Understanding the “Bankruptcy Monster”
If you follow the news at all, you're probably familiar with some of the problems plaguing the U.S. economy right now: rising unemployment, falling home prices, increasing rates of bankruptcy and foreclosure, etc. But you may not be as familiar with why all this is happening now – why it seems our economy is primed for a significant slump.
One writer for MSNmoney.com has claimed that lenders paved the way for economic conditions like these – and in many ways, she's right. Here's what happened.
In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) took effect. The legislation introduced new requirements for those interested in filing bankruptcy under Chapter 7 and added fees & requirements for all bankruptcy filers.
Why BAPCPA Passed
BAPCPA passed in 2005 largely because of tens of millions of dollars spent by lobbyists in the lending industries, who wanted the laws in place so fewer people could "abuse" the bankruptcy system. In fact, sources indicate that very few people filed bankruptcy without genuine need – the vast majority of filers, even before the new law, truly needed the protection bankruptcy offered.
No Lender Restrictions
What BAPCPA didn't introduce, as MSN points out, was restrictions on how lenders could operate.
So, while the economy was booming and credit was easy to come by, lenders had few limits (or few enforced limits) on their lending practices. While many consumers took on more debt than they could handle, they couldn't have done so without the willingness of lenders of all sorts (credit card, mortgage, home equity, etc.).
In addition to a sort of lending free-for-all, experts testifying in front of the U.S. Senate have reported the charging of excessive mortgage fees, miscalculation of how much borrowers owe and the forcing of homeowners into foreclosure, even if they're not behind on their mortgages, sources indicate.
Bankruptcy Court: No Mortgage Modifications
And here's the icing on the cake for mortgage lenders: bankruptcy courts are not allowed to modify the terms of mortgage loans.
While this restriction sounds absurd in today's world of subprime mortgages gone awry, where many families are filing bankruptcy exactly because they can't afford their mortgage payments, it made sense at the time it was first included. In an effort to promote homeownership and protect the newly-created Federal Housing Administration (FHA), New Deal-era legislation prohibited mortgage modifications in bankruptcy court.
In the subprime environment, though, that law had the effect of allowing mortgage lenders to get away with what many experts consider predatory lending practices.
The Bankruptcy Monster
The result of all these forces was what MSN's writer dubbed the "bankruptcy monster." Basically, here's what happened when consumers were told that BAPCPA would be passed, and introduce scads of new restrictions and requirements for those interested in filing bankruptcy:
- CONSUMERS: Uh-oh, we'd better file bankruptcy before BAPCPA takes effect, so we're sure to qualify. (More than two million consumers file bankruptcy in 2005, a record. As a result, few people file bankruptcy in the following months, because those who would have already filed.)
- LENDERS: See? Fewer bankruptcy filings. Our law works!
- ECONOMY: (nose dive)
- CONSUMERS: Uh-oh, we're in way more debt than we can handle. Luckily, we still qualify for bankruptcy with the BAPCPA restrictions. (Consumers file bankruptcy in greater and greater numbers.)
- ANALYSTS: Wait a minute, that law didn't work! Now that the initial pre-BAPCPA rush is long over, bankruptcy filings are steadily approaching their pre-BAPCPA levels!
So, in a way, lenders helped create this "bankruptcy monster:" they offered consumers such vast amounts of credit that, even with the restrictions imposed by BAPCPA, most consumers who needed to file for bankruptcy protection still qualified.
The Good News
Luckily, federal regulators and bankruptcy judges are starting to take action to combat the negative impact of shady lender tactics. Here's a summary of bankruptcy-related news that should benefit consumers:
- The state of Illinois is suing Countrywide for its predatory lending practices during the housing boom.
- Sources note that a California judge ruled that a couple in bankruptcy was not responsible for their mortgage payments, since obviously fraudulent information in their application should have acted as a red flag to the lenders. In other words, the lenders were responsible for sloppy underwriting.
- Federal regulators are reportedly beginning to investigate and limit certain abuses in the credit card industry.