LEXIS-NEXIS® Congressional Universe-Document

LEXIS-NEXIS® Congressional

March 16, 1999, Tuesday

SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 1246 words

HEADLINE: TESTIMONY March 16, 1999 ERIC A. POSNER PROFESSOR UNIVERSITY OF CHICAGO HOUSE JUDICIARY COMMERCIAL AND ADMINISTRATIVE LAW BANKRUPTCY REVISION

BODY:
Statement of Eric A. Posner Professor of Law University of Chicago Some Historical Notes on the Consumer Bankruptcy Provisions of the Bankruptcy Code The current Bankruptcy Code was motivated in part by a report issued in 1973 by a Commission that had been created by Congress to evaluate American bankruptcy law. Of the reasons for bankruptcy reform listed in the report, two stand out to modem eyes. The first reason for reform was the rapid increase in the number of bankruptcies, which had gone from 10,196 in 1946, to 208,329 in 1967. 1 The second reason was that the fresh start was "insufficiently generous." You get no sense from the report that there is any contradiction in saying that both the rapid increase in bankruptcies and the insufficient generosity of the fresh start are problems. But it seems clear that if the fresh start is made more generous, more people will file for bankruptcy; and if you want fewer people to file for bankruptcy, then you have to make the fresh start less generous. The Commission's main recommendation with respect to consumer bankruptcy was to create a uniform system of federal exemptions, to replace the bankruptcy law's incorporation of state exemptions. It did not explain this recommendation in any detail, but it may have believed that incorporation of state exemptions was unfair to people who lived in states with miserly exemptions. (State exemptions, then as now, ranged from the extremely miserly to the extremely generous.) The amounts chosen for example, $5000 homestead - were also not explained. Subsequently, the House sought a more generous federal floor (for example, $10,000 homestead), while the Senate sought to retain incorporation of state exemptions. The final law contained an odd compromise - intermediate exemptions (for example, $7500 homestead) as a de facto floor in those states that did not opt out of the federal exemptions. After the Bankruptcy Code was enacted in 1978, the number of bankruptcy filings shot up, and has risen almost every year. In 1998, there was a new record: about 1.4 million. Almost all of the growth has been driven by the increase in consumer bankruptcy filings. Because of this, people have naturally assumed that the exemption rules and other consumer bankruptcy provisions of the Code are responsible for the increased filing rate. However, the effect of the enactment of the Bankruptcy Code on consumer bankruptcy filings is hard to gauge. There are some reasons for believing that the Code is the culprit. The federal exemptions created in 1978 were more generous than the exemptions in most states at that time, and so people in the less generous states could now do better by filing for bankruptcy. And although most states opted out of the federal system, many states increased the generosity of their own exemptions quite substantially over the 1980s and 1990s. As a result, some academics believe that the,Bankruptcy Code caused the increase in consumer bankruptcies. However, empirical studies have come to conflicting results, and analysis has been confounded by the occurrence of other events that probably had an influence on bankruptcy filings. Perhaps the most important was the de facto deregulation of state interest rate ceilings in 1978. 2 This, and related factors, enabled creditors to issue credit to higher- risk debtors than they had in the past, and these are the very debtors who are most likely to be unable to repay their debts. 1 Sources for statistics and arguments can be found, except where otherwise indicated, in Eric A. Posner, The Political Economy of the Bankruptcy Reform Act of 1978, 96 Mich. L. Rev. 47 (1997), which is attached to this statement. Since 1978, Congress' attempts at bankruptcy reform have been motivated in part by concern about the rapid increase in bankruptcy filings. In 1984, it introduced section 707(b)'s substantial abuse test, which attempted to force high-income debtors into Chapter 13, although it is not clear how much effect this law has had. Yet in 1994, Congress increased the generosity of exemptions. It increased the homestead exemption, for example, from $7500 to $15,000. A married couple can exempt $30,000 of home equity. Taken together, it seems that the net result of post- 1978 bankruptcy reform was an increase in the generosity of the bankruptcy system. So we have a strange repetition of history. The Bankruptcy Code was motivated in part by concern about the number of bankruptcy filings, yet resulted in a more generous bankruptcy system. Bankruptcy reform has been motivated by concern about the number of bankruptcy filings, and yet has also resulted in a more generous bankruptcy system. Why has this occurred? The legislative history of the Bankruptcy Code illustrates the widely held view that legislation will reflect the interests with the most at stake, and not necessarily the interests of the diffuse and unorganized public. As I argued in a recent article, the people with the most at stake, and with the most influence on bankruptcy reform in 1978, consisted of bankruptcy lawyers, bankruptcy judges, consumer groups, and creditors. Lawyers, judges, and consumer groups lobbied hard for a more generous bankruptcy system, and they got one. The creditors did not have as much influence as one might expect, perhaps because their interests conflicted. Bankers seemed to care most about the treatment of mortgages, while unsecured lenders cared more about reaffirmation agreements, the right to redemption, and exemptions. Complicating these matters was the question of whether exemptions should be controlled by the states or by Congress, a question that has so far been resolved in favor of the states. The people least well represented in the hearings leading up to the 1978 Code were the ordinary members of the public who need to borrow money. Although lawyers and consumer groups claimed to represent debtors, it is more plausible that they were interested in helping people who have already incurred a great deal of debt, and so might need the services of a bankruptcy lawyer. In addition, the legislative process lasted over a decade and received little attention from the media. Bankruptcy law was a backwater; no one predicted that bankruptcy reform would change this, so no one alerted the public to what was happening. 2 See Diane Ellis, The Effect of Consumer Interest Rate Deregulation on Credit Card Volumes, Charge-Offs, and the Personal Bankruptcy Rate, Bank Trends, No. 98-05 (1998). These considerations suggest that we should not be complacent about the status quo. The status quo bankruptcy system probably reflects the interests of lawyers and certain kinds of creditors. We should be cautious about assuming that the current generosity of the bankruptcy system reflects the public's interest, and that the public would be opposed to reform. Does the public have an interest in means testing? It is hard to see why it would not. The public has always objected to welfare benefits going to the undeserving poor; it would seem that for similar reasons the public would object to bankruptcy protection going to higher- income individuals. The people who would be most harmed by means testing would not be the public in general; they probably would be bankruptcy lawyers. Bankruptcy lawyers would see a decline in business from those people who are likely to be their most lucrative clients--wealthy people seeking to escape their debts.

LOAD-DATE: March 17, 1999