You’re Going Broke

Last year, there was perhaps no piece of domestic federal legislation more celebrated by conservatives and reviled by liberals than the Bankruptcy Abuse Prevention and Consumer Protection Act. The act, conservatives claimed, would stop alleged widespread abuse of the bankruptcy laws. Liberals argued the new law would deprive consumers crushed by debt of the “fresh start” bankruptcy was originally designed to provide.

Greased by millions in political contributions from the credit card industry, the legislation slid through the Republican-controlled Congress and was signed into law by President Bush last April. It took effect on Oct. 17, sparking an unprecedented run on bankruptcy courts nationwide, including here in Reno, as debtors rushed to file before the new regulations took effect.

I am one of the record 2 million Americans who filed for bankruptcy before the October deadline. Like most of my cohorts, I put off the decision to file for as long as I could. The coming change in the regulations finally pushed me over the edge. Negative reports in the media had convinced me and millions of others that after the new law took effect, it would be almost impossible to file for bankruptcy.

As it turns out, such is not the case. In fact, as the new regulations enter their fifth month, the results so far have been quite the opposite. While some local bankruptcy attorneys continue to insist the changes are draconian and have even caused some lawyers to close up shop, others claim that little has changed. Some even say the new regulations make filing easier than ever. Perhaps a better name for the Bankruptcy Abuse Prevention and Consumer Protection Act would be the Law of Unintended Consequences.

Fear of Financing
The last major change in bankruptcy law occurred in 1978, when the Bankruptcy Act of 1896 was supplanted by the Bankruptcy Reform Act. The act established Chapter 7 and Chapter 13 bankruptcy protection. The former permits debtors to discharge most, if not all, of their debt. The latter prescribes a plan to pay some, if not all, of the debt back. The changes in the law last year attempts to force some debtors who formerly filed for Chapter 7 bankruptcy into Chapter 13.

“The old law gave people a fresh start,” says Reno bankruptcy attorney Robert Broili. “The new law, with a very broad brush, makes it difficult for everyone to file bankruptcy. This is a major shift in what the laws are for. The Founding Fathers did not want us to end up with debtor prisons and people so buried in debt it was hopeless.”

Laws were considerably tougher on debtors in the centuries before the Founding Fathers. In Roman times, the debtor and his family could be sold into slavery to pay off creditors. In cases where there was more than one creditor, the debtor’s body was severed into pieces and divided up. England chucked deadbeats into its notorious debtor prisons and executed more serious offenders well into the 18th century. In colonial America, creditors branded the offender’s palm with a T (for thief) or placed him in stocks, with his ear nailed to the pillory. The ear was cut off upon release to mark the debtor for life. Think about that the next time you earmark a book.

Today’s bankruptcy code is fairly benign by comparison—filing Chapter 7 is a heck of lot more civilized than having your ear lopped off—yet the fear debtors felt in earlier times has seeped into our DNA. Emotionally, the common denominator linking the vast majority of people contemplating bankruptcy is sheer, unadulterated terror.

In my case, thanks to divorce, a failed business venture and expensive legal bills, I had amassed nearly $30,000 in credit card debt. For months, I huddled in my apartment, paralyzed, eating rice and beans, refusing to turn on the heat, saving every last penny in order to make the payments, even after I lost my job. Fear and shame kept me from filing long after I should have bitten the bullet.

And I had it easy.

“Divorce, unemployment, and catastrophic medical bills are responsible for most bankruptcies,” explains Reno attorney Jeff Heath. “Most of the time, in my experience, it’s the last resort. It’s not something they look forward to. It’s a relief valve, that’s what Congress [originally] intended the law to do.”

“People just don’t have the money that the backers [of the new legislation] think they do,” Broili adds.

Attorney Pat Phair has been practicing law in Reno since 1989. She’s seen the same pattern repeated time and time again: Clients with low-wage jobs get hit by some calamity and are suddenly drowning in debt.

“One case, she’s a [keno] runner, $7.10 an hour, no benefits,” Phair says. “She got sick and had to go to the emergency room. They gave her Pepto Bismol. She got sick again and went to the emergency room. They gave her Pepto Bismol again. She got sick a third time, and they removed a kidney stone and gave her an $80,000 hospital bill. She lives in a 32-foot trailer with no credit cards and a parrot with a filthy mouth. This is all she owns. She has $80,000 in medical bills on $7.10 an hour. Now you tell me how she’s going to do that. I’ll tell you: bankruptcy.”

Then there’s the older couple from Fallon who got stuck caring for two babies after the babies’ mother abandoned them. Or the woman who formerly worked six shifts at a casino and was cut back to one shift. “I suspect it’s because she’s not eye candy anymore,” Phair continues. “Maids, porters, they start cutting them back. Most of them aren’t even getting tips.”

Joe and Danielle Stempeck are among Phair’s latest clients. The couple has four children, ages 6 months to 10 years old, and approximately $40,000 in debt. Joe, 33, works as a cable installer. Danielle, 29, stays home to care for the kids. Most of the debt comes from two repossessed vehicles and medical bills.

“A lot of it is medical bills that accumulated when I was on Medicaid,” Danielle says. “My daughter was in the hospital with pneumonia when she was 3 months old. They brought me into the emergency room and put me on self-pay. I wasn’t supposed to be billed for any of this stuff.”

“If we were in a position to pay what we owe, we’d do it,” Joe adds. “I’m not exactly proud about filing for bankruptcy, but it has to be done.”

Almost every case is a financial horror story, but the notion persists that those who file for bankruptcy are losers out to shirk their obligations and cheat the system. That stigma is encoded in the new legislation’s title, the Bankruptcy Abuse Prevention and Consumer Protection Act. How prevalent is such alleged abuse? Not very, according to U.S. Bankruptcy Judge Gregg Zive, who presides over Northern Nevada cases. Divorce, unemployment and medical bills remain the primary indicators for most people who file, Zive says. “I’m not convinced there’s a great deal of abuse.”

Zive’s observations have been confirmed by U.S. Public Interest Research Group, the national government watchdog organization that protects the rights of consumers. PIRG reports that, “Independent studies, such as those of Harvard Law School professor Elizabeth Warren, show that 90 percent or more of bankruptcies are still filed by people who get sick, get laid off, or get divorced, not by abusers. The industry can only document that 3 percent of filers may be abusers, yet the bill would harm all debtors.”

That didn’t stop George W. Bush, after signing the new law, from proclaiming that, “America is a nation of personal responsibility, where people are expected to meet their obligations. If someone does not pay his or her debts, the rest of society ends up paying them.” Nevada Sen. Harry Reid gave ’em hell as well—debtors, that is. “I have been a supporter of bankruptcy reform for a long time,” said Reid, one of 18 Democratic senators who voted for the bill. “I believe that [those who] run up a bill should pay it.” Every congressmember from Nevada, including Reid and fellow Democrat Shelley Berkley, supported the bill.

Such sentiments are widespread. While researching this story, I got into a heated discussion on the subject with a friend who has opposed every decision Bush has made—except the new bankruptcy law—because people should be responsible for paying their debts. “What if something happens, and they can’t pay?” I implored. “What about people like me?” was the implied question. His laser beam eyes scorched a “T” into my forehead. People should pay their debts. Period.

Bankruptcy or Bust?
For those convinced that government has grown fundamentally dysfunctional, the first effect of the new legislation designed to reduce the number of bankruptcies was predictable: The number of bankruptcies increased at an astonishing rate. Lundquist Consulting reports that an all-time high of 2 million personal bankruptcies were filed across the country in 2005, a 32 percent increase. “Our numbers were indicative of what happened across the nation,” says Zive. He says that in the last two weeks before the Oct. 17 deadline, 8,586 cases were filed in Nevada compared to 615 cases for the same period the year before, nearly a 1,300 percent increase. “4,000 cases were filed in the last three days” before the deadline in 2005, Zive says.

“It was a yeoman’s job for the people over at the court to keep up with all the filings,” Broili recalls. “There was a kind of hysteria.”

You can thank the credit card industry for the frenzy. With earnings of more than $30 billion annually, it’s the most profitable business in the United States. Charging interest rates as high as 30 percent and late fees as much as $39, the industry literally rakes in cash. Apparently, it’s not raking in enough. Since 1990, the industry has spent more than $150 million lobbying elected officials to change the bankruptcy laws, doling out roughly twice as much money to Republicans as Democrats, the Center for Responsive Politics reports. According to PIRG, Bank of America-owned MBNA, the nation’s largest credit card company, was also President Bush’s largest corporate campaign donor in 2000.

“It’s a George Bush kind of world,” says Geoff Giles, another Reno bankruptcy attorney. “There’s no room in it for you and me.”

Laura Fisher, spokeswoman for the American Bankers Association, the country’s largest banking trade association, refutes the notion that the credit industry bought and paid for the new legislation. “The financial services industry in general has many issues before Congress,” Fisher says. “You can’t say that they contributed this money just to pass the bankruptcy bill.”

That of course is exactly what most critics of the legislation are saying. The new law almost exclusively targets poor and middle class consumers. Chapter 11 bankruptcy, which large corporations normally file for protection, was barely touched. Amendments designed to protect the most vulnerable debtors and regulate predatory lending practices were gutted. Debtors, obviously not the best at keeping records, are now required to provide detailed financial data for the six months prior to filing. Lawyers are now held accountable for the accuracy of the information their clients provide.

“It’s a catastrophe,” Giles says. “Most of the lawyers who used to do these cases have quit because the paperwork is so difficult. We’re working on non-bankruptcy alternatives because the code has become unmanageable.”

“This is a mess, it’s an awful mess,” Broili agrees. “It’s going to get worse.”

While it’s true that more than a few Reno bankruptcy attorneys have shuttered their practices, not everyone agrees that the new regulations are a catastrophe.

“In my opinion, for most people it really hasn’t changed much,” Heath says. “They’ve added some new hoops to jump through. They made it more expensive for people who are already in dire financial straits to file for bankruptcy.”

Part of the added expense comes from increased court filing fees. The fee for filing Chapter 7, for example, increased from $209 to $254 last October. To add insult to injury, the Republican-dominated Congress buried fee increases for Chapter 7, 11 and 13 bankruptcies in its most recent federal budget. The fee for Chapter 7 now approaches $300. The increase, if passed, will raise an additional $553 million to help cover Bush’s tax cuts.

The aforementioned increase in paperwork—and the time it takes attorneys to fill it out—has also added to the expense. So has the requirement that debtors attend credit counseling before and after filing for bankruptcy. Nevertheless, attorneys such as Heath and Phair remain optimistic that the changes in the law will not affect most people who need to file.

“People are laboring under the impression that you can’t file bankruptcy anymore,” Phair says. “Yes you can—it may even be easier.”

Phair believes one facet that makes it easier to file is the new means test. Formerly, a bankruptcy judge determined whether a debtor had the means to pay debts. Now debtors who earn more than the state’s median income—$38,506 for a single individual in Nevada—must then show that their living expenses do not exceed guidelines established by the Internal Revenue Service’s alternative minimum tax. If they do exceed the guidelines, they then must file Chapter 13 and repay at least some of their debt.

However, for the vast majority of people who file, the two prongs of the means test are fairly generous. For example, Phair’s newest clients, Joe and Danielle Stempeck, make far less than the state’s median income for a family of six, $67,138. They aren’t required to take the second part of the means test and should easily qualify for Chapter 7 protection.

“It hasn’t been as harsh as it was made out to be,” Heath says of the means test. “The adoption of the IRS standards have been beneficial.”

If debtors fail the test, they must file Chapter 13, which establishes a court-supervised, five-year plan to pay back some or all of the debt. It sounds fair enough, but ironically, the majority of Chapter 13 cases, approximately 75 percent, end in failure. Most people in dire financial straits find it too difficult to make payments for the entire five-year period. Once again, legislation designed to reduce so-called bankruptcy abuse ends with consumers unable to pay their debts. Some attorneys question whether the credit card industry got its money’s worth for the millions it contributed to Republican and Democratic politicians.

“They may ultimately live to regret what they pushed through Congress,” Heath says. “Time will tell.”

Till Debt Do Us Part

The new law isn’t all peaches. Under the old law, I filed my own case without an attorney—or pro se, to use legal jargon—with little difficulty. Once the case was filed, I was granted an automatic stay, which prevents creditors from attempting to collect debts for the duration of the case. Now, if a debtor makes a mistake—such as failing to complete credit counseling before filing—the case is automatically dismissed. When the case is refiled, the stay is limited to just 30 days, after which a creditor could, say, foreclose on a debtor’s home. Given the complexity of the new code and the potential for error, hiring an attorney, or at the very least an experienced paralegal, is highly recommended.

“I wanted to file before [Oct. 17], but I didn’t have the money to do so,” says Joe Stempeck. By the time he scratched up enough to hire Phair, he figured it might be too late. “I thought it was going to be impossible.”

As the Stempecks discovered, bankruptcy remains a viable option for those heavily burdened by debt. Early returns from credit counselors seem to be bearing this out. A score of nonprofit national agencies have been approved by the U.S. Bankruptcy Court to provide services to debtors, including those who file in Reno. According to a recent story in the Washington Post, “the overwhelming majority of debtors seen by credit counseling agencies are filing for bankruptcy instead of using repayment plans envisioned by the law’s supporters.” Out of 14,907 people seen at one agency, only 42 signed up for a debt-management plan—or 0.3 percent. “Typically, consumers are too far gone when they get to us,” the head of the counseling service told the Post.

Still, the Stempecks did get hung up by one of the new rules, which changed the time period between filing for bankruptcies from six to eight years. It seems Danielle filed for bankruptcy back in April of 1998, and the couple must delay their new filing to this April.

“It was little depressing,” Danielle says, recalling her 1998 bankruptcy, which resulted when a friend borrowed her car, got in an accident, and Danielle was sued by the victim. “I felt absolutely horrid. I was relieved that it was over, but at the same time, I didn’t want to file bankruptcy.”

There’s been a lull in bankruptcy filings in the wake of the October crunch, but the new law may soon be put to the test. Americans currently share a combined $2 trillion in consumer debt, and credit card users have just been hit with a double whammy: a new regulation requiring creditors to double their minimum payments has gone into effect just as the Christmas bills are coming in (see “Credit is due,” News, Feb. 2). The latest debt instrument of choice, home refinancing, accounted for an additional $400 billion in 2004 alone, and now foreclosures are on the rise. The federal government has its own $8 trillion debt to deal with. Interest rates are going up, the trade deficit is growing, the dollar’s value is shaky. A perfect storm is brewing. Things could get ugly quick.

If everything goes according to plan, the Stempecks will have the hatches battened down before the gale hits. “It’s really exciting because I’ve been looking forward to this for a long time,” Joe Stempeck says. “It’s been a huge weight on my shoulders. We are definitely looking forward to getting this done.”

I know the feeling. Among the dozen debtors gathered with me in court last September, I was the only one acting as his own attorney. With icy stares, the trustees froze those who came before me, debating the lawyers, disputing their client’s listed assets. As I stepped up to the bench, I expected the worst. It was over in less than 30 seconds. “Everything appears to be in order,” one of the trustees said. That was it. I walked out of the building, jumped into the air and clicked my heels together. The official notice that my $30,000 debt had been wiped clean arrived in the mail on Christmas Eve. It’s the best present I’ve ever received.

“Most of my clients are not so ecstatic about giving their creditors the slip,” Heath says. “But once the weight is lifted—spiritually, physically, mentally, debt has been taking its toll—that gives them a new lease on life.”