Help Debtors Before They Go Over the Edge

If you listen closely, you can almost hear the stampede of creditors rushing into Congress seeking to change how the bankruptcy system treats consumer debtors.

The proposed creditor solution to the bankruptcy problem is straightforward enough: Eliminate debtors’ ability to liquidate under the bankruptcy laws and force them to repay creditors out of future income. This solution, however, is far too drastic, too expensive and too cumbersome.

Creditors claim that too many individuals are seeking bankruptcy (1.35 million in 1997 alone); that bankruptcy has lost its stigma; that many debtors can repay their creditors (but choose not to); that every American household is paying $400 for the credit losses caused by bankruptcy; and that if bankruptcy is booming in a strong economy, imagine what we can expect when economic times worsen.

While creditors make it seem like the bankruptcy system is broken and needs fixing, their rhetoric disguises the more complicated and more difficult problem of how to address debt and credit in a market-based economy. Instead of the creditor approach, we need a multifaceted response that leads to responsible creditor and debtor behavior.

Start with some basic facts. Debtor abuse and destigmatized bankruptcy are not the cause of the vast majority of bankruptcies. Indeed, no single factor is powerful enough to explain the increasing numbers of bankruptcies in a booming economy. As anyone who has worked with people in financial distress knows, debtors do not file for bankruptcy relief gleefully; they are not proud that their lives are a mess; they are embarrassed and experience a sense of failure. For many debtors, financial failure is merely the outward manifestation of deeper, noneconomic failures--failures in one’s health, one’s job, one’s family, one’s business, one’s spending choices.

Creditors are not merely bystanders in this whole process. Creditors extend enormous amounts of credit to consumers, sometimes without adequately either pre-screening or monitoring that credit. Creditors regularly extend credit to college students, knowing they have no significant income. Creditors encourage people to charge items and make minimum payments; that is how they make their money. Some creditors even foist fees on people who repay their monthly balances in full.

What is remarkable is that the vast majority of borrowers actually do repay their monthly balances in full. While credit losses total in the billions, credit profits are extraordinary; indeed, consumer credit lending is the single most profitable piece of commercial banking today. People who previously had no access to credit markets are getting credit and repaying.

When individuals experience financial failure, creditors unnecessarily badger them with letters and phone calls. Far too few creditors are willing to communicate with their debtor clients to renegotiate so that payments will continue. And when they do, payments are commonly structured without a much-needed short moratorium on payment. Indeed, it is far easier to work things out with your creditors if you owe $50 million than if you owe $5,000.

Recent studies have cast a shadow on the validity of creditor statistics about debtors’ ability to repay and the cost of our bankruptcy system to all Americans. It is clear that the majority of debtors cannot repay their creditors even part of what they are owed.

We could create a costly system that attempts to limit access to the bankruptcy system. Judges, trustees and debtor lawyers would be spending huge amounts of time, energy and money deciding debtor eligibility. Bankruptcy would become a federalized collection agent for private creditors.

It would be better if we directed our time, attention and money to shoring up existing mechanisms for ferreting out abusers without limiting access to bankruptcy. We could provide debtors who need financial relief with greater financial management skills so that they emerge from the bankruptcy system better able to become productive citizens in a market-based economy.

By raising the level of financial literacy for all Americans, we can focus on keeping debtors from falling off the cliff, rather than waiting to clean up after they’ve fallen.