I hope the bankruptcy bill will lower interest rates generally, but I doubt the effect will be very significant. Most credit card issuers use risk-based pricing, so rates for prudent borrowers presumably will not be changed in response to the bill, as those rates don't presently contain any significant bankruptcy premium.

Unfortunately for high-risk, high-rate borrowers, the market mechanisms that would drive rates down in response to the reduction in bankruptcy risk rarely apply. For the most part, these borrowers were originally extended credit at favorable rates, but because they were late in making payments (2 late payments in 6 months is a common standard) or because their credit score has dropped they get hit with penalty rates of 24% or more. These rates are imposed retroactively to their existing balances, not just to new transactions, so these borrowers' ability to reduce the impact of the penalty rate by simply switching to another credit card provider for new charges is substantially reduced. Moreover, these borrowers' capacity to transfer balances to competing cards is often limited compared to that of low-risk borrowers. As a result, the credit card companies that impose these rates may do so with only limited risk of losing revenue to competitors, and therefore with only limited incentive to pass their reduced bankruptcy costs to these borrowers.

Is there a sweet spot in the risk curve where the bankruptcy premium in current rates is significant and where competition will require a reduction of the premium? I doubt it.

Rather than precipitating a transfer to the prudent from the imprudent, the bankruptcy bill will result in a transfer to the politically connected from the politically unconnected.

I'm curious why the consumer has to unilaterally disarm in the "vicious cycle" discussed above. Why not impose stricter limits on interest rates and follow that with bankruptcy reform? There's an important issue of time lags in the rate at which interest rates will update after this. And since the debt is already there from existing interest rates, this reform seems to put the cart before the horse.

Here we are again in fantasy-land. We eat mushrooms, and they make us believe that giant
banks which are beholden to nothing but the profit motive of their shareholders will
unilaterally reduce their interest rates from
30% because they are just so... warm and caring.
In fact they would have done this long ago, but those shifty irresponsible citizens to which they have been loaning billions and billions of dollars just forced their hand! bah.

Interest rates will ALWAYS be as high as the market will bear absent positive regulation. A company which does otherwise will be punished by its shareholders. This new law reduces the incentive of companies to lower interest rates because they no longer need worry about people escaping even the most aggressive loan sharking.

What under the new scheme prevents MBNA from charging you 200% interest on the debt you currently have? Even the minimal competitive
pressures of the increasingly monopolistic credit industry don't work for you once they decide you are more valuable as a loan-slave than a future borrower. Want out under Chapter 13? OK, we'll
destroy your credit rating for 10 years and by the way, you still have to pay for at least 5!
Ha ha ha ha! Sucker!

This legislation was written and aggressively
lobbied for by MBNA and other credit companies
for a decade until a suitable pro-business
majority took control of the government. Now Posner and others would have us believe that having escaped billions in responsibility for bankruptcies stemming from bad loans, MBNA will be so overjoyed as to forgo billions in profits by reducing its usury. Yeah, and monkeys might fly out of my butt.

An amendment to the new Bankrupcy prohibition was
proposed that would limit maximum credit card
interest to 30%. The amendment was violently opposed and REJECTED 74-24 in the Senate. Why, if the purpose of this legislation is to enable benevolent mega-corporations to be nicer to consumers, would those corporations care about maintaining their right to gouge consumers with high interest? What purpose do those rates serve if the law passes? Obviously, the amendment failed because MBNA intends to continue to charge 30%+ everywhere it can.

Another consideration that proponents of this law ignore is the fact that 100 million Americans negotiated their current debt arrangements in reliance on the existance of Bankruptcy protection for severe economic reversals. This new "reform" changes the law midstream on people who are in good faith trying to repay their debts.

Even if a particular consumer overspent in comparison to forseeable risks of medical (or other) emergency, there is no justification given for dumping responsibility on him or her as opposed to the bank which must have similarily overextended credit in comparison to forseeable risks of default. The plain pro-corporate bias of this law is so facially apparent that it makes me sick.

Behind the Bankruptcy Reform Act, as behind the President’s proposal for social security reform, is an ideology of giving nonwealthy people greater responsibility for their own economic welfare...

First, I agree with the previous comments on the likelihood of banks reducing interest rates in response to this legislation and that, even if they do, quite some time will pass before it happens as the new rules effect borrower behavior.

Second, your comment on the plight of individuals forced into bankruptcy under current rules by medical emergencies is so condescending I'm reminded of the first days this blog was published and people were questioning its authenticity; I mean your comments are just heartless.

However, I'm most concerned with the opening of your last paragraph as quoted. That statement is such a bunch of marketing spin malarkey that I'm surprised you were comfortable publishing it on Easter Sunday. The reason for this legislation and for social security reform is to benefit the wealthy investors and contributors who supported Bush's re-election.

This analysis is clear from reading the details of both packages instead of the rhetoric coming from the politicians. In the long run, as Santayana said, we are all dead but in the meanwhile both of these absurd political trickbags will cost the mass of our society substantial amounts of money and emotional distress.

The required government borrowing in the first two decades, if Bush's SSR plan passes, will put huge profits into the pockets of bond investors and investment banks while pushing up interest rates paid by middle income consumers. The bankruptcy legislation, to its credit with those same investors, is riddled with loopholes that benefit only the wealthiest percent or two.

One can only hope you'll revisit your thinking on these subjects and lend your voice to those of us who are trying to see this emperor's real clothing.

I don't know... I have no background in economics, but I understand that competition drives low prices. No matter how much opponents of this bill try to show otherwise, most consumer debt is voluntary. Since creditors want to attract borrowers, they will compete to please the customer. This means that interest rates and other benefits will favor the consumer as much as possible in order to let the creditor still turn a profit.

How does it not make sense that lowering the risk of lending will lead to lower interest rates? It seems paranoid to suggest otherwise.

"What under the new scheme prevents MBNA from charging you 200% interest on the debt you currently have?"

State usury laws.

Daniel, in a frictionless market your assertion would most lilely be true. However, the US economy is very different from the ideal. Specifically, the card issuers will not lower interest rates unless market forces require them and these days that would mean competitors.

But the competitors in this space are more interested in maximizing profits rather than market share. This isn't paranoia, just pragmatics. If you really want an eyeful on how the credit card business works, bop on over to PBS and watch the frontline episode "Secret History of the Credit Card" (http://www.pbs.org/wgbh/pages/frontline/shows/credit/)

I agree that the reform will lower rates, ceteris paribus, though I am not certain the consumer will be congnizant of these rate decreases (as they may be relatively small and may be offset by other economic variables).

I have a lot of thoughts, which I plan to share later, but I wanted to throw out this one idea and see what others think. The reform requires lower income, higher debts, etc to qualify for chapter 7 bankruptcy. The catch here is that the reform--like so many government actions--creates some unintended consequences which are counterproductive. If someone is in moderate financial trouble with a decent paying job, they have a considerable incentive to lose their job and accrue more debt. Whereas someone may have just filed for bankruptcy pre-reform, but kept their well-paying job and not accrued more debt. Now it seems there would be incentive to intentionally worsen their financial condition as to qualify for the better bankruptcy protection. The reform may produce some considerable moral hazard issues, if I understand it correctly. Am I crazy here? Somebody tell me I am wrong!

State usury laws don't apply to credit cards issued by federally regulated financial institutions, as they are preempted. The institutions can choose to adhere to a federal usury rate or to the rate applicable under their home state's law. That's why the major companies have all located themselves in Delaware, South Dakota and Nevada, states that have no usury ceilings.

"How does it not make sense that lowering the risk of lending will lead to lower interest rates? It seems paranoid to suggest otherwise."

Well, see, that's the basic assumption that
proponents of the bill make. They say, "Interest rates are high because of high default rates."

In fact, interest rates are high because of a number of factors, including softening or total repeal of usury laws, unprecedented amount of debt being extended, and collusion in the marketplace. (for example, rates on one card tied to payment performance on other cards via the magic of FICO scores)

Credit card companies are at least partially responsible for the "risk of lending" that they claim is hurting them and requiring this law. But anyone with 15 minutes and access to the internet can see that major credit card companies have been making record profits. If high default rates were a problem serious enough to warrant wholesale changes in settled bankruptcy laws, it would be reasonable to ask credit card companies to show how their alternative solutions were not working. Of course, this isn't a reasonable law, it is corporate welfare to one of the largest political contributors, MBNA.

So now a bunch of free-contract ideologues want to change the law in a way that reforms the circumstances under which every American with a credit card originally contracted. (Almost as ironic as the States Rights ideologues trying to use the Federal Courts to overturn a FL state decision.) Well, I guess I will go out and bargain with a multi-national bank. I'm certain they will give me a fair deal in the absense of any legislative reason to do so. After all, I am handsome and I have red hair!

One other thing... saying that spending is voluntary is not the same thing as saying that debt is voluntary. Characterizing consumer debt as a choice does not resolve the issue. (And not just because it overlooks the choice made by the creditor to risk loaning the money.)

Unforeseeable reversals (medical emergency, loss of a job) can transform a perfectly reasonable consumer debt into an involuntary servitude. We want to encourage investment in the future, so we look favorably on a young person who might buy an expensive suit to assist in a job interview, or purchase a car upon graduation from college in order to commute to a job. When that job is lost without cause because of a stock market reversal, the question becomes "who bears the risk relative to repayment of the loan."

The consumer is the obvious choice, until we realise that the debt company has evaluated and priced the risk of default into the terms of the loan. This is obvious from the record profits derived even in a period of record defaults.

The bankruptcy "reform" law drastically reduces the risk of default to near zero. The authors of the law resisted inclusion of ANY limit on creditor's ability to charge the highest rate the market will bear.

Corey: they make us believe that giant banks which are beholden to nothing but the profit motive of their shareholders will unilaterally reduce their interest rates

This is true of all businesses and all products. And yet, we do not see million dollar Chevrolets or 20% mortgages or milk that costs $30/gallon. It is not because they are prevented by law from having high prices. It's because the "profit motive" requires them to keep prices at levels where they can actually gain customers.

So now a bunch of free-contract ideologues want to change the law in a way that reforms the circumstances under which every American with a credit card originally contracted. (Almost as ironic as...

A complete non-sequitur. People contracted for certain benefits and costs. People may have considered the state of the bankruptcy code (doubtful, but possible) when they entered into these contracts, true. Of course, that's true of every single contract ever entered into, not just credit card contracts. That doesn't mean the code itself was part of any of these contracts.

If it did -- that is, if your reasoning were valid -- the bankruptcy code could never be changed at all because there would always be millions of existing contracts which one could point to and say, "We shouldn't change the circumstances under which these contracts were entered into." But your logic isn't valid. There's nothing special about the 1978 bankruptcy code.

The bankruptcy "reform" law drastically reduces the risk of default to near zero.

No, of course it doesn't. Nothing in the law "reduces the risk... to near zero." Indeed, for lower income people, the law doesn't change bankruptcy much at all. There is no basis for this hyperbole. Your comments seem predicated on the strange notion that Congress is abolishing bankruptcy.

-----------

Bill: The reason for this legislation and for social security reform is to benefit the wealthy investors and contributors who supported Bush's re-election.

If that were the case, we wouldn't expect it to see bipartisan support.

In the long run, as Santayana said, we are all dead

That was Keynes.

At what point, if ever, will corporations formally be expected to possess and demonstrate responsibility beyond maximizing profit and/or return to shareholders? I won't accept the corporate social responsibility malarky because anyone who has spent time inside a large for-profit corporation knows who wears the pants in that family. And I don't buy the argument that individuals have the ability to seek redress in courts because that playing field is not fair given the discrepencies in legal resources between individuals and corporations, nevermind the tort reform that will flow like manna from the current Congressional high priests of business.

Are we individual human citizens really expected to attribute to corporations some degree of ethical behavior and responsibility to society? One can only hope that the corrective mechanism of pupular democracy will kick in sooner rather than later in response to these latest corporate wealth creation proposals. Problem is, such corrective measures will be painful and disruptive. There must be a better way.

There are CURRENTLY no restraints on credit card
interest rates beyond "ability to gain customers".
This is why all credit cards come with "low introductory rates" and an often unread contract term that allows rates to be raised arbitrarily.
The top "penalty" rate on most if not all cards now is 30%, 40% on some. Many free-thinking individuals find these practices unfair, immoral, and counterproductive to repayment.

So we go from no restraints to no restraints,
but drastically reduce the risk exposure of one side at the expense of the other. Then when confronted, we rely on market theory to reduce fears that Widow Smith will be charged 50% interest on the loan she takes to buy her cancer meds. Maybe your fears are reduced, all I can say is, if this law passes you are in the jungle with the rest of us. I hope you are rich and tenured.

"Indeed, for lower income people, the law doesn't change bankruptcy much at all."

And for Norwegians, it doesn't matter. Means testing to "qualify" for Chapter 7 is the same thing as abolishing Chapter 7 if the means minimums are so low that you have to be homeless to qualify. The whole point in bankruptcy is to provide relief BEFORE people are reduced to the nonproductive status of impoverished property-less beggars.

"If that were the case, we wouldn't expect it to see bipartisan support."

hahahahahahaha... oh wait, you were serious...
I have news, the Democratic Party only looks to be on the side of consumers because they are standing next to the Republicans. MBNA contributes to practically everyone but Nader.

If we remember our civics classes, Congress is not supposed to make retrospective laws. I believe that would be Article I, Section 10, Clause 1 of the good old Constitution... yep, no ex post facto laws. OK, so given that there is over a trillion dollars in debt that was extended with both parties relying on the current regulatory scheme (yes they do), how can we argue in good faith that the imbalanced nature of this current law does not upset settled expectations in an unequal way? Even if we allow the law, why do the debtors have to bear the sole risk of changes to the regulatory scheme...

Because debtors don't have the ability to influence the regulatory scheme! Collective action problem. How fortunate for the creditors that there are increasingly few of them! Collusion by uniform business practice is the number one undiagnosed cause of market failure.

Oh, sorry, technically the Federal prohibition on ex post facto laws would be Article 1, Section 9, clause 3. The clause I cited is the State prohibition.

I guess I might get a bad grade in Con Law.

Posner asks why debtors are ever allowed to discharge their debts. There are two, related, answers: one, nondischargeable debts in excess of one's assets would constitute involuntary servitude and violate the 13th Amendment (this is how I was taught it in school, correct me if I'm wrong); and two, even in the early days of our republic, the usual alternative -- debtor's prison -- was considered unacceptable and abolished (though in recent decades it seems to have been reestablished, at least for child support debts, by the workaround of finding the debtor in contempt of court and fining him the amount of the debt for not paying).

I believe that payback plans such as Chapter 13 and Chapter 11 (both now allowed for individuals, as I understand it) are an acceptable alternative to discharge and would have no problem with seeing Chapter 7 bankruptcy abolished. However, I would first like to see a reform of those aspects of bankruptcy law that unduly discriminate in favor of the rich. There is no way that a homeowner should be allowed to exempt a six-figure house from forfeiture during (any type of) bankruptcy, while someone who has never owned a home is not allowed to exempt a similar amount of assets he does have.

I would also like to see reform in the case of the child support situation. Often courts will impute these people an ability to earn income that vastly exceeds reality, and then jail them for not paying support that exceeds their real income. Ideally the debtor's prison should be re-abolished; but if there must be involuntary servitude, at least make the court responsible for finding the defendant that good job before claiming that it's available to him.

I am a lawyer with 30 years of experience. In the course of my career I have provided advice and representation to Credit Card Companies (CCC) in connection with the operation of their businesses and major transactions.

Judge Posner said: "Under the present system, the prudent and the imprudent consumer pay the same high interest rates, assuming creditors can’t readily determine which consumers are prudent and which are imprudent."

However, the life of the law is experience, not reason as Holmes said.

First, the Credit Card Companies (CCC) can, and do, make very fine determinations on who they will lend to, how much they will lend, and what rates and fees they will charge the debtor. As is explained in the text and transcripts of the Frontline program cited by BillySaysThis above, the CCCs use the stagering data gathering abilities of the Credit Bureaus and the analytic tools provided by Fair Issac and others to make these determinations on a real time basis. (Have you gotten your free credit report yet, if not why not, go to http://www.annualcreditreport.com/ you will be amazed by the amount of information they have).

Second a little history is instructive. Before the early 1980s CCCs could not exploit the national bank loophole to state usury laws, and many, if not most state usury laws were quite restricitive. IIRC, New York limited rates to 12%. In 1980 interest rates shot up as the Federal Reserve tried to get the inflation of the 1970s under control. When the prime rate peaked above 20%, the CCCs went to the legislatures and asked them to raise the usury ceilings, which they did. In the 1980s Banks also gained the right to set up in States other than their traditional homes.

The convergence of these phenomena allowed the banks to set up CCCs in states that would let them charge unlimited rates. It was only then that credit cards with rates well in the 20s appeared.

Since that time, there has been no general decline in credit card rates, despite the fact that money rates have declined fairly steadily from their 1980 highs down to the low single digits. To be sure the CCCs offer low rates, sometimes as a teaser and sometimes to a very limited subset of their customers. But the bulk of the CCC's debtors pay high rates, which are jacked up at the slightest hint of financial trouble.

If the CCCs have been so stingy with rate reductions that could be made because of the much lower cost of funds, why should we expect them to more generous with the much smaller gains attributable to changes in the Bankruptcy Code. Isn't it just as likely that they will apply the profit to increasing market share by lending to riskier customers rather than reducing costs for existing customers?

Two more points:

First on the debtors prison point raise above. Now that many people will not be able to elect between Chapters 7 and 13, they will be the slaves of the bankruptcy court. If you are worried about this prospect, you are justified.

Read "U.S. Gets Tough on Failure to Repay Student Loans", Wall Street Journal 1/6/05 (No URL, $). There was a story about methods used to collect from bankrupt student loan debtors. One aids patient was having his disability payments garnished. Another case was a student, Jonathan Gearhardt who had studied cello in music school. He even found a job playing for an orchestra in New Orleans. His student debt was almost $100,000. He was working and making $20,000/yr and was the envy of his classmates because he was working. Now an orchestra job may only be 15 hours a week of playing and rehearsing, but he also has to put in 4 to 6 hours a day of practice to keep his chops up. The trial job heard his story and discharged his debt. The creditor appealed! and the circuit overruled the trial judge and told the debtor to take a second job!!!!!!!!!!!!!!!!!!!!!!!!!!!

Want another glimpse of the future read 255 B.R. 555. Basically, the reform will encourage this type of judicial micromanagement of debtors lives and discourage the use of Bankruptcy Court. I know that this case was a judicial mugging, because I know the debtor personally and well. The money went entirely into his kid's educations and charity. He had sold the house, which was not a palace. He was driving an old car and taking the bus to work. at the age of 50+ the debtor who is a lawyer,was busting his butt -- 2500 hours, after heart surgery.

This is a very grim view of the future.

Another point. One of the engines of economic growth has been the willingness of Entrepenures to take risks. By depriving them of the ability to use Chapter 7 as a life raft will be interfering with that engine of economic growth?

Finnaly, I want to note that I am not a liberal. I have not voted for a Democrat since 1976. I believe in free markets and freedom of contract. But this is one time that I think a lot of folks on the right have got it wrong.

Posner seems to posit that if the total/overall amount of credit offered were lower, then interest rates would be lower. This is probably true, as if no credit were offered, then the interest rate one received would be perfectly proportionate to one's foreseeable ability to repay over the term of the loan. But this is not a defense of prohibiting bankrupts from squirming out of repayment, it is an argument in favor of limiting the total amount of credit offered and encouraging personal savings. The same gains could be realized by taxing credit card companies that exceed a certain level of credit-lending, much like we "tax by regulation" energy companies that exceed a certain level of pollutant emissions. In fact, we could make entry into the credit-card company more difficult, by drastically increasing the licensing costs. This would jack-up the price of using a credit-card, which would discourage use of a credit-card. Posner could argue that without plugging up the back-end, people would just escape paying their debts, but we could make it easier to escape paying credit-card debt, thus increasing the tax the credit-card companies so much that their continual losses in bankruptcy court would encourage them to stop over-lending credit to those who cannot foreseeably repay. There is no reason why we must plug up the back-end and side with the credit-card companies, other than pro-business libertarian ideology, if the problem is that credit-card companies are lending too much credit.

By "perfectly proportionate to one's foreseeable ability to repay over the term of the loan" I meant the assets one has and one's foreseeable cash flow.

Sorry, by "the credit-card company" I meant "the credit card industry"!

In response to Robert Schwartz's posting of the case from the Bankruptcy Record, I think the ruling in that matter was correct. The lawyer was making well over $100,000 per year at a large law firm but had spread himself too thin. Even at the time of bankruptcy, he still had kids in very nice private schools, and his wife had a $350 per month cleaning lady because she apparently wanted to preserve her clean lifestyle, despite the fact that the wife did not work.

Giving to charity is a luxury that credit card companies should have zero obligation to subsidize at his discretion. The fact that his wife does not even work is also significant. Lastly, private high school for kids is a major luxury. The man had 15 credit cards listed in his bankruptcy liabilities with 6-figure debts to them. Apparently, credit card spending should have been replaced by saving for his kids' education. Credit card companies and their customers should not have to finance that.

His was a straightforward case for Chapter 13; looks like the ruling was correct.

--

A very good lawyer friend in town killed himself about two months ago because he could not keep up his very luxurious lifestyle after his client base dried up and he had to declare personal bankruptcy. It was truly one of the saddest funerals I have ever been to, but he was the one that refused to see reality and cut back to reflect that financial reality. Refusal to cut back and live more modestly, as personally “humiliating” as that might feel, is a private matter and not one for public subsidy through Chapter 7.

Why not bring back debtor's prison?

First,I'd like to thank Judge Posner for making this act understandable to me.Then a few comments to Corey.Interests rates of companies will fall if they can increase their volume of lower risk customers.All it takes is one company to lower rates (if it is profitable to do so) and the others must follow suit or lose customers.Secondly,you never replied to my query(some time ago) on the name of your insurance plan that only allows generics.Would you please do so?Finally, since the bankruptcy plan is only applicable to the population with incomes above the median it has no chance of lowering rates to near zero.

"If bankruptcy is more costly, there will be less of it."

If lending credit is more costly, there will be less of it.

And for Norwegians, it doesn't matter. Means testing to "qualify" for Chapter 7 is the same thing as abolishing Chapter 7 if the means minimums are so low that you have to be homeless to qualify.

And if buses had wings, they'd be 747s. But they don't and they aren't. The means minimums are not "so low that you have to be homeless to qualify." They're based on median household income. If you're in the bottom half, incomewise, it doesn't affect you. This isn't exactly poverty line.

If we remember our civics classes, Congress is not supposed to make retrospective laws. I believe that would be Article I, Section 10, Clause 1 of the good old Constitution... yep, no ex post facto laws.

Ex post facto is a criminal concept. If bankruptcy laws fell into the ex post facto category, then there could never be any changes to the bankruptcy code, ever.

how can we argue in good faith that the imbalanced nature of this current law does not upset settled expectations in an unequal way? Even if we allow the law, why do the debtors have to bear the sole risk of changes to the regulatory scheme...

Any change will affect debtors and creditors "in an unequal way," so again, we're back to the issue of you trying to lock in the bankruptcy code permanently. You act as if the current bankruptcy code is sacred, as if, miraculously, they got the balance between debtor and creditor perfectly right the last time and therefore any change in favor of creditors is somehow unfair.

--------------

In addition to Mr. Schwartz's anecdote about the wealthy lawyer who wanted to lead a lavish lifestyle while not paying his debts, Mr. Schwartz also provides an anecdote about a musician who he feels was treated unfairly. But if we're to accept that anecdote at face value, this person borrowed $100,000 and decided to spend it in such a way that he would have no realistic shot of ever paying it back. Why should we feel sorry for such a person?

I have always operated under the assumption that advocates will trot out the most heartwrenching stories they possibly can in order to sway us. If the best sob stories that an advocate can come up with are ones involving unsympathetic figures, that suggests to me that their case is really weak.

"But if we're to accept that anecdote at face value, this person borrowed $100,000 and decided to spend it in such a way that he would have no realistic shot of ever paying it back. Why should we feel sorry for such a person?"

I do not support the bankruptcy reform, though I would support more minor reforms. But I thought the exact same thing about that scenario.

I was relieved when I read that the reform should effect no more than 20% of filers. If that holds true, then it's probably pretty solid. Though I am very nervous about Congress about being out of touch with what is reasonable to the average joe.

Here's the solution to the bakruptcy problem: the US government should pay off it's own debt which would free up over 300 billion a year in interest that it pays on the debt. This $300 billion a year could be used to pay off the debts of 1% of the US population each year at an average debt level of $100,000.

Oh, but wait! If we don't spend $100's of billions occupying Iraq then Osama bin Laden will take control of the USA and we will all be forced to wear burkas. Oh the horror! I we'd better keep running up that national debt after all.

As a one-time professional musician, I concur with the criticism of Schwartz's story about the cellist. There are plenty of very generous public universities where one can learn to play the cello very well for far less than $100k. Just because someone chooses Oberlin to engage in learning an art, beautiful though it may be, does not entitle one to an extra helping of empathy. I realize that the bankruptcy judge probably errantly thought that 15 hours of rehearsal a week was not full-time (it can be, if he practices like he should, heh heh), but this guy could be making more $$$ doing many other things, including teaching at a public school rather than the semi-pro orchestra thing--or taking on some more private students. Just my .02 as someone who does a lot of music.

Judge Posner,

Your dismissal of the notion that we should have some special consideration for people bankrupted by medical expenses is way too facile.

Sure, it's prudent to have some reserve to meet unexpected expenses, but there's a limit to that. Medical expenses can be large, so large that even someone who manages their finances carefully can be bankrupted by them. This is especially a problem, of course, for the uninsured, for whom the cost of any significant illness can far exceed what they are able to pay.

"Why should we feel sorry for such a person?"

Why should you get to condemn him? Why should we feel sorry for the bank that chose to lend him money? None of us have any concept of why this or that particular person might borrow money or why they might unexpectedly be unable to pay it back without unfair hardship. The current bankruptcy code has substantial protections against abuse already! No one has shown anything but anecdotal evidence of abuse. Certainly nothing that would justify such wholesale changes.

Like with everything else, you want to roll out a bad actor who scammed the system and escaped their debts with their "wealthy lifestyle" intact. Nevermind that HALF of bankruptcies are triggered by high medical expenses.

Who should go to Oberlin? Rich folks who can already afford it? I'm sure that will do a lot for quality and beauty in art. Are there no workhouses? Give the poor people the slave jobs they deserve! bah.

Bankruptcy encourages people who don't already have wealth to invest in their future, by providing them with an escape route if a reversal that is not their fault occurs.

Will anyone on this discussion admit to ever having either gone through bankruptcy or even
faced the serious possibility? Am I the only one?
I lost a job in an unexpected mass layoff one month after being promoted. My credit cards refused to lower my interest rates from 29%. I made 100K in the year before I filed Chapter 7, 25K of which I sent in payments on my debt, not reducing the principal AT ALL. Over ten years, I had spent $125K on my 5 cards, sent a total of $115K in payments, but still owed $62K because of interest and fees. I was never able to get clear of this debt due to periodic no-cause layoffs in the engineering industry and predatory interest rate hikes.

After filing, My leased car was repossessed, I am currently back in school and have $12.67 in my bank account. I would NOT have been able to file under the new means testing, and would be accruing additional debt at a rate of $25,000 PER YEAR because the only jobs now availible in
my previous field pay half as much, (if I could get one with 15% unemployment for engineers.) I would be unable to bargain for a lower interest rate.

So tell me all about how irresponsible I am and how I never should have leased a BMW on a $100K per year salary. I would welcome your critical judgment of my life. Tell me about how I should be selling pipe fittings at Home Depot like the rest of my ex-engineer friends instead of borrowing more money to get a law degree. While you are at it, tell me that students loans should be privatized so that Sallie Mae can charge me the 35% interest that I so obviously deserve.

Messers Neiport and RWS:

You guys are brutal and lacking in a certain amount of imaginative sympathy. The Bankruptcy court opinion I cited was a judicial mugging. Go back and re read it, but this time cross out the adjectives.

The more important point is that judges will be micromanaging a lot more lives under the new law than they were under the old. Get a better paying job wil be a judicial order backed by contempt powers. Ditto make your wife get a job. Whether to pull your kids out of school or to take the bus to work are not matters Judges should be deciding.

The anecdote about the lawyer's suicide is an even more telling point. If the increased difficulty in obtaining a discharge leads to more such stories, or what seems to me to be just as likely in this heavily armed country, distressed debtors shooting up courtrooms or bank offices, then the law will have failed utterly. It is only money and suicides and murders are too heavy a price to pay.

Furthermore, I think RWS made my point about the law discouraging risk taking. If the risk of making a bad investment falls too heavily on the entrepnure who has no other means to spread it, changing the bankruptcy law will only decrease the amount of entrepenureship and impovrish the whole society.

I also note a rather one sided way of looking at debtor creditor relations. Not everything that happens is caused solely by the debtors actions. Creditors must lend money to debtors before there can be a debt or a bankruptcy. The fact is that Creditors actively encourage debtors to borrow money as do vendors.

Creditors could even more easily than debtors adjust their behavior to reduce the risk of default. No law of nature nor of man, requires the CCCs to mail solicitations for credit cards to every man, woman and child in this country every day. But my minor children receive creit card solicitations frequently. As noted above, modern technology allows the CCCs to keep close watch on their debtors finacial status. They could be more agressive about cutting off credit to the over-extended and not issuing credit cards to the already heavily indebted.

Similarly if we are to mulct debtors for excessive optimism about their prospects, why do we let creditors off scott free? Surely the young musician who bought an expensive education was overly optimistic, but should the creditor have accomidated him in his optimism? Surely the creditor knows that Chemical Engineers make more money than Cellists. Why did they continue to loan the musician money knowing what his prospects were? Doesn't the Creditor, to some extent, deserve to lose his money when he makes imprudent loans.

I continue to believe that the so called reform act is a bad idea that will bring us much misery, little justice, and no economies.

Actually Corey, that "half of all bankrupcy filings" statistic from Health Affairshas been pretty much debunked. In order to reach that number, they added in anyone filing for bankrupcy who had paid at least $1000 in medical expenses in the past two years. They also included substance addictions and even GAMBLING "addiction" as a "medical" bankrupcy. The actual percentage of people who are forced into bankrupcy by the sort of catastrophic illness you imply is much lower than 50%.

Oh, its less than half you say? Well then screw them, their plight only matters if they command a potential political majority...

MBNA should certainly be allowed to loan thousands of dollars to drug addicts and gamblers with no risk of unpunished default. Who could imagine a more reasonable business practice than that! They are drug addicts! Who cares if they are loan-slaves!?!

One year after my bankruptcy discharge, I continue to get mailings saying that I am "preapproved" for low APR credit cards at a rate of 4 per week. To be fair, before my discharge I was getting 8 or more per week. Good to see them showing some restraint.

The posting on bankruptcy is the first thing I have completely disagreed with here. Making bankruptcy more painful will result in more income for banks (there's a group that's hard up for money) and decreased health care quality in an already health-care poor country. Lowering interest rates a percent will be good for homeowners and won't matter for credit cards. Another example of making the rich richer and the poor poorer, and it's pathetic you guys would stand up for this and apologize for it.

Robert Schwartz,

I agree with you that courts should be doing much less micro-managing, but I really think it's a poor example to illustrate that point. I do not think someone has a right to borrow $100k and then take a job which he enjoys but which cannot even begin to pay back his debts. The man was very clearly under-employed. As RWS said, even teaching music at a public school would be more reasonable. I am not saying he couldn't have a portion of his debt discharged if he was approaching something close to full-employment. But I see no reason to subsidize his lifestyle. I agree that saying someone can make $60k instead of $50k they currently make would be unacceptable micromanagement, and something which many judges might do. But your example is just a poor illustration of that principle, because the individual is so very clearly under-employed.

First, we can all agree that there are abuses of the bankruptcy system. The question is how to minimize those abuses while not penalizing those who do not seek to abuse the system. Perhaps I am wrong, but I think this reform goes too far and penalizes too many Americans who do not seek to abuse bankruptcy protection. As I said before, if the number of filers effected is around 20% or lower (one estimate I encountered), then I think this reform is probably pretty solid.

Why should you get to condemn him? Why should we feel sorry for the bank that chose to lend him money?

You shouldn't. Since it's a student loan, you should feel sorry for the taxpayers guaranteeing that loan.

Like with everything else, you want to roll out a bad actor who scammed the system and escaped their debts with their "wealthy lifestyle" intact. Nevermind that HALF of bankruptcies are triggered by high medical expenses.

First, that statistic has been thoroughly debunked. The Harvard study did not find that half of bankruptcies were "triggered by" medical expenses, but rather that half of those who filed had medical expenses -- and the threshold was not "high" at all, but rather as little as $1,000 over the two years before filed.

Second, even if that statistic were valid, what would it have to do with these particular changes to the bankruptcy laws? At most, it can be cited to mean that half of bankruptcies are "legitimate" and not abusive of the system -- but how does that mean that some changes to stop the abuses that do occur are not appropriate?

Third, for the record, I didn't roll out that person; someone was actually trying to use him as an argument against these proposed reforms.

Bankruptcy encourages people who don't already have wealth to invest in their future, by providing them with an escape route if a reversal that is not their fault occurs.

But the particular person cited did not experience "a reversal that is not their fault." He experienced a logical and foreseeable and likely consequence of his decisions. He borrowed a lot of money and chose to go into a very low-paying field. We want to encourage people to invest -- but in good investments, not lottery tickets.

So tell me all about how irresponsible I am and how I never should have leased a BMW on a $100K per year salary.

I don't know about that, but something about the scenario doesn't make sense to me. You say you paid $25K out of your $100K income in interest on your credit cards the year before you filed. Presumably if you had just made $100K, the unexpected layoff came subsequent to that point. That means you ran up approximately $100K in credit card debts on a $100K salary, which doesn't sound all that reasonable. Unless you've left something out or I'm misunderstanding the timeline.

MBNA should certainly be allowed to loan thousands of dollars to drug addicts and gamblers with no risk of unpunished default. Who could imagine a more reasonable business practice than that! They are drug addicts! Who cares if they are loan-slaves!?!

I don't think MBNA has any way to reliably determine whether someone is going to be a drug addict or gambler.

More generally, the anti-reform argument seems to be that credit card companies are at "fault" because they lend money to people who are too high of a risk, and that the solution is for them to make credit harder to acquire. But this argument is made by people who are claiming concern for the poor.

But it's not clear to me how it's a benefit to the poor to deny them access to credit.

If people are borrowing money for legitimate reasons (such as unexpected medical expenses), then cutting them off isn't going to help them. If they're irresponsibly borrowing money (such as to live an overly lavish lifestyle) then why should we feel sorry for them?

Can someone explain the rationale (not the legality) for applying the new standards to outstanding debt? It seems that creditors would have taken into account the risk of Chapter 7, thus charging higher interest rates and penalties. Now the bargained risk between creditor and debtor is fundamentally altered in favor of creditors, leaving a windfall to creditors for something they did not bargain for. There seems no rationale economic reason for this unless I am missing something.

While I have little pity for people living beyond their means, there should be some fear of the fine-print language that creditors toss in that allows for hidden penalties and increased interest rates. Before the creditors had some fear of driving these up so far that debtors would file for Chapter 7. Now, there seems little cause for restraint in these changes that drive up interest rates.

Also, can anyone explain to me why these free market principles do not apply to corporate limited liability? I am having a hard time thinking of a libertarian justification for such protection. A corporation can be protected for injuries it causes in an accident, but the injured individual needs to have some extra money in his back pocket?

I'm no expert on bankruptcy law, so just a couple of little comments/questions.

First, most of the criticisms of thew new bankruptcy act are not criticisms of its specific provisions per se. Rather, the general theme is that it is UNBALANCED -- that it cracks down on the little guys while leaving all kinds of loopholes for "fat cats." For instance, it leaves in place the huge homestead exemptions that allow people in some states to escape their debts while keeping multi-million dollar mansions. Where is the good in that? Why not crack down on everyone who defaults on debts -- allow them to keep a small home (so they have a place to live), but force them to sell the mansion to pay their creditors?

Second, how many bankruptcies would be avoided if there were (a) universal health insurance and (b) no-fault divorce laws? I would guess a lot, since medical emergencies and divorce are the two leading causes of personal bankruptcy.

Schwartz and Palooka:

I think the key in evaluating whether the lawyer and the cellist got snowballed is the effect of those decisions. As I understand, the adverse decision only meant that they were not eligible for more generous Chapter 7 relief, which would discharge the debts. They remained fully eligible for Chapter 13 relief, which allows them to put together a workable payment schedule.

The court is not micromanaging their lives by ordering them to get a better job! That would be a 13th Amendment violation. It's just a Chapter 7 eligibility determination.

I agree that the homestead exemption needs to be tightened up significantly. There ought to be a formula that the court uses to determine if the homestead is overvalued, though an exception if the homestead is part of a business venture to help repay the debt, such as a farm.

Another story in bankruptcy--and I think these guys do get screwed--is tort creditors. I know a physician who delivered a baby for free to an immigrant, and the baby had complications, so some plaintiff lawyer picked up the case and sued him for $20 million. If the judgment exceeds his $3 million liability insurance coverage (and I am in John Edwards's state...), he will lose everything, and all his wages are garnished save a little trickle to live on for the rest of his life.

His solution: his money is now in a Swiss bank account, and he has a job lined up in the Dominican Republic should there be an enormous tort liability incurred. Hey, gotta do what you gotta do.

a few comments (I've commented on the bill in general repeatedly over and over again on my own blog, so I won't go into it in great length here)

1. This bill injures even consumers who do NOT file bankruptcy, by impairing their negotiating position with creditors. This is an absolutely critical point, and one which everyone ignores because the people who are driving this debate have no experience either as an advocate for or as an actual person in debt. As a former legal aid lawyer, I know this well: one of the most effective tools in the armory of a person who has fallen behind in their payments, who is in default, but who wants to catch up, is the threat of bankruptcy. "Make a fair deal with me, or I file chapter 7" has probably lead to more default workout payment plans than anything.

2. Financial prudence is a luxury of the wealthy. Some of the statements in Judge Posner's post are just horrifyingly arrogant: "If one is already borrowed to the hilt, an unexpected medical expense may indeed force one over the edge. But knowing that medical expenses are a risk in our society, prudent people avoid loading themselves to the hilt with nonmedical debt." Judge Posner, have you ever been in a situation where your cost of living was more than your income? Have you ever been temporarily unemployed, living off unemployment, and then savings, and then credit cards, and hoping you can find a job soon?

For that matter, when you were a freshman in college -- and presumably clueless like all freshmen in college, were there credit card companies with booths all over campus giving out t-shirts and beer coolers to get you to sign up for credit cards? Have you ever gotten a credit card bill at the end of the month and were shocked to find out how much you spent, because it didn't feel like real money when you were spending it, because there's a deliberate disconnection created between the purchasing and the pain of spending, thus removing the psychological disincentive to pay?

Of course not. I rather suspect that you've experienced none of those things, because you've been a federal judge (what's the appeals court salary now? something in the 150k range as I recall) for many years, and you're a professor, and you are financially sophisticated, highly intelligent, and well-off, and probably have been so for your entire adult life. (At least for the last few decades.)

I've represented victims of predatory lending. I've represented tenants facing eviction and people on social security disability with their water cut off for failing to pay eight dollars of a disputed bill. I've even had periods of (relatively minor) financial trouble myself. And I know: "financial prudence" is a joke when you're poor. "Financial prudence" is becoming a joke when you're middle class, as the credit card companies get so many people in college etc.

3. And lets talk about the credit card companies. First of all, is there any empirical support whatsoever for the proposition that they will lower interest rates if this bill passes? None whatsoever. You may respond with a stack of economic theory as long as your arm, suggesting that in a competitive marketplace interest rates will have to go down to some marginal level actually accounting for risk. However, that theory would be belied by the empirical evidence we have right now, which is that credit card company profits have been skyrocketing. In a competitive marketplace, under traditional economic theory, profits should themselves be reduced to some marginal level as sellers undercut each other. When an industry logs record profits -- especially when that industry is the credit card business and the record profits come at the same time as record bankruptcies -- that's a sign that the marketplace isn't following traditional competition theory. (See, us non-economists have this thing called "evidence" that we sometimes use to make inferences about reality.)

Second, lets face it, the credit card companies bought this bill. Wells Fargo was Grassley's biggest contributor in the last couple of elections, why is this? Wells Fargo isn't exactly a major force in Iowa, far as I know. No, it's so they could buy themselves a law. They did. Supporting a bill that is propped up by such blatant corruption is more harmful to our democracy than bankruptcy is to the economy.

Third, how about abusive practices as to consumers as well as to the democracy? The fact that the credit card companies DELIBERATELY TARGET THE FINANCIALLY UNSOPHISTICATED -- as can be seen most dramatically by setting foot on most any college campus (especially large state universities) about the start of the academic year, when they sucker college freshmen into signing up for these cards, on no income or credit history, and get them mired in debt right from the start -- gives them no claim to any moral high ground. These are predatory lending practices -- and this is before we even get into predatory mortgage loans, payday loans, etc. Any industry that deliberately targets the unsophisticated and inexperienced for deals that they don't have an understanding of should be punished, not supported with legislation.

4. Do you think this is good for the economy? Again, given record credit card profits, there's no question that current loose lending practices are good for the credit card companies, so there's to be no suggestion that diverting more money their way will be helpful, but how about the other end of the equation?
- Will this discourage new small business formation and entrepreneurship? I say yes, since many people form small businesses on personal debt and do so in the hopes it will turn a profit. If that personal debt is functionally non-dischargeable, this will unjustifiably increase the risk of this behavior.
- Will this injure growth in other ways too? I say yes, since it will shift more consumer spending away from productive savings and investment and toward totally unproductive interest payments on past consumption. (Lets remember that many people who file bankrutpcy have already, in interest payments, repaid the entire principal amount many times over.)

For these, as well as many other reasons, this bankruptcy bill is evil.

By the way, Judge Posner: this commentator has an idea for dealing with the problem of income loss which you might identify with.

[i]Will this discourage new small business formation and entrepreneurship? I say yes, since many people form small businesses on personal debt and do so in the hopes it will turn a profit. If that personal debt is functionally non-dischargeable, this will unjustifiably increase the risk of this behavior.
- Will this injure growth in other ways too? I say yes, since it will shift more consumer spending away from productive savings and investment and toward totally unproductive interest payments on past consumption. (Lets remember that many people who file bankrutpcy have already, in interest payments, repaid the entire principal amount many times over.) [/i]

The first point is important, and it merits responding to. I think there is a good argument that there is an inefficiently high level of innovation and new business ventures in this country. As another anecdote, my uncle recently started a big new business that everyone knew had hardly a prayer of working. Yes, it was cool and it was his baby, but it was inefficient and doomed from the start. It would have been better had he not done so. Both bankruptcy and corporate shield protection from creditors foster more innovation than needs to take place in this country. Maybe it is better to take a job with a stable, large company and work oneself up the ladder and get the benefits it pays than to throw hail maries.

As for savings versus investment: By raising the cost of inefficient consumption, less of that will occur. As for college kids, there needs to be responsibility on their part, and the parents need to raise them to be more financially responsible. If they fail in this basic duty, then they will have to run to Chapter 13 and use their college degree to pay off whatever small line of credit they got incrementally. If they borrow more than they can afford to pay off, then the credit card company gets screwed--so it has an obvious incentive to limit the amount of credit it extends.

The problem is not corporations violating people's liberty but an incredible amount of irresponsibility. No one is holding themselves out as being without sin... but that fact should not be overlooked.

RWS: two quick notes.

1. College students are irresponsible. It's part of the package. They've just left home, they're young, they're new adults, they're inexperienced... yes, it would be better if parents would take more responsibilty for educating them, but the fact that they're outright targeted for their known cluelessness means that the moral calculus falls in favor of the kids. I think of it as a scales of justice thing: on one end, we have deliberate exploitation. On the other, we have stupid bad decisions. If I have a choice as to which actor to punish, I choose to punish the corporation that deliberately exploited the clueless college kid rather than the irresponsible college kid.

And the credit card company does not get screwed if they borrow more than they can afford to pay off. Obviously, the credit card company does not get screwed in this situation, because the credit card company goes out and solicits them. The CC companies are unquestionably rational economic actors who wouldn't give credit to people with no assets or income history unless they felt they could squeeze out more in interest and fees than they'd ever lose even if the borrower defaults after paying for a few years.

2. I agree that there's irresponsible use of credit cards and such out there, but even assuming it's a significant factor compared to simple misfortune (cf. again the Harvard study), there's a psychological aspect to this that's inherent in credit cards. As I said originally, the use of a credit card for a transaction creates a disconnection between the pleasure of the purchase and the pain of the expenditure like nothing else. Ordinary debt doesn't do this: when you buy a car, you sign a piece of paper saying exactly how much you're paying a month, and you experience the pain. The same can be said for every conventional loan. Credit cards, though... credit cards... it's really easy to get over your head with credit cards because they run up on a multiplicity of small purchases, and the aggregate impact of those purchases isn't realized by most people until they're made. Shoes today, a couple drinks tomorrow, a few videotapes the next day... and then at the end of the month, whammo, an extra grand on the credit card.

The incentive system is broken when the experience of the cost is completely separated from the experience of the gain.

As long as we're declaring a bill "evil" because of the financial backers of the bill's supporters, let's look at who supports the opposition. Trial lawyers. Most likely bankruptcy lawyers. Do they have a stake in this bill? Of course they do... after it passes, attorney fees will be be replaced by child support/alimony as the first debts to be repaid from a debtor's assets.

You'll have to attack the bill on its merits instead of merely pointing out who will benefit.

Who will and who will not benefit are "the merits."

We can and should decide, as a society, that we do not want to pass laws that provide more wealth to hyper-profitable credit card companies whose wealth is already earned contrary to our social values (as detailed above re: targeting the unsophisticated). We can and should decide that this subsidy should not come at the expense of people who have fallen on misfortune. These are perfectly legitimate policy positions. It is bad policy to subsidize bad people. How is it other than "on the merits" to attack the bill on this basis?

I think Paul Gowder makes a number of excellent points. Perhaps the advocates of this bill could explain how subjecting existing debts to the new law is reasonable, or why there is little in it to impose stricter sanctions on wealthy bankrupts.

Indeed, as for the lowering of interest rates, this is a fine theoretical argument, but I prefer to wait for actual evidence before I accept that there will be a meaningful benefit of this type.

The purpose of this bill is to discourage abuse of the banruptcy program and encourage responsible use of credit. I support both of these goals. Yes, the credit card companies are sure to profit from these objectives, but that doesn't make them any less worthy.

Another thing to remember is that credit cards and banks aren't the only creditors out there.

1. There is already adequate protection against abuse in the system. Bankruptcy judges have immense discretion to dismiss a chapter 7 case or convert it to chapter 13 if "substantial abuse" is found. For example: this guy's bankruptcy will go kaput quicker than you can say "substantial abuse." Under current law. Current law is adequate to deal with these problems. Likewise, the lawyer and cellist examples cited above, the judges had the discretion under CURRENT LAW to prevent the supposed "abuse" (although I personally sympathize with the cellist).

2. Responsible use of credit: should the burden be placed on the sophisticated or the unsophisticated to police use of credit? Should the burden be placed on those who write and understand the fine print, or those who can't understand it? It's insane to talk about "responsible use of credit" when you've got multinational corporations with armies of lawyers, financial analysts, etc. on one side and high-school dropout laborers on the other.

3. The credit card companies are the driving force behind this bill (check out those MBNA donations), as well as the main beneficiaries, since they're the only truly major lending category that doesn't take security.

Paul,

Regardless of the merits of your statements, virtually none of them apply to this bill. Again, opponents are acting as if it eliminates bankruptcy filing. Not only doesn't it do that, but it doesn't even eliminate Chapter 7. All it does is subject it to a means test.

Your legal aid clients, your unemployed people whose cost of living is higher than their incomes, your tenants facing eviction, your people on social security disability, NONE OF THEM ARE AFFECTED BY THIS. Those people are not going to pass the means test.

As for college students, cry me a river. Anybody so unsophisticated that he or she doesn't know how to add up his or her purchases and doesn't know that he or she has to pay them back doesn't belong in college.

I'll give a pass to Amish people. Everyone else has watched a million hours of television growing up and has grown up around adults using credit cards. These people may be irresponsible -- which is kind of the point -- but they are not unsophisticated.

"let's look at who supports the opposition. Trial lawyers. Most likely bankruptcy lawyers. Do they have a stake in this bill? Of course they do... after it passes, attorney fees will be be replaced by child support/alimony as the first debts to be repaid from a debtor's assets."

This is a delusion. Your point that the merits of the bill itself is what's important and not who backs it is a valid one. However, the "trial lawyers" boogey man is not applicable here. Perhaps lawyers are more likely to work closely with bankruptcy code and therefore more likely to form strong opinions about this bill one way or the other. But there is no cognizable reason why lawyers -- especially litigators -- should have a special interest at stake here one way or the other.

An aside -- "trial lawyers" as a whole does not constitute an interest group. Litigators fall under two general groups: plaintiff's attorneys and attorneys that represent large corporations. Those two groups don't really share many common interests. What I just wrote is probably still a gross generalization -- between the various practice groups there aren't that many shared interests either.

It is as though you are asserting a vast conspiracy among all "vice presidents" no matter what they are vice presidents of -- public corporations, private businesses, not-for-profits.

From what I've read, the lawyers who are most vocally opposed to the bill are bankruptcy professors. That should perhaps give us pause.

the means test comes in two parts: a test to see if the debtor is over the median, and, if so, a test to see if there's surplus income. Both are overbroad.

1. The median is not enough. For one thing, increasing economic pressures mean that someone above the median income can still have a heavy debt load.

Second, as the U.S. trustee discussed back re: the 1999 version, the median income figures used are unrealistic. As I read it, the bills use the STATEWIDE median income (see (7)(A) of the amendments to sec. 707 in s.256), despite vast variations in cost of living within a state. So someone in New York City whose income barely makes rent will be tested against the median income of an area that includes upstate New York, where the cost of living is dramatically lower.

2. The surplus income test is absurd. It maxes out, no matter how high one's unsecured debt, at about $170/month. So if you happen to have income over expenses over that amount -- even if you have 50k, 100k of unsecured debt -- right into chapter 13 for you. And the failure rate of chapter 13 plans is very high. (See at least one scholarly article which notes that "most" chapter 13 plans fail). So this functionally means chapter 7 debtors with large unsecured debt will now go into chapter 13 plans, get their credit further ruined, get their income drained for years, then fail to get a discharge.

Plus the standards for finding a surplus are unrealistic. see this example of IRS collection standards

also see Local Loan Co v. Hunt, 292 U.S. 234 (1934) on the evils of removing future wage-earning capacity.

And read this report starting on pg. 13-17 for more about "irresponsibility" and what's really causing increased debt.

And David, are you telling me that 18 year olds who just left home SHOULD be using credit cards willy-nilly? And are you telling me that you've never been surprised by the credit card bill at the end of the month? I'm talking reality here, about how people actually behave and think and experience the world, and how they get trapped by it. I'd suggest the system should be a little merciful for young, inexperienced people with ordinary and common failings.

Others have tried to stave off problems before they occur. Sen. Chris Dodd (D-Conn.) has twice authored legislation in the Senate (including an amendment to bankruptcy reform legislation) that would mandate that credit card issuers granting credit to those 21 and under would have to require the person have verifiable means of income, a co-signer and/or proof of attending a financial literacy course. For Dodd, these are "very simple, common-sense suggestions," which he says were vehemently opposed by the industry.

"The problem is that credit card companies want to have it both ways," says Dodd. "On one hand, they want unfettered access to new customers, irrespective of whether these new customers are financially literate, or have the ability to repay the debts they incur. At the same time, they want to be protected when they overextend credit to these very same customers."

http://www.pbs.org/wgbh/pages/frontline/shows/credit/eight/responsibility.html

And what's the justification for that? Those are entirely reasonable measures, but the credit card companies don't want to give up their collegiate money pot. They FEED off the same "irresponsibility" they're now decrying. They're talking out of both sides of their mouths. It's massive stinking hypocrisy to encourage irresponsibility, to take massive profitable advantage of it, to fight bills to reduce it, and then to turn around and cry "oooh, people are so irresponsible, Congress, oh Congress, please stop the bad mean irresponsible college students!"

And David, are you telling me that 18 year olds who just left home SHOULD be using credit cards willy-nilly?

No; that's why I described the people who were doing so as "irresponsible."

And are you telling me that you've never been surprised by the credit card bill at the end of the month?

Yes, I am.

I know what I routinely buy (i.e., gas, groceries, etc.) and how much it costs; I know how much surplus I have available, and I know what extras I buy. I don't understand where the surprise would come in.

(As long as I'm playing the role of cold-hearted jerk, let me add that "divorce" does not belong in the same category as "health problems." While the latter are typically involuntary, the former is often voluntary. Of course, some divorces are the result of abuse, yada yada yada. But many others are simply a matter of personal choice -- often by people who really can't afford it.)

I agree that the Dodd amendment makes sense. I think the increased transactions costs do not raise interest rates by more than the public policy interest in slowing down the hyperenthusiasm of some young folks for easy money. If they do one of those three things and then still get themselves into hock, then they can deal with a Chaper 13 plan, which is still a nice safe haven, and one much preferable to just letting someone discharge all their debt at the expense of others in their income class who are using credit cards.

There is also a certain amount of shame that some college kids (and grad students) feel when their expenses total more than the allowance their parents give them, or if they run over from student loans. Credit card companies also feed on that shame. Though in the long run, even running up whatever small line of credit they get, say $5000 or less, is totally reasonable for a Chapter 13 reorganization. I think that the Dodd Amendment is a fair antidote to that problem.

R: Natch. I was only using that argument in response to Paul's tirade against the evil Credit Card Companies. My point was that you can't simply point out who gives campaign contributions to certain senators and therefore declare that a particular bill is "evil."

Fair enough. It is still useful to point out I think that "trial lawyers" is not a cohesive interest group in the way that credit card companies are. But alleging that a piece of legislation is a pure interest group grab is probably only persuasive after demonstrating that the legislation at issue doesn't have any other rationale, or at least that the stated rationale is weak, and looks to be a pretext. Anyway, there's no way to avoid interest group grabs -- interest groups exist on all sides of most issues -- and it makes more sense to talk about what's good policy.

I tend to think the bankruptcy bill is bad policy. Credit companies are fully capable of assessing the chapter 11 risk of a given customer and calculating that risk into the customer's interest rate. The argument goes: reducing the availability will lower interest rates for at-risk borrowers (though not as much for low-risk customers). That means they will borrow more. Is it good policy for those likely to default to borrow more? I think, probably not.

Personal responsibility, though nice, doesn't seem to cut in either direction for me. Changing the bankruptcy law isn't going to make irresponsible people responsible. But it may increase their access to credit. Good idea?

Daniel: imagine this hypothetical:

I bribe Congress to pass a bill raising the tax of every American by one dollar and giving that to me. Assume there is a valid economic argument in support of this bill: perhaps I agree to use half of the money gained by this law in order to provide some public service which otherwise would not be provided due to collective action problems, and I provide this service at lower cost than if a federal bureaucracy did so.

Would this still be a bad bill to pass? Would you demand your representatives vote against it?

Yes! Of course! Because -- even if it were arguably good policy in the absence of the bribery (and there are arguments on both sides), it's bad for society to permit legislation to be purchased! It reduces the legitimacy of the system and weakens the democratic process.

Just so here, except that there's also much stronger arguments against the bill even in the absence of the corrupt method by which it was procured.

You're not arguing against the bankruptcy reform act; you're arguing in favor of campaign finance reform. Let's change the hypothetical... let's say a nonprofit organization such as the Sierra Club "bribes" senators to vote in favor of stricter clean air standards or to ban drilling in the ANWR. Would you be against that?

Your hypothetical is faulty because you "assume" a valid economic argument while phrasing the actual bill as something completely nonsensical.

Paul --

I disagree with you on this. We outsource performance of public goods to private actors all the time. Those private actors, if large enougn, make campaign contributions. Your scenario isn't much (or any) different from paying a private construction firm to work on the F.D.R. memorial (or Reagan Library).

Focus on the policy. The sure sign of corruption is where goods are paid out to private actors for no good reason at all.

Put another way -- the fact that you are using the dollar to perform a public good is a sure sign that the fact it was paid to you was not a direct result of your contribution, but instead, was at least motivated in part by the fact that you would use it for that purpose. Otherwise, being a selfish government-briber, you would pocket it. Make sense?

'"If bankruptcy is more costly, there will be less of it."

If lending credit is more costly, there will be less of it.'

John Smith hits the nail on the head. Who benefits from 'easy credit' and who suffers? Even if the 'responsible' consumers who use only cash or who pay off their credit card balances every month are not paying interest expenses, they are still paying more for their goods and services because 'easy credit' acts as a price support across the economy.

Maybe my hypo was a bit contrived, but it doesn't have much work to do. The only point is that a bill which is procured in a fashion strongly suggesting reciprocal payoffs to and by monied interests thereby earns a major strike against it. This isn't
in isolation: I, and others, have advanced dozens of hard policy arguments against this thing.

However, surely the fact that the bill directly benefits the MASSIVE campaign contributors of the people who support it is one of many fair factors to consider. Go to opensecrets.org & check out Biden's kitty, for example. MBNA gave twice as much as the #2 contributor, IIRC, since 1989. Seriously.

As I alluded to before, the political contribution problem is an issue because it heightens the bargaining disparity between individuals and mega-corporations.

It is practically impossible for an individual to bargain with MBNA, as Paul pointed out just about the only leverage an individual could bring to bear was the threat of Chapter 7. This was exactly my experience as I tried to negotiate with my creditor to lower their 30% rates while I looked for another job (each of the 3 times I was laid off without cause last decade.)

Added to that is the collective action problem that individuals have when trying to influence congress. The transaction costs of 300 million people getting together to present one agenda
to congress are prohibitively high. If we allow 4 or 5 multinational banks to buy an audience for their agenda, we are allowing only one side access to Congress.

In this situation, there is a strong need for positive regulation in favor of the side with the massive collective action problem. Otherwise the playing field on which the parties are meant to contract freely is structurally unfair and not at all free. It is absurd and heartless to further tip the balance in favor of the multinational banks here.

A bankruptcy law that forces individuals to drop below the poverty line before they qualify for discharge is NOT a bankruptcy law. The whole point of discharge is to leave people in a position from which they can recover.

If you live in a city and have a credit card, you are above the state median income. Furthermore, your home is worth more than the $125K limit this new law enacts on the homestead exception. This new law compells people who live in cities to sell their house and move to a rural area in order to meet the means test. Of course they will resist this, so in reality this law prohibits Chapter 7 for at least 150 million people. As Paul demonstrates, almost NO ONE meets the means test.

Once interest rates go to 30%, it is NOT possible to pay back principal. You are locked in to a situation where every dollar above expenses goes straight to interest. It feels and looks like slavery.

This country has seen too much prosperity for too long. Policymakers have forgotten the lessons of history about the evil end results of lassiez faire ideology. The People do not long tolerate the top 1% owning 45% of the welath. To the extent that this Congress is setting the stage for populist uprisings and revolutions, I suppose in a way I can be happy about what it is doing.

The Workers have nothing to lose but their chains!

f you live in a city and have a credit card, you are above the state median income.

There is no basis for this statement.

Furthermore, your home is worth more than the $125K limit this new law enacts on the homestead exception.

No. The $125K limit is on equity, not "worth" of the home.

As Paul demonstrates, almost NO ONE meets the means test.

Paul provided some useful information relevant to this discussion. However, he in no way "demonstrates" anything of the kind. By definition, half of households can meet the means test.

I meet that means test.

Judge Posner says: "The Act will not redistribute wealth from the poor to the rich, but from the imprudent borrower to the prudent borrower."
And his story about how this happens makes a lot of sense, with the key assumption being that the credit card industry must be a competitive market, which to the uninformed it certainly seems to be, as there are many, many market players and the key terms of the deal (e.g., the interest rate, the annual fee, the membership perks) are easily understood by and reported to consumers.

But if this is so, why are credit card companies pressing so mightily for this bill? They've spent huge sums lobbying Congress to get this bankruptcy reform bill passed. Why do we think this is so, if the Act's only effect will be the redistribute money between groups of borrowers rather than from borrowers to credit card companies?

Paul Gowder:

Your contention that MBNA et al. will benefit is probably correct. That is because it lowers the cost of issuing credit, which benefits both the buyer and the seller of the commodity. The buyer benefits from a marginally lower price, and the buyer who pays off the debt and uses it wisely benefits more, because the wealth is shifted from the imprudent person to the prudent person and all the prudent people who work for MBNA, because they stayed in school and worked hard to get a good job.

---

On second thought regarding the Dodd amendment that requires cosignors and such for 18-21 year old card applicants, I think that is an issue better left to the laboratories of the states through state law regulation, not a one-size-fits-all federal regulation that may or may not be effective or well tailored to a state's regulatory scheme. That is a conduct and contract regulation that is more appropriately left to the states.

Very quick at-work note: as I said above, the idea that the cost of borrowing will be lowered for borrowers with this bill presumes a functioning competitive market, but that presumption has been refuted by empirical evidence of steadily rising credit card company profits. In a competitive market, profits should be steadily reduced to a marginal point just above cost as a result of sellers undercutting each other, per basic economic theory. Since that hasn't been happening, we can infer that the market is not competitive, and thus that there's no reason to believe that cost savings for cc companies will be passed to borrowers.

On the Dodd amendment: I'm not completely sure, but I believe that there's a serious question as to whether states COULD enact such laws under current law, or whether they'd be preempted in much the same way that state usury law is now considered to be preempted as to credit card companies. I'd have to do some more research (which I don't have time to do right now, alas), but I strongly suspect that such state laws would at least have a strong possiblity of being preempted by federal banking law. So any law such as the Dodd amendment might have to be enacted, or at least explicitly allowed to the states, by Congress.

I did not know that usury laws are preempted. I suspect a state Dodd-like law would probably have some preemption trouble, then. The reform law should provide an out for states to try out such laws, in that case.

This article disputes the idea that the credit card market is not competitive: all of the perks and goodies the companies give (which offset high interest rates on the backside) are being cut back in an increasingly competitive market:

http://www.findarticles.com/p/articles/mi_qn4158/is_200502/ai_n9499460

Regardless, I have a very hard time believing there is some sort of market failure here. It is very inexpensive to enter the credit card market for a financial institution, and clearly they don't have much problem soliciting business, as we all get tons of mail solicitations. Any profits are likely to be temporary as companies respond to the market price pressures.

not sure on this, but here is a story for how the credit card companies will benefit from the bill, and a suggestion that the way in which they will benefit makes for bad policy:

Because the costs of default are lower for creditors, the risk of loaning to high-risk borrowers is lower; therefore credit card companies can offer credit to more high-risk borrowers, and perhaps lower rates while maintaining or even increasing profit margins. Because more high-risk individuals will borrow at the same (or possibly higher) margins, more money.

There is no reason to think that market place competition will eliminate this advantage. There will simply be more customers available to all of the credit companies. The risks will have shifted such that all of the market players can make more money by loaning to individuals who otherwise would constitute too risky an investment.

Here is why it is bad: a good number of those new customers will default. Therefore, there will an increase in bankruptcies. The costs of the defaults will be lower for the credit card companies, because Chapter 7 will be less available. Those costs have been shifted to the borrowers themselves, and to a lesser extent, to all of us. Poor people, encumbered by debt, are a burden to everyone. Most of us aren't willing to shirk that burden. To the extent that they qualify for government programs, the newly bankrupt will rely on those programs. To the extent that they don't qualify, or for whatever reason don't take advantage, we will all have more poor people to worry about.

To acknowledge that this bill is a bad idea, you do not have to acknowlege that often people make bad choices for understandable reasons (though for the sake of your humanity, you should anyway). You just have to concede that more bankruptcies (even though caused by irresponsible behavoir) is not a desirable outcome.

RWS: the link you posted doesn't work, but I question the thesis as you described it. Doesn't the cutting back of perks imply less competition? If there was increasing competition between cc companies for customers, the cc companies would have to increase perks to effectively compete, non?

Try this:

http://www.findarticles.com/p/articles/mi_qn4158/is_200502/ai_n9499460

"0" was missing.

I think the point of the article is that the CCCs are actually making less than a normal return right now and are cutting back perks to boost profitability. If they were making excess profits, the price would be falling due to competition. I just do not see any systemic market failure in the credit market that would rationally justify a departure from the laws of demand and supply. I suspect the opposite: financial markets are exceedingly competitive, especially these days in the United States.

The cut and paste won't stick the whole link onto the screen. Put a zero on the end of the above link to get it to work.

Throughout this entire discussion, I have not heard one word raised on the important questions of contract. Let alone a full analysis of the most important element known as "consideration". Perhaps, a look at these issues may give a better understanding of the bankruptcy issue overall. Both from the pro-reform side and the con-reform side.

RWS: that article still seems to be using a wholly different economics than I ever learned. Increasing competition between sellers (a.k.a. increased demand relative to supply) makes prices go down, not up.

That's pretty much rule 1 of microeconomics. More competitive for suppliers = more supply compared to demand = lower prices. Any thesis which contends the opposite has an uphill battle.

The removal of perks is equivalent to a raising of prices. (Although that article suggests that this withdrawing of perks is being done "to focus on competing on price," that assertion needs to be supported with actual price - interest rate reductions.)

Therefore, unless we're using a completely different, topsy-turvy twilight zone outer-space kind of economics, it can't have been caused by increased seller competition in the credit card market. In fact, it's most likely caused -- credit card company propaganda notwithstanding -- by DECREASED competition.

Businesses always justify customer-screwing measures in their press releases by "competitive pressures" despite the fact that basic economics dictates the opposite. It's just propaganda.

all of the perks and goodies the companies give (which offset high interest rates on the backside) are being cut back in an increasingly competitive market

Agree with Paul, again. If competition is supposed to lower prices, and it is, then how does increasing competition cause price increases? If you run a restaurant, and a new one opens nearby, increasing competition, do you lower the quality of your food in an effort to win back customers?

Similarly, those who argue that there will be a competition-driven lowering of rates because of this bill must explain why, if the benefit flows through to the consumer, the CC companies were so ardent in their support of it.

Perhaps the market here is not so competitive as is claimed.

Oh, BTW, I wish I'd gotten a nickel for every credit card application I've ever recieved. If I had, I would have been a millionaire by now. Least ways, the old nursery rhyme I was forced to learn, " A borrower or lender never be ..." has served me well- so far.

N.E. Hatfield: A borrower or lender never be ..." has served me well- so far.

I dunno. That means you can't allocate a portion of your portfolio into fixed-income investments.

BTW, here's that link that RWS was trying to paste. Glendinning's suggestion isn't that the market is getting more or less competitive, but that the credit-card companies are passing regulation's higher costs along to the consumers. Posner's argument is that the bankruptcy law lowers the cost of lending (by lowering the risk), which would also be passed to consumers in the form of lower interest rates.

I tend to side with Posner, but his argument of lower interest rates also applies to removing bankruptcy altogether, and I don't think anybody here is advocating that. So it all really hinges upon whether we're at the point where bankruptcy is too easy, and I'm not sure how we can measure that. But the new terms sound reasonable enough to me. If you can afford to file Chapter 13, you ought to do so.

Lowering the cost of capital will increase its use. This extension of additional credit may have the effect of increasing the number of bankruptcy filings (even if they result in higher payoffs to the credit issuers). So, even using Posner's analysis, the stated goals of the bankruptcy bill (to lower the number of people filing for bankruptcy) may be thwarted.

This is a bad bill. Not because it's a bad idea for people to pay more of their debts back, lowering the cost of capital, but because it was poorly written and conceived. Read any analysis of the legislation not written by the credit card industry or the bill's sponsors and you will see now nonsensical portions of it are.

There will be absolutely no reduction in interest rates because of the bankruptcy bill. In an industry where the "competitors" work together in defining a system whereby interest rates can jump by a huge amount on any or all of your credit cards because you were late with one payment to only one of the supposed competitors how can any claims of competitice pressures be taken seriously? The only competition is in the introductory offers and once you're in they all treat you the same. Any savings that the CC companies realize from this will go solely to the executives and shareholders. None of it will ever be seen by the customers.

I'd just like to report that my bankrupt, broke,
socialist, unemployed self just received 3 new credit card "pre-approvals" in the mail today.

Should I go for the pretty green Visa or the Mastercard with the picture of the Statue of Liberty on it? Both advertise a 0% introductory APR...

I Chapter 7 discharged $20K on MBNA just last year and now I am getting card applications again. I bet by now the credit card companies have collectively used up a 200 year old fir tree just by sending ME junk-mail.