Bankruptcy: reform versus education

After an eight-year battle, bankruptcy reform finally became law when President Bush signed it on April 20. The bill was passed on the strength of the belief that too many people who wipe out their debts with the bankruptcy process could, in fact, repay at least a portion of their debt. The new law will force more people into the repayment plan version of bankruptcy (Chapter 13), rather than allow them to file Chapter 7, which essentially allows them to wipe out their debts.

It will be interesting to assess the effects of this law after it has been in place for a few years. The American Bankruptcy Institute commissioned a study that says under the current system less than 4 percent of Chapter 7 filers would be candidates for any repayment plan at all. The new law subjects bankruptcy filers to a “means” test, which attempts to determine their ability to repay their debt. If the new test forces more than 4 percent of those Chapter 7 filers into Chapter 13, the law will simply prolong their period of financial hardship until they fail under the repayment plan.

In the best of circumstances, when a person files for Chapter 13 bankruptcy, he or she gets a court-appointed trustee to establish a repayment plan to fit their situation. In most cases, however, there are too few trustees available to give every filer a customized plan. Most filers get forced into template plans designed for everyone but suitable for no one. If it turns out that the number of people failing to meet the requirements of their Chapter 13 repayment plans increases dramatically, something is going to need to be done about improving those plans.

My hunch is that after a few years, we will discover that we don’t have a bankruptcy problem in this country, we have a debt problem. It isn’t that too many people game the bankruptcy system, it is that too many people run up unsustainable levels of debt. Although credit card companies pushed for this legislation, I am skeptical that it will do much to change the amount of money collected from over-extended borrowers.

Much more important is financial education to help people understand what is realistic in terms of managing debt. This is a matter of working with schools, colleges and community education programs to get people into basic budgeting courses. Community-oriented lawmakers should consider taking the lead on this effort; if they were successful, I suspect the lasting impact of those efforts would be far more substantial than the effects of bankruptcy reform will ever be.