Marketplace Scratch Pad

Wiping out their debt

Scott Jagow Jan 5, 2010

Here’s what can happen when potentially well-intended regulation is watered down or poorly crafted. Remember the 2005 personal bankruptcy reform? It was designed to deter people from filing Chapter 7, which allows them to escape repaying their debts. Chapter 13 requires them to sign up for repayment plans. Well, Chapter 7 filings shot up 42% last year.

Overall, personal bankruptcy filings hit 1.41 million through November, up 32% from 2008. Chapter 13 filings made up less than a third of those. More from the Wall Street Journal:

“That suggests it was largely ineffective,” Ronald Mann, a law professor at Columbia University, said of the 2005 overhaul. “I don’t think anybody who’s knowledgeable about the bankruptcy system thought the statute was well crafted.”

During this recession, the housing crisis and high unemployment rate have prompted more people to file for bankruptcy who may never have considered the option before, experts said. Filings from 2008 showed more people with high income and high education levels resorting to bankruptcy petitions, according to an annual survey of consumer-bankruptcy filers’ demographics by the Institute for Financial Literacy…

The article relates the predicament of a Minnesota couple on the verge of filing:

He kept the business afloat with a $70,000 line of credit and an additional $70,000 in credit cards. Two years ago, he walked away from the business for a truck-driving job. Despite the steady income from Mr. Parker’s job, bankruptcy is the only way to get out of debt. They are debating whether to file a Chapter 7 or 13 petition.

“It’s not like I want to rip anybody off. We’ve made mistakes that didn’t work and we’re starting over,” Mr. Parker said. “You can blame the government or you can blame banks, but…humans take risks and they make mistakes.”

Very true. The question is, how should people be made to pay for those mistakes? Is severely damaged or non-existent credit enough? Or should partial repayment be a requirement? Clearly, under the new laws, many people are failing the Chapter 13 test and are seen as having little to no ability to pay back the debt.

Is that a function of their previous financial choices? Or an economy in which their homes are worth much less, they don’t have a job or their salary’s been cut?

The view from Wisconsin attorney Tim Dewane:

With home prices falling, he said people may not have the option to sell their homes and pay off debt.

“Maybe they had two incomes and now they have one,” he said. “What are they supposed to do?”

It’s wrong to assume people who file for bankruptcy mishandled their money, he said.

“That’s tunnel vision at best,” Dewane said. “You’ve got to put yourself in that person’s situation. What would happen if you lost your job? Bankruptcy is not always caused by financial irresponsibility.”

You agree with that?

The number of bankruptcy filings can also be an economic indicator. 24/7 Wall Street has this analysis:

For each bankruptcy there is likely to be a lending institution that will become more cautious about offering loans in the future. For each loan that is not given, a business or individual may face solvency problems. The closing vice of poor credit availability undermines recoveries of both business and consumer spending.

If bankruptcy rates stay high early in 2010, it is a sign that a sustained economic recovery has not taken hold yet.

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