The stories at a recent bankruptcy hearing in the federal courthouse downtown were fairly typical. A man in his mid-20s was laid off for a few months from his $12.50-an-hour job at Kimberly-Clark. During that time, he used his credit cards for living expenses. By the time he went back to work, he couldn't afford to make the minimum monthly payments and faced losing his car. A couple from East Knox County amassed $43,000 in medical bills that their insurance wouldn't cover. He makes 30 cents a mile driving a truck, and she works as a clerk at a motel, earning $5.50 an hour; their combined income couldn't keep up with the bills. A 17-year UPS employee was hospitalized and fell behind in his child support payments and credit card bills. A woman dressed in hospital scrubs, who had just gotten out of bankruptcy in 1996, explained that her car broke down, and she couldn't afford the payments on the new one she bought to get to work.
Over the next three to five years, each of them will make payments of a few hundred dollars every month—almost all of their income after moderate living expenses—to the Chapter 13 bankruptcy trustee's office, which will in turn distribute those payments to the debtors' creditors. During their bankruptcy terms, they can't use credit cards, can't refinance any loans, and won't be eligible for new credit. Some of them will pay most of what they owe and come out of bankruptcy with a relatively clean slate. Even after they've repaid their debts, however, their credit history will be tarnished by the bankruptcy; they'll be able to get credit, but only at inflated interest rates, and many lenders won't assume the risk at all.
The stories are all different, but the factors that combine to push people into bankruptcy are almost always the same: overwhelming credit card debt, unpaid medical bills, or the unexpected loss of a job. Most of them file bankruptcy as a last resort, hoping to hang onto their cars or their houses or mobile homes.
"People get jolted by some precipitous event," such as illness or unemployment, says George Kuney, a University of Tennessee law school professor and director of the school's center for entrepreneurial law.
More and more people have been filing bankruptcy over the last 10 years. The number of bankruptcy filings in the U.S. jumped from 718,000 in 1990 to a high of 1.4 million in 1999, and another record is expected this year. In Tennessee, which has the highest rate of bankruptcy in the country, more than 48,000 people filed in 2000. That's a rate of 1 in 43 households, compared to 1 in 118 in New York and Connecticut, where the rate is lowest.
From 1995 to 2000, the number of filings in the Knoxville office of the U.S. Bankruptcy Court (which handles cases in Knox and the surrounding counties) jumped from 3,499 to 5,287, with a high of 5,718 in 1998. Through the end of April, 2,171 new bankruptcy petitions were filed here, indicating an increase over even the 1998 numbers.
"A lot of the recent increase we've seen could be because people perceive that the reform will eventually go into effect and they want to file under current law," says E. Brian Sellers, an attorney who represents banks and creditors against bankruptcy filings.
Most observers say that the rise of easy credit and the increase in credit card debt over the last decade have been the biggest contributors to the swell in filings. The common perception that people who file bankruptcy are taking advantage of a system that allows them to pile up massive debts, then simply wipe them away, is a myth, according to most people involved in the process.
But that perception, fueled by the lobbying of banks and credit card companies, has prompted Congress to take action on new legislation that would make it more difficult for many debtors to erase credit card debts and unpaid medical bills by filing bankruptcy. Proponents of the new law say that if it's passed, it will eliminate fraud, reduce the number of filings and lower costs for the average credit card user. Critics agree that the new law would reduce bankruptcy filings, but they also argue that people trapped by financial obligations they can't afford will have a harder time finding relief. The real blame for the increase in bankruptcies, they say, lies with credit card companies that offer high credit limits and burdensome interest rates to people who can't really afford them.
"They're handing out credit cards like candy," says Gwendolyn Kerney, the sole Chapter 13 trustee for the Knoxville office of the East Tennessee District of U.S. Bankruptcy Court. "If you're in financial trouble and somebody sends you a credit card, you're going to use it whether you can pay it off or not. And it just goes from there."
That's why many consumer advocates and bankruptcy attorneys are so distressed by the pending legislation. "The new law can best be characterized as a creditor's wish list," says attorney Richard Mayer. "It gives them the statutes they've always wanted. In my opinion, the system we have is a fair system. It's balanced between creditors' rights and debtors' rights. The new law would be a lot harsher; it tilts the balance in favor of the creditors. There's been a significant rise in [credit card] solicitations, and in my mind you can directly attribute the rise in consumer debt and the number of bankruptcies to that."
Under the legislation—currently under consideration in Washington, D.C. by a joint committee of congressmen and senators seeking a compromise after each house approved separate versions of the bill—bankruptcy petitioners would be subject to a "means test" in order to file Chapter 7, the less restrictive of the two personal bankruptcy categories. Chapter 7 allows filers to liquidate any assets and immediately discharge debts. Only the poorest petitioners would be allowed into Chapter 7, forcing all others into the more rigorous Chapter 13, where a schedule is set up to pay off all secured debt (such as home and car loans) and between 10 and 100 percent of unsecured debt (credit card and medical bills). And all petitioners would have to attend a credit counseling class, even those who are simply facing a pile of unexpected medical bills.
Kuney says the pressure to force people into Chapter 13 may be misplaced. "Many Chapter 13s end up converting to Chapter 7s," he says. "Chapter 13 takes all of your disposable income. Then, if another precipitous event occurs, you default on your Chapter 13 payment and convert to Chapter 7. But you've spent a year, or two or three years, paying off a debt that gets discharged."
Mayer says the means test is a burden that people in the midst of financial ruin don't need, especially when most of them will still be allowed into Chapter 7 after the test. "The harshest part is that around Knoxville, most of the people who file Chapter 7 will still be eligible for Chapter 7," he says, "but they'll have to provide tax returns and a detailed schedule of all income for the six months preceding, including all wage stubs, where before they only had to swear to how much they were making."
The purpose, the bill's supporters say, is to dissuade people who can afford to repay their financial obligations, but just won't, from filing for bankruptcy by making the process longer and more complicated. Critics say the real reason for the means test isn't to prevent abuse but to discourage even legitimate filings.
"What the law intends to do is make it more difficult and less appealing to file bankruptcy," Mayer says, explaining that both attorney's fees and filing costs will probably go up if the bill is approved and the means test and mandatory credit counseling are put into effect, because lawyers and administrators will have more work to do on each case. "Realistically, it will make it more expensive and more time-consuming to file bankruptcy."
Both Mayer and Kerney concede that bankruptcy fraud is a problem. But they insist that the effects of such abuse are minimal. "There are people who take advantage of the system," Kerney says. "But it's the trustee's job to weed them out."
Anyone who avoids making payments while in a bankruptcy schedule, or who is found to have lied in the petition, is dismissed from bankruptcy and could face criminal charges.
"The new law will make it easier to get 'gamers' out of the system," Mayer says, using an industry term for people who hope to escape legitimate debt by claiming bankruptcy. "But less than one-tenth of 1 percent of filers are people trying to abuse the system. We don't see that."
That doesn't mean, though, that bad judgment doesn't play a role in piling up mountains of debt. Many people who declare bankruptcy got in poor financial shape by buying too much stuff that they couldn't afford. Sometimes they're in a precarious position, and then lose their jobs or get sick. But sometimes the piles of bills just finally overwhelm them, leaving them with no choice but bankruptcy.
"I don't think you can point the finger at the credit card industry. It's a shared responsibility," Sellers says. "Misuse and abuse also contribute to the problem. We're not saving as much money these days, like we were during my parents' generation. Usually people go from paycheck to consuming. The overall tendency is to consume and not plan on where you're going to get the money to pay for this...It's easy to get in dire financial straits and have to have the ability to seek a fresh start, and that's what the bankruptcy code allows. Creditors understand that. But they want something to protect them as much as debtors."
his isn't the first time legislators have tried to tighten the restrictions on bankruptcy filings. A similar bill was approved by Congress in 1998 but was vetoed by Bill Clinton. President George W. Bush, however, has promised to sign the new bill if it reaches his office. Opponents of the legislation say that its support is based in part on the millions of dollars in campaign funding candidates from both parties received last year from the banking and credit card industry.
"They contributed $50 million in lobbying fees and other contributions to have this bill enacted," Mayer says.
The proposed law has been bogged down since March, when it was sent to a joint committee after separate versions of the bill were approved—by large margins—by the House and Senate. But the recent shift that has given Democrats a majority in the Senate seems to have provided impetus for moving the bill forward; new Senate majority leader Tom Daschle has promised to deliver a compromise bill soon.
The main differences in the two bills are over the homestead exemption and whether damages awarded against abortion-clinic violence can be discharged. The Senate version allows a maximum homestead exemption of $125,000. That means that home assets up to that amount wouldn't be calculated into a bankruptcy petitioner's total assets when figuring a repayment schedule. In Tennessee, the homestead exemption is just $7,500, but some states, like Texas and Florida, have unlimited home exemptions, and they don't want to give those up. The House version allows states to set their own maximum, or to have unlimited exemptions, and representatives from Texas and Florida have promised not to accept the Senate's $125,000 cap.
The other key difference is the Senate's provision that would keep anti-abortion protesters from escaping legal judgments by filing bankruptcy. The House version has no such provision, even though under the current law child support, alimony and other court-ordered payments can't be discharged through bankruptcy.
Both the homestead exemption and the discharge of anti-abortion damages are highly emotional political issues, and no one knows when or whether they'll be settled. But George Kuney, the UT law professor, says it could happen at any time, given the overwhelming support of banks and credit issuers.
"It could break free at any moment," Kuney says. "[T]here are issues between the two, and the two issues cause some problems...But there's a general feeling that the credit industry wants this to go through; it's just a question of some political wheeling and dealing."
There's already been a record number of filings across the country in the first few months of this year, probably in anticipation of the new law. Kuney predicts that there will be an even greater surge after the bill is signed, in the 180-day window before it would become effective.
Advocates of the new law and credit industry spokesmen claim that consumers will see their interest rates drop significantly if the bill is put into effect. But others are doubtful.
"One other myth propagated by the credit card industry is that as a result of increased filings the fees for using a credit card are $400 more a year for the average American," Mayer says. "Six months after the new law passes, I dare say I won't see my $400. They'll still charge the same fees and interest rates they charge now. I don't think it's going to result in lower credit card payments whatsoever. It's just not going to happen."
Kuney says the credit counseling that would be required under the new law is "a step in the right direction" toward decreasing consumer debt and the number of bankruptcies filed each year. But he'd like to see educational programs instituted earlier so that people understand what they're getting into when they accept credit.
"People tend to view a $5,000 credit limit as $5,000 that they have," he says. "They don't see it as a $5,000 liability that, if they pay the minimum, will take them 30 years to pay off...We teach sex education, home economics, safety programs; stop, drop and roll if you're on fire. Nobody really addresses credit. We basically have a zero savings rate, and large portions of the population are living paycheck to paycheck, with negative cash flows if they have large credit card balances...[Education] is really not seen at the high school level, and that's really where we need to get that information in, occupying the same timing of education as health and sex-ed. It doesn't do much good to hand somebody birth control after they're pregnant."
Rep. John Duncan of Knoxville supports the House version of the bill, but he's proposed another bill of his own that would strike back at the credit card industry. Duncan's proposed bill is unlikely to pass—it only has minimal support among his colleagues and has languished since it was introduced—but it has raised some awareness of predatory credit solicitations aimed at college students. The bill would limit the amount of credit that card companies could extend to college students to 20 percent of their annual incomes.
"It is just not right to start young people out or encourage young people to go so far into debt just as they are starting out," Duncan said from the floor of the House in March.
Chapter 13 trustee Gwendolyn Kerney says the system works fine the way it's set up now. She's discouraged by the rise of bankruptcy filings and would like to see credit issuers take more responsibility. But bankruptcy, she says, is a legitimate way to resolve financial disaster and get a fresh start while still paying a fair share of your obligations.
"We pay $42 million a year back to creditors" through the Knoxville Chapter 13 program, Kerney says. "There's nothing wrong that needs to be fixed. We're self-supporting. We get no government money. We make a plan and distribute as much as we can back to creditors."
The trustee's office takes about 4 percent of the money put into each plan to pay salaries and operating costs. "It's never over 4 percent," Kerney says. "Nobody makes any money off of it. It goes back to creditors."
Despite the number of bankruptcy filings each year, the stigma of personal financial failure is still attached to the process. Even once debts are discharged, through either Chapter 7 or Chapter 13, a bankruptcy can be a stain on a credit report for seven to 10 years. Lenders are often reluctant to loan to people who have a bankruptcy on their records and often only do so at huge interest rates. Buying a car or a house becomes difficult. And not everyone learns the lesson the first time; the bankruptcy court records are full of repeat filers, sometimes people who have filed as many as three or four times.
"They're ashamed and embarrassed when they come in here," Mayer says. "It's always a last resort."
Kerney says Chapter 13 filers have an easier time after their debts are paid. "For people who pay back 100 percent, we always send a letter to the credit bureaus," she says. "There's some negative connotations to having it on your report, but to anybody who knows the difference, it helps."
But the social and financial embarrassment of bankruptcy isn't what it used to be. No one's sure if that's good or bad; some people say that's a factor in the rising number of filings, and others say it's a welcome relief for people who get too far behind to ever catch up.
"Major corporations we do business with—airlines and such—have gone through bankruptcy and come out on the other side, and we've become used to hearing that," Kuney says. "The bankruptcy code of 1978 was meant to erase some of the stigma of bankruptcy, and it's done that. Reasonable minds can argue about whether that's been the right thing to do, or whether we ought to hold their feet to the fire, but certainly the stigma has been lessened. There's a sense that it's a way out, a way to get a fresh start and that it's O.K. to do."