If the stigma is really gone, it could take brute force to get careless borrowers to pay. So lenders want tough new barriers to full bankruptcy. President Bush has asked the Justice Department to report on this issue next year.
In my experience, however, most bankrupts walk shamefaced down that road. Bankruptcy court is the place where no one meets your eye. While preparing this column I sought interviews from people who went broke a few years ago to learn what has happened to their credit since. The Consumer Fresh Start Association, a new bankruptcy-survivors organization in Princeton, Ill., called more than 60 of its members to see who might talk, even anonymously. All but three declined. They’re still too embarrassed.
So why are creditors spreading the immorality tale? Perhaps to keep Congress from looking too closely at the lenders’ own role in ushering borrowers into the poorhouse. Here are some common myths about bankruptcy, some held by debtors as well as by creditors:
A creditor myth: Bankruptcy is being widely abused by people with good incomes who find it convenient to duck their debts. A controversial study, made in 1982 by the lender-backed Credit Research Center at Purdue University, proclaimed that 29 percent of bankrupts could repay their bills over five years, if forced to by law.
Most academic studies sharply disagree. The debts of all but a small fraction of bankrupts are largely unpayable. On average, their short-term loans are almost twice the size of their annual incomes, according to Elizabeth Warren, coauthor of a new bankruptcy study, “As We Forgive Our Debtors.” By contrast, the consumer debt of the average American rarely tops 20 percent of income.
This is not to say that no abuse exists. But it’s mainly in courtrooms, in the view of the bankruptcy lawyers, judges and trustees who responded to a survey by the American Bankruptcy Institute. Debtors may hide some cash, under-value assets or go on a spending binge prior to filing for bankruptcy. If recaptured, this money might give creditors a few extra cents on the dollar. But tougher laws would not have kept these debtors out of court in the first place, the ABI concluded. The surge in the number of bankruptcies has little to do with outright abuse.
A creditor myth: Most bankrupts get into trouble by borrowing money irresponsibly. In fact, bankrupts follow varying paths to their destiny. Some lose their jobs, some crumple in divorce, some fail when their small businesses do. In 1984, intense lender lobbying got the bankruptcy laws tightened up a bit. But still the numbers climbed-due in part to the mini-depressions of the 1980s in the rust belt, the farm and energy states, and now the Northeast.
Large numbers of irresponsible borrowers do indeed run up too much credit-card debt. In a study of 260 bankrupts, MasterCard found them holding an average of three bank cards and 15 other open lines of credit.
But they didn’t steal them at gunpoint. They applied and qualified. So why did so many lenders give them credit lines long enough to hang themselves with?
The obvious answer is that lending has been so profitable. Between 1983 and 1988, credit cards earned three to five times more than the ordinary banking rate of return, according to a study by Lawrence Ausubel of Northwestern University. The high rates of credit-card interest (often 18 to 20 percent) paid by solvent borrowers more than covers the losses from those who go broke.
In short, it has made good business sense to lend more money to risky borrowers, even when default rates were soaring. This fact helps explain why individuals’ debt load climbed from 65 percent of disposable personal income in 1980 to a staggering 84 percent last year. But I ask you: why should Congress crack down on broken bankrupts to help creditors collect on some loans that they knew from the start might have to be written off ? It seems unsporting.
A creditor myth: We can’t stop them from getting away with murder. In fact, creditors can. The ‘84 law made it easier to challenge bankruptcies if lenders think the debtor can repay. Visa has done so, recovering $45 million in the past two years. But many lenders feel that the recoveries simply aren’t worth their cost.
A debtor myth: Life after bankruptcy will be swell, with no choking debts and new credit at hand. There is certainly new credit, in modest amounts. The same folks who helped bury you the first time stand ready to do so all over again. According to the Credit Research Center, 16 percent of new bankrupts get an installment loan or credit card within one year (this includes old cards reissued to consumers who agree to reassume their old debts). Within five years, some 53 percent get some kind of credit. But the amounts tend to be small and probably don’t include a mortgage, says Philip Corwin of the American Bankers Association.
In real life, says Robert Throckmorton, head of Consumer Fresh Start and himself a former bankrupt, the years after bankruptcy are rough. “In many states, you’re blackballed by lenders,” he says. Throckmorton couldn’t get a car loan 10 years after bankruptcy, even though he was paying half of the price in cash. Another bankrupt, a military retiree now in a factory job, can’t find any credit four years after filing. (Bankruptcies stay on your credit report for seven or 10 years, and a lender can ask about them even after that.) The United Finance Co. in Oregon, which lends to ex-bankrupts gingerly, charges monstrous first-year interest rates, like 30 percent on a small loan.
Bankrupts may also find it hard to get a job. By law, employers aren’t allowed to discriminate, but Fresh Starters say they suffer it all the time. One computer repairman says he was offered a job last January. When the company pulled his credit report, it told him good-bye.
One can only agree with the creditors that bankruptcy is a bad idea. But as their lending decisions helped sink you in the first place, they should at least lay off the whines.
