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Warren Graham's Legal Blog: The American Consumer as Bankruptcy Roadkill
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Location: New York, New York, United States

I am a practicing lawyer who lives and works in Manhattan, and specializes in Bankruptcy, Corporate Restructuring and Creditors' Rights, Commercial Litigation and Real Estate Law. I grew up in the New York City Area, and am a graduate of the University at Buffalo (B.A. 1976) and Fordham University School of Law (J.D. 1980). I have a wide variety of interests, but am particularly interested in history, politics, economics/finance and religious affairs, and am a frequent writer on a variety of those topics, and others. On a personal note, I'm a 54 year old man, married for 27 years, with two daughters, ages 24 and 20, respectively. Legal topics of interest may be found on my blogsite, http://warrenrgrahamlegal.blogspot.com, while non-legal commentary may be found at http://warrenrgraham.blogspot.com. The content of these sites will be centralized and easily accessed locations for both legal and non-legal analysis and commentary, as well as a description of my legal practice for clients and potential clients. Keep checking back, as I expect the content to change and grow regularly.

Monday, November 17, 2008

The American Consumer as Bankruptcy Roadkill

In the midst of the recent around-the-clock, 365 day-a-year, 4-year presidential campaign cycle, it is nearly impossible to hear anything over the din of paid chatterers and candidates’ spinmeisters posing as news analysts. But recently, and finally, there has been some small and largely unnoticed public discussion about a subject which has flown below the radar screen for years, except, perhaps, among certain lawyers, judges and academics. I refer to the Federal Bankruptcy Code, as substantially rewritten and enacted in 2005.

This despicable piece of anti-consumer, anti-middle class legislation kicked around in Congress for a number of years. President Clinton, to his credit, pocket vetoed it several times. The law, which Congress was please to call, without embarrassment, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, or BAPCPA, was ultimately signed into law by President Bush. In a perfect world, and for the reasons discussed here, it should be a legitimate subject of public discourse in the current political and (especially) economic climate. But here’s the rub: both political parties are equally to blame for this outrage masquerading as “reform,” foisted upon an unsuspecting public and on the middle class, in particular.

BAPCPA is, first and foremost, a calculated attack by the credit card industry on consumers. It imposes a “means test” in order to qualify a debtor for bankruptcy relief and discharge of debt. If a debtor flunks the means test, he or she must file, under Chapter 13 for what can be a long-term, onerous debt repayment plan. The means test, which references, on a state-by-state basis, median income, ends up excluding nearly all but poor people (as we all know, the “middle class” ain’t what it used to be). There are numerous other obstacles, too technical and extensive for this treatment, to simple discharge in bankruptcy for the “average Joe.”

In the halcyon days of 2005, when everyone in America, it seemed, was a real estate mogul, gaining paper wealth from unprecedented appreciation of home values, the ever-increasing credit card debt load did not really pose a problem, except for the poor and assetless. After all, virtually anyone who owned a home could use it as a “piggy bank” to retire credit card debt periodically through serial refinancings, which was made unbelievably easy by lenders, mortgage brokers and charlatans. The charlatans, of course, cheated both the borrowers and the lenders, by arranging for no-verification loans for unreliable borrowers, to the ultimate detriment of lenders, while simultaneously building in adjustable variable rates or balloons, which set traps for the unwary homeowners, but which could be evaded by yet more serial refinancings. This system worked just fine, on the unsupportable and profoundly naive theory that home prices would continue to rise indefinitely.


We now see, of course, that home prices are, in fact, subject to the vagaries of the business cycle and, in our current case, the irresponsibility of the lending industry, the securities industry (subprime, anyone?), the Federal Reserve Board and yes, the borrowers themselves. As a result, the ballooning credit card debt can no longer be retired with the wave of a refinancing wand. Many consumers cannot make even the minimum payments on the large balances they are carrying on their credit cards, and their houses, in many cases, are not worth the debt they owe against them (especially in the case of owners who bought houses at the top of the market in the last year or two). Foreclosures, as we all know, are at record levels, with no end in sight.


Against this cheerful backdrop, we have a middle class, the perennial losers in nearly all economies in decline, now coming face to face with the cruel realities of BAPCPA. The prime political mover behind this “reform” was Senator Chuck Grassley, of Iowa. One might infer from this that Iowans, who have for years been chowing down on the plentiful pork that is federally subsidized, corn-based ethanol, have no need for bankruptcy relief. The ultimate prime mover, though, was the credit card industry; perhaps foreseeing an increase in default rates down the road, with the ever-ballooning national credit card balance. The legislation was accompanied by some other interesting developments, such as large increases in “overlimit” fees and late payment fees, which, in some cases, exceeded the total balance due on the credit cards. Overlimit fees, moreover, were actually triggered by accrual of interest on balances which were not even over the limit, but which, in and of themselves, took a balance over the limit; a real slap in the face to customers. Another outrage visited on these borrowers, made drunk on free and easy credit pushed on them by credit card companies, could be found in the exorbitantly high interest rates on balances. These rates could be increased, without notice, on the whim and caprice of the lender, even if the borrower had never missed or made a late payment, but simply on the basis of a periodic review of the borrower’s FICO score, or a missed or late payment on a different credit card. Particularly galling is the fact that the highest rates were imposed upon people increasingly most hard pressed to carry the balances. Citibank, in fact, took the unusual step of redomesticating itself to South Dakota, which overtly campaigned for big bank business by eschewing a usury limit. Citibank was thus able to assess against its most financially overextended customers, an interest rate of 32.99%, roughly equal to what one might expect to be offered by someone working the waterfront (except for the knee-breaking).

Unfortunately, and with this swollen credit Sword of Damocles hovering over the head of the American public, Congress allowed BAPCPA to become the law of land; allowed, I say, because Congress did not really write the legislation. It handed over its legislative pen to teams of lawyers working for the credit card industry. The price? Campaign contributions, of course. And the profound shame inherent in this falls equally on both Democrats and Republicans, in both houses, who passed the legislation with sweeping majorities. Chuck Schumer (inadvertently, one assumes), derailed BAPCPA for awhile, by tacking on a rider denying discharge to individuals who were liable for damages due to destruction of property of abortion clinics. This rider forced the conservative Republicans to abandon their support for the Bill. When that provision died in the next version of the Bill, and in the Senate/House reconciliation version, Schumer came around, and voted for BAPCPA. Joe Biden, a Democrat and that party’s current contender in the vice-presidential sweepstakes, presents an even more interesting case. Delaware has long been the home of big Chapter 11 Cases. It is a debtor-friendly jurisdiction, and large companies have traditionally been able to file there simply by virtue of Delaware’s being the state of their incorporation, whether or not that company has an office there, or has ever transacted business there. Of course, such “mega-cases” pay off handsomely for Wilmington, Delaware’s capital city and home to its Bankruptcy Court (an otherwise pretty poor and blighted city), as high-priced lawyers, accountants, and consultants come to town, stay at luxury hotels, patronize the better eateries, and are forced by a very protective local bar to engage local counsel for all court hearings. At the same time, Wilmington is the world capital of credit card companies, and therefore, an important constituency and contributor to Senator Biden’s political coffers. The original iteration of BAPCPA eliminated state of incorporation as a sole basis of venue for filing; in other words, a multibillion dollar Texas company, for example, which had no connection with Delaware other than on its certificate of incorporation (Delaware is a favorite choice for incorporation for reasons beyond the scope of this piece), would have to subject itself to Texas-style rough justice. This did not sit well with Senator Biden, who had vested interests, it seems, on both sides of the bankruptcy street, debtor and creditor. As a condition to his support of BAPCPA, Senator Biden insisted on the removal of the offending venue provision. As a result, Delaware remains the comfortable home for mega-case, complex Chapter 11’s; a sure source of delight to both Senator Biden and the Wilmington Chamber of Commerce.


Both Senator Schumer’s and Senator Biden’s stories are testament to that phrase famously uttered by that well-known wit, and craftsman of the bon-mot, Otto von Bismarck (huh??) to the effect that: “If you like laws and sausages, you should never see either one made.”

BAPCPA also made injurious changes to the business bankruptcy laws, which make reorganizations both more expensive and less likely to succeed. Nobody cared when this legislation was passed, as there were precious few business bankruptcies. Nobody cared about the anti-consumer provisions of BAPCPA either, when the middle class had no need for bankruptcy relief, and only the poor (who, alas, have no political lobby), were nearly the only constituency turning to the bankruptcy courts for help.

Now, our middle class is terribly and visibly squeezed, in a vise of falling home values and exploding debt. Its members will soon learn that bankruptcy may not be a viable course available to them for the discharge of obligations they can no longer meet. Do not feel sorry for the credit card companies; they brought this on themselves and upon their customers. In any case, the losses they will experience from increased defaults will be nicely cushioned by their unconscionably high interest rates and outlandish fees. Do not feel sorry for our politicians who will soon (and rightly) feel the backlash and outrage of their constituents for supporting a law that blocks any path to financial recovery. They have already been compensated for their efforts. By all means, do feel sorry for the overextended, honest working stiff, who has been suckered into the maw of rampant easy credit and gross consumerism. But do not expect this issue to make its way into the public consciousness until after the election, as neither party wants to bring it up. Nearly everyone, in both parties, has his or her dirty paw prints all over the “reform” that is BAPCPA.

Copyright 2008
Warren R. Graham

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