Asymmetrical Information

Does the new bankruptcy law not make it more difficult to file for bankruptcy, and therefore make it go without saying that fewer people file for bankruptcy after the law was passed?

Even if not, just because people have some leeway in deciding when to file doesn't mean that bankruptcy cannot be a product of 'bad luck'. To suggest so is ludicrous.

I'm not familiar with the new law, but why would anybody bother filing if it holds no benefit for them? I would think that the obvious outcome of any law making it less advantageous/more difficult to file bankruptcy would be a decline in bankruptcies.

wallster,

"I would think that the obvious outcome of any law making it less advantageous/more difficult to file bankruptcy would be a decline in bankruptcies."

Yes, but it would not cause a spike in fillings before the law changed unless people could choose when and when not to file.

Opponents of changing the law argued that most people filed bankruptcy because they had no choice remaining. If that were true it would suggest that people could not control the actual timing of the filings because they filed only when forced to by external events (e.g. creditor's demands, loss of income etc) . Instead we see people carefully choosing the time of their filings to avoid filing under the new law suggesting that external events did not play a significant role in the timing.

Strategic bankruptcy is a surprise?

People don't file for bankruptcy when they are homeless and hopeless -- by then it's too late to make a difference. Consumers file for bankruptcy when they still have a little something left that they want to protect and still retain hope of getting back on their feet, using bankruptcy.

But, oh, you wanted to talk about strategic bakruptcy filings. Well, how about considering how it is that K-Mart first went bankrupt, then emerged from bankruptcy to buy Sears? How about considering how businesses will run to a Chapter 11 to shed labor contracts originally executed under threat of labor strikes wasting the corporate assets?

Of course there are alternatives to taking one's debt collectors and assets to the bankruptcy court. Once it becomes obvious that one will never recover from a debt disaster, self-caused or not, and bankruptcy is not a helpful response, then some people will take their assets and go underground. People can get paid "under the table."

People have to eat even if they have to cheat to do so.

I do some bankruptcy work (albeit on the creditors side). People that file frequently do so before its gotten so bad that banks/collection agencies are obtaining judgements and levying on property. For many of them, though, there is no doubt that this is going to be a future occurrence if they don't file, get a new job making twice as much, or come into an inheritance. For most people on the edge of solvency, guess which one is more likely. Just because people have a window of several months to file in doesn't mean that traumatic events weren't the root cause -- filing is usually the last option after depleting savings or whatever.

Jane: If bankruptcy was primarily driven by unforseeable bad luck that left people with no choice, individuals would not be able to be as strategic about filing as they have been.

Shannon: Instead we see people carefully choosing the time of their filings to avoid filing under the new law suggesting that external events did not play a significant role in the timing.

Perhaps, to some extent.

But you're both ignoring opportunity cost and the cost of uncertainty. If I'm in a position in which it is 90% likely that I will need to file at some point in the near future, and on date X it becomes more expensive to file and will allow me to keep less of my stuff, what am I going to do?

Jane, especially, I think misconstrues this. Most non-emergency medical requirements, I believe we can say, are largely a matter of bad luck (put aside lifestyle choices for this analysis). With early stage surgery and therapy, one has some degree of flexibility as to when to begin (you're not immediately bundled off in a screaming chopper to the nearest surgeon or what have you). Are people "strategic" about choosing when to start? Sometimes - people will put off knee surgery for various reasons, evaluate against future uncertainty, etc.

If the knee surgery were about to become much more expensive, might you have it immediately? What about if there were a 10% chance it would heal on its own?

I sat next to a bankruptcy master on a plane one day. She said 80+% of her cases involved people who lived it up on credit cards, bought fancy cars, etc. and then couldn't pay because they or spouse lost a job. Rarely did she see bankruptcies caused by health issues. When she did, she was able to - under old and new proposed (at the time) law - she was allowed to look at the circumstances and mitigate the takings. She
said sometimes it boggled the mind why the bankrupt was ever offered a credit card, but in
most instances the credit offered was proper and
the debts came on swiftly and irresponsibly.

Both of these support the idea that bankruptcy is a calculated and timed decision, and that changes to the benefits around filing for bankruptcy would impact whether or not people did so.

That bankruptcy is a calculated decision is hardly news, but aren't you a bit short of data points to draw conclusions about the laws effects on future filings? You might try reading the rest of the post you cite:

"Obviously one cannot infer anything about the long-term effect of the change in the law from these figures because of the extraordinary intervening effect of the law."

Or is this yet more selective quoting?

There is far more to this issue than many would like to admit.

I personally have been involved in a bankruptcy that involved a newly single-mom, her ex-husband, two children, and a tax bill to the IRS that the ex-husband was assigned responsibility for by the state court but did not pay, and the IRS was pitiless and did not recognize the judgement of the state court.

So...

The single-mom had to pay, even though she had been judged not responsible by a state court, because the federal IRS decided that she was indeed responsible, and she had to file for bankruptcy to keep her house so that her children had a place to live.

This doesn't even begin to consider the dyslexia suffered by her son.

So, the new law makes things OH SO MUCH BETTER, right?

Only for the creditors, who don't have to worry about the future of dyslexic children.

Do your own math, your own calculus regarding which "side" holds the greater benefit to society at large in the long run.

So, the new law makes things OH SO MUCH BETTER, right?

I love how you manage to tell a story about the IRS screwing somebody and somehow spin that into "the bankruptcy bill is bad".

Only for the creditors, who don't have to worry about the future of dyslexic children.

So you're advocating what, exactly -- that people with dyslexic kids should be able to borrow and spend as much as they want, and then tell the lenders to go fuck themselves?

Do your own math, your own calculus regarding which "side" holds the greater benefit to society at large in the long run.

The side that honors its obligations.

People should pay their creditors. There are medical horror stories and unfair entanglements which people suffer under, but the ones who simply spend too much money and then go "oops" deserve little mercy...and there are plenty of that kind of irresponsible people around. Hey, I would like to have everything my heart desires and beyond--oh, but I know that I would have to buy all of those things and experiences, not steal them!

Some advocates of easy bankruptcy seem to be arguing that there is no need for the debtor to bear the costs of their debt - simply declare the debt null and void and !viola! it disappears.

But someone has to pay that debt. Debts represent real goods and services which have been consumed. Who should pay it? No matter how tragic the circumstances which led to the debt (insert anecdote about poor bedridden kittens who have lost their mittens here) - who should pay it?

I can't think of a single reason why anyone other than the person who ran up the debt should end up stuck with the tab.

Fishbane and Wallster are dead on. If bankruptcy appeared imminent, say within the next 6-9 months, why wouldn't I go ahead and file while the laws were more favorable to me?

Further, I have no problem with tightening the bankruptcy laws, but the credit card companies crying about how bad it is with so many people defaulting on their debts is a tad hard to take. My 19 year old son, working part time while he goes to college, gets 8-10 credit card offers a month. (@24% interest!) Meanwhile, my wife and I get "automatic" increases of $5,000-$15,000 in the limit on our current cards. Once, when calling to have the original limits re-instated, the oh so helpful CSR informed my wife that if we kept the new limit, we could use the card to buy that new car we wanted!

Why would any lender be willing to give a solidly middle class Reagan Fan a $22,000 unsecured loan? At 14% interest, why would a solidly middle class Reagan Fan take that deal?

I'm as free-market as the next guy, so if I decide to sign up for 19 cards and run myself eye-ball deep in debt, that is my problem and I don't expect the government to bail me out. However, it goes both ways. If lending companies decide to give me $100,000 in unsecured loans, they shouldn't go crying there ought to be a law to protect them, either.

My somewhat low opinion of the president would have been much improved if he had sent this bill back to Congress and told them to address the predatory practices of the lending companies which caused the problems to begin with and then and only then would he sign off on tightening the bankruptcy laws.

One reason for the drop after the law took effect, is that in order to file, you have to complete a credit counselling program. There is a lot of scrambling to set up the programs now.

The original post was just bad logic. The causes of bankruptcy may primarily be "bad luck", whereas the actual choice and schedule to file may be very well planned.

Prior to the new law going into effect, people already suffering from "bad luck" (or stupidity, or whatever has resulted in their current financial difficulties) were looking forward to bankruptcy as an option. Once bankruptcy became their best option (and often pride was the only thing preventing it from being their best option), they'd take it - but not until.

Once the new law was announced, they saw this option going away. Many people filed who would not have filed at all because they didn't want to risk not being able to solve their problems with non-bankruptcy options. Had the law not gone into effect, these people wouldn't have filed when they did, and many would've solved their problems through alternative means.

In the final analysis, new bankruptcy law or not, those who cannot pay for themselves become wards of the state. That means that ALL of us, collectively, pay their welfare. Had the new law not taken effect, creditors who'd made poor judgments about who to give credit to would be responsible for their own mistakes. Now it's us. This bankruptcy law brings us closer to socialism, not further from it.

I've got to join the pile-on of Jack here. I know a few people who have dyslexia. At least one of them comes from a fairly affluent background. I don't think there are any special treatments at a secret Swiss clinic that do anything more than is done through the educational system. Its unfortunated for the kid, no doubt, but not particularly relevant to judging the merits of the mother's bankruptcy.

I guess it's all the creditors' fault then... for failing to predict who's going to have bad luck.

Hmmm, about those "predatory lenders", why not "just say no"? "No, I will not get more credit cards and buy more stuff". There is a huge difference between "bad luck" and no self control...Or is this when the "Instant Gratification Defense" comes into play?

Maybe people would be amazed to learn whom about them are the real deadbeats. Keeping up appearances seems to be one part of the game, because heaven forbid one cuts back a bit! Since it has become more difficult to "time cheques" because of the changes banks made about them, the game must have become even more interesting. People may owe credit companies, but do not forget the small business owner who gets to sweat it out every month!

Jane: If bankruptcy was primarily driven...

Jane, especially, I think misconstrues this....

This has been a two-person blog for a very long time and now it is a group blog. Can't do much for the credibility of one's ability to address a written argument if the same party incorrectly identifies the author.

I'd be interested to know how Hurricane Katrina, which devastated the Gulf Coast economy affected the amount of bankruptcies filed.

--Cobra

Because people obviously don't respond to financial incentives.

My problem with the current bankrupcy system is that it doesn't penalize later lenders, since the guy who gives me money right at the end of my downward spiral has equal standing to the person who loaned me the first money back when I was just starting to borrow. This made sense back when a creditor couldn't track how much you owed, but the credit bureaus take away that excuse now.

IMHO, creditors should line up on a first-come, first-loaned basis. If I can only pay A, but then B comes along and makes a big loan to me that I can't pay (assuming I don't lie to B about A), that should be a risk of business for B.

The real flaw is that unsecured creditors wish to offer credit like everyone is a high business risk, but not lose profits accordingly. If a credit card company wishes to put up with the risk and charge accordingly, that's fine by me. They just shouldn't try to change the rules when they aren't making "enough" money.

Does this imply that the US will be able to choose when it declares bankruptcy rather then repay the Chinese, Japanese, etc., the money the Republicans has been borrowing from them .

Funny how easy it is to pass judgement in such a case when one is secure in their circumstances. Sort of like the ease with which one can casually and flippantly lob pronouncements on fat people. "Why can't they just take responsibility and stop eating?" and "I don't understand why they don't just pay their bills" both show somewhat less than a commanding grip on the issues and subject matter at hand. I sincerely hope that none of you or your families ever find yourselves in either circumstance.

I'm very surprised at the surprisingly one-dimensional and shallow tenor of the article, a quality that I'm not used to seeing on this blog, especially when the previous article and its discussion of risk, return and the sometimes hidden nature of risk. It doesn't take Ivy league brainpower to figure why people who were already in a death spiral would choose to step up and file before the deadline - even if they may have chosen to tough it out a couple more months, the deadline forced a decision. If the deadline was a catalyst to action, it also makes perfect sense why filing was down after the deadline.

The idea that the majority or even a significant number of filers were engaged in some "strategic plan", although compelling on paper, is as hollow as the meme that illegal immigrants come to the US specifically to go on welfare and steal benefits. To embrace this idea is to believe that there was statistically significant class of people out there who set out to leverage themselves to the gills specifically to file before the guidelines got tough.

Sorry. Okay, let me reset... "MY GOD! You mean that the bankrupcy laws got tougher, so record numbers of people filed before the deadline? And filings DROPPED OFF AFTER THE DEADLINE???? Those thievin' deadbeat bastards!!! I'm shocked, I tell you, SHOCKED!!!

Regarding Jack's comment: first, a state court has precisely ZERO authority over the IRS. Second, this is a common situation: A and B get divorced, the divorce decree says A must pay the debt owed to X. A doesn't pay X, X pursues B for the debt. Read carefully: the divorce decree is between and enforceable against A and B ONLY. Any third party creditor who is not a party to the proceeding (that would be X) *is not bound* by the decree. X's debt remains fully enforceable against B. B's remedy is a cause of action (potentially a contempt action) against A for violation of the court order.

What you described is not even abusive by the IRS. It is not their problem that H and W owed a bunch of taxes and got divorced. H and W are still jointly and severally liable, and they cannot magically get rid of liability by changing their status as to each other (divorce). W, of course, is not liable for any post-divorce debts.

a few quick details to flesh things out just a tad - according to the Federal Bankruptcy Court's own filing records, for the 12 month period from Sept 04 through Sept 05 the US averaged 30,000 petitions per month. In October almost 500,000 petitions were filed. In the 30 day period SINCE October 17 only 3,000 petitions were filed nationwide.

Another poster asked about the impact of Katrina on the filings. I have no data on the subject but my gut feeling is that with the Courthouses and many law offices in the are inoperable and the recovery efforts ongoing, filing bankruptcy is the LAST thing on most folks mind. I would expect an anualized increase in the number of filings in the stricken area but I don't think (and this is pure conjecture) they were part of the "spike"

I would have liked to see what dollars-and-cents effects the new law has versus the old. Surely in a free market debts to which the old law applied would have higher interest rates then debts to which the new law applied... right? It would have been interesting to see the interest rate difference.

It's still possible. Any company that wanted could add a contract rider on their debt, such that the customer would have essentially the same abilities to discharge the debt as in the old law. Of course, it would be much easier if the law officially recognised both types of debt (easy-bankruptable and hard-bankruptable), and perhaps required that any institution offerring hard-bankruptable debt must also offer easy-bankruptable debt.

I also like the suggestion above that later creditors should have a harder time collecting in a bankruptcy than earlier ones. That's sensible policy.

And finally, to Mack, who said The idea that the majority or even a significant number of filers were engaged in some "strategic plan", although compelling on paper, is as hollow as the meme that illegal immigrants come to the US specifically to go on welfare and steal benefits.

That's not an accurate description of the claim being made. The claim is that the specifics of the policy affect people's choices. If bankruptcy law is lenient, people will choose debt more carefully; if benefits are harder for illegal immigrants to obtain, potential migrants will consider other ways to get the income they need.

I do think there's something wonky about the bankruptcy change. Debts you chose before the law change shouldn't receive new treatment unless the old treatment was manifestly wrong. In a very real sense, when you agree to a contract an implicit part of the contract is the legal environment. It's a little odd that a group of people who aren't parties to the contract can change the terms of it.

-Billy

point's of clarification to my post above (this is what I get for posting at work!)
http://www.washingtonpost.com/wp-dyn/content/article/2005/11/21/AR2005112101516.html

bankruptcy laws in the u.s. allow entrepreneurs to take risks.....

i don't know how one would measure the influence the new law has on would-be entrepreneurs with a potentially good idea?

Look, nobody held a gun up to the heads of the credit card companies and said, "You must loan these people money regardless of their ability to pay you back."

Once the bankruptcy rates began to rise, all the financial institutions had to do is raise their standards on who they issue credit. Instead, they did the exact opposite. And got even more defaults.

In a free market, people can make stupid decisions that put their economical success in jeopardy. I have no beef with making these people pay their debts. But so can companies. When lenders decide to loan money to people who are unable or unlikely to pay it back, why should the government step in and get involved? A free market works both ways. The companies knew the rules when they mailed out the offers to uncredit worthy people.

You would think after these same people loaned billions of dollars to 3rd world dictators who stiffed them, they would have learned to be more careful to whom they loaned. Oh, wait! The government bailed them out then as well!

This law had nothing to do with making consumers responsible for their debts. That would have been a good thing. Rather, it had everything to do with credit card companies being more reckless with less exposure.

It should have been called The Help Stupid Lending Companies Make More Money Act.

I'm as free-market as the next guy, so if I decide to sign up for 19 cards and run myself eye-ball deep in debt, that is my problem and I don't expect the government to bail me out. However, it goes both ways. If lending companies decide to give me $100,000 in unsecured loans, they shouldn't go crying there ought to be a law to protect them, either

So which is it -- should you be allowed to borrow and then blow off your creditors, or should you have to repay the money? Because you just advocated both positions, there.

Creditors aren't asking for special protections. They're asking that borrows NOT have special protections. "If you borrow something, you have to pay it back" isn't special treatment for creditors -- it is the default way things are supposed to work.

Guys, this was the lawyer's doing, mmmkay. I imagine that they've been busting their ass for the last few months to get all possible filings done before the magic date. To do otherwise could constitute malpractice. It's not like you one day realize you can't pay your electric bill and run over the court and file. It takes a fair amount of time, as does anything involving the law. My guess is that the the rate will remain low for a while, but eventually crawl back up to at or near where it is. I also predict a large number of vacations amongst bankruptcy attorneys over the next month or two.

Look, nobody held a gun up to the heads of the credit card companies and said, "You must loan these people money regardless of their ability to pay you back."

Once the bankruptcy rates began to rise, all the financial institutions had to do is raise their standards on who they issue credit. Instead, they did the exact opposite. And got even more defaults.

Your new research topic is "anti-redlining laws." For extra credit, examine the tort issues surrounding them. Predatory lending practices, though plausible and probably real, are a separate issue and should be set aside from the current exercise.

Brian R.: Not so at all. It is usually not until many months of trying to work things out after bad luck falls that the decision to file happens. By then it is quite a calculated decision. So what? It says nothing about whether bad luck happened or not.

It is hardly a surprise that a highly publicised tightening of bankruptcy regs would cause those pondering bankruptcy to file earlier than they might otherwise. To claim that this demonstrates intent is clearly mere assertion. To also claim that reduced filings of bankruptcies after the deadline shows strategic intent is also silly as the regs were changed specifically to reduce filings. Would you expect any other result?

Are some bankruptcies an abuse of the system? Certainly yes, but the assertion that the current filing phenomenon proves anything in regards to the proportion of filings due to 'bad luck' versus some sort of malfeasance are clearly twisting data to fit an ideological position rather than what the data actually indicates.

They aren't being "strategic," they're being tactical. And all that means is that they had a little elbow room left... with they now no longer have. There may well be people who treat bankruptcy as a business decision, thus exploiting it because they can. This doesn't mean that, for most, it is a necessary evil that has become even more painful (and possibly too painful to be born). One could make an argument similar to yours if the change were something like the reinstitution of debtor's prisons, which harldly makes the decision to enter a debtor's prison a strategic one.

Damn! Too many typos to be borne!

About the debtors prison thing, suppose it came down to a choice between going to prison and settling, say... Australia? Would the fact that this resulted in a large number of new Australian settlers mean that the inability to pay one's debt was, er... "strategic."

That is one of the silliest things I've ever heard. First of all, even if your reasoning is at all well-founded to begin with, and that both the spike and fall were due to planning, that is a variation in planning over the course of a couple months. Since this seems to indicate to you that they are calculating people trying to take advantage of the system, let me try to explain a little better how personal finances work. People who go bankrupt do not just go from day to day with ample funds and then suddenly one day wake up to find their account empty and file for bankruptcy later that afternoon. They have had financing problems probably over the course of years and try different options to get themselves out of their situation and eventually sometimes have to resort to bankruptcy after much deliberation. This is not a light decision; bankruptcy ruins your credit and denies you in many ways as many financial oppurtunities for success as it affords you. Additionally, and I know this has already been pointed out but it really can't be stressed enough, it is obvious that the main effect of limiting the ability to file for bankruptcy would be that there are fewer people who file. I don't understand how you could have thought you had a well thought out view with so much ignorance inherent in what you said.

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