Cracks In The Facade

On the bankruptcy debate, a small amount of light is beginning to shine on a position held dearly by the "Reality Based Community".

Jon Chait, LA Times:  "The more likely explanation [for the increase in bankruptcy filings] is that the rise in health insurance costs has driven more people into bankruptcy. A recent Harvard study found that half of Americans who declared bankruptcy did so because of illness or medical bills."

E. J. Dionne, Washington Post: "[Harvard law professor Elizabeth] Warren and her colleagues surveyed Americans in bankruptcy courts and found that half said illness or medical bills drove them to bankruptcy."

Paul Krugman, NY Times: "One recent study found that more than half of bankruptcies are the result of medical emergencies."

Noam Scheiber, TNR: "As Paul Krugman pointed out today, the bill makes no exceptions for families wiped out by medical expenses (which make up more than half of all bankruptcies)..."

NY Times story: "A recent study by bankruptcy and medical experts at Harvard University found that more than half of the 1,771 personal bankruptcy filers in five federal courts cited medical bills as a primary reason they filed."

Could all of these sources be wrong?  Law professors Todd Zywicki and Gail Heriot critiqued this study a while back.  Professor Warren of Harvard has been guest-blogging on the bankruptcy bill at Josh Marshall's site, and does not seem to have responded to either Zywicki or Heriot (and isn't it great for Googlers that the rebuttals were not offered by Professors Johnson and Smith?).

And finally, reality is beginning to seep in to some of the bastions of the Reality Based Community.  The NY Times Week in Review discussed the bankruptcy bill, and provided this:

Elizabeth Warren, a law professor at Harvard, is the co-author of a study arguing that more than half of all bankruptcies are linked to medical costs (the study is controversial in part because its trigger for medical expenses is just $1,000). In Senate testimony, she said, "Most debtors are filing for bankruptcy not because they had too many Rolex watches and Gameboys, but because they have no choice."

But Todd J. Zywicki, a professor at George Mason University School of Law, said that financial distress cannot explain the surge in personal bankruptcies in the 1990's. They were not preceded, he said, by equally steep increases in unemployment, divorce or health-care costs.

Professor Zywicki has a number of theories on why bankruptcies have increased, but if asked to rank them, he said that the No. 1 would be "the generosity of the bankruptcy code - it makes it so easy."

And the Washington Post ran a belated response from Gail Heriot which read, in part:

In "A Bill Bankrupt of Pity," E.J. Dionne [op-ed, March 1] claims that a recent study on bankruptcy found that half of bankruptcy debtors "said illness or medical bills drove them to bankruptcy." In fact, the study, "Illness and Injury as Contributors to Bankruptcy," found no such thing. The number of actual debtors who said that illness or injury was even a significant cause of their bankruptcy was much smaller (28.3 percent). And many of those had quite modest medical bills and missed very little work.

To be able to claim that half of all bankruptcies had a medical cause, the authors had to include a number of dubious case categories, including bankruptcies caused by chronic gambling, alcohol and drug addiction, and birth or adoption, as well as all cases in which the debtor had paid more than $1,000 in medical bills over the two years leading up to the bankruptcy.

Ms. Heriot has some blog commentary as well at he Right Coast, and includes this poignant thought - "I had hoped that having a blog would avoid the need to write letters to the editor...".  Darn.  But hey, she got her letter published!

Now, the medical argument being wrong does not mean the critics of the bill are wrong.  And is the medical argument wrong?  At this point, I have not seen anyone rise in its defense, but the day is young. 

In any case, we are always fascinated by the reaction of the "reality based community" to a study which seems to meet their political needs.  The Stassen study purporting to show that abortion increased under Bush was not exactly convincing, but it convinced some Dems.

And while we are on the subject of the difference between evidence and unsupported assertion, perhaps we can take up a second popular talking point on the bankruptcy bill.  Let's see, here is Krugman again:  "To the extent that there is significant abuse of the system, it's concentrated among the wealthy - including corporate executives found guilty of misleading investors - who can exploit loopholes in the law to protect their wealth, no matter how ill-gotten.

One increasingly popular loophole is the creation of an "asset protection trust," which is worth doing only for the wealthy."

Chait, again:  "The worst abuses are loopholes allowing corporations or wealthy individuals to declare bankruptcy and keep millions of dollars safe from creditors. One such device is something called an "asset protection trust" — a kind of savings fund that can't be touched by creditors."

The NY Times editors:  "Contrast that with the bill's gaping "millionaire's loophole," detailed by Gretchen Morgenson of The Times. The bill spares this popular gimmick, which lets wealthy people file for bankruptcy yet still protect major resources in five states that cater to sheltering assets from creditors in special trusts."

Indeed, let us contrast that with the research provided by Gretchen Morgenstern.  Who is using these trusts?

Asset protection trusts have become increasingly popular in recent years among physicians, who fear large medical malpractice awards, and corporate executives, whose assets are at greater peril now because of new laws. The Sarbanes-Oxley legislation, for example, requires chief executives and chief financial officers to certify that their companies' financial statements are accurate; anyone who knowingly certifies false numbers can be fined up to $5 million.

Hmm, were these issues back when the earlier version of this bill first passed in 1998?

Perhaps because the current bill was written so long ago, some legal authorities say, it does not address the new state laws that have allowed asset protection trusts to flourish.

And are these trusts "flourishing?

While it is difficult to quantify how much money is sitting in domestic asset protection trusts, their popularity is undeniable, bankruptcy specialists said. "I've heard figures for foreign asset protection trusts and those probably are in the billions," said Adam J. Hirsch, a law professor at Florida State University. "I haven't seen any figures for domestic asset protection trusts, but they could very well be the same."

They could be the same?  They could be TEN TIMES AS LARGE!  Or not.

Now, do these trusts actually produce the legal result claimed by their promoters?

Money held in asset protection trusts can elude creditors because federal bankruptcy law exempts assets governed by "applicable nonbankruptcy law." Intended to preserve rights to property under state law, the exemption makes it difficult for creditors to get hold of assets that they would not be able to seize through a nonbankruptcy proceeding in state court.

Emphasis added, and wait a second - do they know if these assets will be protected, or are the legal eagles just guessing?  This website says that these trust are essentially the latest marketing gimmick of the estate/insurance promoters, and probably won't hold up to a serious legal challenge:

The Domestic Asset Protection Trust (“DAPT”) was created largely as a marketing tool to attempt to exploit the growing market for the Foreign Asset Protection Trust (“FAPT”). After the Anderson and Lawrence cases,   the FAPT went out of vogue, and many planners are now advocating the use of DAPTs as a primary asset protection planning vehicle for clients. However, as with the FAPT before it, the benefits of the DAPT are largely theoretical, and as of this writing there have been no significant court cases validating the benefits of DAPTs in tough debtor-creditor situations.

Emphasis again - no significant cases?  A similar point is made here.

As to the notion that these trusts are the exclusive province of "the rich", we see that $2,500 per year will be enough to get the good people at Capital Trust in Delaware on your side (minimum balance for an asset protection trust - $10,000).  Just so you know, $2,500 per year will not buy a lot in the way of private jets and yachts.

I have a suggestion: just out of respect for the process, couldn't someone from the Reality Based Community invent some evidence for the rest of us to rebut?  Even a supporting anecdote would be fine.  Right now, the Times and others are fretting about something that has not happened, may very well not be possible, and, in any case, is surely not driving the increase in default s or charge-offs on consumer debt.

Better talking points, please.

MORE: Todd Zywicki gets space in the NRO to defend the bankruptcy bill.  Hmm, conservatives never figured to be monolithic on this.

UPDATE:  Let's hear from both sides - Bizzyblog responds to Zywicki's NRO column.

Comments

[Paul Zrimsek]

To raise again a point I made on the earlier thread: even assuming that asset-protection trusts have been a means of abuse in the past, are they going to be any use once the law is changed to means-test upper-income filers out of Chapter 7? It's hard to see how shielding assets is going to accomplish anything important in a Chapter 13 bankruptcy.

[TM]

Good point. I suppose the filer could just file and quit their job, but if they keep working, Ch. 13 will focus on income, not assets.

[Jimminy]

Linguists have been able to reconstruct (presumed elements of) the ancient Proto-Indo-European language by comparing the modern versions of its descendant languages.

Anyone care to pick up the ball from Tom and reconstruct the proto-talking-points-memo that must have been the common ancestor of the bankruptcy editorials that he references above?

[Bandit]

'found that half said illness or medical bills drove them to bankruptcy."'

They made no mention of assuming huge mortgages, home equity loans and running up credit card and other personal debts.

[Nell Lancaster]

There's a response to the Zywicki argument here. It seems more soundly based than the assertion that half of bankruptcies are caused by medical bills.

[TM]

Yeah, I like that rebuttal. Regardles of phoney arguments being offered by bill opponents, one might still ask - what is the need for this new bill?

The numbers do not exactly show an industry in crisis.

[TC]

I agree - where is the need for the new bill?

I am concerned about the aggressive pushing of credit, especially by commission earning mortgage brokers. If the money dealers are not going to be restrained, it seems unfair to limit the spendthrift borrower’s access to Ch 7. Imprudence, gullibility, and greed should not be grounds for a sentence of enforced penury.

[Robert Schwartz]

I have many years of experience in the consumer credit business. I said it before and I will say it again. This is a bad bill. It was bought and paid for and is exclusively for the benefit of the Credit Card Companies. it will not save you a nickle, ever. That this has anything to do with Credit Card interest rates is absurd. The Credit Card Companies won the right to charge the rates they charge in the early 1980s when the prime rate was bumping 22%. Have they lowered their rates now that prime is 4.5% and they are funding their credit card loans with market money at 2 or 3%?

It shines and it stinks like mackerel rotting in the moolight.

[The Sophist]

Nell, TM and TC -

I too appreciated the Bizzyblog rebuttal, especially from a moral judgment standpoint, but I felt he didn't address some of the most powerful arguments of Prof. Zywicki.

I was on the fence on this one for a while, but Zywicki convinced me of the overall soundness of this particular reform. I mean... what are we worried about with this bill? Surely not the anti-fraud provisions, or the priority of payments provision (alimony and child support moving up to #1 in priority), right?

Seems to me most critics are afraid that some debtors won't be able to take advantage of Chapter 7 and will be forced into a Chapter 13 filing.

But as Zywicki points out, under a Chapter 13 filing you still get a discharge at the end of the court-administered period of 3 - 5 years.

Further, even this forcing of people into Chapter 13 is subject to a means-test which seems pretty fair to me:

The most important and controversial provision of the legislation is the “means-testing” of chapter-7 bankruptcy relief.... To calculate the debtor’s available “disposable income,” [in a Ch 13 filing] a judge uses his own subjective preferences to determine the debtor’s allowed living expenses.

The means-testing provisions of the bill will bring some rationality to this system. Those who make above the state median income (adjusted for family size), and can repay a substantial portion of their debts without significant hardship, would be required to file in chapter 13. At the end of the chapter-13 plan, this high-income filer would still get a discharge, just as other bankruptcy filers do. There is no “endless treadmill of payments,” just a requirement that high-income debtors repay what they can.

In determining whether the debtor can repay a substantial portion of his debts, the legislation makes allowances for a whole range of expenses right off the top. First, it creates a standardized slate of expenses based on the relevant family size and regional cost of living, for such things as clothing, food, transportation, etc., eliminating the subjective judicial navel-gazing of the current system. It then subtracts from your income all of the debtor’s actual payments on secured debts, such as a home mortgage, car loan, or the like. The debtor can subtract any actual expenses for health care for himself or a dependent, as well as payments for health insurance premiums. Finally, there is an allowance for children’s educational expenses. If after subtracting out all of these expenses, the debtor still can repay $10,000 or 25 percent of his debts over a 5-year period, then he would be presumed to have to file in chapter 13.

The debtor could rebut this presumption by showing “special circumstances” that make it too much of a hardship to file in chapter 13, in which case the debtor would still be permitted to liquidate his debts in chapter 7.

Seems pretty generous in terms of determining whether a debtor would have adequate income to be forced into Chapter 13.

Subtracting actual payments for secured debt (the most important debts of any person or family -- mortgage and car, and in some cases, furniture and appliances) is a pretty important concession, as is deducting medical and healthcare costs, as well as educational costs. I'm hard pressed to think of someone who has these things as a victim of avaricious credit card companies driven to file for bankruptcy, when... oh no, instead of Ch 7, he has to file under Ch 13 and repay some of his debts!

I mean, seriously, is anyone who is able to pay $10,000 or 25 cents on the dollar over 5 years after the above allowances someone who is properly described as the poor wretched victim of predatory sub-prime lenders?

But, the means-test affects a small percentage of bankrupt filers in any event:

So how many people would be affected by means-testing? The estimates are that some 7-11 percent of current bankruptcy filers would be affected by the means-testing provisions of the bill. Roughly 80 percent of bankruptcy filers earn below their state median income, and so will get tossed out of the means-test immediately. For that 80 percent — roughly 1.2 million of the 1.5 million bankruptcy filers last year — the means-test will be completely irrelevant. They will be permitted to file chapter-7 bankruptcy just as under the current system. Roughly half of the remaining 20 percent of filers won’t be able to repay enough of their debt to meet the repayment criteria, so they will be dropped out as well and be permitted to file just as today. So in the end, only the highest-income filers with the largest repayment capacity will be affected.

So apparently, those folks who are financially in bad shape, and presumably really can't pay, won't be affected by means testing at all. To get all hot and bothered because of the rich bankrupts'seems a little odd, to say the least.

And then we learn that just in case all this protection wasn't enough, the means-tested Ch. 13 requirement is merely a rebuttable presumption, so if your circumstances dictate it, you can get out of it.

It seems a stretch to describe this as "enforced penury".

As for the need for reform, well, too many people seem to believe that without these reforms, the credit companies will just suck it up and write down the bad loans, then take that out of the CEO's paycheck. A common theme seems to be, "Stick it to the money men!" Sadly, the truth is far closer to Zywicki's point that these costs for bad loans and bankruptcy writedowns are passed on to those of us with good credit. I'd say that presents a need to stop fraud and wealthy bankrupts taking advantage of the system.

One last note -- Bizzy's respond was significantly weakened, I thought, due to his focus on secured lending, such as mortgages and car payments. Those wouldn't be affected much if at all by these reforms, I believe, as they are secured by the underlying home/car/asset.

-The Sophist

[TM]

Good job, Sophist - have you got a blog?

My (casual) impression is that supporters of this bill are laying in the weeds, figuring it will pass anyway.

But if someone can find a table-pounding supporter, bring 'em on!