For better or worse, the use of personal bankruptcy to make a fresh start is about to be sharply curtailed.
Legislation moving through the Senate this week is, to backers, a long overdue tightening in an era of rising indebtedness and bankruptcy declarations.
But even as it promises to make it harder for debtors to "game the system," the policy change will fall heavily on Americans who face illness or sudden healthcare costs, which some experts say account for roughly half of personal bankruptcies.
The first overhaul of US bankruptcy law in a quarter century will mark a clear shift in the balance of power in a nation where credit is king. Overcoming opposition from Senate Demo- crats this week, the measure will mark a victory for President Bush and Republicans. But debate over the legislation is putting new focus on the challenges that ordinary Americans face at a time of job loss and soaring medical costs.
"Longtime unemployment is at its highest level ever," says Travis Plunkett, legislative director of the Consumer Federation of America. "This bill simply doesn't balance responsibility between families in debt trouble and the creditors whose practices have contributed to the rise in bankruptcies."
Drafted before 9/11 and big corporate bankruptcy scandals, the bill aims to make it harder for individuals to escape debt by declaring bankruptcy.
From 1983 to 2003, bankruptcy filings have increased 500 percent. To the bill's supporters, this represents a "bankruptcy tax" that other consumers pay in the form of higher penalty and late fees on their credit cards and higher down-payment requirements on auto loans. Banks and credit-card companies say many who declare bankruptcy are gaming the system and could afford to pay more.
At the heart of the proposed new law is the creation of a "means test" to help sort out those who can afford to pay back at least a portion their debts and those who cannot. Under the current system, individuals can file under Chapter 7, which allows many to keep some protected assets while discharging their debts.
Under the proposed new bankruptcy regime, individuals with incomes above the state median will have to make a case to a bankruptcy court to determine whether the filing should be dismissed for abuse of the system or converted to a repayment plan under Chapter 13.
Driving the debate are diverging views over why consumers get deeply into debt. Republicans and moderate Democrats who support the bill say the issue is one of personal responsibility and a need to restore the integrity of the bankruptcy system. Critics, including most consumer groups, say the real issue is the vulnerability of American families.
"It will affect people's ability to raise children, educate them and afford medical care," says Marc Abrams, a bankruptcy lawyer at Wilkie Farr & Gallagher in New York. "When bankruptcy was conceived, it was supposed to give an individual a fresh start. This is the end of the fresh start."
The measure comes on the heels of a tough winter, when consumers are paying high energy prices to heat their homes. In fact, according to Mark Wolfe, executive director of the National Energy Assistance Directors' Association, many people can no longer afford their utility bills. "We are hearing that energy bills are pushing more people into bankruptcy," says Mr. Wolfe. "We will work harder to get utility forgiveness programs approved."
The medical profession may be the most affected by the proposed changes in the law. According to a recent Harvard study between 46 percent and 54 percent of personal bankruptcies are the result of illness or medical bills.
"This new law will leave a more middle-class people in a desperate situation," warns David Himmelstein, an-author of the report. "This will close the door for a whole lot of people."
Hospitals, which often are owed the debt, may turn to collection agencies rather than writing off the debt. "It means more people will be dunned by collection agencies," Dr. Himmelstein says. He anticipates doctors will be forced to do the same thing, or worse. "As more and more people are uninsured and coverage worsens, doctors are already making decisions on what patients to accept. This law makes it more difficult." A doctor himself, he adds that most physicians are not aware if their patients are in bankruptcy.
Supporters of the legislation say it doesn't portend a return of Dickensian debtor prisons. "For 90 percent of the people who file for bankruptcy, there will be no effect," says Laura Fisher, a spokeswoman for the American Bankers Association. "It will only affect people who have the means to pay some of their debt, a portion of it."
She estimates lenders lose about $60 billion a year as a result of bankruptcy filings. This includes department stores, mortgage companies, credit-card companies. And, she says individuals with large medical bills may still be able to get their debts wiped clean.
In the proposed bill is wording that allows a judge to take into account special circumstances such as large medical bills. Still the process imposes burdens such as legal costs on individuals, even if they win relief from their debts.
GOP sponsors say that the means test is targeted at a narrow group of individuals - only about 7 to 10 percent of bankruptcy filers who have above-average incomes and the means to pay back their debts. If the means test only weeds out 100,000 to 150,000 abusive filings, as much as $3 billion could be recovered and passed through to other consumers, experts told senators last month.
Bankruptcy reform has been a top priority of banks, credit-card companies, and retailers for the past decade. Finance and credit-card companies have contributed more than $40 million to federal candidates since 1990, most to Republicans, according to the Center for Responsive Politics. Consumer groups say that is reflected in a bill that is skewed toward corporate interests and does not place needed restrictions on abusive lending by creditors, especially those who target vulnerable consumers.
"Creditor practices are literally driving consumers into default," says John Rao, staff attorney of the National Consumer Law Center. "By the time these people land in bankruptcy, they owe more in interest and fees than they do on the original loan."
Retailers, another group in favor of the proposed bill, hope it will help them recoup some of their losses and could result in lower prices for consumers. "The numbers we have seen is the average consumer pays $400 more in higher prices than they would if the bankruptcy laws were not abused," says J. Craig Shearman, a vice president at the National Retail Federation, which has worked for the legislation for the past ten years.
Credit-card companies estimate that about 20 percent of all bankruptcy filers have some assets or means to pay off their debts. But after special circumstances, only 10 percent of all filers will be affected. "Not a high number numerically, but its a lot of money," says Jeff Tassey, who manages the bankruptcy coalition.
If credit card companies can recoup some of that money, will they reduce credit card interest rates? Possibly, says Mr. Tassey. Or, they may add more airline miles or rebates or any of the other ways they market the cards, he says. "To some extent, they will be able to extend more credit at competitive prices."