Study Shows that 2005 Bankruptcy Reform Helped Credit Card Companies, Not Consumers
The most important legal change to the US bankruptcy code since it was enacted in 1978 was the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (or BAPCPA for short), headed by Senator Chuck Grassley of Iowa, passed by the 109th Congress and signed into law by President George W. Bush in April of 2005. (The provisions of the bill went into effect in October of 2005.)
As is typical of similarly worded legislation, the "Consumer Protection" mentioned in the title actually helped creditors and the lending industry, and consumers only indirectly, or by extension. Essentially, the bill made it more difficult for consumers to file bankruptcy by requiring a means test, providing fewer automatic protections for filers, adding fees and paperwork requirements, and mandating that filers complete a debtor education and credit counseling course.
Of course, the claim here was that by making the requirements for filing bankruptcy more stringent and therefore weeding out filers who might be exploiting the bankruptcy system, consumers would win out by seeing lower interest rates and cheaper credit in the future, as banks and lending institutions were able to protect more easily against the risk of default or non-payment. They would pass on their savings to consumers, the story went.
A recent study has focused on this promise of BAPCPA to make credit cheaper for consumers. Three years later, Harvard Economics professor Michael Simkovic asked in his research, did the promise pan out? Has BAPCPA resulted in lower prices in terms of fees and interest rates for consumer credit?
In order to determine the effects of BAPCPA, Simkovic simply sifted through data from the past couple of years to determine if its implementation impacted a number of categories related to consumer credit, including number of personal bankruptcies, credit card lender charges, late fees, over-limit fees, interest rates and grace periods, all numbers that are easy to find and empirical in nature. In order to make sure, however, that no outside factors are influencing the comparison, Simkovic added objective factors to control for outside influence (such as tracing the risk-free rate determined by five-year Treasury yields).
Simkovic found, first of all, that after BAPCPA was passed, both personal bankruptcies and credit card company losses "sharply declined." His data showed a drop from the mid-600,000s in personal bankruptcy filings to the mid-100,000s, a plunge of around half a million filers! Similarly, the losses sustained by credit card companies dropped by 25% in 2006 compared to 2005, and by 15% in 2007 compared to 2005. Both percentage drops in losses are significant, and bear out the promises of lawmakers of the effects of the bill that a drop in bankruptcy filings would mean fewer losses for credit card companies.
The real question, however, is did these significant drops in losses mean savings for consumers? Not surprisingly, over-limit fees and late fees have been steadily climbing for years, and, according to Simkovic's research, this climb was unaffected by BAPCPA. Specifically, late fees increased by 5% from April 2005 to December 2007, and over-limit fees increased by 17% over the same period. (These are the most common fees associated with consumer credit cards; data quoted in Simkovic's data suggests that 35% of credit card users were charged late fees in 2005.)
Interest rates, however, would be the most likely to be affected by BAPCPA overall, since they account for 70% of credit card company revenue. And it makes sense that less chance of losses for the company would push them to lower interest rates, since interest rates are easier to compare when shopping for a credit card than fees, which can be hidden in fine print and difficult to find.
However, Simkovic found that interest rates rose by 8% during the period of his study, April 2005 to December 2007. When compared to his baseline rate to compensate for rises due to natural growth of the economy, Simkovic found that the average APR and the risk-free rate diverged greatly. The risk-free rate actually dropped in that period by 12% after passage of BAPCPA.
If APRs on standard credit cards had followed the risk-free rate, they would have dropped from 17.7% in April 2005 to 17.3% in December 2007, a small but easily measurable drop that would have saved consumers money. Instead, they saw the 8% growth rate mentioned above.
Clearly, the promise of BAPCPA, to decrease losses by credit card companies and other consumer lending institutions, was fulfilled, but not to the benefit of consumers. While consumers saw increases immediately following the effective date of BAPCPA, credit card companies saw record profits in the order of $10 billion across the industry.
To be sure, the study window was very short, and long-term trends could still swing in favor of consumers in the upcoming years. But the borderline recession of 2008 coupled with all the other ills of the US economy has made credit harder to get for consumers, not easier. And when credit card companies have gotten used to tasting such escalating profits, it's hard to imagine they'd go on a diet for the benefit of the average cardholder.