Blog sponsored by Bankrupt-Law.com


Increase comes even though more stringent standards were adopted in October;
lenders watch closely.
June 12, 2006: 7:14 PM EDT


WASHINGTON (Reuters) - A new U.S. law to deter American consumers from
seeking bankruptcy protection made filings plunge to a 20-year low in the
first quarter of 2006, but a rapid rise in new cases since then raises
questions about whether the law is working as expected.
The 2005 bankruptcy reform law was pushed through Congress by banks and
credit card companies that sought to prevent abuse by individuals trying to
wipe their financial slates clean from runaway debt.
By making it more difficult to file for personal bankruptcy, the companies
reasoned that consumers would be more likely to negotiate a repayment plan.
"I think the law so far is working as it was intended," said James Chessen,
chief economist for the Washington-based American Bankers Association trade
group. "Some of the abuses have been wrung out of the system."
But credit card companies and banks are keeping an eye on the recent
increase in filings.
The law took effect Oct. 17, 2005, prompting a surge of 619,322 personal
bankruptcy filings for that month as debt-laden consumers rushed to court.
New cases plunged to 13,758 in November, then rose to 21,636 in December,
27,235 in January, 35,352 in February and 49,977 in March, according to the
Administrative Office of the U.S. Courts.
That compares to the monthly average of 130,183 new cases in 2004.
Some experts say the upward trend is likely to continue, but it may take
several more months before a clearer picture emerges.
"Some people think that merely reducing the number for filings regardless of
who they are and what kinds of problems they have is a success," said
Melissa Jacoby, a bankruptcy law professor at the University of North
Carolina.
"Other people think that the bill will only be successful if it keeps out
abusive filers and allows legitimate filers to continue to use the system
successfully," Jacoby said. "If really, the only question is whether filings
stay lower, then my suspicion is that it will be unsuccessful in that
regard."
For homeowners, ARMs pose a danger
The uncertain U.S. economy is a key factor in personal bankruptcies.
"We are starting to see more bankruptcies being filed. They're taking
longer, they're more complicated," said Maureen Thompson, legislative
director of the National Association of Consumer Bankruptcy Attorneys.
"These numbers will continue to creep up as people face a number of economic
factors."
Those factors include traditional ones, such as poor money management, loss
of a job, medical expenses and divorce. But some consumers are also falling
behind on monthly mortgage payments as interest rates continue to rise.
Other homeowners may be overextended with adjustable-rate mortgages, or
ARMs, which could reset soon. At the end of 2005, almost a quarter of all
outstanding home loans were ARMs.
"We're going to start to feel those numbers this year and next," said Jeffry
Taylor, economist at the National Association of Federal Credit Unions in
Arlington, Virginia.
More than $300 billion in ARMs are subject to interest rate resets this year
and that figure is expected to reach $1 trillion in 2007, according to DB
Global Markets Research.
Not all ARMs will be problematic, Jacoby noted, adding: "But still, that's a
lot of loans that are going to be in default risk."
Another emerging trend is consumers' stubborn preference for filing for
bankruptcy protection under Chapter 7, rather than Chapter 13.
Under Chapter 7 protection, a filer's assets are liquidated and proceeds are
paid to creditors, wiping away the debt. Under Chapter 13, a filer with a
steady income can keep assets such as property, but must enter into a
multi-year repayment plan.
In February, 19,591 new cases were filed under Chapter 7, and 15,761 under
Chapter 13. The gap widened in March, the most recent month for which
statistics are currently available.
Banks watch bankruptcy trends
Banks have also sought to make bankruptcy filings more difficult because of
their impact on earnings.
In the first quarter, U.S. banks reported record profits, due in part to
fewer losses from unpaid credit card loans, according to the Federal Deposit
Insurance Corp.
Charge-offs from those loans rose significantly in the last three months of
2005 when there was a surge in last-minute bankruptcy filings before the law
changed. But charge-offs then fell 32.5 percent, or $1.4 billion, in first
quarter of 2006.
Before the new law took effect, lenders such as department stores, mortgage
companies and credit card companies lost an estimated $60 billion annually
due to bankruptcy filings.
"Bankers are monitoring the numbers very closely to ensure that the law
accomplished what it was passed to accomplish," said Patricia Milon, senior
vice president of America's Community Bankers, a Washington trade group.
"Bankers feel what was passed was very balanced," she said. "There should be
no backsliding."
The bankruptcy law also created various income tests, including a "means
test" to determine if an individual is eligible for Chapter 7. The test is
triggered if the debtor's monthly income is above the state median.
Another provision requires financial counseling before a bankruptcy filing
and again before debts are discharged.
Debtors also face steeper court fees for bankruptcy filings. The fee for
Chapter 7 rose to $299 from $274, while the Chapter 13 fee increased to $274
from $189.
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