The goals of the controversial 2005 Bankruptcy Reform were to both lower the number of those filing bankruptcy and also to increase the amount recovered post bankruptcy by forcing consumers into Chapter 13 bankruptcies. Seeing the latest data, it is clear that both of these goals have been failures - however the unique way in which they have failed is worth investigating.
2005 Bankruptcy Bill: Post-Mortem
One of the goals of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act
was to bring down the number of bankruptcy filings, which had ballooned
during the mid-1990s. Let's look at the latest in consumer bankruptcy
filings numbers. I know the numbers are small -- you can see a bigger picture here -- but just know that the X-axis ranges from 1998 to 2009 and that parabola-like spike happens in the last half of 2005.
This graph is taken from Option Armageddon here, and I'm going to let Rolfe call it like he sees it:
By the way, when economists talk about "pulling demand forward," this is the kind of dynamic they have in mind. What Cash4Clunkers did to demand for cars, what the first-time homebuyer credit is doing for home sales, the Oct '05 law did to demand for bankruptcy filings -- to a much greater degree.
More recently, bankruptcies have flat-lined around 120K per month. I suspect they will trend higher over the next few years as lower home values make it difficult/impossible to refinance debts using home equity. Obviously higher unemployment won't help either...
Yes, it seems very clear that bankruptcies were high right before the reform went into place to take advantage of the old regime, and then dropped to reflect this move in demand. Supporters of the bill called an early victory, saying that this drop would be permanent. However the rate, with a time lag, has returned to the previous equilibrium. That time lag is important; we'll discuss one reason the mean-reversion in this graph has taken some time in a minute.
Another goal was to shift consumers from Chapter 7, which wipes your debt, to Chapter 13. Chapter 13 puts you on a payment plan, especially if you have high income relative to your debts, and thus allows greater recovery to those who are owed money. How has this transition gone?
From credit slips, we get this graph:
So the idea that we'd transition bankruptcy from chapter 7 to chapter 13 also has turned out to be a bust. In so much as the goal of the bill was to deter risky borrowing ex ante (and thus reduce filings) or increase bankruptcy payouts ex post (by moving people to chapter 13), it was a failure. Since lobbying is costly, if you were the CEO of a credit card or financial company, would you have fired the team responsible for writing this bill for Congress?
Actually no, you'd give that team a giant raise.
This is the argument Ronald Mann builds on in his provocative paper Bankruptcy Reform and The "Sweat Box" of Credit Card Debt. His argument is that the bankruptcy reform bill wasn't about ex ante filing reductions or ex post recovery increases; it was about delaying the actual time it took to begin a bankruptcy claim. Many of the features of the bill -- including 'credit counseling', raising filing fees, debt-relief agencies, etc. -- are designed to raise the time barrier between financial distress and the act of filing a bankruptcy. And what happens during that time? The person in question is paying triggered high-interest rates on credit card loans.