An interesting article on the effects of the bankruptcy bill on banks. The 2005 bankruptcy bill made it harder for debtors to file Chapter 7 Bankruptcy and forced more into Chapter 13 bankruptcy instead. Essentially the difference is this: In a Chapter 7, the bankruptcy court accounts for all of the debtor’s assets, deducts the statutory exemptions to which the debtor is entitled, liquidates the remainder (if any) and distributes it to the creditors. It’s over relatively quickly and, frequently, there are not many assets available for distribution. In a Chapter 13, the debtor is instead required to set up a 3 to 5 year plan wherein a chunk of the debtor’s income goes to the bankruptcy court for distribution. It takes a long time to get that “fresh start” under the bankruptcy laws.
The Bloomberg article suggests that this is backfiring on the banks. They had hoped to force more debtors into paying off more of their credit card debt this way. And, apparently, they are. However, now, partially as a result, they are getting more foreclosures.
The new bankruptcy laws are helping drive foreclosures to a record as homeowners default on mortgages and struggle to pay credit card debts that might have been wiped out under the old code, said Jay Westbrook, a professor of business law at the University of Texas Law School in Austin and a former adviser to the International Monetary Fund and the World Bank.
“Be careful what you wish for,” Westbrook said. “They wanted to make sure that people kept paying their credit cards, and what they’re getting is more foreclosures.”
. . .
“The law had an unintended consequence of taking away a relief valve that mortgage borrowers used to have,” said Rod Dubitsky, head of asset-backed research for Credit Suisse Holdings USA Inc. in New York. “It’s bad for the mortgage borrowers and bad for subprime investors because it means more losses.”
I did not warn against this specifically when I was commenting on the bankruptcy bill, but I think I was driving in this general direction.
I also tend to think that the bankruptcy law will make the next recession tougher to shake off. Your typical small business owner has to sign personal guarantees for any credit extended to his business. Recession comes. Business goes under. Business owner is on the hook for the business debts. Now, instead of being able to get a fresh start after a few months through a Chapter 7, he’ll have the anvil of a Chapter 13 hanging around his neck for 5 years. There are probably going to be a lot of entrepreneurial types alongside the genuine deadbeats in Chapter 13 plans.
By getting debtors mired in Chapter 13s instead of quickly discharged in a Chapter 7, I think there is more drag on the economy.
I know of at least one new (less than three years old) house that is in foreclosure near our neighborhood. The bright orange sign is on the door. I’ve also noticed an increase in the “get out of debt” reconsolidation ads on the radio.
Man, I was irked when Evan Bayh voted for this bill…like the banks needed extra protection from debtors they would extend tons of credit to willy-nilly, then impose all kinds of ridiculous fees & jack up interest rates for making one payment one day late, and all that kind of behavior. So, this news wants to make me say, “serves you right.”