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Last night around the dinner table, I was saying how my day involved pulling 32 bankruptcy court files. "Guess," I said, "what was the average age of the car in which the debtor was claiming an exemption?" As my children rolled their eyes at another boring dinner conversation, my wife said "six months," and a guest offered "one year."
The answer is . . . .
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Several years ago, Lucette Lagnado wrote a series of Wall Street Journal articles on the use of formal debt collection techniques for debts owed to hospitals by patients. That series probably helped set off a chain reaction of Congressional hearings, state legislative initiatives, lawsuits, and self-regulation measures by the hospital industry. As Bob Lawless has reported, the Boston Globe is nearly done with a set of investigative reports that broaden and deepen the inquiry regarding debt collection practices in Massachusetts, framing each article so far on a major institution or actor that shapes the debt collection process (e.g., debt collection companies, small claims court, and — perhaps the most intriguing — the constable). Like the Wall Street Journal series, the Globe investigation apparently has been a wake-up call of sorts, this time to the Massachusetts court system.
The Globe investigation comes at a time of reawakened interest among debtor-creditor scholars in the use of formal collection procedures for consumer debts (including some important systematic in-the-trenches studies being conducted now by Rich Hynes at William and Mary and separately by Sidney Watson and colleagues at Saint Louis University). In the past several decades, many scholars have assumed that the formal judgment collection process was too expensive and cumbersome for relatively small consumer debts, and largely have focused their research energies elsewhere (e.g., federal bankruptcy, or laws that regulate informal collection techniques such as phone calls or letters). With technology that facilitates spreading default risk and encouraging debtor repayment through other means, one might have expected even less use of the arcane formal process by repeat player claim holders today than a decade or two ago. The Globe investigation does not study changes over time, but it does invite the question of whether technological developments and innovation in the credit and collection industries actually have increased, rather than decreased, the use and cost-effectiveness of arcane state collection procedures.
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Readers of this blog will want to take a look at a four-part series from the Boston Globe called "Debtor’s Hell." In the words of the Globe, this series is an "investigation into the world of
consumer debt in the United States found a system where debt collectors
have a lopsided advantage, debtors are often treated shabbily by
collectors and the courts, and consumers can quickly find themselves in
a life-upending financial crisis." The Boston Globe‘s series comes on the heels of a July 5 article in the NY Times ($) about possible regulatory responses to increasingly aggressive debt collection practices.
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The NYT ran a story that connects two dots—the housing bust and a slowing economy. Because housing has been a big employer, as new home construction comes a standstill, the effects will reverberate through the economy. Thus comes the answer to a question I’ve heard many times: So long as I’m not strung out on some crazy mortgage, why should I care if the housing market implodes? Because it affects the whole economy.
Now let’s add a third dot to the picture—the impact of an effectively unregulated home mortgage market. Over the past five years, lenders have sold billions of dollars of mortgages that are designed to go into eventual default because the borrowers cannot possibly afford to pay them. These so-called “creative mortgage products” have two powerful effects: They fueled the boom, pouring more money into an overheated housing market. Now they will accelerate the bust, pushing more people out of their homes through distressed sales, thereby accelerating price collapses on the way down. In other words, a housing bust doesn’t just happen. Regulators who won’t regulate have an effect as well.
Note the irony: Much of the middle class takes the hit either way. When the housing market exploded, houses became unaffordable in many cities. Last week we talked about firefighters and teachers who cannot afford to live in many cities. (“Great news—get a second job,” said a federal reserve economist.) Families took on terrible risks to try to get a home before they were completely closed out.
Now Vikas Babjas and David Leonhardt describe who will be hurt most by the housing implosion: people who work in the real estate industry. “On average, real-estate jobs pay somewhat less — about 7 percent less a year on average — than those in other parts of the economy. But real estate has also been one of the only industries creating good jobs for workers without college degrees in recent years, especially in construction and contracting work.” A big chunk of the middle class crumbles away.
Housing prices rise and fall for many reasons. The effects of interest rates are widely appreciated, but mortgage rules—or lack of rules—play an important part too. A boom and bust in housing may be hard to avert, but better regulation of home mortgage would have moderated the rise in housing prices as well as the subsequent contraction in the economy when housing cools off.
Regulation has become a dirty word, but many middle class people will pay a steep price for poor oversight of mortgage lending.
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In the late 1980s, when the upsurge in bankruptcies had just begun and folks were searching for explanations, cries of a decline in stigma rang out. Interestingly, despite an essential absence of data from debtors themselves, this explanation was long-lived. Indeed, it was cited frequently during the Congressional debates that preceded BAPCPA. But as any sociologist would tell you, a decline in stigma as an explanation just doesn’t make sense. Rates of bankruptcy filings are cyclical; stigma does not wax and wane in that way.
Just last month, Sociological Focus published my article, "Managing the Stigma of Personal Bankruptcy" (co-authored with Dr. Leon Anderson), in which I provide evidence that the stigma associated with filing is alive and well. For those unable to access the article, allow me to summarize. Although the sample was small, 95 percent of the debtors reported that they felt stigmatized by their bankruptcies. For example, a retired mail carrier stated: "I thought of it as a mark against my name . . . It was too embarrassing . . . I feel like I failed. You know, to go bankrupt, that’s a sign of failure."
Not only did the debtors vocalize their feelings of stigma, but they also managed it in ways that are classic among other stigmatized groups. For example, they tried to conceal their bankruptcies, especially from their parents. One man, a father of two young boys, reacted in the following way when he was asked if his mom knew he had filed: "OH HELL NO!!! No, no, no, no way, no way. Nope. And she won’t ever know. Never! Never. . . . She’d be like, ‘Argh, you piece of shit. Why did you do that?" Debtors also practiced avoidance, whereby they avoided situations that might expose them. An example of this was described by a woman who said that she would never again take her kids to their family dentist because debts to him had been discharged. Rather than risk the potential embarrassment, she concluded that they would have to find a new dentist. Finally, the debtors went to great lengths to differentiate themselves from all those other "deadbeats" out there who supposedly abuse the system. They insisted that their own bankruptcies were bankruptcies "of necessity," not extravagance or abuse. And finally, three-quarters of them insisted that under no circumstances whatsoever would they set foot in bankruptcy court again. One man, who blamed his wife for their bankruptcy, said that he would divorce her first. Another said that he’d kill himself before he’d file again. This is probably an exaggeration, but it demonstrates the power of the stigma of bankruptcy.
I have no doubt that there are folks out there who file without feeling a shred of remorse or stigma. But my research suggests that they are the minority. For centuries, bankruptcy has been highly stigmatized. And, I would argue, it still is.
Update: We have opened the comments for this posting.
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The title to this post is neither spam nor a joke. A new service, called Prosper Marketplace, gives individual lenders "the privilege to bid" on loaning up to $25,000 to individual borrowers. Building on the success of E-bay, Lending Tree, and, well frankly, Match.com. Prosper allows borrowers to post a picture of themselves and a story of why they want or need money. Borrowers also submit credit information and receive a rating from AA to HR ("high risk".) Borrowers can join "groups" to add to their credibility, such as "Veterans Helping Veterans," "Marquette University Alumni and Friends," and "Teacherloans.com." Prosper charges a modest fee for each loan completed. The Wall Street Journal and Salon have both reported in detail on Prosper.
While it is too early to know if Prosper will live up to its name (the first loans are just hitting the 120 day period after which they can be labeled in default), I think the early interest in the site reflects frustration with the lending industry. Traditional banks are viewed as too slow and stodgy. Credit cards are viewed as overpriced and too aggressive in collection. Prosper’s model is to literally "bank" on people’s interest in each other. The bidding process combats lender greed, and the vetting process forces borrowers to answer very personal questions about why they need the money. Prosper provides a public glimpse at the variety of reasons that people borrow small sums of money, including to fund a wedding, to make up a gap period before college financial aid arrives, and to pay the closing costs on a house purchase. These types of transactions are usually hidden from view because payday lending and credit card data are proprietary and confidential. The willingness of Prosper’s borrowers to share their financial lives is perhaps a reflection of society’s comfort with borrowing money as a routine part of American consumer behavior.
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Among the many changes in the 2005 amendments to the bankruptcy law (known as the Bankruptcy Abuse Prevention and Consumer Protection Act or "BAPCPA") were provisions designed to restrict what bankruptcy attorneys had to say to clients and what they could not say to clients. Yesterday, a federal judge in Dallas found one of these provisions unconstitutional but upheld other parts of the law. The case is Hersch v. United States, No. 3:05-CV-2330-N (N.D. Tex., July 26, 2006), and the plaintiff was represented by Howard Marc Spector. The opinion is available here.
BAPCPA lumps bankruptcy attorneys in with all debt relief agencies and then states that no debt relief agency can advise a debtor to incur more debt before filing bankrutpcy. Not surprisingly, Judge David Godbey ruled this provision unconstitutionally restricts speech. I’m no constitutional scholar, but one cannot imagine a more direct regulation of speech (maybe I just lack imagination). Other provisions of BAPCPA require bankruptcy attorneys to make lengthy disclosures to all clients. Despite cases holding the government cannot compel business to make speech, Judge Godbey found this provision constitutional. He analogized to compelled disclosures doctors had to make before performing abortions and that the Supreme Court upheld in the Casey decision.
There is a lot more I would like to say about this case, but I have to run. Blog readers can breathe a sigh of relief. As an experiment, I have turned on the comments for this posting. My fellow bloggers also may have more to add.
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Congress is putting the final touches on a pension reform bill as the House-Senate Conference is ironing its final differences. This bill deals with some relatively arcane but nontheless vital issues,
especially for workers with traditional defined-benefit pension plans.
When companies make pension promises to workers, they are in effect binding themeselves to pay future debts. How do we know these promises aren’t pie in the sky that the companies will never be able to pay? Because the government requires companies to "fund" these future pension obligations. It does so by making a bunch of actuarial calculations on what these future promises will cost, and how many assets the companies will need to cover them. When companies don’t have enough assets to cover these liabilities, as set forth in the pension regulators’ formula, their pension plans are deemed "underfunded."
In the big pension reform of the 1980s, Congress gave companies with underfunded pension plans 30 years to make catch-up payments, and even then they only had to reach a target of assets sufficient to cover 90% of pension liabilities.
The new bill clamps down (at least somewhat). For example, it would require fully funding underfunded pensions within 7 years (the airlines have squalked they’ll fold with that requirement, so will probably get a carve-out exception). And by "fully funded," they mean it this time: 100% coverage, not just 90%.
Good news for future pensioners (i.e., current workers, i.e., most of us), right? Not necessarily. One of the clear results of Congress’s sensible clamp down on underfunded pensions is that other companies will do just what the airlines are doing in bankruptcy: discontinue defined-benefit pension plans for their workers. When we account honestly for how expensive these plans really are to American businesses, the unfortunate price for our commendable transparency is the unhappy realization that many companies simply can’t afford the promises they’re making (or, more precisely, the promises that were made some time ago). Whether they were dishonest in making those promises back then, grossly optimistic, or just incompetent is, sadly, now water under the bridge. Whatever the reason, as the true costs of defined-benfit pension plans set in — and are drawn into the light by the new pension bill which makes them harder to hide — companies will simply get out of defined-benefit plans altogether and move to defined-contribution plans (the fancy name for 401(k)s). We’ve seen this happening already with historical data gathered by the Survey of Consumer Finance. So instead of shouldering the huge risk of uncertain future health care costs and longevity increases of a baby-boom population, businesses will pass that risk along to their workers. If the workers make poor investment decisions and lose all their future pension money, they’ll always have the final, ultimate defined-benefit plan of all: social security. At least for now. (That’s an underfunded pension plan that Congress has
so far avoided.)
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Katie Porter’s earlier post on debt trading (which has gotten some attention at The Conglomerate) reminded me of some poking around that I had been doing. Trading claims in bankruptcy is huge, in the billions of dollars per year. Although Katie Porter’s post was in the context of consumer bankruptcy, bankruptcy claims trading can have decisive effects in huge corporate reorganizations. A corporate debtor in financial distress may find itself no longer dealing with a lender interested in a long-term relationship but with a so-called "vulture investor" interested only in maximizing short-term profits. Of course, without the ability to resell a loan, the lender might not have made the loan in the first place. None of this is to say that bankruptcy claims trading is either good or bad, but we don’t know much about it.
I was trying to see if one could get data on bankruptcy claims trading and trading in distressed debt generally. (And by "I," I mean by my extremely capable faculty assistant.) It turns out you can get such data, if you have thousands of dollars to pay for expensive data subscription services. With the other things on my plate, I could not justify the time and money to invest in such a research project, but it strikes me as a fruitful area for investigation. Because we have so few data, it’s an empirical project where the researcher would have something to say no matter what the data showed. Even a paper with descriptive data would make a huge contribution.
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When it comes to the bankruptcy filing rate, fiscal year 2006 (10/1/2005 onward) is turning out to be a very odd period. First, filings surged to historic heights in early October. Then, in the second quarter, filings dropped to the lowest rate since the mid-1980s. An intervening event was the mid-October effective date of an omnibus bankruptcy reform bill, the most extensive changes to the formal bankruptcy law in a generation. Most bankruptcy filers are individuals rather than business entities, so it appears that individuals became sensitive to changes to the Bankruptcy Code and may have altered their plans accordingly. Does this mean that individuals also can be expected to alter their borrowing behavior because of the bankruptcy law changes? Not so fast, say Professors Susan Block-Lieb and Ted Janger in an article just published in volume 84 of the Texas Law Review.
Block-Lieb and Janger apply insights from behavioral decision research suggesting that individuals’ cognitive limitations, and not strategic behavior, provide an explanation of consumer overextension that is more consistent with consumer credit data. They also consider the possibility that lenders capitalize on these cognitive limitations. Whatever happens with the official bankruptcy filing rate reported by the government, Block-Lieb and Janger warn in their Texas article that “overleverage is here to stay.”
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