Let's punish lenders of easy credit

By Liz Pulliam Weston

The bankruptcy-reform law of two years ago should be renamed the Drive More People Into Bankruptcy Act of 2005.

As you probably know, the law sent bankruptcy cases to record highs that year, as nearly 2 million people rushed to file before tough new restrictions went into effect. But the law continues to have unintended consequences.

Credit card companies and other lenders have used the law as an excuse to crank their wide-open spigots even wider. During the first year of the law's implementation, bankruptcy researcher Michelle White notes, revolving debt per household rose at a real rate of 4.6%, the steepest increase in five years.

• Talk back: What should be done about the bankruptcy mess?

"Because (the legislation) changed bankruptcy law in a pro-creditor direction, credit card issuers responded by expanding the supply of credit," White wrote last summer in a working paper for the National Bureau of Economic Research. "But more credit card loans combined with reduced access to debt relief in bankruptcy seems certain to result in severe financial distress for at least some debtors."

High risk for you, not for them

Credit card issuers continue to intensify their marketing efforts. They mailed 363 million card offers to so-called high-risk households in the third quarter of 2007, according to research firm Synovate, up from the 347 million offers in the second quarter. (See "Risk your house to save your credit cards?") High-risk households are those that have tapped more than 30% of their available credit lines, and they receive, on average, six new credit card offers a month.

We're already seeing the fallout from this credit binge:

• Credit card default rates have spiked. In the first five months of this year, credit card companies wrote off 4.6% of payments as uncollectible, according to data from Moody's Investors Service, up nearly 30% from the corresponding period in 2006. Late payments also have risen.

• Bankruptcy filings are soaring. The number of cases filed this year is running 40% higher than last year, according to the U.S. Justice Department. More cases were filed in the first nine months of 2007 than in all of 2006.

• The real-estate mess will add to people's woes. Falling home prices and soaring foreclosures will push more borrowers into distress. Fewer people now can borrow against home equity to pay off credit card debts. Many will seek bankruptcy as they try to keep their homes or to avoid being sued by lenders if the mortgages on their lost homes exceed the properties' value.

Relief isn't cheap or easy, however. The 2005 law basically doubled the cost of a typical Chapter 7 liquidation filing to about $2,500, including legal fees, and boosted the cost of a Chapter 13 repayment to about $3,500. The increased fees and paperwork mean it takes longer to pull together the typical case, and that's just how lenders want it.

"Any delay by debtors in filing for bankruptcy, even if only for a few months, benefits lenders," White wrote, "by giving them additional time to harass debtors with collection calls, persuade them to make payments on credit card loans even though the loans would be discharged in bankruptcy and collect part of their earnings using wage garnishment."

White, an economics professor at the University of California, San Diego, isn't exactly a "free the people" softie when it comes to bankruptcy law. She notes that many people bring financial ruin upon themselves by abusing credit cards and over-borrowing in general. She's among the economists who assert that credit card abuse, rather than job loss, medical bills or divorce, is the leading cause of bankruptcy. And she says the U.S. still has the most pro-debtor bankruptcy laws in the world.

But even she tacitly acknowledges creditors got a free ride with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Though the law cracked down on debtors, it did nothing to rein in the credit card issuers and other lenders whose practices helped fuel the bankruptcy boom.

Continued: A look at the numbers

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