First part is an article that uses her working paper as a reference.
Second is a summary of the paper.
PS: White is harsh on debtor's. But, if even the people who think a lot of debtors get a free ride are calling for reform, that scary.
--------------------------------------------------------
The bankruptcy-reform law of two years ago should be renamed the Drive More People Into Bankruptcy Act of 2005.
As you probably know, the law sent bankruptcy cases to record highs that year, as nearly 2 million people rushed to file before tough new restrictions went into effect. But the law continues to have unintended consequences.
Credit card companies and other lenders have used the law as an excuse to crank their wide-open spigots even wider. During the first year of the law's implementation, bankruptcy researcher Michelle White notes, revolving debt per household rose at a real rate of 4.6%, the steepest increase in five years.
"Because (the legislation) changed bankruptcy law in a pro-creditor direction, credit card issuers responded by expanding the supply of credit," White wrote last summer in a working paper for the National Bureau of Economic Research. "But more credit card loans combined with reduced access to debt relief in bankruptcy seems certain to result in severe financial distress for at least some debtors."
High risk for you, not for them
Credit card issuers continue to intensify their marketing efforts. They mailed 363 million card offers to so-called high-risk households in the third quarter of 2007, according to research firm Synovate, up from the 347 million offers in the second quarter. (See "Risk your house to save your credit cards?") High-risk households are those that have tapped more than 30% of their available credit lines, and they receive, on average, six new credit card offers a month.
We're already seeing the fallout from this credit binge:
* Credit card default rates have spiked. In the first five months of this year, credit card companies wrote off 4.6% of payments as uncollectible, according to data from Moody's Investors Service, up nearly 30% from the corresponding period in 2006. Late payments also have risen.
* Bankruptcy filings are soaring. The number of cases filed this year is running 40% higher than last year, according to the U.S. Justice Department. More cases were filed in the first nine months of 2007 than in all of 2006.
* The real-estate mess will add to people's woes. Falling home prices and soaring foreclosures will push more borrowers into distress. Fewer people now can borrow against home equity to pay off credit card debts. Many will seek bankruptcy as they try to keep their homes or to avoid being sued by lenders if the mortgages on their lost homes exceed the properties' value.
Relief isn't cheap or easy, however. The 2005 law basically doubled the cost of a typical Chapter 7 liquidation filing to about $2,500, including legal fees, and boosted the cost of a Chapter 13 repayment to about $3,500. The increased fees and paperwork mean it takes longer to pull together the typical case, and that's just how lenders want it.
"Any delay by debtors in filing for bankruptcy, even if only for a few months, benefits lenders," White wrote, "by giving them additional time to harass debtors with collection calls, persuade them to make payments on credit card loans even though the loans would be discharged in bankruptcy and collect part of their earnings using wage garnishment."
White, an economics professor at the University of California, San Diego, isn't exactly a "free the people" softie when it comes to bankruptcy law. She notes that many people bring financial ruin upon themselves by abusing credit cards and over-borrowing in general. She's among the economists who assert that credit card abuse, rather than job loss, medical bills or divorce, is the leading cause of bankruptcy. And she says the U.S. still has the most pro-debtor bankruptcy laws in the world.
But even she tacitly acknowledges creditors got a free ride with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Though the law cracked down on debtors, it did nothing to rein in the credit card issuers and other lenders whose practices helped fuel the bankruptcy boom.
U.S. households with at least one credit card, according to the Federal Reserve Bulletin:
*
1977 -- 8%.
*
2001 -- 76%.
Low-income households (bottom 20% of all households) with at least one credit card:
*
1977 -- 11%.
*
2001 -- 43%.
Total owed on U.S. credit cards, according to CardWeb.com:
*
1990 -- $172.6 billion.
*
2006 -- $745.1 billion.
Make lenders more responsible
So White has proposed a rather elegant solution: Penalize the lenders who continue to push credit on the weakest borrowers.
To understand how this would work, you need to understand the difference between "rational consumers" and "hyperbolic discounters."
We rational consumers are the ants in the ant-and-grasshopper story, saving for a rainy day and paying our credit card balances in full every month. Hyperbolic discounters, by contrast, want to start saving at some point in the future, but in the present they want to spend.
"Thus a hyperbolic discounter is like a person who always wants to start dieting tomorrow, but never today," White wrote. Each month, "they resolve to start paying off their debt, but when the next bill arrives they consume too much and postpone repaying until the following month."
Hyperbolic discounters make up a good chunk of the households that Synovate refers to as high-risk. About 28% of U.S. households are using more than 30% of their credit limits, Synovate says, and half of those are using more than 75%.
A look at possible solutions
The changes in the bankruptcy law should have made all borrowers more cautious, because erasing debt has become more difficult. But we rationals have always been cautious, and the live-for-today hyperbolic-discounting grasshoppers don't think that far ahead.
Because of that, "just moving the rules of bankruptcy in a pro-creditor direction is at best a very partial answer," White wrote. "Instead, an appropriate policy response to this kind of over-borrowing must both discourage hyperbolic discounters from borrowing too much and penalize lenders who take advantage of hyperbolic discounters' tendency to over-borrow."
Some economists have suggested fencing in creditors by doing away with rewards for credit card use, which they say encourage over-borrowing. But that, of course, would penalize us rational types. Another solution, which I support, is returning to old-school usury laws, which limit how much interest lenders can charge. Unfortunately, that doesn't seem to be in the cards.
A third option: Change how debt is treated in bankruptcy courts. Instead of treating all credit card debts and other unsecured loans the same, as we do now, White suggests treating loans differently depending on when they were made and how indebted individuals were at the time the loan was extended:
* First, the courts would figure out reasonable debt loads for rational consumers at various income levels.
* Debts above those levels would be eligible to be erased in bankruptcy.
* When multiple lenders were involved, debts would be ranked in chronological order, with the most recent being discharged first.
Determining "rational" levels of debt needn't be difficult. We could say that any credit extended to people using more than 30% of their current credit limits, or whose total debt payments (mortgage, car loan, student loans, credit cards) exceed 40% of their incomes, qualifies as irrational. Loans extended to these folks after their debts hit these levels would be eligible for expedited erasure in court. No means testing, no burdensome paperwork -- just cancel the debts, and it's done.
f lenders are rational, this system should discourage them from continuing to offer money to already-overextended grasshoppers. We'd be saving the least sensible among us from themselves and short-circuiting a lot of family financial and emotional distress.
--------------------------------------------------------------
"The number of personal bankruptcy filings in the United States increased more than fivefold between 1980 and 2004. By then, more Americans were filing for bankruptcy than were graduating from college or getting divorced."
The number of personal bankruptcy filings in the United States increased more than fivefold between 1980 and 2004. By then, more Americans were filing for bankruptcy than were graduating from college or getting divorced. When Congress reformed bankruptcy laws two years ago, its aim was to crack down on those who were using bankruptcy as an easy way to escape their debts. The reform made filing for bankruptcy more difficult by requiring debtors with higher incomes to repay more, by making it much more complicated and expensive for all debtors to file, and by increasing the number of debtors who are ineligible for bankruptcy. These reforms caused the number of filings to drop dramatically - from 2 million in 2005 to 600,000 in 2006.
But the reforms had an unintended effect, contends Michelle J. White in Bankruptcy Reform and Credit Cards (NBER Working Paper No. 13265). While bankruptcy filings dropped, financial distress increased. How did this happen?
The answer is that by making it harder for consumers to escape their debts, the new law dramatically reduced lenders' losses from default and bankruptcy. As a result, they started lending more, even to consumers with bad credit. Credit card debt increased more quickly during the past two years than at any time during the previous five years.
Consumers should have responded to the new harsher bankruptcy law by borrowing less, which would have lowered their risk of getting into financial distress. But not all consumers behaved in this rational way. Instead, many behaved shortsightedly and took advantage of the greater availability of credit to borrow more than they could easily handle --- ignoring the risk of financial distress. (Economists refer to this shortsighted behavior as "hyperbolic discounting" - consumers who are hyperbolic discounters intend to start paying off their debts immediately, but each month they consume too much and end up postponing repayment until the following month. So their debts steadily increase.)
The new bankruptcy law exacerbated the problem of shortsighted consumers borrowing too much, because it prevented many of them from using bankruptcy to limit their financial distress. Many consumers in financial distress are unable to file for bankruptcy under the new law, because they cannot afford the costs of filing, cannot meet the new paperwork requirements, or are ineligible. This means that their debts will not be discharged and they will remain vulnerable to creditors' collection calls and to wage garnishment that may take funds they need for basic necessities. Because of the new bankruptcy law, consumers can end up in deeper financial distress than would have been possible before 2005.
Survey evidence presented by White supports the idea that most debtors get into financial distress because of shortsighted behavior, rather than because they behave rationally but experience adverse events. In one survey of bankruptcy filers, 43 percent pointed to "high debt/misuse of credit cards" as their primary or secondary reason for filing. Another survey in 2006 found that two-thirds of those who sought credit counseling before filing for bankruptcy cited "poor money management/excessive spending" as the reason for their predicament, compared to only 31 percent who pointed to loss of income or medical bills.
White argues that lowering the costs of filing for bankruptcy would help debtors who are in the worst financial distress by making it easier for them to file. But changes in bankruptcy law cannot solve the basic problem of shortsighted consumers borrowing too much, since these consumers generally ignore the provisions of bankruptcy law until after they are in financial distress. Instead, White argues that changes in credit market and truth-in-lending regulation are more likely to work because they motivate lenders to lend less to the most vulnerable consumers.
The full version of professor Michelle White's paper can be purchased at http://www.nber.org/digest/nov07/w13265.html (Click on the Paper # link)
Second is a summary of the paper.
PS: White is harsh on debtor's. But, if even the people who think a lot of debtors get a free ride are calling for reform, that scary.
--------------------------------------------------------
The bankruptcy-reform law of two years ago should be renamed the Drive More People Into Bankruptcy Act of 2005.
As you probably know, the law sent bankruptcy cases to record highs that year, as nearly 2 million people rushed to file before tough new restrictions went into effect. But the law continues to have unintended consequences.
Credit card companies and other lenders have used the law as an excuse to crank their wide-open spigots even wider. During the first year of the law's implementation, bankruptcy researcher Michelle White notes, revolving debt per household rose at a real rate of 4.6%, the steepest increase in five years.
"Because (the legislation) changed bankruptcy law in a pro-creditor direction, credit card issuers responded by expanding the supply of credit," White wrote last summer in a working paper for the National Bureau of Economic Research. "But more credit card loans combined with reduced access to debt relief in bankruptcy seems certain to result in severe financial distress for at least some debtors."
High risk for you, not for them
Credit card issuers continue to intensify their marketing efforts. They mailed 363 million card offers to so-called high-risk households in the third quarter of 2007, according to research firm Synovate, up from the 347 million offers in the second quarter. (See "Risk your house to save your credit cards?") High-risk households are those that have tapped more than 30% of their available credit lines, and they receive, on average, six new credit card offers a month.
We're already seeing the fallout from this credit binge:
* Credit card default rates have spiked. In the first five months of this year, credit card companies wrote off 4.6% of payments as uncollectible, according to data from Moody's Investors Service, up nearly 30% from the corresponding period in 2006. Late payments also have risen.
* Bankruptcy filings are soaring. The number of cases filed this year is running 40% higher than last year, according to the U.S. Justice Department. More cases were filed in the first nine months of 2007 than in all of 2006.
* The real-estate mess will add to people's woes. Falling home prices and soaring foreclosures will push more borrowers into distress. Fewer people now can borrow against home equity to pay off credit card debts. Many will seek bankruptcy as they try to keep their homes or to avoid being sued by lenders if the mortgages on their lost homes exceed the properties' value.
Relief isn't cheap or easy, however. The 2005 law basically doubled the cost of a typical Chapter 7 liquidation filing to about $2,500, including legal fees, and boosted the cost of a Chapter 13 repayment to about $3,500. The increased fees and paperwork mean it takes longer to pull together the typical case, and that's just how lenders want it.
"Any delay by debtors in filing for bankruptcy, even if only for a few months, benefits lenders," White wrote, "by giving them additional time to harass debtors with collection calls, persuade them to make payments on credit card loans even though the loans would be discharged in bankruptcy and collect part of their earnings using wage garnishment."
White, an economics professor at the University of California, San Diego, isn't exactly a "free the people" softie when it comes to bankruptcy law. She notes that many people bring financial ruin upon themselves by abusing credit cards and over-borrowing in general. She's among the economists who assert that credit card abuse, rather than job loss, medical bills or divorce, is the leading cause of bankruptcy. And she says the U.S. still has the most pro-debtor bankruptcy laws in the world.
But even she tacitly acknowledges creditors got a free ride with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Though the law cracked down on debtors, it did nothing to rein in the credit card issuers and other lenders whose practices helped fuel the bankruptcy boom.
U.S. households with at least one credit card, according to the Federal Reserve Bulletin:
*
1977 -- 8%.
*
2001 -- 76%.
Low-income households (bottom 20% of all households) with at least one credit card:
*
1977 -- 11%.
*
2001 -- 43%.
Total owed on U.S. credit cards, according to CardWeb.com:
*
1990 -- $172.6 billion.
*
2006 -- $745.1 billion.
Make lenders more responsible
So White has proposed a rather elegant solution: Penalize the lenders who continue to push credit on the weakest borrowers.
To understand how this would work, you need to understand the difference between "rational consumers" and "hyperbolic discounters."
We rational consumers are the ants in the ant-and-grasshopper story, saving for a rainy day and paying our credit card balances in full every month. Hyperbolic discounters, by contrast, want to start saving at some point in the future, but in the present they want to spend.
"Thus a hyperbolic discounter is like a person who always wants to start dieting tomorrow, but never today," White wrote. Each month, "they resolve to start paying off their debt, but when the next bill arrives they consume too much and postpone repaying until the following month."
Hyperbolic discounters make up a good chunk of the households that Synovate refers to as high-risk. About 28% of U.S. households are using more than 30% of their credit limits, Synovate says, and half of those are using more than 75%.
A look at possible solutions
The changes in the bankruptcy law should have made all borrowers more cautious, because erasing debt has become more difficult. But we rationals have always been cautious, and the live-for-today hyperbolic-discounting grasshoppers don't think that far ahead.
Because of that, "just moving the rules of bankruptcy in a pro-creditor direction is at best a very partial answer," White wrote. "Instead, an appropriate policy response to this kind of over-borrowing must both discourage hyperbolic discounters from borrowing too much and penalize lenders who take advantage of hyperbolic discounters' tendency to over-borrow."
Some economists have suggested fencing in creditors by doing away with rewards for credit card use, which they say encourage over-borrowing. But that, of course, would penalize us rational types. Another solution, which I support, is returning to old-school usury laws, which limit how much interest lenders can charge. Unfortunately, that doesn't seem to be in the cards.
A third option: Change how debt is treated in bankruptcy courts. Instead of treating all credit card debts and other unsecured loans the same, as we do now, White suggests treating loans differently depending on when they were made and how indebted individuals were at the time the loan was extended:
* First, the courts would figure out reasonable debt loads for rational consumers at various income levels.
* Debts above those levels would be eligible to be erased in bankruptcy.
* When multiple lenders were involved, debts would be ranked in chronological order, with the most recent being discharged first.
Determining "rational" levels of debt needn't be difficult. We could say that any credit extended to people using more than 30% of their current credit limits, or whose total debt payments (mortgage, car loan, student loans, credit cards) exceed 40% of their incomes, qualifies as irrational. Loans extended to these folks after their debts hit these levels would be eligible for expedited erasure in court. No means testing, no burdensome paperwork -- just cancel the debts, and it's done.
f lenders are rational, this system should discourage them from continuing to offer money to already-overextended grasshoppers. We'd be saving the least sensible among us from themselves and short-circuiting a lot of family financial and emotional distress.
--------------------------------------------------------------
"The number of personal bankruptcy filings in the United States increased more than fivefold between 1980 and 2004. By then, more Americans were filing for bankruptcy than were graduating from college or getting divorced."
The number of personal bankruptcy filings in the United States increased more than fivefold between 1980 and 2004. By then, more Americans were filing for bankruptcy than were graduating from college or getting divorced. When Congress reformed bankruptcy laws two years ago, its aim was to crack down on those who were using bankruptcy as an easy way to escape their debts. The reform made filing for bankruptcy more difficult by requiring debtors with higher incomes to repay more, by making it much more complicated and expensive for all debtors to file, and by increasing the number of debtors who are ineligible for bankruptcy. These reforms caused the number of filings to drop dramatically - from 2 million in 2005 to 600,000 in 2006.
But the reforms had an unintended effect, contends Michelle J. White in Bankruptcy Reform and Credit Cards (NBER Working Paper No. 13265). While bankruptcy filings dropped, financial distress increased. How did this happen?
The answer is that by making it harder for consumers to escape their debts, the new law dramatically reduced lenders' losses from default and bankruptcy. As a result, they started lending more, even to consumers with bad credit. Credit card debt increased more quickly during the past two years than at any time during the previous five years.
Consumers should have responded to the new harsher bankruptcy law by borrowing less, which would have lowered their risk of getting into financial distress. But not all consumers behaved in this rational way. Instead, many behaved shortsightedly and took advantage of the greater availability of credit to borrow more than they could easily handle --- ignoring the risk of financial distress. (Economists refer to this shortsighted behavior as "hyperbolic discounting" - consumers who are hyperbolic discounters intend to start paying off their debts immediately, but each month they consume too much and end up postponing repayment until the following month. So their debts steadily increase.)
The new bankruptcy law exacerbated the problem of shortsighted consumers borrowing too much, because it prevented many of them from using bankruptcy to limit their financial distress. Many consumers in financial distress are unable to file for bankruptcy under the new law, because they cannot afford the costs of filing, cannot meet the new paperwork requirements, or are ineligible. This means that their debts will not be discharged and they will remain vulnerable to creditors' collection calls and to wage garnishment that may take funds they need for basic necessities. Because of the new bankruptcy law, consumers can end up in deeper financial distress than would have been possible before 2005.
Survey evidence presented by White supports the idea that most debtors get into financial distress because of shortsighted behavior, rather than because they behave rationally but experience adverse events. In one survey of bankruptcy filers, 43 percent pointed to "high debt/misuse of credit cards" as their primary or secondary reason for filing. Another survey in 2006 found that two-thirds of those who sought credit counseling before filing for bankruptcy cited "poor money management/excessive spending" as the reason for their predicament, compared to only 31 percent who pointed to loss of income or medical bills.
White argues that lowering the costs of filing for bankruptcy would help debtors who are in the worst financial distress by making it easier for them to file. But changes in bankruptcy law cannot solve the basic problem of shortsighted consumers borrowing too much, since these consumers generally ignore the provisions of bankruptcy law until after they are in financial distress. Instead, White argues that changes in credit market and truth-in-lending regulation are more likely to work because they motivate lenders to lend less to the most vulnerable consumers.
The full version of professor Michelle White's paper can be purchased at http://www.nber.org/digest/nov07/w13265.html (Click on the Paper # link)