Unintended Consequences
We can take some comfort, perhaps, in the idea that laws written by private industry backfire about as often as any other kind. Now we just need an example of the other kind, for comparison..
Credit card issuers and other lenders spent a small fortune to get bankruptcy reform legislation passed. Now the new law is costing them even more.
An unprecedented spike in filings before reform took effect in fall 2005 is chewing into lenders' bottom lines, and the subsequent lull is showing signs of being short-lived.
Credit card issuers and other lenders spent a small fortune to get bankruptcy reform legislation passed. Now the new law is costing them even more.
An unprecedented spike in filings before reform took effect in fall 2005 is chewing into lenders' bottom lines, and the subsequent lull is showing signs of being short-lived.
Tags: Bankruptcy
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Bankruptcy law backfires on credit card issuers
The industry muscled through tough changes that were supposed to make more filers repay some of what they owe. But that isn’t happening.
By Liz Pulliam Weston
Credit card issuers and other lenders spent a small fortune to get bankruptcy reform legislation passed. Now the new law is costing them even more.
An unprecedented spike in filings before reform took effect in fall 2005 is chewing into lenders' bottom lines, and the subsequent lull is showing signs of being short-lived. Bankruptcy attorneys say their caseloads are starting to pick up, and credit counseling agencies -- which provide now-mandatory sessions for consumers who want to file -- say they're seeing significantly more people than they initially predicted.
All this is raising questions about whether lenders will profit as much from the new bill as they hoped.
It wasn't supposed to be this way. The new law contains a “means test” that was supposed to steer higher-income filers toward repayment plans. Lenders expected a rush of consumers trying to beat the bankruptcy deadline, but nothing like the surge that actually occurred. More than 500,000 bankruptcy cases were filed in the two weeks before the law took effect, compared with a normal weekly volume of 30,000 to 35,000. So far this year more than 2 million cases have been filed, 49% more than the same period last year and eclipsing all previous records.
"I think the actual magnitude really surprised some people," said Cynthia Ullrich, a director in the Fitch Ratings credit card group. "The feedback we received (from credit card issuers) is that it was larger than anticipated."
The hurting begins
Once a consumer files bankruptcy, lenders have 60 days by federal law to "charge off" the filer's accounts -- essentially recognizing that the debt is uncollectible and taking the loss. Fitch predicted the charge-off rate for major issuers could rise more than 30% to 7.5% in the next few months, compared with 5.7% of accounts currently.
Some issuers have already admitted their pain:
* J.P. Morgan Chase & Co., the nation's largest credit card issuer, said its charge-off volume would rise 44% in the fourth quarter to $2.3 billion from $1.6 billion for the same period a year ago.
* Capital One warned its charge-off rate could rise up to 1 percentage point from the year's previous range of 4.05% to 4.14%.
* Discover said it expected the bankruptcy surge to add $250 million to its costs.
Lenders initially said that the rush of filers merely accelerated losses that would have happened anyway -- that people essentially decided to file sooner, to beat the deadline, rather than a little later.
Indeed, filings dropped sharply to 9,447 the week following reform, according to Lundquist Consulting.
But the following week, filings rose to 14,291. Some of those cases appear to be backlog -- filings under the old law that courts are just getting around to reporting -- but the numbers are expected to climb as weeks pass. How far is the question.
Counselors see lots of traffic
Sam Gerdano, head of the nonpartisan American Bankruptcy Institute, said he wouldn't be surprised if filings remain extremely low at least through the first half of the year.
"We could be seeing records in the other direction," Gerdano said, "with filing numbers we haven't seen since the 1980s."
But some believe the respite will be shorter than lenders hope.
"There was a real lull for awhile, but we're starting to pick up again," said Los Angeles bankruptcy attorney Leon Bayer. "We're getting back to normal now."
Credit counselors report a similar uptick. Demand for pre-bankruptcy counseling, which is now required before consumers can file, has been unexpectedly strong at the 71 agencies affiliated with the National Foundation for Credit Counseling that have been approved by the Department of Justice to provide such services, said foundation President Susan Keating.
"The volume is significantly higher than their original projections," Keating said. "We originally expected our client volume of 1 million to double in 2006 (because of the new requirement). Now we're thinking we may be looking at even more."
Few able to repay
Bankruptcy attorneys and many consumer advocates worry the counseling requirement will allow agencies to divert potential filers into debt repayment plans that the debtors can ill afford. But Keating said her agencies, which currently represent 80% of the counselors approved by the Justice Department, aren't seeing many clients who have the ability to repay their debts.
"The conversion rate of customers who are eligible to go into an alternative, a debt-management plan, has been very, very low," Keating said. "These customers are really in serious financial trouble and have no alternative other than filing for bankruptcy."
That's certainly been true at Riverside, Calif.-based Springboard, which counseled 2,200 pre-bankrupts between Oct. 17 and Nov. 28, said President Dianne Wilkman. Wilkman said her counselors, who mostly talk with customers by phone, sometimes have to strain to average the 90 minutes the Justice Department requires of pre-bankruptcy counseling sessions because their clients' situations are so cut and dried.
"After 45 minutes you're left with saying, 'So, what about those Dodgers?'," Wilkman said. "But then with other clients with more complex situations, you use much more than 90 minutes."
The bottom line?
Even if filings don't return to previous levels, the reform law may not contribute much to lenders' bottom lines. Fitch and Barclay Capital have predicted charge-off rates will "normalize" to usual levels, but won't drop.
"If a consumer can't pay their bills, they might not file for bankruptcy" but their accounts will still be charged off, Fitch's Ullrich said.
Lenders may recoup some money from filers who are forced into Chapter 13 repayment plans rather than being allowed to erase their debt in Chapter 7 bankruptcy. But the dollar amount recovered may not be significant, given the small number of bankrupts that will be diverted to Chapter 13 -- less than 3%, by Gerdano's estimate -- and the high number of Chapter 13 plans that fail. Under the old law, about two-thirds of Chapter 13 cases never completed their repayment plans; that percentage isn't expected to change much under the new law, Gerdano said.
"The official word is that (lenders are) still confident the law will have its desired impact" of reducing bankruptcy filings and increasing repayments, Gerdano said. "But it may take a year before you know who really won and who really lost."
For more on the new bankruptcy law and how it works, visit MSN Money's Decision Center on bankruptcy.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
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