resolve the issues, many IRAs may remain under threat. And, there is no guarantee the courts will agree with me on how the cases should be resolved.

The situation begins with the 2005 changes to the bankruptcy law. One of the few ways these changes were favorable to consumer debtors was to clarify and expand the exemptions available to retirement assets, including IRAs. Most retirement assets are exempt from the bankruptcy process, meaning debtors can retain these assets even after the bankruptcy case.

Debtor Audits, RIP

Hot of the presses that the EOUST has (again) suspended its "required" debtor audits due to budgetary constraints.  Initially they were supposed to do 1 in every 250, and that number fell in recent years to one in every 1,500 or so due to constraints, and sometimes they just run out of money toward the end of the fiscal year.  This is the most precocious suspension I'm aware of.  (But it sounds like such a great idea on paper...)

Stripping Down Bankruptcy Jargon

A Credit Slips commenter recently asked that blog posts explain (or at least spell out) acronyms and specialist terminology. This inspired me to report back on a corporate bankruptcy terminology set that University of North Carolina Law students collaboratively produced last year (technically, a wiki) in business bankruptcy, an advanced transition-to-the-profession seminar. In both comments and emails, Credit Slips readers helped me expand the list of terms (and also offered great ideas for practical writing projects). So thanks again for your contributions, and thanks also to the Spring 2012 seminar alumni - some of whom are practicing bankruptcy law or clerking for bankruptcy courts right now, or headed there soon - who tackled the collaborative vocabulary project, and the entire seminar and its experimental elements, with such great spirit and a 100% perfect attendance record! So, some observations. 

Bankruptcy and Politics: Junior Senator from Massachusetts Edition

Politics is not my strong suit -- this, ironically, from the faculty sponsor of both the Democratic and Republican student associations at Michigan Law.  (No, I am not confused; I was asked presumably because each group wanted a political independent, and I don't like to play favorites.)  So I have what may be a naive but is nonetheless a genuine question regarding Senator-Elect Warren's upcoming trip to Washington: does this increase the likelihood of substantive amendment of the bankruptcy laws in the next few years?

I'm not talking about full-throated repeal of BAPCPA or anything like that (although maybe I should?), but does having a bankruptcy expert as one senator matter?  Is it a salience focus for committees?  E.g., is it more likley we'll see home mortgage policy addressed through amendments to Chapter 13?  Does it somehow beef up the CFPB knowing they have a "champion" in the Senate?  Does it mean the venue fights will roar back to life?

I'd be curious if those more in the know have thoughts (with apologies in advance if this is dumb/trite).

A Valuable Resource: NCBRC.org

Sometimes we forget that, with all its flaws, consumer bankruptcy is still a remarkable institution, providing meaningful relief to more than two million Americans a year (counting co-debtors and dependents). The system’s singular feature is that most individuals can find a private attorney to represent them at a relatively low flat fee, typically worth it in light of the benefits of a bankruptcy discharge to most debtors.  In other areas of consumer law, it is much harder for individuals to find a private attorney.  Despite changes in bankruptcy law in 2005 that increased the cost of access to the system, the consumer debtor bar has figured out how to deliver services for reasonable fees.

If the need to appeal arises, however, the affordability equation often breaks down, a problem made worse by the wretched drafting of the 2005 law, creating hundreds of difficult new legal issues.  A debtor in bankruptcy may have a good legal case on appeal but no way to pay a private attorney for the expense of researching and writing a brief and preparing for oral argument.  An appeal adds thousands of dollars of additional cost.  The National Consumer Bankruptcy Rights Center was formed to address this problem, helping to protect debtors’ rights as well as the integrity of the consumer bankruptcy system by making sure that cogent arguments are made at the appellate level.  NCBRC (pronounced Nic-Bric) provides assistance by either working directly with debtors’ attorneys or by filing amicus (friend of the court) briefs in courts throughout the country.

Anyone interested in consumer bankruptcy law should find NCBRC’s web site, www.ncbrc.org, useful as a resource, both for its bank of briefs and its blog about important consumer cases.

Tax Rebates Lead to Bankruptcy Filings

Jialan Wang has a blog post up summarizing her and her co-authors very interesting NBER paper estimating that at least 30,000 to 60,000 liquidity constrained households this will be priced out of bankruptcy because of the increased costs that came with the 2005 changes to the bankruptcy law. Actually, the research does not find that tax rebates lead to bankruptcy filings -- that was just a cheesy trick to get you to read the post. The researchers find that, after receiving tax rebates, people are more likely to file bankruptcy as they now have funds they can use to pay for the bankruptcy fees. They then use the randomization of the delivery of tax rebates in 2001 and 2008 to identify the effect that the higher fees caused on the bankruptcy rates of liquidity constrained households. It is a clever research design, and Credit Slips readers will want to check it out.

Evaluating Mandatory Financial Education in Bankruptcy

In 2005, Congress amended bankruptcy law to require individual debtors with primarily consumer debts to complete an "instructional course on personal financial management" to be eligible to receive a discharge of their debts. Adding financial education as a bankruptcy requirement divided the bankruptcy community, even debtor advocates, judges, academics, and others who almost uniformly did not like the 2005 amendments. Part of the mixed sentiment about the financial education may be that it is hard to dislike something as innocuous-sounding as education (although Professor Lauren Willis makes a good case against it in this article). And there were certainly bigger fish to fry in opposing the 2005 laws. Still, many complained that this was one more example of creditors getting Congress to lard on duties for debtors, driving up the cost and work of obtaining bankruptcy relief and setting up debtors to have their cases dismissed if they tripped up by failing to complete the educational course.

Dr. Deborah Thorne and I have a new study that looks at how debtors themselves feel about the mandatory financial education course. It is a chapter in this book, Consumer Knowledge and Financial Decisions (ed. Douglas Lamdin, Springer, 2012) and available to read here. In the 2007 Consumer Bankruptcy Project, we asked debtors whether they believed that the information from the financial education class 1)would what they learned in the financial education class have helped them avoid bankruptcy originally, and 2) would help them avoid financial trouble in the future. While only 33% thought a financial instruction course similar to the one required of bankruptcy debtors could have helped them avoid filing, 72% thought it would help them avoid future financial trouble. As we report in detail in the chapter, some demographic groups were much more positive about the value of financial education than others.

NACBA warns of student loan "debt bomb"

At its annual Capitol Hill Day in Washington this week, the National Association of Consumer Bankruptcy Attorneys sounded an alarm about the growing student loan problem, calling it a “debt bomb.” NACBA released a survey of its members indicating that more potential clients these days have unmanageable educational loans and are facing aggressive collection efforts. See http://www.nacba.org/Legislative/StudentLoanDebt.aspx. It has become common for people to have two mortgage-size debts, one for a home and another for an education. The educational loan problem is looking something like the one a few years back with subprime mortgages.

Absent “undue hardship,” very hard to establish, student debt can be a life sentence because these loans are not dischargeable in bankruptcy. NACBA supports making private students loans dischargeable again (as they were before the 2005 law). Beyond that, it favors going back to the pre-1990 approach of allowing discharge of any student debt after five years. If the education isn’t paying off enough to make the loan repayable after that much time, something has to give so that people can get on with their lives--and some day buy a home, start a family, and save for their kids’ education and their own retirement.

As a participant in the Capitol Hill Day, I found congressional staff reacted very sympathetically. They are mostly young people carrying big student loans or with friends who have them. They know how hard it is to manage this debt even when you have a decent job. They easily recognize what a big problem this is for their generation and even more so for the next one. This issue isn’t going away.

How to Address Apparent Racial Disparity in the Consumer Bankruptcy System

The article discussed in the N.Y. Times story today is heavily empirical. It is also deliberately light on the prescriptive. Bob Lawless, Dov Cohen and I did make two modest proposals: (1) that a question about race of the debtor should be included on the form for a bankruptcy petition to make it possible to confirm (or disprove) the finding that African Americans file in chapter 13 at a much higher rate than debtors of other races (about double in the data we have), and (2) that all actors in the bankruptcy system—judges, trustees, attorneys and clients—be educated about the apparent racial disparity and the possibility that subtle racial bias may be producing it. The Times certainly helped with the second one!

Beyond that, we leave it to others and to each of us individually to come up with policy responses. In my view, Henry Hildebrand, a longtime chapter 13 trustee in Tennessee, got the big picture exactly right; he is quoted in the Times story as saying we should “use this study as an indication that we should be attempting to fix what has become a complex, expensive, unproductive system.” He will probably reappraise his views if he finds out that I agree with him! Those of us who participate in or study the system know that its complexity is onerous.

New Duties for Debtors: Form Amendments in the wake of Lanning and Ransom

Lanning and Ransom are the Supreme Court's two recent decisions on the interpretations of the means test added to the Bankruptcy Code by BAPCPA. Courts are actively puzzling out how to apply these decisions, which generated as many questions as they answered (Lanning, in particular). I recently learned that the Bankruptcy Rules Committee is planning to propose a new version of the means test form, B22, to accommodate Lanning and Ransom. The revised form would have a line that required debtors to list changes in circumstances and provide details. I'm troubled by these potential revisions because I think it is an unduly aggressive interpretation of the two decisions to create an affirmative duty by debtors, and their counsel, to disclose changes in income or expenses, above and beyond what is already required by the Bankruptcy Code. 

The Consumer Bankruptcy Fee Study

Thanks to Katie and my friends at Credit Slips for the guest blogging gig.  I appreciate the invitation and the opportunity.

In my next couple of posts, I am going to report on the Consumer Bankruptcy Fee Study (see Katie's post below).  Today, I'm making a pitch to the consumer debtor's attorneys who have received (or will receive) an invitation to participate in a survey about their consumer bankruptcy practices.  To date, the Consumer Debtor Attorney Fee Survey has been distributed to ~400 lawyers who represent consumer debtors.  I expect to send out a couple of additional "waves" in the next weeks.  As I said in my cover note,

From the Sixth Circuit with Love (for Creditors)

Last Friday, the U.S. Court of Appeals for the Sixth Circuit released an opinion in a case called Carroll v. Baud. The decision, which generally ended badly for the consumer bankruptcy filers involved in the case, involved technical interpretive issues caused by the drafting mess that was the 2005 bankruptcy law. What caught my eye were not the holdings themselves, but the way the court got there.

After an extensive analysis finding that the plain language of the statute could support a result either for the debtor or the creditor, the court came up with its own statutory tie-breaker: in doubtful cases, rule for the creditor. The Sixth Circuit explained, "Where each competing interpretation of a Code provision amended by BAPCPA is consistent with the plain language of the statute, we must, as the Supreme Court did in Lanning and Ransom, apply the interpretation that has the best chance of fulfilling BAPCPA’s purpose of maximizing creditor recoveries." This statement is hardly a passing fancy of the court. It repeats the point in several places, including an extensive analysis of the idea in several pages in the middle of the opinion.

The court puts its thumb on the scale for haves instead of have-notes. Its reasoning is simply outrageous, not least of all because the Supreme Court cases it cited do not support its result.

One More Time on Ransom

Yesterday, the Supreme Court decided Ransom v. FIA Card Services (née MBNA Bank). The issue was whether, to determine the amount of income available to pay creditors, a debtor could deduct hypothetical car payments on a car he already owned. That would seem to be result Congress directed in the 2005 bankruptcy amendments, but the Supreme Court disagreed. We already have blogged about the case a lot (here, here, here, and here).

The Court has spoken, and there is little point to repeating why I thought the case should come out differently. The Court's need to parse hopelessly muddled language is striking. Buce, writing at Underbelly, has written a fantastic post along this theme ("Justice Kagan's Torture Memo"). He makes an important point:

Rather, there seems to have developed a sense among the lower courts that what Congress intended to do was jam it to the debtor good and hard, and that if Congress get it right the first time, then we must help them. Bankruptcy lawyers have fashioned a new canon of statutory interpretation: if the statute seems to favor the creditor, apply the statute; if it seems to favor the debtor, assume it's a mistake and favor the creditor anyway.

Exactly. I agree with every single word Buce writes (with one exception), and I can't write as well as him. Go read the post.

The one tangential point where I disagree with Buce is that he should give Justice Thurgood Marshall more credit. Justice Marshall wrote some great bankruptcy opinions because his law practice often involved the problems of everyday persons, an experience that most every other Supreme Court justice lacks.

Technical Corrections to Bankruptcy Code

On December 23, President Obama signed a bill that made technical corrections to the Bankruptcy Code. As the term "technical corrections" suggests, this is a topic of interest probably only to the bankruptcy geeks in the crowd. The bill was not intended to make any substantive changes but only to correct drafting mistakes from the 2005 changes to the bankruptcy law.

It only took five years and even the technical corrections are too few for a horribly drafted law. Maybe there is a nugget for the persons who have a more general interest in bankruptcy. In addition to being a huge policy mistake, the 2005 law created a lot of problems for lawyers and judges because of its poor drafting. As a service to our readers, here is a copy of the enrolled bill. The public law version is not available as of this writing.

A Lot of Wisdom over at the NYT

Tara Siegel Bernard has a post up over at the New York Times Bucks blog about economic indicators, outstanding credit, and bankruptcy filings. She quoted some guy named "Lawless" who really sounds like he knows what he is talking about--probably a good-looking guy too. Punch line -- less credit means fewer bankruptcies all other things being equal (which they rarely are).

The U.S. Trustee's Office Already Has Decided Ransom

During this past week in Bankruptcy with Bob, otherwise known as my bankruptcy course, we covered the means test. As my students now know, the means test is the screen that the U.S. Congress put on chapter 7 back in 2005. If you're below the state median income for a household of your size, you can file chapter 7. If you're above median income, the means test starts with your gross income and takes a series of deductions based on IRS guidelines to determine your disposable income. If your disposable income meets certain thresholds, meaning you can afford to pay back unsecured creditors some part of what you owe, you must file chapter 13. There are exceptions and more details, but that description works as a general matter. The Executive Office of U.S. Trustee (EOUST) helps keep track of the numbers to plug into the test, but in one particular way, it has taken a legal position on a contested issue without making clear its position is contested.

Seen this Movie Before?

For the past several years, we have watched various industries struggle, including the automotive, airline and entertainment industries. Although troubled companies within these industries have their own unique issues, they also share common experiences relating to the recent recession, competition and product/technology obsolescence. Recessions and in turn bankruptcy often are said to facilitate creative destruction, but I actually like a phrase recently used by Chrysler’s CEO, Sergio Marchionne, "creative reconstruction."

U.S. bankruptcy laws—in particular, chapter 11—give companies an opportunity to recreate themselves. In this sense, creative reconstruction might be a more apt phrase for the utility of chapter 11 (see my previous post on that topic here). A company can use the chapter 11 tool not only to reorganize its capital structure but also to streamline or transform its operations (e.g., eliminating outdated product lines or technologies). In those instances, the protection of the automatic stay, the flexibility of the executory contract and lease provisions and the time granted companies to reorganize are critical. It is here that the 2005 amendments to the U.S. Bankruptcy Code arguably weakened the utility of chapter 11 for many companies.

Rather than rehash the issues created by the 2005 amendments, I would like to focus on the potential for creative reconstruction in chapter 11. And I would like to do so by reflecting on the recent experiences of Movie Gallery and Blockbuster. Both companies incurred significant debt as the result of M&A activity during 2004 and 2005 (see, e.g., here for Movie Gallery and here for Blockbuster). Both companies faced increased competition from new technologies and new market entrants (Netflix, Redbox, etc.). And now only one company remains, but it too is on the verge of extinction.

The Utility of Chapter 11

First, I want to thank Bob Lawless and the other authors of Credit Slips for inviting me to guest blog this week. I am honored to share this space with you, and I look forward to a robust dialogue.

Second, I have to say that guest blogging at Credit Slips feels like coming home to me. Before changing careers, I had the privilege of serving as a law clerk to the Honorable William T. Bodoh, and I practiced as an associate and then a partner in Jones Day’s corporate restructuring practice group for about ten years. I welcome this opportunity to share my passion for everything bankruptcy with others interested in the field.

As you might suspect from my days in practice, I am a strong proponent of the utility of chapter 11 of the U.S. Bankruptcy Code as a restructuring tool. I want to emphasize that I view chapter 11 as a "tool"—not a "fix"—in the context of financial distress. The effectiveness of this tool depends largely on who is using it and how it is being used. Companies do not fail because of chapter 11; rather, companies fail because, among other things, they wait too long to invoke the chapter 11 tool (see here), they do not understand how best to use that tool (see here), or perhaps they simply have outlived their economic utility (see here).

The effectiveness, however, also depends on the construction of the tool itself. So how do we assess its construction? Although there are a number of very useful studies on the topic, I suggest we look back at the origins of chapter 11 and three of its important features: its dual goals of rehabilitation and value maximization (referenced recently here in Congressional testimony); its design to mitigate the collective action problem (see here at pp. 95-98 for an interesting discussion); and its ability to promote negotiation and consensual resolution.

The dual goals of rehabilitation and value maximization require transparency and information sharing to all, and by all, key constituents. The collective action problem merits strong rules maintaining the status quo while constituencies gather around the negotiating table. And negotiation needs a flexible framework and a neutral third party with the discretion and power to adapt the rules to the particular needs of the case. Does chapter 11 currently measure up?

Over the years, chapter 11 has increasingly moved away from its original objectives and, in many respects, been captured by special interest groups. This shift has created weaker rules and less flexibility. It also has limited the contributions of our specialized and very talented bankruptcy bench.

During my time at Credit Slips, I hope to explore the strengths and weaknesses of chapter 11 in its current state, including its role in facilitating obsolescence (see here), creating value and exploiting information asymmetries (see generally here and here). Chapter 11 has changed and perhaps not all for the best. I suggest that we might best move it forward by looking backward.

Supreme Court Rules in Lanning

The Supreme Court has just issued its opinion in Hamilton v. Lanning, a case interpreting the "means test" that the 2005 bankruptcy amendments added to chapter 13. The issue was chapter 13's requirement that the debtor commit his or her "projected disposable income" to a plan, and whether projected disposable income should be determined in a mechanical way (based on the debtor's income for the past six months as defined in the means test) or whether projected disposable income should include reliance on some estimate of the debtor's income in the future during the plan period. The Supreme Court rejected the mechanical approach, which was argued for by the debtor trustee and the National Association of Consumer Bankruptcy Attorneys, and adopted the forward-looking approach. The decision, authored by Justice Alito, was 8-1, with a dissent by Justice Scalia arguing the plain meaning of the text supported the mechanical approach.

I'm certain there will be loads of technical commentary forthcoming on this case, debating whether the Supreme Court's interpretation of the statute was correct. I have some non-technical observations.

First, it isn't clear that debtors are "hurt" or "helped" by this decision in terms of what they will be required to pay. Some debtors will have incomes that have picked up right on the eve of filing, so their forward-looking income is higher. But other debtors will have earned more in the past six months, filing in an income trough with bleak prospects. We could empirically test which system is better, but of course, to the best of my knowledge, nobody did this. (Query whether such data would have been persuasive to the Court if it had existed).

Second, I am quite sure this decision hurts debtors. How can I reconcile that with my first observation? Because it's not just the law that matters. In many contexts, including this one, the cost of the law will determine the justice received. The mechanical approach is easier to apply and is less likely to spawn litigation, which consumers filing bankruptcy can ill afford. Faced with a choice of filing a plan that is likely to begin a lawsuit, some consumers will just give up and drop out of chapter 13 or not bother to file at all. By holding that "only in 'unusual' cases, a court may go further and take into account other 'known or virtually certain information' about the debtor's future income or expenses," the Court will add a layer of complexity to lawyers' and debtors' decisionmaking in chapter 13. And legal decisions don't come free.

Can You Deduct an Expense for a Car You Own?

The news came today that the Supreme Court has granted cert in Ransom v. MBNA Bank. The issue is whether the Bankruptcy Code means what it says. OK, I'm giving away what I think is the right answer.

The question is whether an above-median income chapter 13 debtor, in calculating "projected disposable income," can deduct an ownership expense for a car even if the debtor owns the car free and clear such that the debtor is not making an debt or lease payments on the car. The Fifth and Seventh Circuits said the plain meaning of the statute clearly allowed the debtor to do so. The Ninth Circuit said the statutory language directed a different result. If you're wondering how so many federal judges can differ over the "plain meaning" of a statute, you're obviously not a lawyer.

The Congressional Research Service Says No Real Effect from BAPCPA

According to a story in this morning's BNA Bankruptcy Law Reporter, the Congressional Research Service (CRS) released a study stating the 2005 amendments to the bankruptcy law (the Bankruptcy Abuse Prevention and Consumer Protection Act or BAPCPA) will not permanently reduce the U.S. bankruptcy filing rate. Those findings fit with what we have been seeing the past few months. Even on a per capita basis, the March 2010 bankruptcy filing rate matched the rate from before the 2005 amendments.

CRS reports are not publicly released as a matter of course, and the Bankruptcy Law Reporter is a subscription service. Hence, I can't link you anywhere for this information. If someone does have a copy of the CRS report, I will be happy to make it available here through Credit Slips and/or pass it along to Open CRS.

Early Thoughts on Milavetz

This morning, the Supreme Court issued its decision in Milavetz on prebankruptcy attorney-client counseling and bankruptcy attorney disclosures. I've got to get to a meeting so I don't have time for an extended post. The early reporting has been technically correct but misleading, e.g., Reuters, "US top court upholds lawyer bankruptcy advice law." The decision upheld the law but construed its most troubling provision--section 526(a)(4)--in a very narrow way, eliminating almost all concerns about the statute. It appears to come out about the way I expected.

White House Dinner Crashers' Bankruptcy

Some of the news reports on the White House dinner crashers (Tariq and Michaela Salahi) have noted that they own a winery that filed for Chapter 11 (reorganization) bankruptcy and then converted to Chapter 7 (liquidation) bankruptcy. My prurient interest was engaged, so I tracked down the petitions and relevant filings (linked below).  What follows is my attempt to sort out the Salahi family's business doings, as well as some musings about where we should really look for bankruptcy abuse--small business filings where the business is the alter ego of the owner, but where corporate law might not allow veil piercing.  In these cases the sophisticated creditors get personal guarantees, but the tax authorities, tort creditors, and unsophisticated creditors get screwed by the corporate form.

As far as I can tell, however, from the PACER filings, this part of the story has been misreported.  There are two separate, but apparently affiliated entities that filed for bankruptcy separately.  First, Oasis Vineyards, Inc., filed for Chapter 11 in December of 2008.  Oasis Vineyards has three shareholders:  Mr. Salahi (5%), his mother (40%, also president of Oasis Vineyards), and his father (55%).  The petition schedules assets of $333K and liabilities of $1.9M.  Tariq Salahi, a Salahi Family limited partnership, Oasis Enterprises, Inc., and Salahi's parents are listed as codebtors (cosignors or guarantors) of various obligations.

In April 2009, the US Trustee filed a motion to convert the case to Chapter 7 liquidation or have it dismissed because the debtor failed to file its monthly operating reports and had not filed a plan of reorganization.  (This is pretty standard; it appears that several monthly operating reports were subsequently filed simultaneously.)  The court has postponed ruling on the motion to convert or dismiss because of the death of the debtor's counsel.

Second, Oasis Enterprises, Inc., a/k/a Oasis Winery, of which Tariq Salahi is the president and sole shareholder, filed for Chapter 7 bankruptcy in February 2009.  That case is still pending.  The scheduled assets are $339K and liabilities oare $982K. The petition states that Oasis Enterprise's income fell from $1.7M in 2007 to a mere $35,000 in 2008.  Ouch.  In 2008, a bank repossessed a $150K Aston-Martin car (resulting in a $85K deficiency) and a $90K Carver 350 Mariner Boat from Oasis Enterprises (resulting in a $56K deficiency judgment).

Looking Forward in the Supreme Court

This just in from our Washington, DC, bureau: the Supreme Court has granted certiorari in Hamilton v. Lanning, No. 08-3009 (10th Cir. Nov. 13, 2008), where the Tenth Circuit adopted the "forward-looking test" for how much a chapter 13 debtor has to pay creditors. The alternative is the "mechanical test" adopted by the Ninth Circuit in an often-discussed and often-criticized decision called Kagenveama.

The forward-looking test allows for a more flexible consideration of the debtor's circumstances in the future. The mechanical test, as the name implies, requires only the application of the amounts fixed in the statute. As the Tenth Circuit said, reasonable people could read the Bankruptcy Code to reach either result. The forward-looking test can account for changed circumstances of the debtor, such as a decline in income that often precedes a bankruptcy filing.

Of the four bankruptcy cases the Supreme Court has on its docket right now, Hamilton may have the greatest practical effect on real people. It will not only determine the rules for those who file chapter 13 but, as a result, also play a big role in whether chapter 13 will be a good solution for many persons with financial problems, especially homeowners facing foreclosure.

Means Test Changes Won't Mean Much

Controversy abounds these days about whether government programs should adjust downward to reflect cost-of-living and income declines. I’d like to stir up a little controversy here at Credit Slips about Bob Lawless’ recent post that said the drop in median state income will "make it harder to file bankruptcy." First, I don’t quite follow the logic of the concern. Even if the income cut-off drops, "median" still means that half of all people are below the number. I would expect those considering bankruptcy to occupy the same places in the distribution of incomes in their state, regardless of median income fluctuations. So, it seems to me then that the fraction of potential bankruptcy debtors with above-median income would remain constant, even if the median income drops. The legal standard isn't changing, so I don't think it is fair to call the change in median income a "tightening" of the bankruptcy law. Second, even if bankruptcy filers don’t experience the general decline in income of the state’s entire population, the effect of a change in median income on bankruptcy eligibility is likely to be very, very small. Bob admits the change won't affect "a lot" of people but also says it won't be "a few." I think it really will be just a few. Why? Because the fraction of those made ineligible because of the means test is really tiny, and so even over an anticipated 1.5 million bankruptcy cases in 2009, we are looking at a minute change when we talk about adjusting the operation of the means test. In 2008, only 10% of chapter 7 debtors had above-median incomes. And nearly all of that 10% passed the means test once expenses are deducted. According to its report, the U.S. Trustee filed a motion to dismiss for abuse in 2,881 Chapter 7 cases--that works out to 4% of all above-median cases and .4% of all chapter 7 cases. Those numbers are hard to square with any fear that there will be any measurable change in the fraction of people made ineligible for chapter 7 this year. Importantly, these numbers don’t reflect how the very existence of a median income test may discourage people from filing a bankruptcy case or may push people directly to chapter 13 rather than risking an abuse determination. But again, that effect—whatever its magnitude—probably won’t change with median income fluctuation.

Tightening the Bankruptcy Laws in the Midst of a Deep Recession

Beginning on November 1, some people might suddenly find they are now ineligible for chapter 7 bankruptcy. Making it harder to file bankruptcy in the middle of our financial crisis may not be the best policy idea to come down the pike, but it is exactly what Congress set in motion in 2005. Here is why.

Amici Bankruptcy Professors Pottow & White "Win" on BAPCPA 11 U.S.C. 522(p)

Yes, self-serving, but What Is To Be Done?

A few years ago, my Michigan Law colleague Jim White (J.J. White to some) -- who has guest blogged for Credit Slips -- and I picked up a BAPCPA case trickling though the Ninth Circuit.  (OK, I started it and then bugged him about it.)  We got together and wrote a brief to file as amici and sent it off dutifully to CA9 back in 2007.  Then we forgot about it (even missed oral argument).  Until yesterday, that is, when we saw that the Ninth Circuit handed down the decision reversing the bankruptcy and district court judgements that had so exercised us.

Here's the link: Greene v. Savage (In re Greene) (9th Cir. Oct. 2, 2009).  Summary follows the break.

The Supreme Court and What Attorneys Can Say

Some other obligations have kept me away from blogging for the past few weeks. One great thing about a group blog is having great colleagues who pick up the slack. I had wanted to say a few words about the Supreme Court's June 8 decision to hear United States v. Milavetz. At this point, the Court's announcement is old news. This post is about what is at stake in the Milavetz decision and why Credit Slips readers might want to watch this case when it gets argued in the fall.

There have been several Credit Slips posts (here and here) about the lower court decisions in Milavetz. Some issues that were raised in the lower court decisions have dropped away, and before the Supreme Court, the case will involve section 526(a)(4) of the Bankruptcy Code, a provision added by the 2005 amendments. It provides that "a debt relief agency shall not advise an assisted person or prospective assisted person to incur more debt in contemplation of such person filing a case under this title or to pay an attorney or bankruptcy petition preparer fee or charge for charge for services performed as part of preparing for or representing a debtor in a case under this title." Yes, that is language that perhaps only a lawyer could love but probably not even then. The upshot is that section 526(a)(4) aims to prohibit bankruptcy lawyers from advising clients to incur debt right before they file bankruptcy. It was not intended to prohibit bankruptcy lawyers from charging for their services, although that might be a natural reading of the language. Rather, the section also tries to prohibit lawyers from advising clients to borrow money to pay attorneys' fees for a bankruptcy filing.

Chapter 13 Rate Down Sharply in March

The 2005 changes to the U.S. bankruptcy law were supposed to move more debtors into chapter 13 with the idea that they would have to pay at least a portion of their debts. In March, however, the chapter 13 rate dipped below the old chapter 13 filing rate. Not only do these latest figures suggest the 2005 law is not working as its supporters promised but also that the latest spikes in bankruptcy filing rates are from persons in the most desperate financial conditions.

Of the noncommercial petitions filed in March 2009, only 25.5% were chapter 13 cases. These data come from Automated Access to Court Electronic Records (AACER), which defines a "commercial" case as one that involves a corporation, limited liability company, or similar entity, one with an employer identification number (EIN) (instead of or in addition to a Social Security number), or one with a designation such as "doing business as" (d/b/a). All other cases are noncommercial cases.

From 2001-2004, the Administrative Office of U.S. Courts (AO) reported that 29.3% of nonbusiness cases were chapter 13s. "Nonbusiness" is not the same as "noncommercial." AACER uses a better, more comprehensive definition to calculate "noncommercial" cases, but if we look at all bankruptcy cases together, the numbers don't change much. The AO reports 28.7% of all cases as a chapter 13 from 2001-2004, and 25.0% of all cases in the AACER data during March 2009 were chapter 13s.

Warning: Credit Card Practices Can Be Detrimental to Your (and Their) Health

Here is another example from the list of “things that we saw coming, but nobody cared.”  Credit card companies are suffering from record default rates. In the fourth quarter of 2008, credit card companies charged off – declared as uncollectible – a whopping 6.3 percent of their debt. Aside from a fluke spike in the data in the first quarter of 2002, this was the largest charge-off rate since the Federal Reserve began collecting these data in 1980.

Interestingly, these record setting losses for credit card lenders come after the punitive changes to the bankruptcy code were supposed to weed out the “deadbeat” borrowers and lead to lower default rates. Apparently, things did not work out as planned.

BS Bankruptcy Numbers

We've already seen a lot of bs numbers in the cramdown debate. The Mortgage Bankers Association keeps pushing its ridiculous figures. And now Todd Zywicki has joined the fray with an op-ed in the Wall Street Journal a couple of weeks ago.

Professor Zywicki that claimed that "A recent staff report by the Federal Reserve Bank of New York estimated a 265 basis-point reduction on average in auto loan terms as a result of the reform."

One little problem. That's not what the Fed staff report found. Professor Zywicki was off by 250 basis points (a doozy of a mistake!), as well inserting a causal link not supported (and arguably contradicted) by the Fed staff's study. The study states that "The decline in the average auto loan spread was 15 basis points lower after BAR for unlimited exemption states, a 5.7 percent decline relative to the mean over all states (265 basis points)." In other words, the average rate spread is 265 bp. The decline in rates, to which Zywicki was referring was only 15bp, and that was only in states with an unlimited homestead exemption.  That it was not 265 bp was abundantly clear from the regression tables.

But that's not all. It's not as if Professor Zywicki simply mistook a 15 bp drop for a 265 bp drop.  That 15 bp isn't what it appears to be.  The study used two statistical specifications and looked at states with limited and states with unlimited homestead exemption to see what impact there was on auto loan rates post-BAPCPA, which enacted an anti-auto cramdown provision (the infamous "hanging paragraph" that says that there's no bifurcation of claims for cars purchased primarily for personal use in the previous 910 days).

In one specification it found nothing with statistical significance regardless of the homestead exemption level, which means that it couldn't rule out the possibility that the change in rates was random.

In the other specification, post-BAPCPA there was a marginally statistically significant 15 bp drop in five-year auto loan rates in states with unlimited homestead exemptions. There was no statistical significance in the drop in other states. What's funny about this is that homestead exemptions have no bearing in Chapter 13--exemptions are only available in Chapter 7. So if the study had aggregated all states for its regression, it seems unlikely that it would have gotten stronger statistical significance.

So we have at best very weak evidence of a 15bp drop in rates. But it doesn't follow that the drop was due to the anti-auto-cramdown provision. The study also found a significant decline in auto-loan delinquencies in the short period after BAPCPA. The most plausible story, I think, is that surge in bankruptcy filings before BAPCPA's effective date cleared out the pipeline of troubled loans so that post-BAPCPA auto loan default rates were lower. My guess is that they've climbed right back up.  Notice that this has nothing to do with cramdown. This has to do with moving forward some filings that would have happened later. So we have a 15bp drop that might not even be statistically significant and only in some specifications and only for states with unlimited homestead exemptions, and it probably isn't attributable (or at least most of it) to the anti-cramdown provision, but instead to BAPCPA causing a filing pile-up. So where did Professor Zywicki get this 265 basis point number from? That's the spread that exists between five year auto loans and five year Treasuries. It has nothing to do with bankruptcy.

Sometimes a little common sense is needed when looking at numbers, too. In December 2005, auto loan rates were at around 6.63% (663 bp). If 265 bp was right, it would have been a 40% decrease in auto loan rates! Whatever impact bankruptcy has on credit costs, I don't think there's anyone who could honestly argue that 40% of the cost of auto loans is due to the ability to cram down loans on cars purchased primarily for personal use within the previous 910-days with a purchase money security interest. There just aren't that many folks filing for Chapter 13 bankruptcy, much less who fit into this particular set of circumstances, to have this kind of impact on pricing, regardless of the loss severities.

Yet another case of baloney numbers shaping the bankruptcy debate. I hope the WSJ runs a correction on this.  Now there's some fact-checking for you. 

[Update 3.6.09: Based on correspondence with Don Morgan, one of the NY Fed study's authors and Professor Zywicki, a few new points emerge:

First, I misread the study too.  The 15bp finding is in a regression that measure the "difference-in-differences" in the spread between auto loans and Treasuries pre- and post-BAPCPA for states with and without unlimited homestead exemptions.  The study does not report the post-BAPCPA rate drop in auto loan rates.  The author, however, tells me that it turns out to be 46-56 bps, and to have strong statistical significance. So let the record stand corrected on this.  

Second, regardless of whether the number is 15, 46, 56, or 265bps, the finding of a correlation does not mean there's causation.  But that's precisely what Professor Zywicki was pushing in the WSJ.   Unfortunately, it's just not a tenable claim.  

It's possible that BAPCPA resulted in lower auto loan rates.  But in order to make a reasonable causation argument, one must first explain the similar or larger rate drops in 2000-2001 and in 2003 and in 2007 that have nothing to do with BAPCPA.  Otherwise, the causal argument is reduced to the fallacious post hoc ergo propter hoc variety.  

The chart below, taken from the NY Fed study shows with the solid and dotted lines the spread between auto loan rates and Treasury's for states with and states without unlimited homestead exemptions.  They move in sync, and they clearly fall after BAPCPA.  But they also fall equally sharply before and after BAPCPA.  Auto loan rate spreads over Treasury jump around a lot, and the mere fact that they fell after BAPCPA doesn't prove anything.    

(fwiw, Chart 5 appears to be incorrectly labelled in the study.  The study says that the "Left axis measures interest rate on new automobile loan (5 year) minus rate on government bond (5 year)."  If so, then 15bps would appear to be roughly the right measure.  Instead, the rate spread must be the right axis in bps, and the left axis must be measuring the difference in the auto-loan-treasury spread between limited and unlimited homestead exemption states.)  

The problems with Professor Zywicki's causality argument don't end there.  Any causality argument must also distinguish between general impacts of BAPCPA (e.g, delinquency pipeline cleared out) and the auto-cramdown provision.  This type of event study cannot provide support for that.  The rate drop could be due to the hanging paragraph, but there's no responsible way to make that claim without addressing these other factors, and the NY Fed study doesn't attempt to do that. The fact that Professor Zywicki was off by 209-219 bps, rather than by a full 250 bps (something he couldn't have known from the study) doesn't absolve him of making an untenable causal claim. 

The  bankruptcy policy debate should happen on the basis of the best possible evidence.  If more restrictive bankruptcy laws result in cheaper credit, that's a very important policy consideration, and for the integrity of the policy debate, we need to be working off the best numbers available. I've updated this post to make sure that the correct numbers are clear.  I'm still hopeful that Professor Zywicki will make clear that he doesn't stand by either his 265 bp claim or his untenable claim of causality.]

[Updated 3.7.09

Professor Zywicki has corrected on the 265 bp claim.  He still seems to be making causal assertions, however, such as that the study finds "the impact of eliminating cramdown was a reduction in interest rates of 56 or 46 basis points."  That's not quite right.  The study can't test the elimination of cramdown; it can only test the impact of BAPCPA as a whole.  In fairness, Zywicki later refers to the study finding the impact of BAPCPA, rather than the specific cramdown provision.  Regardless, Professor Zywicki still has no response to all of the equally large jumps up and down in the auto loan rate to Treasuries before and after BAPCPA, which casts serious doubt on any causal story.]

Seventh Circuit Decides Hotly Debated Means Test Issue

One of the more divisive post-BAPCPA consumer issues has been whether a debtor who has no monthly vehicle loan or lease expense can claim a vehicle ownership deduction when applying the means test. Until Wednesday, no circuit court of appeals had considered the issue. The four bankruptcy appellate panels that had rendered opinions were evenly split, as were the bankruptcy courts. Now the Seventh Circuit Court of Appeals has weighed in on the issue in In Ross-Tousey v. Neary, 2008 WL 5234070 (7^th Cir. Dec. 17, 2008). The court reversed the district court and held that when conducting a means test analysis a debtor may claim a vehicle ownership expense even if the vehicle is not encumbered by a debt or lease payment. According to the court of appeals, this result was dictated by the plain language of the statute, the legislative history, and the underlying policies of the means test.

The importance of the decision extends beyond the car ownership allowance.

8th Circuit Rules Section 526(a)(4) Unconstitutional as Applied to Attorneys

The United States Court of Appeals for the Eighth Circuit just ruled on a matter of first impression among circuit courts--the constitutionality of the treating attorneys as "debt relief agencies" under provisions of the 2005 Bankruptcy Abuse Prevention and Creditors' Consumers' Protection Act. (Freudian slip...) In so doing, the 8th Circuit struck down a major BAPCPA provision that inartfully restricts attorneys' ability to give clients advice about how to prepare their finances in contemplation of filing for bankruptcy.

Revisiting the 2005 Amendments When Times Get Hard

As a follow up to my earlier post about the forces that have made bankruptcy less workable for reorganizations, I note a new Businessweek article.  Retailers are feeling the pain of reduced consumer spending and tough credit terms, and now they are discovering that the 2005 bankruptcy amendments will make it harder--or impossible--for some of them to reorganize.

In an article entitled, When Chapter 11 is the End of the Story, reporters have started interviewing failing retailers who are facing new hurdles because of the changes in the law. The conclusion?  Companies that might have reorganized before 2005 may now be pushed into liquidation.