As anyone who follows the world of bankruptcy knows, as of October 17, 2005, substantial and, from the point of view of consumers, painful changes were made to the Federal Bankruptcy Laws. At the behest, primarily, of the credit card providers and banks, who had been lobbying for years, new legislation was drafted and approved setting the stage for stricter requirements governing (primarily, though not exclusively) personal bankruptcy. This legislation came at great cost to its proponents, and it was expected that it would lead to fewer defaults and more repayment plans, all of which would redound to the benefit of the banks and credit card issuers.
While it is still too early to say, with any certainty, what the overall effect on defaults will be, it seems that, statistically, Chapter 7 filings are rising again, and the expected relative increase of Chapter 13 repayment plans may not, in fact, be materializing. Fewer debtors than one might expect have been disqualified from Chapter 7 relief by “means testing.”
In addition, at the same time that the new bankruptcy laws were taking effect, credit card issuers and banks were finding creative ways to avoid usury problems by domiciling themselves in creditor-friendly states, such as South Dakota, and default rates for consumers now exceed 30% in some cases. Defaults, for those consumers (virtually all of them, I daresay) who have not read the fine print in their credit card disclosures, may be caused not only by late payments, but by high debt to income ratios observed in periodic reviews by card issuers, and defaults under other credit card agreements. The consolidation of issuers, of course, means that there are only a few issuers out there now. Coupled with this have been changes to “minimum payment” rules, so that where a credit card holder carrying a balance might have been able to carry a $250 per month minimum payment, the combination of 30+% APR’s and higher minimum payment rules may have increased that to $600, or more.
Multiply that by the 5 or 6 cards that a consumer might be holding, and, well, one can easily see where this is going. But that same cardholder is now facing higher obstacles to Chapter 7 filings, simply by being, statistically, in the “middle class” and exceeding his or her state’s median income.
What will the result of this be? It’s hard to tell, but one likely scenario is higher defaults with no bankruptcy option. For those cardholders who own a home, with equity, Chapter 13 may not be a viable option because of the sheer amount of debt they are now carrying, relative to their incomes, so the risk of losing their homes may be substantially enhanced. If this happens on a large-scale basis, there will surely be an outcry to “reform” the “reform.” The credit card issuers and banks, having paid dearly for this legislation, may well have overplayed their hand.
Furthermore, those cardholder who can, have, in large numbers, been paying off their balances, outraged as they are by being socked with APR’s exceeding 30%. This has already hurt the bottom line of credit card issuers and their bank affiliates, who make nothing on cardholders who don’t carry a balance. The pot of gold for them is in cardholders carrying balances and paying high rates, and even better, those consumers paying late fees when they get in over their heads, or overlimit fees when, as in many cases, the suddenly increased interest rates take them unexpectedly over their limits. Late fees and overlimit fees are often now in the $40-$50 range.
The result? Less income for the creditors as consumers have wised up. MBNA and Capital One, two huge credit card providers, are seeing their profits sink. Other credit card providers are reporting similar results. Highly dependent on the consumer’s desire to run up debt, these companies are now seeing their profit margins drop sharply. In a nutshell: high consumer debt equals big profits; low consumer debt levels equals low profits.
During the last five to ten years, beginning in the halcyon days of the late 1990’s when, it seems, everyone was an internet or high tech millionaire on paper, Congress was amenable to bankruptcy reform to address real or perceived abuses. The banks had the will and the cash to finance legislation and, after years of almost getting there, finally crossed over into the “Promised Land” in 2005. By contrast, consumers, many of them unsophisticated, who had been given credit cards, with low “teaser” rates, just couldn’t resist the lure of easy credit, big screen TV’s.
Predictably, they acted irresponsibly. But while the lobbyists worked their magic for MBNA and Chase, the consumer had no lobby with which to oppose bankruptcy reform. I’m sure that for the most part, they had no clue as to what was in store for them. Those consumers in the lower economic strata still have no lobby, but they will still be eligible for Chapter 7 relief. The challenge for the banks is that the pain is moving up the ladder to the middle class homeowner. The howling is bound to be heard, and soon.
Copyright 2006 Warren R. Graham
Warren R. Graham is a New York attorney with the Firm of Cohen Tauber Spievack & Wagner LLP. He is a frequent writer on a variety of topics, including legal matters, political and religious affairs. His opinions are his own and do not necessarily reflect the views of his firm or its members. Additional information on him may be found at http://warrenrgraham.blogspot.com