Erasing debt may soon get harder

After losing his job, Isaac Cardona figured he was about a quarter of a century in debt - if he could keep up with the minimum payments on the 27 credit cards he carried.

But unlike some 1.4 million Americans in 1998, he decided not to declare bankruptcy. Instead, he worked with a credit-counseling organization to plan a way out of debt. Now, he's about 60 months away from paying off all his bills.

"I had a pretty good job," he says. "I racked up bills and, when bonus time came around, I'd write a big check."

As Congress closes in on the biggest overhaul of bankruptcy laws in a generation, Mr. Cardona's method of handling debt is about to become the law of the land. The bill makes it much harder for most people to simply declare bankruptcy and start over.

Business supporters say the new law will ensure that people who can afford to pay back some of their debt do so - correcting an "abuse" of the system that drove up the cost of borrowing for average American families by some $400 a year.

But consumer groups and other critics say it's the wrong law at the wrong time - and that it targets victims of an aggressive credit-card marketing system without reining in the companies responsible for predatory practices. Moreover, it leaves intact loopholes for the rich, such as the homestead exemption in states like Texas and Florida that allows debtors to declare bankruptcy and still hold on to homes and ranches worth millions.

"If there is indeed an economic downturn in progress at the moment, there will be a lot of people in the middle who will need the protection of the bankruptcy law," says Lawrence Ausubel, an economist at the University of Maryland in College Park. "The current legislation could drastically curtail their access to a fresh start."

Some 1.3 million Americans declare bankruptcy every year. Experts say most cases are the result of some life-changing event, such as divorce, layoff from a job, or a medical emergency. The number of people opting out of debt today is about five times what it was when the system was last revised in 1978.

Two previous Congresses passed similar laws to overhaul the bankruptcy system by big margins, but they were vetoed by President Clinton. Now President Bush has promised to sign a bankruptcy bill.

At the heart of the debate is a controversial new means test, which would determine whether a family could file for bankruptcy under Chapter 7 of the federal code - a boon to debtors because it allows many to walk away from unsecured loans such as credit-card debt. Most of the people filing for bankruptcy every year use this provision.

The proposed new bankruptcy law would force those above a certain income standard to pay off a portion of their debt under a court-approved plan - and to go though debt counseling. Debtors earning less than the state median income (about 80 percent of all bankruptcy filers) wouldn't be affected by the new law.

Here's how the new means test would work: It starts with a family's income, then subtracts medical expenses, mortgage payments, car payments, and some education expenses. Using Internal Revenue Service figures, it also calculates what families in different parts of the country would need to pay for food, clothing, shelter, transportation, utilities, and phone bills. On this basis, a court then determines whether or not a family can afford to pay off at least 25 percent of its debt over five years.

"The idea of means testing is nothing revolutionary," says Todd Zywicki, a law professor at George Mason University here who has advised the Judiciary Committees in the House and Senate on this bill. "The difference is that now we'll have a more consistent and regularized menu of what expenses would be allowed for a debtor - as opposed to the current system, when judges have full discretion to decide whether one debtor can have cable TV and go to two movies a month, while another can only eat at McDonald's."

But consumer groups say that such a rigid formula is unfair and doesn't address a major source of the debt problem - aggressive credit-card marketing and reckless lending.

"This bill does not balance responsibility between working families and creditors whose reckless lending practices have contributed to bankruptcy rates," says Travis Plunkett of the Consumer Federation of America.

Other experts worry that the new law could drive families who need help out of the bankruptcy system altogether.

"The insolvent consumer has two options: One is to seek formal protection by filing a bankruptcy petition. The other is to hang up on creditors, change one's phone number, [and] leave no forwarding address," says Professor Ausubel. The new legislation "makes formal bankruptcy less attractive, so it will likely induce consumers to go into informal bankruptcy instead."

The Trapp family of Plantation, Fla., slipped into bankruptcy when medical costs for one of their children soared. When they filed for Chapter 7 bankruptcy, they owed $124,000 in medical bills and about $60,000 in credit-card bills. Under the terms of the new law, they would be presumed to be "abusers" because Mrs. Trapp's income (before she quit her job to care for her daughter) would be counted into the means test.

"If the bill had been law, we would have had to hire lawyers and go to bankruptcy court to defend ourselves," says Charles Trapp. "We would have had to go to credit counseling to learn how to manage our money. But I don't think they could have taught us how not to run up medical bills for a sick child."

(c) Copyright 2001. The Christian Science Monitor