Bankruptcy Filings Up Despite Reforms
Increase comes even though more stringent standards were adopted in October; lenders watch closely.
June 12, 2006
Reuters
WASHINGTON (Reuters) - A new U.S. law to deter American consumers from seeking bankruptcy protection made filings plunge to a 20-year low in the first quarter of 2006, but a rapid rise in new cases since then raises questions about whether the law is working as expected.
The 2005 bankruptcy reform law was pushed through Congress by banks and credit card companies that sought to prevent abuse by individuals trying to wipe their financial slates clean from runaway debt.
By making it more difficult to file for personal bankruptcy, the companies reasoned that consumers would be more likely to negotiate a repayment plan.
"I think the law so far is working as it was intended," said James Chessen, chief economist for the Washington-based American Bankers Association trade group. "Some of the abuses have been wrung out of the system."
But credit card companies and banks are keeping an eye on the recent increase in filings.
The law took effect Oct. 17, 2005, prompting a surge of 619,322 personal bankruptcy filings for that month as debt-laden consumers rushed to court.
New cases plunged to 13,758 in November, then rose to 21,636 in December, 27,235 in January, 35,352 in February and 49,977 in March, according to the Administrative Office of the U.S. Courts.
That compares to the monthly average of 130,183 new cases in 2004.
Some experts say the upward trend is likely to continue, but it may take several more months before a clearer picture emerges.
"Some people think that merely reducing the number for filings regardless of who they are and what kinds of problems they have is a success," said Melissa Jacoby, a bankruptcy law professor at the University of North Carolina.
"Other people think that the bill will only be successful if it keeps out abusive filers and allows legitimate filers to continue to use the system successfully," Jacoby said. "If really, the only question is whether filings stay lower, then my suspicion is that it will be unsuccessful in that regard."
FOR HOMEOWNERS, ARMS POSE A DANGER
The uncertain U.S. economy is a key factor in personal bankruptcies.
"We are starting to see more bankruptcies being filed. They're taking longer, they're more complicated," said Maureen Thompson, legislative director of the National Association of Consumer Bankruptcy Attorneys. "These numbers will continue to creep up as people face a number of economic factors."
Those factors include traditional ones, such as poor money management, loss of a job, medical expenses and divorce. But some consumers are also falling behind on monthly mortgage payments as interest rates continue to rise.
Other homeowners may be overextended with adjustable-rate mortgages, or ARMs, which could reset soon. At the end of 2005, almost a quarter of all outstanding home loans were ARMs.
"We're going to start to feel those numbers this year and next," said Jeffry Taylor, economist at the National Association of Federal Credit Unions in Arlington, Virginia.
More than $300 billion in ARMs are subject to interest rate resets this year and that figure is expected to reach $1 trillion in 2007, according to DB Global Markets Research.
Not all ARMs will be problematic, Jacoby noted, adding: "But still, that's a lot of loans that are going to be in default risk."
Another emerging trend is consumers' stubborn preference for filing for bankruptcy protection under Chapter 7, rather than Chapter 13.
Under Chapter 7 protection, a filer's assets are liquidated and proceeds are paid to creditors, wiping away the debt. Under Chapter 13, a filer with a steady income can keep assets such as property, but must enter into a multi-year repayment plan.
In February, 19,591 new cases were filed under Chapter 7, and 15,761 under Chapter 13. The gap widened in March, the most recent month for which statistics are currently available.
BANKS WATCH BANKRUPTCY TRENDS
Banks have also sought to make bankruptcy filings more difficult because of their impact on earnings.
In the first quarter, U.S. banks reported record profits, due in part to fewer losses from unpaid credit card loans, according to the Federal Deposit Insurance Corp.
Charge-offs from those loans rose significantly in the last three months of 2005 when there was a surge in last-minute bankruptcy filings before the law changed. But charge-offs then fell 32.5 percent, or $1.4 billion, in first quarter of 2006.
Before the new law took effect, lenders such as department stores, mortgage companies and credit card companies lost an estimated $60 billion annually due to bankruptcy filings.
"Bankers are monitoring the numbers very closely to ensure that the law accomplished what it was passed to accomplish," said Patricia Milon, senior vice president of America's Community Bankers, a Washington trade group.
"Bankers feel what was passed was very balanced," she said. "There should be no backsliding."
The bankruptcy law also created various income tests, including a "means test" to determine if an individual is eligible for Chapter 7. The test is triggered if the debtor's monthly income is above the state median.
Another provision requires financial counseling before a bankruptcy filing and again before debts are discharged.
Debtors also face steeper court fees for bankruptcy filings. The fee for Chapter 7 rose to $299 from $274, while the Chapter 13 fee increased to $274 from $189.
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