SPEAKERS CONTENTS INSERTS Tables
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62–437
2000
BANKRUPTCY REFORM ACT OF 1999
(PART I)
HEARING
BEFORE THE
SUBCOMMITTEE ON
COMMERCIAL AND ADMINISTRATIVE LAW
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
ON
H.R. 833
MARCH 16, 1999
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Serial No. 10
Printed for the use of the Committee on the Judiciary
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
COMMITTEE ON THE JUDICIARY
HENRY J. HYDE, Illinois, Chairman
F. JAMES SENSENBRENNER, Jr., Wisconsin
BILL McCOLLUM, Florida
GEORGE W. GEKAS, Pennsylvania
HOWARD COBLE, North Carolina
LAMAR S. SMITH, Texas
ELTON GALLEGLY, California
CHARLES T. CANADY, Florida
BOB GOODLATTE, Virginia
ED BRYANT, Tennessee
STEVE CHABOT, Ohio
BOB BARR, Georgia
WILLIAM L. JENKINS, Tennessee
ASA HUTCHINSON, Arkansas
EDWARD A. PEASE, Indiana
CHRIS CANNON, Utah
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JAMES E. ROGAN, California
LINDSEY O. GRAHAM, South Carolina
MARY BONO, California
SPENCER BACHUS, Alabama
JOE SCARBOROUGH, Florida
JOHN CONYERS, Jr., Michigan
BARNEY FRANK, Massachusetts
HOWARD L. BERMAN, California
RICK BOUCHER, Virginia
JERROLD NADLER, New York
ROBERT C. SCOTT, Virginia
MELVIN L. WATT, North Carolina
ZOE LOFGREN, California
SHEILA JACKSON LEE, Texas
MAXINE WATERS, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ROBERT WEXLER, Florida
STEVEN R. ROTHMAN, New Jersey
TAMMY BALDWIN, Wisconsin
ANTHONY D. WEINER, New York
THOMAS E. MOONEY, SR., General Counsel-Chief of Staff
JON DUDAS, Deputy General Counsel-Staff Director
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JULIAN EPSTEIN, Minority Chief Counsel and Staff Director
PERRY APELBAUM, Minority General Counsel
Subcommittee on Commercial and Administrative Law
GEORGE W. GEKAS, Pennsylvania, Chairman
ED BRYANT, Tennessee
LINDSEY O. GRAHAM, South Carolina
STEVE CHABOT, Ohio
ASA HUTCHINSON, Arkansas
SPENCER BACHUS, Alabama
JERROLD NADLER, New York
TAMMY BALDWIN, Wisconsin
MELVIN L. WATT, North Carolina
ANTHONY D. WEINER, New York
WILLIAM D. DELAHUNT, Massachusetts
RAYMOND V. SMIETANKA, Chief Counsel
SUSAN JENSEN-CONKLIN, Counsel
JAMES W. HARPER, Counsel
C O N T E N T S
HEARING DATE
March 16, 1999
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OPENING STATEMENT
Gekas, Hon. George W., a Representative in Congress from the State of Pennsylvania, and chairman, Subcommittee on Commercial and Administrative Law
WITNESSES
Boucher, Hon. Rick, a Representative in Congress from the State of Virginia
Forman, Leon S., Esquire, Blank, Rome, Comisky and McCauley, Philadelphia, PA
Jackson Lee, Hon. Sheila, a Representative in Congress from the State of Texas
King, Lawrence P., Charles Seligson Professor of Law, New York University School of Law, New York, NY
Kubica, Janet, President and CEO, Postmark Credit Union, Harrisburg, PA, on behalf of the Credit Union National Association
LaFalce, Hon. John, a Representative in Congress from the State of New York
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Lee, Joe, United States Bankruptcy Judge, Eastern District of Kentucky, Lexington, KY
Mabey, Ralph R., LeBoeuf, Lamb, Greene and MacRae, former Bankruptcy Judge, Salt Lake City, UT
Moran, Hon. James P., a Representative in Congress from the State of Virginia
Posner, Eric A., Professor, University of Chicago Law School, Chicago, IL
Rothman, Hon. Steven, a Representative in Congress from the State of New Jersey
Shepard, James I., Esquire, Bankruptcy Tax Consultant, former member of the National Bankruptcy Review Commission, Fresno, CA
Skeel, David A., Jr., Professor, University of Pennsylvania Law School, Philadelphia, PA
Slaughter, Hon. Louise McIntosh, a Representative in Congress from the State of New York
Smith, James E., President and CEO, Union State Bank and Trust, Clinton, MO, on behalf of the American Bankers Association
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Smith, Hon. Nick, a Representative in Congress from the State of Michigan
Torres, Frank, Legislative Counsel, Consumers Union, Washington, DC
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Ausubel, Lawrence M., Professor of Economics, University of Maryland, paper entitled ''A Self-Correcting 'Crisis': The Status of Personal Bankruptcy in 1999.''
Durbin, Hon. Richard J., a U.S. Senator from the State of Illinois: Prepared statement
Federal Reserve Bank of New York report, ''Current Issues in Economics and Finance''
Forman, Leon S., Esquire, Blank, Rome, Comisky and McCauley, Philadelphia, PA: Prepared statement
Gekas, Hon. George W., a Representative in Congress from the State of Pennsylvania, and chairman, Subcommittee on Commercial and Administrative Law: Prepared statement
Jackson Lee, Hon. Sheila, a Representative in Congress from the State of Texas: Prepared statement
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King, Lawrence P., Charles Seligson Professor of Law, New York University School of Law, New York, NY: Prepared statement
Kubica, Janet, President and CEO, Postmark Credit Union, Harrisburg, PA, on behalf of the Credit Union National Association: Prepared statement
Lee, Joe, United States Bankruptcy Judge, Eastern District of Kentucky, Lexington, KY: Prepared statement
Mabey, Ralph R., LeBoeuf, Lamb, Greene and MacRae, former Bankruptcy Judge, Salt Lake City, UT: Prepared statement
McCollum, Hon. Bill, a Representative in Congress from the State of Florida: Prepared statement
Posner, Eric A., Professor, University of Chicago Law School, Chicago, IL: Prepared statement
Shepard, James I., Esquire, Bankruptcy Tax Consultant, former member of the National Bankruptcy Review Commission, Fresno, CA: Prepared statement
Skeel, David A., Jr., Professor, University of Pennsylvania Law School, Philadelphia, PA: Prepared statement
Slaughter, Hon. Louise McIntosh, a Representative in Congress from the State of New York: Prepared statement
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Smith, James E., President and CEO, Union State Bank and Trust, Clinton, MO, on behalf of the American Bankers Association: Prepared statement
Smith, Hon. Nick, a Representative in Congress from the State of Michigan: Prepared statement
Torres, Frank, Legislative Counsel, Consumers Union, Washington, DC: Prepared statement
BANKRUPTCY REFORM ACT OF 1999, PART I
TUESDAY, MARCH 16, 1999
House of Representatives,
Subcommittee on Commercial
and Administrative Law,
Committee on the Judiciary,
Washington, DC.
The subcommittee met, pursuant to notice, at 10 a.m., in Room 2141, Rayburn House Office Building, Hon. George W. Gekas [chairman of the subcommittee] presiding.
Present: Representatives George W. Gekas, Steve Chabot, Asa Hutchinson, Jerrold Nadler, John Conyers, Jr., Melvin L. Watt, William D. Delahunt, Tammy Baldwin, and Anthony D. Weiner.
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Also present: Raymond V. Smietanka, Subcommittee Chief Counsel; Susan Jensen-Conklin, Subcommittee Counsel; James W. Harper, Subcommittee Counsel; Peter Levinson, Full Committee Counsel; Audray Clement, Subcommittee Staff Assistant; and David Lachmann, Minority Professional Staff Member.
OPENING STATEMENT OF CHAIRMAN GEKAS
Mr. GEKAS. The hour of 10 o'clock having arrived, the hearing of the Subcommittee on Commercial and Administrative Law of the Committee on the Judiciary on the subject of bankruptcy reform will come to order. But since there are no witnesses ready to testify and because we require the presence of at least one other member to constitute a hearing quorum, we will recess until one of those contingencies should occur.
We stand in recess.
[Recess.]
Mr. GEKAS. The time of the recess has artificially expired because we have noted the presence of the gentleman from Virginia, Congressman Boucher, who has been a staunch supporter and original cosponsor of the effort on bankruptcy reform that was begun last term and which is continuing with gusto this term. As soon as he arrives, we will let you know.
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But in the meantime, we will seize the gavel for the purpose of accommodating Representative Boucher and a member's statement that he has prepared for the record.
With that, we recognize the gentleman from Virginia.
STATEMENT OF HON. RICK BOUCHER, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF VIRGINIA
Mr. BOUCHER. Thank you very much, Mr. Chairman. It gives me a great deal of pleasure to be here this morning to say that I am pleased to be participating with you in what I hope will be the first of many bipartisan exercises by this committee during the course of the 106th Congress. And it is fitting, indeed, that this bipartisan exercise occurs on the highly important subject of bankruptcy reform.
In an era when disposable incomes are growing, when unemployment rates are low, and when the economy is strong, consumer bankruptcies should be rare. Contrary, however, to this expectation, in 1998 there were 1.4 million personal bankruptcies filed, and that was an increase of 40 percent above the number in 1996 when the number of filings exceeded 1 million for the first time.
Bankruptcies of convenience are driving this increase. Bankruptcy was never meant to be used as a financial planning tool, but it is becoming the first stop rather than a last resort as many filers who can repay a substantial portion of what they owe use the complete liquidation provisions of Chapter 7 rather than the court-supervised repayment plans contained in Chapter 13.
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Our legislation will direct more filers into Chapter 13 plans. This is a consumer protection measure. The typical American family pays a hidden tax of about $550 per year arising from the increased costs of credit and the increases in the prices of goods and services occasioned by the discharge of $50 billion each year in consumer debt arising from bankruptcy proceedings. By requiring that people who can repay a substantial part of their debt do so by using Chapter 13 plans, we will lessen that hidden tax.
Another key point should be made about the provisions of our bill. The alimony or child support recipient is clearly better off under our bill than that person is under current law. At the present time, the child support or alimony recipient stands seventh in the rank of priority for payment of claims in bankruptcy. She is behind farmers making claims against grain elevators. She is behind fishermen making claims against warehouses.
Under our bill, the child support or alimony recipient will receive priority number one in the distribution of the bankrupt's estate. Her claim will be first in line for payment, and other provisions also make it easier for her to execute against the assets of the bankrupt's estate than is the situation under current law.
Last year, this measure, when considered as a conference report, received 300 votes on the floor of the House, reflecting a broad bipartisan agreement that this reform is necessary. It truly is a bipartisan measure, and I want to commend you, Chairman Gekas, for introducing the bill promptly during the course of this Congress, scheduling this series of hearings in a very timely manner, and I look forward to working with you as we obtain reporting of this measure by the full Judiciary Committee and approval of the measure on the floor of the House of Representatives.
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The time has come for this much needed reform, and I truly believe that with your leadership and with our shared effort, the 106th Congress will be the time when that reform is achieved.
Mr. GEKAS. We thank the gentleman, and we note what he noted, that the bipartisan flavor of this legislation is reflected not only in the votes cast during the last Congress but in the new cosponsorship of the new bill in the current session, of which, of course, the gentleman from Virginia is a prime figure.
So we thank you, and we excuse you to run around, do your errands, and we will see you on the floor.
Mr. GEKAS. We now recognize the gentleman from Michigan, Representative Nick Smith, who, I must say, in the last Congress and in the first stages of this Congress, has been very active—some would say overactive—in the pursuit of his quest that Chapter 12 of bankruptcy never falls behind in the consideration by the Congress and is very insistent that a fail-safe measure on Chapter 12 be passed into law pending the outcome of the full bankruptcy reform proposals that we have before us. So we congratulate him on his continuing effort, and we say to the gentleman that he may proceed to give his opening statement. His written statement will become a part of the record.
We note the presence of a working quorum, a hearing quorum, and the presence of the gentleman from Massachusetts, Mr. Delahunt, the gentleman from North Carolina, Mr. Watt, and the gentleman from New York, Mr. Nadler. With that, we——
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Mr. WATT. I call for a recorded vote, Mr. Chairman.
Mr. GEKAS. Pardon me?
Mr. WATT. I call for a recorded vote.
Mr. GEKAS. I don't know what that means.
Mr. WATT. I want to vote right now while we got the majority. [Laughter.]
Mr. DELAHUNT. This is probably the best shot we have.
Mr. GEKAS. We can vote on whether you want to continue with listening to the members. I might vote no.
Mr. WATT. We might all vote no. [Laughter.]
Mr. GEKAS. Representative Smith is recognized for 5 minutes.
STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MICHIGAN
Mr. SMITH. Mr. Chairman and committee, thank you very much, and thank you for passing out my bill H.R. 808 to give a momentary extension on the Chapter 12 provisions.
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Some comments in general. When I came to Congress 6 years ago, about 5 years ago, I introduced a bankruptcy bill because it seemed to me that we in our effort to be fair to those that were having financial difficulties, we were ending up increasing the cost and the availability of financing to farmers and others simply because of the nervousness or weariness of lenders to lend out that money.
In general, our bankruptcy laws as a whole, I agree with this committee, are badly in need of reform. An interesting statistic: During only 6 months of 1998, more bankruptcies were filed than during the entire Great Depression. By declaring bankruptcy, sometimes it has become too easy for debtors to skirt their financial obligations. It is not unreasonable that we should ask those who can afford to pay some of their unsecured, non-priority debts to do so. But the bottom line, as I see it out in my area of Michigan, is that by providing too much protection in the bankruptcy courts, the result is less availability and higher cost of borrowing for everybody else.
Specifically, a couple comments on Chapter 12. That is the chapter that is only available to family farms. The traditional definition of the family farms of $1.5 million of debt I think needs to have consideration for expansion upward of the $1.5 million. The current provisions, not less than 80 percent of that debt be related to agricultural activity, needs a new look-see. As family farms grow bigger and expand and because of the near disastrous situation that we have experienced in this last year of low commodity prices as well as natural weather disasters, we have a lot of farmers across the country that very well may be declaring bankruptcy in the near future. Those are the kinds of farmers that are good farmers, that have cut down on their employment and simply work longer hours trying to get them through this period of lower demand partially because of the Asian crisis, partially because of other reasons. These farmers need some consideration to not be forced to sell their tools that are their only means of getting back in the game, if you will, to survive in agriculture.
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So I compliment the committee for looking at the overall bankruptcy provisions and particularly want to urge you to continue examining the Chapter 12 provisions to accommodate the larger family farms that don't meet the particular specifications that we passed in the original family farms, commonly called the Chapter 12 provisions.
I thank the committee for the opportunity to give you my comments this morning.
Mr. GEKAS. We thank the gentleman, and we excuse him, with our gratitude. And as we have noted to him personally before, he should remain in close contact with the Chair to mark the developments in this reform measure as it pertains to Chapter 12 and the other segments of the reform effort.
Mr. SMITH. And I will keep in close contact with the Chair and certainly also Mr. Nadler, who has an appreciation for our agricultural problems.
Mr. NADLER. Mr. Chairman, I have some questions of Mr. Smith.
Mr. GEKAS. The custom when we have members—of course, we can breach the custom any time we want to—is to dismiss them so that they don't have to stay.
Mr. DELAHUNT. I just have one quick question.
Mr. GEKAS. The gentleman from Massachusetts.
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Mr. DELAHUNT. I respect the gentleman and I know what he is doing on behalf of family farmers. Coming from a coastal district in Massachusetts, the experience that your constituents are unfortunately going through at this point in time is exactly—it is being replicated exactly by fishermen in coastal regions. At some point in time, I would like to talk to you possibly about amending your legislation or amending the bill here, because what we are seeing is families that have been engaged in fishing for generations in Massachusetts and all up and down the Atlantic coast and presumably the Pacific coast who are experiencing extremely difficult times because of the depletion of fishing stocks.
Again, I think what you are doing obviously deserves serious consideration.
Mr. SMITH. Mr. Delahunt, maybe I need a refresher, but it used to be that fishermen were included in the agricultural sick code, and I don't know if they are included in Chapter 12 or not. But it deserves consideration.
Mr. DELAHUNT. Thank you. I don't know and that is a good point. But thank you, Mr. Smith.
Mr. GEKAS. The gentleman from New York?
Does the gentleman from Michigan wish to submit himself to one comment or question from the gentleman from New York?
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Mr. NADLER. I have a couple questions for the gentleman from Michigan.
First of all, I want to commend the gentleman from Michigan for his industry and persistence on this question of Chapter 12 renewal.
Congressman, you sponsored, I cosponsored last year a 2-year extension of this bill. We had, of course, a bill that was originally 3 months, then it was 6 months, that we reported out. Last year we actually had this Chapter 12 actually sunset for a few weeks, I think it was, and now we are doing a 6-month extension.
I just want to ask what you think, if there is any good reason we shouldn't be doing a 2-year or longer extension, why we should be doing these 3-month, 6-month extensions so that this can be hostage to the more controversial provisions of the omnibus bill.
Mr. SMITH. I guess, Mr. Nadler, it would be my impression that if we are not successful in getting the total bankruptcy reform package out this year, let's quit playing games with it and let's make Chapter 12 permanent.
Mr. NADLER. I would agree with you, and I hope we would do that.
Let me just ask one other question. The provisions in Chapter 12 for family farms—and let me say, by the way, I have a particular affinity for this because I spent 8 years of my childhood on a family farm in New Jersey which my parents owned, and perhaps one of the reasons I became a Democrat—it is hard to say that far back, but I knew when I was 8 or 9 years old that there were two really nasty people in the world. One was named Dwight Eisenhower, and the other was named Ezra Taft Benson, who was the Secretary of Agriculture. I wasn't sure what they did that was nasty, but they seemed to have it in for my father and for other small chicken farmers for some reason.
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But in any event, I saw the problems that could be caused, and we lost the farm—my parents lost the farm to foreclosure over 40 years ago, and I remember that very clearly.
I just want to ask you one thing. Some of the provisions of this for Chapter 12 are considerably—in fact, the Chapter 12 provisions are considerably more favorable to debtors than are the provisions in Chapter 13 for non-farm debtors, and this bill would make the provisions in Chapter 13 far harsher for debtors.
Do you think there is a good reason to treat them differently, in other words, to be having what I would call a reasonable system for farm debtors and a very harsh system for non-farm debtors?
Mr. SMITH. Well, when I was in the Michigan Legislature, I introduced provisions for welfare payments not to force carpenters, for example, to sell their tools, to be eligible for some temporary relief on welfare. And I think the question of forcing a person to sell their tools of trade that is going to give them the best chance of recovering is reasonable, whether it is the carpenter or the fisherman or the farmer.
I continue to believe that this should be limited to the small family farmer that is having the most difficulty surviving, and so I would hope we would keep our provisions in that most of their income has to come from agriculture. It can't be somebody that is playing games with the advantages of the Bankruptcy Code here just because they have a country estate.
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Mr. NADLER. Thank you very much.
Mr. GEKAS. We thank the gentleman.
Mr. SMITH. Thank you.
[The prepared statement of Mr. Smith follows:]
PREPARED STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MICHIGAN
I appreciate the opportunity to appear today before the Subcommittee on Commercial and Administrative Law to discuss an issue of significance for America's families—the Bankruptcy Judges, United States Trustees and Family Farmer Bankruptcy Act of 1986, commonly known as Chapter 12. I would like to thank this committee for passing my bill, H.R. 808, that extends the provisions of Chapter 12.
In general, our bankruptcy laws as a whole are badly in need of reform. During only 6 months of 1998, more bankruptcies were filed than during the entire Great Depression. By declaring bankruptcy, it's become too easy for debtors to skirt their financial obligations. Bankruptcy law, which is supposed to balance the rights of creditors with the notion that a bankrupt debtor should be allowed a ''fresh start,'' has become a form of un means-tested welfare. It is not unreasonable that we should ask those who can afford to pay some of their unsecured, non-priority debts to do so. By providing too much protection in the bankruptcy courts, the result is less availability of funds and a higher cost of borrowing for everyone else.
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Chapter 12 is a form of bankruptcy relief only available to ''family farmers'' which allows these producers the option to reorganize debt, rather than having to liquidate, when declaring bankruptcy. A family farmer is an individual with over 50 percent of gross income derived from agricultural. To qualify under Chapter 12, producers must have under $1.5 million in debt, with not less than 80% of that debt related to agricultural activity.
Chapter 12 was enacted temporarily to respond to the farm crisis in the 1980's and was scheduled to sunset September 30, 1998. Last October, Congress extended Chapter 12 for another six months as part of the Omnibus Consolidated and Emergency Supplemental Appropriations Act. Today, Chapter 12 is scheduled to expire March 31, 1999. Last week, the House passed my bill H.R. 808, to temporarily extend Chapter 12 provisions for another six months. It is my hope that the Senate will soon act upon this legislation so we can send it to the President before the expiration date.
As you are all aware, times are very tough in farm country these days. While the rest of the economy is booming, America's farmers and ranchers have been reeling from a series of disasters related to historically low commodity prices, shrinking export markets, and bad weather. While credit is available to qualified borrowers and the farm credit system is currently sound, there are some producers who just won't be able to make ends meet in the short term—some bankruptcy filings are inevitable.
Not only should Congress not let Chapter 12 expire, these provisions should be made permanent. I am pleased to see that H.R. 833, the Bankruptcy Reform Act of 1999 does this. The cyclical nature of ranching and farming means that inevitably, producers will face periods of severe economic downturns. Rather than having to craft special legislation to deal with these periods, general bankruptcy protection for farmers should always be available, just as Chapter 13 is for consumers.
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While Chapter 12 needs to be made permanent, which assures producers that this risk management tool will be available, modifications are needed to modernize it for the next century. Because it is not uncommon for family farmers to carry debt above $1.5 million, the debt ceiling should be extended to at least $2 million. This would assure that the majority of family farmers still have the option to use Chapter 12 if they have to. Also, only producers who were qualified family farmers the previous taxable year are now eligible to use Chapter 12. I would recommend extending that period to two years. This would include family farmers who for whatever reason did not qualify under the legal term one of the two taxable years.
I am glad to see that the committee is tackling general bankruptcy reform and again, I appreciate the opportunity to appear before you. I look forward to moving ahead on this processes and I would be happy to answer any questions you might have.
Mr. GEKAS. Now we turn to the lady from Texas, Representative Sheila Jackson Lee, who, in the last Congress, entered the debate on bankruptcy reform very early, and I must say remained in a debating mode straight through to the end of the session last time, and here she is beginning on this year's schedule to participate in the debate on bankruptcy reform. We recognize the lady for 5 minutes.
STATEMENT OF HON. SHEILA JACKSON LEE, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS
Ms. JACKSON LEE. Thank you, Chairman Gekas, very much and to ranking member Nadler, both of you, for your leadership on what is a very important issue.
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First, Mr. Chairman, let me acknowledge my participation in this issue and legislative initiative last Congress, and as well my participation on the conference committee. I say that because this year, this Congress, I hope that we will strike a chord of reconciliation to the point that bankruptcy is not a partisan issue or the needs of those who file bankruptcy and, in fact, will take this opportunity, the 106th Congress, to assure that we can find common ground.
I truly believe in the unfettered access to credit and the responsibility in the utilization of credit. I hope, however, that the issues that I bring before you under H.R. 833, we can find a way to respond to some of my concerns.
Let me start out by noting that there are well over a billion credit cards in circulation, a dozen credit cards for every household in this country. From 1994 through 1996, credit card issuers mailed more than 2.5 billion card solicitations each year. In 1997, mail credit card solicitations jumped by 20 percent to 3 billion.
I provide that data simply to say that there are not good and bad, there is not right and wrong. There is right on all sides and wrong on all sides. In particular, I would say to my friends in the credit card industry that we must work together to realize that the unsolicited submission of credit cards does in some way hasten some of the ills and problems that many of our citizens have had.
So I come not to divide the committee but, more importantly, to see that we can come together. I would also offer, however, the thought that haste makes waste, and I hope that we will take the time to have extensive hearings. I do note that there is a full hearing today with representatives from the consumer element and that there will be hearings further on this week.
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Individuals with the financial ability to pay their financial obligations should be required to pay. Certainly no one is suggesting that the Bankruptcy Code should provide a shield for individuals interested in defrauding creditors. Unfortunately, H.R. 833 and its provisions will create a modern-day debtor's prison through the use of reaffirmation agreements. Simply put, honest debtors will be coerced into signing away future earnings in an attempt to satisfy previous debt obligations.
Proponents of H.R. 833 claim that the bill's intent is to restore personal responsibility. However, one of the bill's thrusts is actually about the redirection of the money of bankruptcy filers, particularly Chapter 7 filers, to banks, credit card companies, and other credit lending institutions by making Chapter 13 almost mandatory.
The facts are that over 60 percent of all bankruptcy filers were unemployed at some time within the 2-year period prior to their filing—legitimate reasons for moving into bankruptcy. But instead of helping people, H.R. 833 redirects a significant portion of debtors' income to banks and credit card companies and, in turn, will hurt a lot of women and children who are dependent on child and spousal support.
It is ironic that the consumer lending industry actively solicits unsuspecting consumers through the mail with terms of easy credit, buy now or pay later. And then after addicting debtors to this ''financial crack,'' lenders are advocating for reform. Of course, debtors are responsible for financial obligations, Mr. Chairman, and I totally agree that we have got to get a grip on this problem. It would be interesting, and I hope that we will have economic studies to find out in the last 2 years of a good economy whether or not we have had that peaking of filing, and that will be something that we should be concerned about.
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Several commentators have suggested that consumer lenders have begun to relax their underwriting guidelines to increase market share. In our testimony last year, we determined that even though credit card companies are looking for reform, they have had only 4 percent default in debt. Additionally, we know that the National Bankruptcy Review Commission could not decide on the value of means-testing as to whether or not that really works.
I am for bankruptcy legislation that is fair, legislation that recognizes the importance of a debtor's financial obligation. In 1997, the average bankruptcy filer had a debt-to-income ratio of 1.25 to 1, 125 percent of their income, as opposed to just a few years ago 0.74 to 1, a few short years ago.
According to Bankruptcy Law Professor Elizabeth Warren of the Harvard Law School, the debtors that enter bankruptcy are usually experiencing turbulent times. Sixty percent of bankruptcy filers have been unemployed within a 2-year span prior to their filing, and 20 percent of filers have had to cope with an uninsurable medical expense.
We need to protect women and children in this process, Mr. Chairman, and according to the Consumer Bankruptcy Project, an estimated 300,000 bankruptcy cases involve child support and alimony. In Chapter 7, alimony and child support payments survive; consequently, women and children are benefitted when the debtor can discharge other financial obligations in order to make payments on non-dischargeable debts.
H.R. 833 creates a broader category of non-dischargeable debt, thus lowering the potential for women and children to receive necessary support payments for their existence. Mr. Chairman, women and children would be in direct competition for the limited resources of the discharged debtor. I do not see why we cannot collectively come together, Mr. Chairman, and ensure that we protect them.
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Let me close by saying this: The means test is an artificial formula that has its genesis in a discretionary living expenses equation as determined by the Internal Revenue Service collection standards. Mr. Chairman, if we are not using the IRS as standards for other valuable decisions that this Congress makes, I don't know why we would do so and then place that burden upon our constituents. I do believe that we can work together, and I thank Ranking Member Nadler for his leadership. I happen to support legislation helping our family farmers. There is a lot of common ground. But there are a lot of problems with H.R. 833 that should be fixed.
I would say finally, Mr. Chairman, that although I applaud the consumer provisions of educating our consumers in H.R. 833, might I caution you to consider the fact that some of the help that will come to these most desperate consumers are by paid fees. And I would like to see those fees being paid by the industry and opening up consumer counseling and education to all the world, if you will, because we all have a problem with consumer credit. And I hope, Mr. Chairman, we can work together.
Mr. GEKAS. We thank the lady, and we assure her that her written statement will become a part of the record.
[The prepared statement of Ms. Jackson Lee follows:]
PREPARED STATEMENT OF HON. SHEILA JACKSON LEE, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS
Thank you Chairman Gekas and Ranking Member Nadler for giving me this opportunity to come before this committee and express my concerns about H.R. 833, the Bankruptcy Reform Act of 1999.
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During the 105th Congress, I served as a member of this distinguished committee and as a conferee on the Bankruptcy Reform Act of 1998. I come before you today, not as a Democrat but as an individual concerned about the potential impact this legislation will have on America's families—most importantly, children.
I come not to divide the committee but asking for temperance and deliberateness in the development of legislation aimed at reforming the bankruptcy system. I am reminded of the time-tested adage, that ''haste makes waste.'' This committee must exercise its authority to enact legislation in a cautious manner to do otherwise is improvident and irresponsible.
Individuals with the financial ability to pay their financial obligations should be required to pay. Certainly, no one is suggesting that the bankruptcy code should be provide a shield for individuals interested in defrauding creditors. Unfortunately, H.R. 833 and its draconian provisions will create a modern day debtor's prison through the use of reaffirmation agreements. Simply put, honest debtors will be coerced into signing away future earnings in an attempt to satisfy previous debt obligations. Proponents of H.R. 833 claimed that the bill's intent is to restore personal responsibility. However, one of the bill's thrusts is actually about the redirection of the money of bankruptcy filers, particularly Chapter 7 filers, to banks, credit card companies and other credit lending institutions by making Chapter 13 almost mandatory.
The facts are that over 60% of all bankruptcy filers were unemployed at sometime within the two-year period prior to their filing. But instead of helping people, H.R. 833 redirects a significant portion of debtors income to banks and credit companies, and in turn, hurt a lot women and children who are dependent on child and spousal support.
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It is ironic that the consumer lending industry actively solicits unsuspecting consumers through the mail with terms of easy credit, buy now—pay later jargon. And then after addicting debtors to this ''financial crack'' lenders are advocating for reform. Of course debtors are responsible for financial obligations they incur; however, lenders must assume responsibility for their actions in creating the precarious financial crisis we are discussing.
Several commentators have suggested that consumer lenders have begun to relax their underwriting guidelines to increase market share because of the profitability of credit cards. Bankruptcy Reform must call for responsibility from everyone with an interest at stake. Congress must end the ''financial entrapment'' of debtors who lack financial sophistication.
I am for bankruptcy legislation that is fair—legislation that recognizes the importance of a debtor's financial obligation to his family while balancing the debtor's obligations to his creditors. Debt relief must be available for debtors whose debts exceed their ability to repay their financial obligations. In 1997, the average bankruptcy filer had a debt to income ration of 1.25 to 1 (125% of their income) as opposed to just .74 to 1 (74% of their income) a few short years ago.
According to Bankruptcy Law Professor Elizabeth Warren of the Harvard Law School, the debtors that enter bankruptcy are usually experiencing turbulent times. 60% of bankruptcy filers have been unemployed within a two year span prior to their filing. 20% of filers have had to cope with an uninsurable medical expense. Approximately 1.5 individuals out of every three bankruptcy filers, are recently divorced.
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We must protect women and children. According to the Consumer Bankruptcy Project, an estimated 300,000 bankruptcy cases involved child support and alimony orders. In Chapter 7 alimony and child support payments survive; consequently, women and children are protected when the debtor can discharge other financial obligations in order to make payments on non-dischargeable debts.
H.R. 833, creates a broader category of non-dischargeable debt; thus, lowering the potential for women and children to receive necessary support payments for their existence. Mr. Chairman, women and children would be in direct competition for the limited resources of the discharged debtor.
We must protect women and children. Imagine women and children standing in line with credit card issuers, retail stores, installment stores and other unsecured creditors waiting for alimony and child support payments from a post-discharged debtor. H.R. 833 places women and children on equal footing with other creditors. Women and children do not have the ability to charge an interest of 23% or request late fees from a debtor but credit card companies and other unsecured creditors can and do. This bill is a catastrophic threat to our families who rely on support payments.
The ''means test'' is an artificial formula that has it genesis in a discretionary living expenses equation as determined by the Internal Revenue Service collection standards. This mathematical formula will ignore in many cases or understate the real expenses, financial and personal circumstances of the debtor. H.R. 833 is unacceptable because it will force bankruptcy filers into Chapter 13 pursuant to an arbitrary and capricious formula that is harsh and extreme. The damage of trying to accomplish this goal through a ''means test'' might be irreparable. The National Bankruptcy Review Commission rejected the means test formula. Simply stated, the ''means test'' is a mean test because it will hurt women, children and honest debtors who are looking for a fresh start.
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If we deny access to Chapter 7 to the wrong debtors, and those debtors fail to complete required repayment plans, they will return to Chapter 7 with a diminished capacity to repay their non-dischargeable debt—including child support and alimony. The ''means test'' advocates a cookie-cutter mentality to an individual problem. Bankruptcy legislation must take into account the specific needs of the debtor, his financial obligation and the ability to repay financial obligations.
Bankruptcy courts must have the plenary authority to consider the specific circumstances of the debtors that come under their jurisdiction.
Congress must provide adequate safeguards to prevent debtors from being ''pushed into'' Chapter 13—because the bright-line test has been satisfied without thoroughly reviewing the individual's ability to pay. H.R. 833—would severely restrict the availability of debtors to seek protection utilizing State exemption laws. Texas law provides debtors with unlimited homestead exemption protection.
H.R. 833—fails to protect the interest of women and children! This draconian bill subrogates the alimony of former spouses and child support payments to the debtor's unsecured debt interest. Bankruptcy reform must ensure that a debtor's domestic obligations have the highest priority.
Unfortunately, H.R. 833—falls short of protecting America's most vulnerable citizens—women and children. It is essential that bankruptcy reform protect post-bankruptcy domestic support payments. Forced participation by a debtor in a plan requiring contributions from future income sources has little probability for success. It is critical that we have additional time to consider the long-term consequences of bankruptcy reform. This committee can not offer legislation that is a mirror image of last year's conference report.
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Bankruptcy legislation must protect the rights of families, as well as guarantee a fresh start for honest debtors. The days of debtors' prison have faded into America's history but there appears to be a movement afoot to attach financial obligations to a debtor for an indefinite period of time regardless of the ability to pay.
H.R. 833 would force a debtor to carry his debt responsibility as an eternal albatross. The President, 110 federal bankruptcy judges and a coalition of bankruptcy law professors opposed this approach to bankruptcy reform. We must protect women and children. I have reservations about creating non-dischargeable debts that could set in opposition post- bankruptcy, credit card debt against child support, alimony payments, educational loans, and taxes.
We must protect women and children. Although H.R. 833 suggests that alimony and child support payments are priority obligations, women and children are in competition with secured creditors for the debtor's financial resources.
We must protect women and children. H.R. 833 instead creates a hierarchy system that gives secured creditors the highest priority while family obligations are secondary interests to be paid—after secured creditors.
The greatest challenge before us in the bankruptcy reform efforts of the 106th Congress is solving the widely recognized inadequacies of the law in the area of consumer bankruptcy. As it has always been in the Congress, the key to this process, is, of course, successfully balancing the priorities of creditors, who desire a general reduction in the amount of debtor filing fraud, and debtors, who desire fair and simple access to bankruptcy protections when they need them.
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I also want to thank Congressman Jerrold Nadler, the distinguished gentleman from New York and the Ranking Member on the Subcommittee on Commercial and Administrative Law. He has been a leader and a strong advocate these past two years for the consumer. He has been on the battlefield, and I have been there with him to insure that women and children are not locked out, that debtors receive equal and balanced treatment, and that there is true bankruptcy reform.
Thank you.
Mr. GEKAS. We turn to the lady from New York who has just joined us, Representative Slaughter, whose written statement will become a part of the record and from whom we will hear for 5 minutes. Thank you.
STATEMENT OF HON. LOUISE McINTOSH SLAUGHTER, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK
Ms. SLAUGHTER. Thank you, Mr. Chairman.
Mr. Chairman, Mr. Nadler, Mr. Delahunt, thank you very much for allowing me to offer my views this morning on the bankruptcy bill.
Just 5 years ago, I introduced the Spousal Equity in Bankruptcy Amendments to give priority to child and spousal support payments in bankruptcy proceedings. That legislation became law as a part of the Bankruptcy Reform Act of 1994. Thanks to those and other child support enforcement reforms, child support collections have increased by about 70 percent since 1992.
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I regret to say, however, that the bill the subcommittee is now considering would reverse the progress we have made in recent years. In its current form, this bill will have a damaging impact on women and children who are owed child support and alimony.
By making large amounts of consumer debt non-dischargeable in bankruptcy, the bill will make alimony and child support compete against money owed on credit cards. After a debtor goes through bankruptcy proceedings under this bill, he or she will still have credit card and other types of consumer debts left to pay, and those debts will compete with child support and alimony for the limited resources of the debtor. The bill will effectively take us back to the days when the Bankruptcy Code gave child support and alimony no greater importance than the purchase of a television set or jewelry with a credit card.
The proponents of the bill claim to have repaired the damage the bill does by including provisions that strengthen the rights of child support collection agencies and raise the priority of child support and alimony in bankruptcy proceedings. Those provisions are well-intentioned, but they do not overcome the damage done by the bill. The provisions ignore the reality that after bankruptcy proceedings are over, the bankrupt debtor will be left with additional credit card and consumer debt. And when aggressive credit card collection agencies are calling, it will be easier to pay them rather than the former spouse or the powerless child.
This bill is tough on families in distress. But it fails to deal effectively with the root cause of rising bankruptcy rates, which is the easy availability of credit. The bill requires lenders to make additional disclosures, and it encourages creditors to make good-faith settlements with debtors before bankruptcy. But it does nothing to discourage lenders from offering credit to borrowers who are literally already head over heels in debt.
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The fact that we each receive about five credit cards in the mail every week shows us the availability of it and that nobody is watching.
The Consumer Federation of America reports that in recent years the credit card industry has stepped up its marketing to low- and moderate-income individuals and, most importantly, to minors. In 1997, the amount of credit card debt carried over from month to month rose above $450 billion—double what it was just 5 years ago. In just 1 year, 1996, credit card debt grew three times faster than incomes. As a result, nearly 60 million American households carry credit card balances averaging more than $7,000, costing these households more than $1,000 a year in interest and fees. This growing credit card debt is the main reason for the rise in personal bankruptcies.
H.R. 833 is opposed by children's rights advocates and women's groups who are concerned about the damage it will do to children and families in crisis. It is also opposed by labor unions, consumer groups, public interest groups, and judges, lawyers, and scholars who are concerned about the integrity of the bankruptcy process.
We must not make it harder for non-custodial parents to pay child support. We should not be placing new obstacles in the way of a parent's ability to pay support. In my county—Monroe County, New York—more than $135 million in past-due child support is owed to 41,000 children. The numbers are similar for New York State as a whole. And of the over $1 billion owed in child support in 1997, only about $800 million was collected. The accumulated total child support arrears owed in my State is $3 billion. Across the Nation, the gap between potential child support and actual child support collected is estimated to be $34 billion.
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I support efforts to reform our bankruptcy laws to make debtors responsible for the debt that they incur. But if we want to reduce bankruptcy rates, we have to attack the root cause, which is the easy availability of enormous lines of consumer credit. And in the process of doing so, we need to protect the interests of the most vulnerable parties.
I urge the subcommittee to address the problem with this bill that it creates for women and children who are owed child support and alimony. And I urge the subcommittee to seek a balanced approach to bankruptcy reform that prevents abuses of the bankruptcy system, while allowing the good-faith debtors the ability to take care of their families while they deal with their debts.
And, Mr. Chairman, I would like to—we are working on an amendment to require that the statement of terms and conditions on credit card applications be written at least as large as the smallest print in the ad itself.
I thank you very much for your kind attention.
Mr. GEKAS. We thank the lady, and we will be glad to review her proposed amendment any time she wishes to submit it to us and to the minority.
Ms. SLAUGHTER. I thank you very much.
[The prepared statement of Ms. Slaughter follows:]
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PREPARED STATEMENT OF HON. LOUISE MCINTOSH SLAUGHTER, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK
Mr. Chairman, Mr. Ranking Member, members of the Subcommittee: thank you for allowing me to offer my views on the bankruptcy bill that you are now considering.
Just five years ago, I introduced the Spousal Equity in Bankruptcy Amendments, to give priority to child and spousal support payments in bankruptcy proceedings. That legislation becaom law as part of the Bnakruptcy Reform Act of 1994. Thanks to those and other child support enforcement reforms, child support collections have increased by about 70 percent since 1992.
I regret to say, however, that the bill the Subcommittee is now considering (H.R. 833), would reverse the progress we have made in recent years. In its current form, this bill will have a damaging impact on women and children who are owed child support and alimony.
By making large amounts of consumer debt non-dischargeable in bankruptcy, this bill will make alimony and child support compete against money owed on credit cards. After a debtor goes through bankruptcy proceedings under this bill, he or she will still have credit card and other types of consumer debt left to pay—and those debts will compete with child support and alimony for the limited resources of the debtor. This bill will effectively take us back to the days when the bankruptcy code gave child support and alimony no greater importance than a television or jewelry purchased with a credit card.
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Proponents of H.R. 833 claim to have repaired the damage the bill does, by including provisions that strengthen the rights of child support collection agencies and raise the priority of child support and alimony in bankruptcy proceedings. These provisions may be well- intentioned, but they do not overcome the damage done by the bill. These provisions ignore the reality that, after bankruptcy proceedings are over, the bankrupt debtor will be left with additional credit card and consumer debt. And when aggressive credit card collection agencies are calling, it will be easier to pay them rather than the former spouse or the powerless child.
This bill is tough on families in distress. But it fails to deal effectively with the root cause of rising bankruptcy rates, which is the easy availability of credit. The bill requires lenders to make additional disclosures, and it encourages creditors to make good-faith settlements with debtors before bankruptcy. But it does nothing to discourage lenders from offering credit to borrowers who are already over their heads in debt.
The Consumer Federal of American reports that in recent years the credit card industry has stepped up its marketing to low and moderate-income households, and to minors. In 1997, the amount of credit card debt carried over from month to month rose above $450 billion—double what it was just five years before. In just one year (1996), credit card debt grew three times faster than incomes. As a result, nearly 60 million American households carry credit card balances averaging more than $7,000—costing these household more than $1,000 a year in interest and fees. This growing credit card debt is the main reason for the rise in personal bankruptcies.
H.R. 833 is opposed by children's rights advocates and women's groups, who are concerned about the damage it will do to children and famnilies in crisis. It is also opposed by labor unions, consumer groups, public interest groups, and judges and scholars who are concerned about the integrity of the bankruptcy process.
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We must not make it harder for noncustodial parents to pay child support. We should not be placing new obstacles in the way of parent's ability to pay support. In my County—Monroe County, New York—more than $135 million in past-due child support is owed to 41,000 children. The numbers are similar for New York State as a whole. Of the over $1 billion owed in child support in 1997, only about $800 million was collected. The accumulated total child support arrears owed in my state is $3 billion. Across the nation, the gap between potential child support and actual child support collected is estimated to be $34 billion.
I support efforts to reform our bankruptcy laws to make debtors responsible for the debt they incur. If we want to reduce bankruptcy rates, we need to attack the root cause, which is the easy availability of enormous lines of consumer credit. And in the process of doing so, we need to protect the interests of the most vulnerable parties—the children who could be denied vital support.
I urge the Sbucommittee to address the problem this bill creates for women and children who are owed child support and alimony. I urge the Subcommittee to seek a balanced approach to bankruptcy reform that prevents abuses of the bankruptcy system, while allowing good-faith debtors the ability to take care of their families while they deal with their debts.
Mr. GEKAS. With that, we abruptly end the members' presentations for this session of the Commercial and Administrative Law Committee hearing, and we thank both our colleagues for their presentations. Their written statements will become a part of the record, as we have previously indicated. We thank them.
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Ms. JACKSON LEE. Mr. Chairman, just a question on amendments. You are saying that we can submit the amendments during the course of the hearings that you will be having that we might want to propose?
Mr. GEKAS. You can submit them at any time to the majority and the minority for review for possible inclusion in the mark-up vehicles that are yet to come.
Ms. JACKSON LEE. Thank you, Mr. Chairman.
Mr. GEKAS. And if they are accepted right at the start, they will be part of the bill that we will be marking up. If they are not, you will still have the option as members to offer those amendments at mark-up.
Ms. JACKSON LEE. Thank you, Mr. Chairman.
Mr. DELAHUNT. Mr. Chairman, a point of information.
Mr. GEKAS. Yes, the gentleman from Massachusetts.
Mr. DELAHUNT. You know, the question of the gentle lady from Texas provoked another question from me to the Chair. I understand that there is a mark-up that is tentatively scheduled for next week. Or is that firmly scheduled?
Mr. GEKAS. That is on the schedule.
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Mr. DELAHUNT. It is on the schedule.
Mr. GEKAS. Yes. We have it on the schedule, and we have notified everyone to that effect.
Mr. DELAHUNT. Great. Thank you.
Ms. JACKSON LEE. Thank you very much.
Mr. GEKAS. By all means.
We are ready now to listen to an opening statement by the gentleman from New York, which will be followed by a brief opening statement by the Chair, and then we will invite panel number one to take their places at the table.
Mr. NADLER. Thank you, Mr. Chairman.
Today we begin another hearing on bankruptcy legislation. I want to reflect, if I may, on the word ''hearing.'' It implies that we are here to listen to the testimony and to the insights of experts in the field in order to inform our judgments and our actions. I would note that we have assembled over the next 3 days an impressive array of witnesses, including some of the most outstanding practitioners, scholars, and experts in the field. I refer not just to those witnesses requested by the minority, but also to those called by the majority, and I want to commend you, Mr. Chairman, for calling these outstanding individuals.
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I hope that in the course of this hearing there will be some listening on the part of the members of the subcommittee, that this will not simply be a pro forma exercise on the way to a predetermined result. That would certainly be a waste of all of our time and a waste of the efforts of both the majority and the minority staff who worked very hard to put these hearings together.
It is for that reason, Mr. Chairman, that I was so troubled to read in yesterday's Congress Daily A.M. the following report, and I quote: ''Gekas' office has made no secret of the fact that it believes the hearings likely will prove a rehash of issues already discussed last Congress and claim the meetings primarily are for the benefit of committee Democrats, like subcommittee ranking member Jerrold Nadler of New York, who are opposed to Gekas' approach.''
''Commenting on the upcoming hearings, one Gekas staffer remarked, 'It will be a restatement for those who claim not to be up to snuff with knowledge.'''
I certainly hope this report reflects rather youthful staff bravado more than the chairman's oft-stated commitment to fulsome hearings. Yet I share the National Bankruptcy Conference's observation when the legislation before us was reintroduced, ''Reintroduction of this omnibus bankruptcy bill is especially disappointing because it disregards the policy concerns expressed by the administration, over 20 groups representing the interests of women and children, civil rights groups, consumer advocates, along with a variety of other groups.'' Modestly omitting the membership of groups like the National Bankruptcy Conference, which represents the finest in the profession.
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There has been a great deal of comment and insight and new studies since we considered this issue in the last Congress. We will hear from the authors of a study commissioned by the independent and non-partisan American Bankruptcy Institute, which shows that the studies funded by industries with a direct financial interest in this legislation, which we heard about last year, may have overstated the problem of individuals who are able to pay but do not by perhaps a mere 500 percent.
We will also hear from the General Accounting Office who will, at the request of the minority, provide a critical discussion of this and other studies on this topic, which I hope will help provide an important perspective to the members of the subcommittee.
There have been other new studies. For example, just last month the Federal Reserve Bank of New York issued a report that concludes that, ''While these changes in personal characteristics and attitudes imply a higher risk of delinquency, we conclude that they are relatively unimportant in explaining the overall rise in bad debt. Much more important is the higher debt burden among cardholders: the new borrowers owe substantially more relative to their income, so even small drops in income can cause financial distress. Type of occupation also matters. The new borrowers are more likely to work in relatively unskilled blue-collar jobs; delinquency rates are higher among such workers, perhaps because their income is more closely tied to the business cycle. Greater indebtedness and the shift in cardholding toward people in more cyclical occupations help explain how such a mild economic slowdown in 1995 could have driven charge-offs so high today.''
These findings seem to confirm the work of the FDIC, of Professor David Moss at Harvard, and Professor Larry Ausubel of the University of Maryland, who has previously testified before the subcommittee.
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Similarly, in a recent paper, Professor Ausubel notes that the so-called bankruptcy crisis has actually responded to market forces and has seemingly evaporated without any of the proposed draconian changes to the Bankruptcy Code. According to Professor Ausubel, and I quote, ''The bankruptcy crisis began in the first quarter of 1995, as the seasonally adjusted quarterly personal bankruptcy rate per thousand population—which had broadly been in decline since 1992—began to accelerate at a 12 percent annual rate. The crisis peaked from fourth quarter of 1995 to third quarter 1996, when the bankruptcy rate increased at a 30 percent annual rate for a full year. It then began a pronounced deceleration following the second quarter of 1997 as growth declined to less than a 4 percent annual rate. Today, there looks to no longer be a crisis: the personal bankruptcy filing rate per thousand population has grown at an annual rate of only 1.5 percent in the past year, and at a seasonally adjusted annual rate of only 1.0 percent in the past quarter.''
Mr. Chairman, I ask unanimous consent that both the Federal Reserve and the Ausubel studies be made part of the record. And I also ask unanimous consent for an additional 1 minute, if I may.
Mr. GEKAS. Without objection—all except the 1 minute. You can have 2 minutes.
Mr. NADLER. Thank you.
[The studies referred to follow:]
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A SELF-CORRECTING ''CRISIS'': THE STATUS OF PERSONAL BANKRUPTCY IN 1999
BY LAWRENCE M. AUSUBEL, PROFESSOR OF ECONOMICS, UNIVERSITY OF MARYLAND (ON SABBATICAL AT UNIVERSITY COLLEGE LONDON)
MARCH 10, 1999
EXECUTIVE SUMMARY
Alarmed by the ''bankruptcy crisis''—the explosion in personal bankruptcy filings in the 1995–97 period—the 105th Congress came close to enacting a harsh bankruptcy bill, but ultimately enacted nothing. This brief report assesses the state of personal bankruptcy as of March 1999, concluding that despite the inaction of Congress, the crisis ended by itself in 1998. The personal bankruptcy filing rate per thousand population grew at an annual rate of only 1.5% in the last year, and at a (seasonally-adjusted) annual rate of only 1.0% in the last quarter. Delinquency and chargeoff rates on credit cards peaked over a year ago and are now flat or improving. The economic reason for this precipitous improvement appears to simply be that the bankruptcy crisis is self-correcting: profit-maximizing lenders respond to an unexpected increase in personal bankruptcies by curtailing new lending to the consumers teetering closest to bankruptcy. Thus, the legislative changed reintroduced in the 106th Congress should be viewed as alarmist and unnecessary.
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BACKGROUND
During the period of 1995–97, the United States witnessed a sharp explosion in the rate of personal bankruptcies. In the final quarter of 1997, the (seasonally-adjusted) quarterly personal bankruptcy rate stood at 1.287 per thousand population, up 72.2% from the rate only three years earlier. [See the Table at the end of this Report.] Sharp jumps also occurred in other measures of consumer default, such as delinquencies and chargeoffs on MasterCard and Visa cards. The increase in bankruptcies provoked considerable alarm, especially as it occurred during a period of relative economic prosperity.
Legislators concerned with the ''bankruptcy crisis''—at the urging of lobbyists for lender organizations concerned with their profits—introduced bills into the 105th Congress proposing broad restrictions on consumer bankruptcy protection. Their proposal, self-styled as ''needs-based bankruptcy,'' was incorporated into several bills, including H.R. 2500, H.R. 3150, and S. 1301. The ''Bankruptcy Reform Act of 1999,'' recently introduced as H.R. 833 in the 106th Congress, incorporates similar restrictions. The harsh proposal would have the effect of forcing many debtors, who are currently eligible for Chapter 7 bankruptcy filings, instead into Chapter 13 filings.
THE RECENT DATA
This brief report relies exclusively on U.S. government data, as seasonally adjusted by the author. For the number of personal bankruptcy filings, I use the quarterly statistical releases of the Administrative Office of the U.S. Courts (http://www.uscourts.gov/Press—Releases/CY98BK.pdf). For U.S. population, I use the estimates (for the first day of the middle month of each quarter) of the U.S. Census Bureau (http://www.census.gov/population/estimates/nation/infile1-1.txt). The quarterly personal bankruptcy filing rate per thousand population is merely the number of personal bankruptcy filings divided by the U.S. population in thousands, seasonally adjusted. The unadjusted number of personal bankruptcy filings, the seasonally-adjusted number of personal bankruptcy filings, the seasonally-adjusted quarterly personal bankruptcy rate per thousand population, and the annualized growth rate in the seasonally-adjusted quarterly personal bankruptcy rate per thousand population are reported in the Table at the end of this Report. The annualized growth rate of the seasonally-adjusted quarterly personal bankruptcy rate per thousand population is also plotted in the Figure at the end of this Report.
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As can be seen from the Table and Figure, the ''bankruptcy crisis'' began in the First Quarter of 1995, as the (seasonally-adjusted) quarterly personal bankruptcy rate per thousand population—which had broadly been in decline since 1992—began to accelerate at a 12% annual rate. The crisis peaked from Fourth Quarter 1995 to Third Quarter 1996, when the bankruptcy rate increased at a 30% annual rate for a full year. It then began a pronounced deceleration following the Second Quarter of 1997, as the growth declined to less than a 4% annual rate. Today, there looks to no longer be a crisis: the personal bankruptcy filing rate per thousand populations has grown at an annual rate of only 1.5% in the past year, and at a (seasonally-adjusted) rate of only 1.0% in the past quarter.
Similar trends are apparent in the delinquency and chargeoff rates on credit card lending. Both appear to have peaked over a year ago and are now flat or in decline.
It is also worth recognizing that, while the current bankruptcy rate today stands 75% above where it stood four years ago (at the start of the ''bankruptcy crisis''), it stands a less-shocking 41% above where it stood seven years ago. The smaller increase over the longer time comes from comparing the current bankruptcy rate with its previous cyclical peak (First Quarter 1992) versus its previous cyclical trough (Second or Fourth Quarters 1994).
ECONOMIC ANALYSIS
Generally speaking, the long-term increase in the personal bankruptcy rate over time appears to have arisen from a long-term increase in the household debt burden. There has been a close statistical connection between the bankruptcy rate and the debt burden, and it only stands to reason that more debt leads to more bankruptcies.
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More specifically, the severe nature of the ''bankruptcy crisis'' of 1995–97 appears to have arisen from an unfortunate combination of a sharp increase in the household debt burden beginning in 1993 and a misappreciation, by some lenders, of the importance of debt burden in predicting the probability of bankruptcy. With 20–20 hindsight, one can today say that consumers with heightened debt-to-income ratios often have dramatically higher incidence of default and bankruptcy. However, the magnitude of this effect was less apparent earlier in the 1990's. In the period beginning 1993, some lenders went about extending large amounts of additional credit to consumers who were already significantly borrowed up, unaware of the extent to which these consumers were rapidly becoming major default risks. These lenders then appear to have been genuinely surprised by the upward spike in defaults and bankruptcies in 1995–97. This aspect of the ''bankruptcy crisis'' is unlikely to be repeated, as these lenders have now updated their lending formulas to reflect the importance of debt burden in predicting default.
Indeed, the ''bankruptcy crisis'' is self-correcting. Lenders choose the amount of credit that they are willing to extend, and the riskiness of the consumers to whom they are willing to lend. In turn, the willingness of lenders to tolerate default risk is determined by the profitability of lending. For example, in the current lending environment, a typical credit-card interest rate is 15.7%, while the cost of funds is only about 5%. This rather large interest-rate spread makes it profitable for issuers to extend credit to consumers with rather high probabilities of default.
But observe that this economic story does not lead one to expect continuing unmitigated and exponential growth in the rate of bankruptcies. Lenders will only extend credit to the extent that it remains profitable. The high rates of default at the peak of the bankruptcy crisis began to impinge on the profitability of lending and—as a consequence—lenders tightened their underwriting standards. This is what made the ''bankruptcy crisis'' self-correcting.
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By the same token, one should not expect that a harsh revision of the bankruptcy law—as in H.R. 833—will lead to a sharp reduction in the bankruptcy rate. As we have already said, lenders determine the level of default risk they are willing to tolerate according to the expected profitability of lending. A tightening of the bankruptcy law will be viewed by lenders as improving the probability that they are able to collect on risky account, i.e., it will increase the expected profitability of lending. As a consequence, lenders will extend credit to inherently riskier consumers than they do today, lending to reverse any potential improvement in the bankruptcy rate.
For a fuller discussion of the economic issues, see the prior article s and testimony of the author:
''The Failure of Competition in the Credit Card Market,'' American Economic Review, Vol. 81, No. 1, March 1991, pp. 50–81.
''Credit Card Defaults, Credit Card Profits, and Bankruptcy'' American Bankruptcy Law Journal, Vol. 71, Spring 1997, pp. 249–270.
Testimony before the Subcommittee on Financial Institutions and Regulatory Relief of the Committee on Banking, Housing, and Urban Affairs of the United States Senate, Hearing on Bankruptcy Reform, Wednesday, February 11, 1998.
Testimony before the Subcommittee on Commercial and Administrative Law of the Committee on the Judiciary of the United States House of Representatives, Hearing on Consumer Bankruptcy Issues, Tuesday, March 10, 1998.
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Mr. NADLER. Mr. Chairman, also, I am somewhat disturbed that we have scheduled three days of hearings in 1 week, and a markup the following week. It seems that if we are seriously intending to take into account the legislation what we hear today, that speed is a little prohibitive.
Finally, and far more seriously, Mr. Chairman, I wish to make what our prosecutors would call a missing witness charge. For more than a year, Mr. Kim Kowalewski of the Congressional Budget Office, has been studying some of the fundamental economic issues which go to the very heart of our ability to understand what is causing the record number of bankruptcies. His work is widely respected in the field. In fact, he was even asked to provide assistance to the National Bankruptcy Review Commission.
We have been unable to get any results from his work. We have been unable to get CBO to allow him to testify at these hearings, despite a request from you, sir, the chairman. His work is continuously sent outside CBO for peer review. The scope of his work has been expanded by CBO leadership well beyond the inquiries put forward by the members of this committee. And this work which results from the request I made a year ago in January, we are told will be completed after the markup next week.
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Who does CBO work for anyway? Why is this work, which is going to be released in a few weeks and which bears directly on this matter before the committee, being suppressed until after the markup?
Mr. Chairman, I know that you have requested that Mr. Kowalewski testify. If there is some reason why he cannot be permitted to inform the committee of his more than 1 year of work, then I would ask that you join the minority in making a bipartisan request that CBO Director Dan Crippen come before this subcommittee this week during this hearing and explain himself, and his agency and why they are hiding this witness and this information.
We need information, I believe the American people have a right to this information, and CBO has no business suppressing it.
So, in conclusion, I ask that you, Mr. Chairman, join us in making the request that if Mr. Kowalewski cannot come before us and testify this week for some reason, that Mr. Crippen, the head of CBO, come before us and tell us why he is not permitting the testimony and the research to come before us in this hearing.
Thank you, Mr. Chairman.
Mr. GEKAS. The gentleman's time has expired.
We note the presence of the gentleman from New York, Mr. LaFalce, who wishes to testify as part of the members' presentation, as well as the gentleman from New Jersey, Mr. Rothman. You are invited to take a place at the witness table, and we will permit a 5-minute presentation. Your written statement will become a part of the record.
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Mr. CHABOT. Mr. Chairman?
Mr. GEKAS. The gentleman from Ohio is recognized.
Mr. CHABOT. If I could just have one moment. I don't want to make a lengthy opening statement, having already made some opening statements, but I just wanted to, again, commend the chairman for holding this hearing, and rather than the criticism that he has received from some of my colleagues on the other side for moving forward relatively expeditiously, I think we should heap praise on the chairman for actually moving this important issue forward.
Mr. GEKAS. Which I accept.
Mr. CHABOT. I thought you might accept that. We are dealing with an awful lot of important issues in this Congress; saving Social Security, trying to give the American people some tax relief, decide what we do with the so-called surplus, which I think we shouldn't spend. But one of the most important issues we are dealing with in this Congress, quite frankly, is reforming bankruptcy because it is heaping on the shoulders of the American people what, in effect, is a tax of $550 a year in higher prices because of the abuse of the bankruptcy system.
So I compliment you for moving this forward expeditiously and look forward to listening to the panel members today.
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Mr. GEKAS. We thank the gentleman.
Mr. LaFalce is recognized. He is a member of the Banking Committee, and for a generation he has been part of the ongoing debate on bankruptcy and bankruptcy reform, and we welcome his commentary.
STATEMENT OF HON. JOHN LaFALCE, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK
Mr. LAFALCE. Thank you very much, Mr. Chairman, Mr. Nadler, gentlemen. I ask unanimous consent to put the entirety of my statement in the record.
Mr. GEKAS. Without objection.
Mr. LAFALCE. Thank you. Mr. Chairman, you are holding hearings on a very important issue, bankruptcy reform. I don't think that we can deal intelligently and fairly with the issue of bankruptcy reform unless we also deal with the difficulties posed by the practices of credit card issuers. And so I would strongly exhort you to have hearings devoted exclusively to that issue. I am not saying only have hearings on that issue, but do have a set of hearings dealing with the practices of credit card companies in an attempt to examine the extent to which the bankruptcy problems are being caused by the credit card companies themselves.
Mr. GEKAS. If the gentleman would yield for a moment. It is ironic that you would state that concern when we stated early last Congress and were informed, by various means, that the Banking Committee would consider it a stomping on their feet if we delved into those issues that are reserved for the Banking Committee. And so I want you to know that it is not out of fear or trepidation or wantonness that we have not——
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Mr. LAFALCE. As long as you want to, and I want to, I take that as a statement that you will have hearings on the issue.
Mr. GEKAS. What I am saying to you is that, insofar as the Banking Committee is willing to send to us conclusions drawn from hearings that it would hold on the concerns that you articulate, we will be glad to accommodate. I simply want to state——
Mr. LAFALCE. You are 100 percent correct that the Banking Committee should be having hearings on it, and I have been exhorting the chairman to do that. I am simply saying, though, that it is certainly appropriate for the Judiciary Committee, as part of its hearings on the problems of bankruptcy to have a hearing on that issue.
I also say this: The Senate bankruptcy bill did include a component on the practices of credit card companies.
Now, I have introduced a bill, which I would like to include as a component of any House bankruptcy bill that might move. Rather than go into the specific provisions of the bill that I have introduced at this time, which, in considerable part, borrows from the actions taken by the Senate in the last Congress, let me simply pose a number of questions that I hope that your subcommittee and committee would be asking all those individuals proposing rather serious changes in the bankruptcy laws.
And here are some of the questions, Mr. Chairman:
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Why has the credit card industry increased its solicitations amongst known debtors, students and others that it knows have a limited ability to repay debt?
Why does it continue to send out misleading teaser rate promotions that attempt to lure consumers with promises of low interest rates, while often hiding the permanent interest rate and potential penalties that can readily raise interest rates to 25 percent or more?
Why are credit card issuers reimposing annual fees, charging new fees or canceling the accounts of cardholders who routinely pay off their monthly card balances on time?
Why do they continually entice cardholders to add to their debt burdens through the use of third-party convenience checks while not disclosing or not adequately disclosing the additional fees and higher interest charges that often apply to those checks?
Why are issuers sending unsolicited credit cards by mail, often in violation of current law, disguised as telephone calling cards or other consumer benefit cards?
Why are some card issuers imposing fees of $29 on consumers whose payments, sometimes for $5 or $10, are received 1 or 2 days late, while also shortening payment periods and making it harder for consumers to find payment due dates in monthly bills?
Why are issuers now requiring minimum monthly payments that are smaller than monthly finance charges in order to discourage repayment of debt and to add to debt burdens, even when no purchases are made?
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Why are many companies also imposing inactivity fees, again as high as $29 a month, on account holders who choose not to use their cards while trying to pay off their debt?
Mr. Chairman, these are only a few of the practices employed by too many credit card companies to entrap consumers into escalating debt, to add unnecessarily to credit cost and discourage responsible credit card use. The practices are unfair, they are costly to consumers, and in many instances, they simply should not be allowed to continue, much less be adequately disclosed.
The bill that I have introduced, H.R. 900, would limit many of the most egregious and unjustifiable practices of credit card issuers. And I would encourage you to pursue this issue and to be open to any bill that the Banking Committee might report or to be open to an amendment that could be brought to the bankruptcy bill at an appropriate time, whenever that appropriate time is before the Rules Committee—or whether permitted by the Rules Committee as a floor amendment.
I would love to offer it jointly with you and Mr. Nadler, Mr. Chairman.
Mr. GEKAS. We thank the gentleman, and we thank him for his offer. We want him to know that, as currently constructed, our current bill does include some of the answers to the concerns that you have raised, perhaps not all of them to your satisfaction and to others', but we have not failed to address those problems, and we will continue to address them as we move on toward markup.
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We thank the gentleman for his remarks.
The gentleman from New Jersey, Mr. Rothman, is recognized for 5 minutes.
STATEMENT OF HON. STEVEN ROTHMAN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW JERSEY
Mr. ROTHMAN. Thank you, Mr. Chairman.
Mr. GEKAS. His written statement will become a part of the record.
Mr. ROTHMAN. Thank you kindly. My colleagues, it is good to be with you again, as always.
Let me set forth what I believe are some basic principles in considering the issue of bankruptcy reform. The first principle is that people who borrow other people's money should repay it if they can.
Second principle is that in circumstances where people who borrow other people's money are not able to repay in full, and if after consideration of reasonable and necessary expenses they are still able to pay a portion of the money they borrowed from someone else, they should pay that portion they can afford to pay. But if they cannot pay any of it, they should be excused from their debts entirely and be given a fresh start.
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Those are the principles that guide me in the consideration of the discussion of bankruptcy and bankruptcy reform. I am here to say that I support the Gekas bill because I believe that it is a reasonable step toward eliminating the worst abuses of the bankruptcy system, yet preserves the majority of the benefits that the bankruptcy system was supposed to provide.
As I understand it, today, 70 percent of people who file for bankruptcy are placed in Chapter 7 and 30 percent are placed in Chapter 13. If the Gekas bill were to become law, that number would change as follows: Not 70 percent, but 63 percent of the filers would still be in Chapter 7 and 37 percent would then be in Chapter 13. I am told that this bill would affect, at the most, only 10 percent of Chapter 7 filers. Ninety percent of those filing for Chapter 7 would not be affected at all, and the 10 percent would merely face the presumption.
The bill also makes some other beneficial changes, not just holding those who would abuse the system accountable for the portion of the debts they can afford to repay, but it also moves alimony and child support from seventh to first priority, closing a loophole in that bankruptcy system that debtors can use to avoid or delay these payments.
There is a debtors bill of rights, there is prohibition against credit card company penalties, there are enhanced disclosures, there is consumer education, there are alternative dispute resolutions required, and there are studies authorized by the Gekas bill. I believe it is a bill worth supporting.
I just want to mention in my previous life I was a lawyer, a mayor of a small city of 25,000, and a surrogate court judge for a county of almost a million people. I worked in a mom-and-pop kind of a neighborhood law practice, and many of my clients were working people, or less than working class people in an economic sense, and they literally went from big job to big job. And if those who hired them for the big jobs stiffed them on payment after their work, they suffered grievously or went out of business. I cannot tell you the dozens of times these folks would come to me and ask me, ''Steve, how could they let this happen? I did the work. My people did a good job. And the guy who hired me said, 'I'm going to go bankrupt again. Take 50 cents on the dollar for your work.'''
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This bankruptcy reform issue may also be seen as part of our effort in the United States to reinstill a sense of personal responsibility. Part of that was apparent in the welfare reform laws, part of that in making cigarette manufacturers responsible for the poisons they have caused people to become addicted to, and laws making polluters pay and others.
There will be those who will resist this move toward more personal responsibility, but I believe that the rest of society who has to pay for these abuses should not have to pay, and that is why I support this very reasonable bankruptcy reform bill. I thank the Chair for allowing me to make my presentation.
Mr. GEKAS. We thank the gentleman for his remarks, and we look forward to further cooperation at the full committee when we determine the final text of the bill to be presented to the full committee. We thank the gentleman.
Does the gentleman from Virginia wish to make a statement or is he auditing this hearing? [Laughter.]
Mr. GEKAS. The gentleman from Virginia, Mr. Moran, is recognized for any remarks he wishes to render.
STATEMENT OF HON. JAMES P. MORAN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF VIRGINIA
Mr. MORAN. Well, thank you, Mr. Chairman. I have been trying to be kind of a presence at these hearings because I really feel that what we have is a reasonable, balanced and should be bipartisan piece of legislation. It is better than last year's bill, and yet last year's bill passed overwhelmingly on the House floor.
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This year, we have additional consumer protections. We have basically a bill of rights for consumers. The credit card companies are going to have to notify consumers that if they just pay the minimum payment they could be paying until they are buried deep in the ground, and they are only paying on interest costs. That is the kind of information that is important for consumers to be aware of. We are going to try to do away with these mills, really, bankruptcy mills, where people try to exploit others to get them through the bankruptcy system not for the benefit of the consumers, but for their own economic advantage.
There are a number of built-in safeguards here, but the most important is this is income based. If you have an income that is only meeting your daily needs; in other words, less than the median income of about $51,000 for a family of four, then this doesn't really apply to you. You have the choice of either going Chapter 7 or Chapter 13. I think that is very fair.
We are only trying to go after the people who have the means to pay off their debts, but instead of using their financial ability to pay off the debts, are declaring bankruptcy and passing that debt on to other people who do pay their debts. That figure of $400 a year that each American family is having to pay just to make up for the bad debts of others is wrong. That is something we should assume responsibility for, and I would hope that any legislation is going to act in such a way that that $400 burden is going to be relieved because it is just so unfair. It is almost immoral, really, for that kind of bad debt to be passed on by people who can afford to pay off their debts.
And the fact that we have 1.4 million bankruptcies, more than we have college graduates, that does not reflect the prosperity that we are experiencing in the country. It reflects the fact that people are gaming the system.
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And so I would hope that we could get a bipartisan bill out of this committee, that we could get the support from both sides of the aisle, that we could get a bill enacted this year. And I know that that bill is going to put as a priority child support, protection of widows and divorced spouses and so on, and single parents, but it is going to go after the people who are really putting a stain on the entire system of bankruptcy. It is not what the bankruptcy system was ever intended to do, and I hope we are going to right it with this legislation and that we can get it passed early. It will set, I think, a very positive, constructive signal that this Congress can get along, that it can work constructively together, and that we can do the right thing for the vast majority of the people of this country.
Mr. GEKAS. We thank the gentleman, and we look forward to further debate on this matter. Thank you.
Mr. MORAN. Thank you, Mr. Chairman.
Mr. GEKAS. The Chair will acknowledge the presence of the gentleman from Arkansas, Mr. Hutchinson. Does he have an opening statement of any type?
Mr. HUTCHINSON. No, Mr. Chairman, I do not. I am here to listen and learn. This is a very helpful hearing that you are having, and a very important piece of legislation, so I look forward to the testimony.
Mr. GEKAS. I thank the gentleman.
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I was interested in the criticism hurled this way by the gentleman from New York relative to the content of the article in the National Journal's Congress Daily A.M. in which the gentleman from New York took great delight, it seemed, in pointing out that Gekas' office has made no secret of the fact that it believes the hearings likely will prove to be a mere rehash of issues already discussed last Congress.
Except for the word ''rehash,'' which is sort of pejorative, I think it is fair and productive for us to say that what 60 witnesses produced last term—that is 60 witnesses and several hearings—not counting the hearings and testimony on the Senate side, really covered the entire territory required for us, for the public, and for Members of Congress and for all concerned to learn what is to be learned about the need for bankruptcy reform. And so when we reproduce a bill in this Congress, which for the most part reiterates the work of the previous Congress and carries with it the same body of support, and testimony, and the same criticisms that were foisted and some corrected from the last Congress, then it is proper to say that, indeed, we are allowing a full review, rehash—as the gentleman from New York is probably very happy to use that word. We are reviewing, and restating, and reiterating, and reconstituting, and re-endorsing the work of the last Congress and the statements of those witnesses who will be endorsing and re-endorsing their own statements in these hearings yet to come. I think it is very helpful to re-educate the Members of Congress, to re-educate those who are interested in bankruptcy reform and to reinform the American public that we are intent on proceeding with meaningful reform.
Later, in that same article, again, the gentleman from New York was ecstatic in being able to point out that ''these meetings are primarily for the benefit of committee Democrats, like subcommittee ranking member Jerrold Nadler, who are opposed to Gekas' approach.''
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Of course, we made certain that whatever we can do to get Mr. Nadler and some of his supporters to fully understand the severity of the problem—that the country is sick and tired of bankruptcy, 1,400,000 bankruptcies—per year so that they can have full knowledge about what is going to happen if we continue down this path, to have full exposure to all that we are doing, to have extra meetings, extra witnesses, extra forums. We have had staff briefings, and breakfasts, and luncheons, and memos back and forth ad nauseam to inform the Democrats and the minority, those who oppose bankruptcy reform, so that they should know everything about the subject. I plead guilty. I am proud of pleading guilty that we have taken these extra steps.
And, further, ''It will be a restatement for those who claim not to be up to snuff with knowledge.'' That is exactly correct. Although it sounds awful the way Mr. Nadler reported it and repeated it, and even I was shocked at it when I first heard it from his statement. Now, I read it, and I am parsing—parsing, you understand, is a way of doing things in Washington these days—that it will be a restatement for those who claim not to be up to snuff with knowledge.
If they did not understand the statements of the salient witnesses that produced testimony last year, maybe this year they will understand it. Those who did not understand what happened last year, even if the testimony is repeated this year, might have a better chance to understand what the concerns are.
I think that we are doing a good job. That is what this article is saying. We are doing a good job. We are making sure the Democrats, the minority, know everything we are doing, that we provide staff briefings, that we provide expert testimony on one of the primary issues of which they stated concern last term and this term, spousal support, family support, children, alimony, all of those issues, and, on top of that, we restage hearings in which we give them full blank-check rights to call witnesses of their own—which they must acknowledge. If they don't, then we have another battle on our hands—that their witnesses many times have been called by the majority. And where they have failed to call witnesses who favor their position, we took it upon ourselves to make sure that witnesses favoring their side and opposing our bill would be a part of the witness table at these hearings.
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I feel good about it, and I feel great about the criticism. It gave me an extra forum to demonstrate that we, indeed, are going the extra mile to try to help resolve an issue, not oppose bankruptcy reform, but to try to bring a sensible reform to a much-needed arena in our world of commerce and, indeed, in our family life in this country.
[The prepared statement of Mr. Gekas follows:]
PREPARED STATEMENT OF HON. GEORGE W. GEKAS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF PENNSYLVANIA, AND CHAIRMAN, SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW
Today, we commence the second of four hearings that the Subcommittee will hold on the topic of bankruptcy reform and H.R. 833, the Bankruptcy Reform Act of 1999, a bill that I introduced last month.
We begin today's hearing with a Members Panel, where my colleagues will have an opportunity to share with us their thoughts about this bill, which I hope will be largely favorable, if only because of my pride of authorship. But seriously, I want everyone to understand one simple fact: H.R. 833 is exactly the same in all respects as the conference report on H.R. 3150, a bill that was overwhelmingly supported by Republicans and Democrats alike, as evidenced by a 300 to 125 vote in the waning days of the last session.
Given that level of support and given the fact that in the last Congress alone we held four days of hearings on H.R. 833's predecessor—during which we heard from more than 60 witnesses—some have argued that there is absolutely no need for any additional hearings on H.R. 833. While these arguments are compelling, I have nevertheless insisted that we hold comprehensive and fulsome hearings that fully develop the issues.
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Last week's hearing is a perfect example of the value of holding hearings. Among the witnesses who testified, was a bankruptcy judge who had presided over more than 35,000 cases during her tenure on the bench and who was invited, I might add, at the request of my colleague, Mr. Nadler. Without hesitation, this judge said, and I quote, ''I agree with Chairman Gekas that people who can pay should pay. I think that is fundamental.'' And, with regard to the needs-based test, which is the heart of H.R. 833, this judge unequivocally stated, ''I predict that [this test] will affect my caseload not one iota.''
The statements of this bankruptcy judge clearly underscore the two primary goals of H.R. 833. First, to restore the fundamental concept of personal responsibility in the bankruptcy system by requiring those who have the ability to repay, to do so. And, second, to ensure that only those debtors who have the ability to repay are targeted, while those who lack this ability will receive their ''fresh start'' forthwith and not be affected by these reforms, to quote the judge again, ''one iota.''
Today's hearing is no exception. In addition to our colleagues, we will hear from some of the nation's leading bankruptcy experts and academics. The first panel will provide a historical perspective of bankruptcy law and reform that should be most enlightening. Following this panel will be one devoted to the need for consumer bankruptcy reform.
Mr. GEKAS. So, with that, we invite the members of the first panel to come.
I think that the next set of concerns that the gentleman from New York might have will be personally recorded with the chairman——
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Mr. NADLER. Mr. Chairman, I have a unanimous consent request. That is all I have.
Mr. GEKAS. I am getting to that. I am getting to that.
Right now, I am simply saying to you, whatever other concerns you might have about scheduling hearings, staff briefings, memos, et cetera, I am willing to meet with you so that you will be even further satisfied that we are trying to do the right thing.
In the meantime, I have a unanimous consent request to allow the testimony of the Honorable Bill McCollum before the House Judiciary Committee's Subcommittee on Commercial and Administrative Law to be entered into the record.
[The prepared statement of Mr. McCollum follows:]
PREPARED STATEMENT OF HON. BILL MCCOLLUM, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF FLORIDA
Mr. Chairman, thank you for providing me with an opportunity to testify on the need for bankruptcy reform as outlined in H.R. 833. I appreciate the time and attention the Chairman has dedicated to this important issue and commend you for holding these hearings.
Two years ago, I introduced H.R. 2500, the Responsible Borrower Protection Bankruptcy Act, as it became clear that reform of the existing bankruptcy system was sorely needed. At the time the bill was introduced, our nation was witnessing an epidemic of personal bankruptcies. From 1986 to 1996, real per capita annual disposable income grew by over 13 percent but personal bankruptcies more than doubled. In 1996, for the first time ever, there were more than 1 million personal bankruptcy filings. In fact, bankruptcies have increased over 400 percent since 1980.
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At the time, it was estimated that personal bankruptcies would rise by 20 percent in 1997 to 1.3 million personal bankruptcy filings. In fact, the increase in personal bankruptcy filings in 1997 was even larger than expected, with the Administrative Office of the Courts reporting over 1.4 million personal bankruptcy filings, constituting a 23 percent increase. That is more than one bankruptcy per every 100 American households. Last year, there were again more than 1.4 million filings.
Bankruptcy will cost our nation more than $50 billion in 1998 alone. That translates into over $550 per household in higher costs for goods, services and credit. If we do not make reforms now, responsible borrowers and consumers will continue to pay the price in the form of higher costs for goods, services and credit.
Mr. Chairman, what is most disturbing about this rate of increase is the fact that it is occurring at a time when the nation is experiencing a robust economy with the lowest unemployment rate in more than 20 years. If we do not address personal bankruptcy reform now, while the economy is doing well, the problem will only become worse during a recession.
H.R. 833 fundamentally reforms the existing bankruptcy system into a needs-based system. Only those who truly cannot repay their debts will be able to use the complete bankruptcy in Chapter 7 of the Bankruptcy Code. Those who can repay their debts will have to use Chapter 13 and work out a repayment plan.
Needs-based reform is intended to address a flaw in the current bankruptcy system which encourages people to file for bankruptcy and walk away from their debts, regardless of whether they are able to repay any portion of what they owe, by using the straight bankruptcy of Chapter 7. Under the current bankruptcy system, the vast majority of those who file are not even examined to determine if they are able to repay even a portion of what they owe. Such a misuse of our bankruptcy laws is fundamentally unfair to those who play by the rules and take responsibility for their personal obligations. Needs-based reform would directly address this flaw by requiring that those who have the ability to repay file in Chapter 13 and work out a repayment plan. H.R. 833 outlines a formula for determining ability to repay which takes into account income, debts, and expenses.
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Mr. Chairman, our nation's bankruptcy laws play a vital and necessary role in our society. We must ensure that our bankruptcy system does not encourage those who can take responsibility for their debts not to do so. Under the current system, about 70 percent of those who file for personal bankruptcy file in Chapter 7, while only about 30 percent file in Chapter 13.
If Congress fails to fix the flaws in the current bankruptcy system now, then responsible borrowers will continue to pay the price. Mr. Chairman, I am confident that, under your leadership, these three days of hearings will make it clear that adoption of the bankruptcy reforms outlined in H.R. 833 is vital to ensuring that our bankruptcy laws operate fairly, efficiently and free of abuse. I comment the Subcommittee for tackling this important issue and look forward to continuing to work with you in addressing this issue.
Mr. GEKAS. I understand the gentleman from New York has a similar request.
Mr. NADLER. Yes, Mr. Chairman. I stated in my statement I praised the chairman and the majority——
Mr. GEKAS. Which we accept.
Mr. NADLER [continuing]. For holding these hearings, for calling not only the minority witnesses, but a good set of majority witnesses that I think will help elucidate the problem. So I fully agree with the chairman, and I praised him for doing that.
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The only reservation I stated was that the scheduling of these hearings, 3 full days of hearings this week with a markup next week, doesn't seem to leave much time between now and next week for whatever comes out of these hearings to be incorporated in a bill.
But in any event, I have a unanimous consent request, Mr. Chairman. Our colleague, the Senator from Illinois, Mr. Durbin, was unable to testimony at last week's joint hearing. He was the ranking senator on the Subcommittee of Jurisdiction, the other body, and I ask unanimous consent that this testimony, which he has submitted in writing, be made part of the record.
Mr. GEKAS. Without objection, it is so ordered.
[The prepared statement of Senator Durbin follows:]
PREPARED STATEMENT OF HON. RICHARD J. DURBIN, A U.S. SENATOR FROM THE STATE OF ILLINOIS
Introduction: I'd like to thank the Senator Grassley and Senator Torricelli, as well as Congressman Gekas and Congressman Nadler, for inviting me to testify today on this important issue. I hope my experience from last year will help you as you begin your deliberations.
A constant theme that guided me throughout the consideration of bankruptcy legislation was balanced reform. You cannot have meaningful bankruptcy reform without addressing both sides of the problem—irresponsible debtors and irresponsible creditors.
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The bill that passed the Senate last year was a balanced, bi-partisan effort. Senator Grassley and I worked very hard to develop a bill to address abuses by both debtors and creditors. Our bill passed the Senate by a vote of 97–1.
Unfortunately, the bill we worked so hard to develop, was decimated in conference and the result was a one-sided bill designed to reward the credit industry and penalize American consumers. I could not support it. I hope this year will be different.
In order to discuss serious bankruptcy reforms, we must have a better understanding of the problem.
LATEST STATISTICS:
Last year, was a record year for bankruptcy filings. Almost 1.4 million people filed for personal bankruptcy. This number (1,398,182) represents a 3.5% increase from 1997.
In Illinois: 62,000 people filed for personal bankruptcy in 1997, a 18 percent increase in the 53,000 filed in 1996.
Latest Figures Show: In 1997, all 50 states had record filings.
These figures are disturbing and we want to address abuses but we should not create a nation of financial outlaws
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Bankruptcy is the last if not the only social safety net for the middle class
So we need to deal with the problem, but not in radical and draconian ways.
FACTORS CONTRIBUTING TO BANKRUPTCY FILINGS
1. Probably the single biggest cause of bankruptcy filings is credit extended to people who never should have been given credit in the first place.
PERSONAL BANKRUPTCY RISES WITH CONSUMER DEBT:
The rise in personal bankruptcies almost exactly tracks the rise in average consumer debt.
Credit card solicitations: In 1997, the credit card industry sent out 2.4 billion pre-approved credit card applications. There are only about 78 million credit worthy households in the U.S.
Nationwide credit card charges: According to Federal Reserve figures, American consumers racked-up more than $5 billion in revolving debt during January of 1999 alone.
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Nationwide outstanding credit card debt: Total credit card debt now stands at approximately $555 billion with $450 billion coming from general purpose cards such as VISA, MasterCard and American Express. (SEE CHART)
Impact on consumers: The result of all this credit can be devastating on an individual. A slight increase in the amount of credit card debt that a person is carrying can make them significantly more likely to declare bankruptcy.
Nationwide credit card interest: In 1996, U.S. consumers paid $65 billion in interest on credit cards.
So in these times, it is even more important for people to be fully informed about and careful with the credit card debt they rack up. That's why this legislation is more important than ever.
WHAT DID LAST YEAR'S SENATE BILL DO?
The key provisions dealt with abusive filings—i.e. people who can still afford to pay but try not to—and abusive serial filings.
Here are the key provisions:
Reform of the abusive filings provision: Allow creditors to assert that a particular bankruptcy is abusive and get it dismissed.
Limitation on ability to file multiple bankruptcy petitions: Under the bill you cannot get 10 bites at the apple.
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Provided a better way of getting information: It required that debtors file more comprehensive information with the court—income tax forms, debt schedules, etc.
Required timely filing of plans: Required people to file their plans in a timely manner rather than the current system which has no deadline.
Provided for outside auditing of bankruptcy filings: This would improve our ability to catch fraudulent filings.
The bill also prevented creditor abuses:
Most importantly, the bill was balanced. It addressed abusive creditor practices. For example, if a creditor unjustifiably objected to the discharge of a debt, the creditor would suffer penalties. If the debtor tried to renegotiate their debts, and the creditor refused to bargain in good faith, the court could take it into account.
Very often creditors charge debtors all of the attorneys fees that the creditor racked up in pursuing the debt. That often leaves debtors in bankruptcy owing more. The bill limited the abilities of creditors to do this.
Predatory lending provisions: High-cost home mortgage lenders have been gouging elderly and financially unsophisticated homeowners with low to moderate incomes with a variety of abusive lending practices. Last year's Senate bill prohibited abusive lenders who have preyed on unsophisticated consumers from recovering their claims against homeowners in bankruptcy. Specifically, the provisions prohibited recovery if the mortgage:
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— failed to comply with disclosure requirement;
— contained excessive default interest rates;
— required lump sum balloon payments on loans of less than 5 years;
— used negative amortization or required prepaid payments paid in advance of loan proceeds;
— was made without regard to the consumer's repayment ability;
— or failed to meet special home improvement loan requirements.
REASONS WHY THE HOUSE BILL WHICH IS VIRTUALLY IDENTICAL TO THE BANKRUPTCY CONFERENCE REPORT IS NOT A GOOD STARTING POINT FOR BANKRUPTCY REFORM
The conference report did not provide balanced bankruptcy reform that would curb both creditor and debtor abuse. It watered down or eliminated altogether important provisions we fought to include in the Senate bill.
1. Needs-based bankruptcy: The conference report imposed a rigid and arbitrary means test that we thought would send waves of debtors into Chapter 13 repayment plans without regard to whether they could succeed. The test created a presumption based on IRS tax collection standards which a debtor could rebut only on a showing of extraordinary circumstances.
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But, we now know that the means test would only apply to 3% of Chapter 7 filings: A study released by the American Bankruptcy Institute found that by using the test from the House bill, 97% of sample Chapter 7 debtors had too little income to repay even 20% of their unsecured debts over five years. As a result only 3% of the sample Chapter 7 filers had sufficient repayment capacity to be barred from Chapter 7 under the rigid means test.
WHY SHOULD WE PASS LEGISLATION THAT WILL ONLY APPLY TO 3% OF THE CASES?
2. Reaffirmations: A reaffirmation is a debtor's agreement to continue paying off a debt to a particular creditor despite filing bankruptcy. In other words, a side agreement to continue paying a debt normally forgiven in bankruptcy. For example, people may need to keep their cars to keep their job, so they reaffirm a car debt. Other times, however, people reaffirm debts because they are intimidated by aggressive creditors.
The conference report eliminated provisions that prevented reaffirmation of secured debts for personal property under $250—where creditor abuses like those in the Sears cases have repeatedly occurred. Where unsecured debt is reaffirmed, the court does not consider reaffirmation's effect on the debtor's dependents or the debtor's future ability to pay child support, and has no real power to review coercive creditor behavior in the course of obtaining the agreement.
3. Penalties for bad creditor behavior: The conference bill gutted provisions making specific coercive behavior a violation of the automatic stay, dropped penalties for reaffirmation violations from $5,000 to $1,000, rolled back current law that permits a court to award punitive damages to redress stay violations under appropriate circumstances, and also prohibited class actions, which are currently allowed.
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4. Consumer disclosures: The conference bill stripped the requirement that credit card companies inform consumers on a monthly basis of the consequences of making only the minimum payment on their individual account, and permitted credit card companies to terminate customers who pay in full after a period of inactivity or on the expiration date.
5. Nondischargeable debt: The conference report made non-dischargeable (unforgivable) all debts that were not ''necessary'' to individual creditors incurred 90 days before bankruptcy. It also made all cash advances more than $250 incurred 90 days before bankrupt nondischargeable. These debts will compete directly with alimony and child support in the post-bankruptcy world. The conference also deleted fee-shifting provisions for dischareagability litigation that would have discouraged frivolous litigation and the depletion of funds.
6. Homestead exemption: The conference report rejected a uniform cap on homestead for all states in favor of a lengthened residency requirement that would only catch bankruptcy filers who move to Florida or Texas or other states with high homestead exemptions prior to filing bankruptcy.
7. Predatory lending: The conference report stripped out the predatory lending provisions, which were designed to protect consumers, particularly elderly homeowners over the age of 65 living alone.
WHY LAST YEAR'S SENATE BILL IS BETTER:
It's cheaper: The House bill basically sets up a federal bureaucracy to ferret out a few extra dollars from debts. But, we now know from the ABI study that the means test will only apply to 3% of the cases and we have to ask ourselves whether it is an efficient use of resources.
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It's fairer: Last year's Senate bill is flexible enough to get the big spender and to look closely at the poorer person.
It's easier to administer: Last year's Senate bill uses current bankruptcy procedures. It can be used immediately.
CONCLUSION:
I urge this Committee not to use the so called ''conference'' bill that failed to gain the support needed to pass, as the starting point for meaningful bankruptcy reform.
Instead, use a more balanced approach to address the abuses without making the so called ''reform'' worse than the problem. Last year's Senate bill was not perfect, but it was a good start.
Thank you.
Mr. GEKAS. We invite the members of the first panel to approach the witness table.
James I. Shepard was appointed to the National Bankruptcy Review Commission by then Senator Bob Dole, where he served as commissioner from 1995 to 1997. Prior to and following his service with the Commission, Mr. Shepard served as a bankruptcy tax consultant. He is an adjunct professor of law at the McGeorge School of Law in Sacramento, California, and at the San Joaquin College of Law graduate tax program in Fresno, California. Mr. Shepard has practiced law in Colorado, Iowa, and Nebraska. In 1987, Mr. Shepard became associated with a major accounting firm in Fresno, California. He has written and lectured extensively on bankruptcy taxation matters. He obtained his bachelor of arts from the University of Iowa, and thereafter received his juris doctorate and master's of law degrees in taxation from the University of Denver.
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He is joined at the witness table by Professor Eric Posner of the University of Chicago School of Law. After receiving his bachelor of arts and master's in philosophy, summa cum laude, from Yale University, he went on to obtain his juris doctorate from Harvard Law School, magna cum laude. His other work experience includes service as a law clerk to the Honorable Stephen F. Williams of the United States of Court Appeals for the District of Columbia. He, thereafter, was an attorney adviser at the Justice Department's Office of Legal Counsel. Before joining the faculty of the University of Chicago's School of Law, Professor Posner was an assistant professor at the University of Pennsylvania Law School from 1993 to 1998. His recent publications include articles in the economics and history of bankruptcy law, the economic theory of contract law and international law.
With these first two gentlemen is Professor David Skeel, professor of law at the University of Pennsylvania Law School. Prior to joining the faculty at that institution, he was an assistant professor of law at Temple University from 1990 to 1998.
Professor Skeel received his law degree from the University of Virginia School of Law, where he was an editor of the Virginia Law Review and a member of the Order of the Coif. He, thereafter, clerked for the Honorable Walter Stapleton of the United States Court of Appeals for the Third Circuit.
Professor King is with us, the Charles Seligson Professor of Law at New York University School of Law. He is also counsel with the New York law firm of Wachtell, Lipton, Rosen and Katz. After receiving his bachelor's degree from the City College of New York in 1950, he obtained his law degree from New York University in 1953, and his master's of law degree from the University of Michigan in 1957. Professor King served on the Advisory Committee on Bankruptcy Rules of the Judicial Conference of the United States from 1983 to 1992. He was the reporter for the committee from 1979 to 1983. Prior to that, he served as the associate reporter for the committee from 1968 to 1976. Professor King was a consultant with the Commission on the Bankruptcy Laws of the United States from 1972 to 1973, and he was a senior adviser to the National Bankruptcy Review Commission from 1996 to 1997. Professor King is editor-in-chief of Collier on Bankruptcy, a leading bankruptcy treatise. In addition, he is co-editor and chief of Collier Bankruptcy Practice Guide.
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Ralph Mabey received his law degree from Columbia University in 1972, where he served on the Board of Editors of the Columbia Law Review. Thereafter, he was a United States Bankruptcy Judge for the District of Utah from 1979 to 1983. Currently, Mr. Mabey leads the corporate restructuring and reorganization practice of LeBoeuf, Lamb, Greene and MacRae, where he has served as counsel in several multi-billion cases, including Baldwin United, Columbia Gas System, Federated Department Stores and TWA. From 1987 to 1993, Mr. Mabey served as an appointee of the Chief Justice to the United States Judicial Conference's Advisory Committee on the Bankruptcy Rules. He has also served as the managing editor of the Norton Bankruptcy Law Adviser and on the editorial board of the American Bankruptcy Law Journal. He currently is a contributing author to Collier on Bankruptcy and the Collier Bankruptcy Manual.
Judge Joe Lee is a United States Bankruptcy Judge for the Eastern District of Kentucky. Before assuming the bench in 1961, Judge Lee served in the United States Air Force from 1943 to 1949, where he was a member of the Eighth Air Force Division in England during World War II. After obtaining his law degree from the University of Kentucky, Judge Lee clerked for the Honorable James Milliken, Chief Justice of the Kentucky Court of Appeals and for the United States District Judge Hiram Church Ford. He was also counsel for a congressional subcommittee in the U.S. House of Representatives. In addition to receiving numerous awards for his distinguished judicial service and other accomplishments, Judge Lee served as editor-in-chief of the American Bankruptcy Law Journal from 1982 to 1990.
Leon Forman has concentrated, for about 60 years, on various points of law practice; on bankruptcy, reorganizations, workouts and other banking and commercial lending matters, including loan restructurings, debtor-in-possession financing, and lender liability. He received his juris doctorate degree from the University of Pennsylvania Law School, where he was a member of the Board of Editors of the Law Review. A partner with the Philadelphia law firm of Blank, Rome, Comisky and McCauley, Mr. Forman was previously associated with Wexler, Weisman, Forman and Shapiro, which later merged with his current firm. Mr. Forman is a member of numerous professional organizations, including the American College of Bankruptcy, where he serves as scholar in residence. He is also a member of the National Bankruptcy Conference, the American Law Institute and the Commercial Law League of America.
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With that introduction, we will inform the members of the panel, as we will continuously, that their written statements will form a part of the record without objection, and they will each be allotted 5 minutes for a review of that written statement.
Mr. Shepard will begin.
STATEMENT OF JAMES I. SHEPARD, ESQUIRE, BANKRUPTCY TAX CONSULTANT, FORMER MEMBER OF THE NATIONAL BANKRUPTCY REVIEW COMMISSION, FRESNO, CA
Mr. SHEPARD. Thank you, Mr. Chairman. It is an honor to be invited to appear before this subcommittee today. My comments today are based on some of my observations regarding my service on the National Bankruptcy Review Commission, its process and the need for bankruptcy reform.
The 2 years of serving on the Commission, where hearings were held nationwide and presentations made by debtors, lawyers, creditors' lawyers, bankruptcy judges and representatives of numerous organizations, easily leads one to the conclusion that bankruptcy has grown too important to entrust to those who work within the bankruptcy industry. The drafting of bankruptcy laws should not be left to those who have a vested interest in the implementation of those laws, whether creditors, debtors, lawyers or judges.
First of all, bankruptcy is a big business. If the debtors' lawyers who filed the more than 44,000 business cases in 1998 received an average of $30,000 in fees, a conservative estimate, that group received a total of over $1.3 billion. If the consumer debtors' lawyers received an average of $1,000 for each of their 1.4 million cases, that group received nearly $1.4 billion. That means that the debtors' lawyers were paid approximately $2.7 billion for filing the cases in 1998. Assuming that the creditors' lawyers were paid just half of that amount and adding in the rest of the rest of the participants in the system, bankruptcy is easily a $5 billion-a-year industry at the expense of the American public, and these figures don't include the cost of the judicial system, the cost of administering the cases or the debt that was discharged.
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So what is the proper role of the bankruptcy law and the courts? Bankruptcy judges should be discouraged from rendering result-oriented decisions, those where the Bankruptcy Code lacks clarity and allows the court to read it in a manner never contemplated by Congress. Such judicial legislation creates law that was not intended and invades the province of Congress. Inconsistent and illogical application of law creates an attitude of disrespect for the law, particularly where it creates special benefits for those who don't deserve it.
The public's perception of fairness and equality of law is an asset which must be protected and not jeopardized by permitting debtors to use bankruptcy as a means of improperly avoiding their obligations. Thus, where bankruptcy becomes too appealing and causes people to be less responsible, the law must be changed.
And where the cost of bankruptcy to the public, whether in increased interest rates, increased restrictions on credit, increased cost of goods or increased costs of Government become excessive, the law must be changed. One county property tax assessor said to me, ''Just tell me how much bankruptcy will cost, and we can adjust the rates to make up the difference.'' Well, how did we get here?
During the 2-plus years of its existence, the prior Commission, the Commission on the Bankruptcy Laws of the United States was charged with rewriting our bankruptcy laws, a collection of outdated, sometimes unworkable and frequently undesirable laws, which had served the country for 90 years without a major change since the promulgation of consumer bankruptcy laws in the Chandler Act of 1938.
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The present Commission, the National Bankruptcy Review Commission, on which I served, was given a more narrow charge, determining the problems with the Code and suggesting changes for improvement. The prior Commission held only four public hearings and conducted their discussions mostly in executive session. The present Commission conducted nearly all of its discussions in public meetings. A major effort was made to communicate with organizations, individuals, and the media.
The present Commission conducted discussions largely in the public eye. Thus, the need for an extensive airing of the Commission's report and the reasons for reform is not nearly as great. Those with a direct interest in bankruptcy laws have been heard from.
What are the reasons for reform? While premised on the Bankruptcy Act of 1898, the Bankruptcy Code contained many new and untested ideas, an expansion of Chapter 13, greater protection for the debtors under 362, the promulgation of the Rules for Business Reorganizations, for instance. We have now had 20 years to learn the new concepts and procedure and how the courts interpret it and apply the Code.
The Code has been tested, and while adjusted periodically, has found to be lacking. In addition, the world is a much different place than it was 20 years ago. Bankruptcy cases and filings have grown exponentially. Without question, credit and lending policies have changed. More people have access to credit now than was seriously considered 20 years ago.
One of the factors contributing to our robust economy is consumer spending, financed, to a large degree, with the consumer debt. If credit is curtailed to protect against excessive losses, many of those who borrow and spend wisely, but do not have sufficient assets to collateralize a loan, will be unable to obtain credit, and the economy will shrink.
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The Commission, as you know by now, was greatly politicized and deeply polarized. There was no attempt to forge a compromise on some of the most important topics, such as the consumer recommendations and the general Chapter 11 issues. The Commission began, under the chairmanship of former Congressman Mike Synar of Oklahoma. His unfortunate and untimely death early in his work deprived the Commission of his ability to forge a consensus, an attribute for which he was well known.
Mr. GEKAS. Will the gentleman draw his conclusions as best he can now?
Mr. SHEPARD. I will. Clearly, bankruptcy reform is necessary. We have had 20 years of experience with the Code, and we have now found it to be shortcoming.
Lastly, I would hope that Congress, when addressing these needs, keeps in mind that satisfying the needs and demands of the debtors, creditors, lawyers and judges will make them happy, but will it be in the best interests of the public, the 260 million people who did not file bankruptcy in 1998 and yet are required the bear the burden of the system.
Thank you.
[The prepared statement of Mr. Shepard follows:]
PREPARED STATEMENT OF JAMES I. SHEPARD, ESQUIRE, BANKRUPTCY TAX CONSULTANT, FORMER MEMBER OF THE NATIONAL BANKRUPTCY REVIEW COMMISSION, FRESNO, CA
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I. INTRODUCTION.
Thank you for inviting me to speak today. It was an honor to be appointed to serve on the National Bankruptcy Review Commission and to have the opportunity to seek improvements in the bankruptcy laws of this country. Today, I will comment upon some of my observations regarding the Commission's work, its process, and the need for bankruptcy reform The two years of serving on the Commission, where hearings were held nation wide and presentations made by debtors' lawyers, creditors' lawyers, bankruptcy judges, and their organizations and representatives of numerous interested groups, easily leads one to the conclusion that bankruptcy has grown too important to entrust to those who work within the bankruptcy industry, those who profit from the bankruptcy system—the drafting of bankruptcy laws should not be left to those who have a vested interest in the implementation of those laws, either creditors or debtors.
A. Bankruptcy is a Big Business.
In studying the need for bankruptcy reform legislation, I would hope that the members of Congress keep in mind that there are only two things in bankruptcy for the players in the system, the lawyers and other professionals, money and power—the Bankruptcy Code and courts provide the power and the system provides the money. The recently released statistics on case filings in 1998 has produced some interesting inferences. If the debtors' lawyers who filed the 44,367 business cases in 1998 received (or will receive) an average of $30,000 in fees, a conservative estimate according to most bankruptcy judges, that group received (or will receive) a total of over $1.3 billion dollars. If the consumer debtors' lawyers received an average of $1,000 for each of their 1,398,182 cases, a reasonable estimate, that group received nearly $1.4 billion dollars, for a total of approximately $2.7 billion dollars paid to the debtors' lawyers. Assuming that the creditors' lawyers were paid just half of that amount and adding in the accountants, turn-around specialists and other hangers-on, bankruptcy is easily a $5 billion dollar-a-year industry, at the expense of the American public; and these figures don't include any of the costs of the judicial system, the costs of administering the cases, or the debt that was discharged. The numbers point to a conclusion which is entirely inescapable, bankruptcy is a big business for lawyers and other professionals.
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B. The Proper Role of the Bankruptcy Courts and Bankruptcy Law.
Further, it must be recognized that bankruptcy courts cannot function as a ''court of all social ills,'' real or perceived. Section 105(a) of the Bankruptcy Code—which, in the words of Judge Robert Ginsberg, who also served on the Bankruptcy Review Commission, is the ''last bastion of a desperate lawyer''—is not the authority for a court to rewrite nonbankruptcy law according to the result it seeks. Bankruptcy judges must be discouraged from rendering result oriented decisions, those where the Bankruptcy Code is read in a manner never contemplated by Congress; such judicial legislation creates law that was not intended and invades the province of Congress. The Bankruptcy Code cannot be the source of omnipotent power, staving off the demands of creditors and rewriting law to suit the needs of every individual debtor. Nor can every small business with overwhelming financial problems be allowed to remain sheltered in that hospice of dying businesses, chapter 11, until all assets are wasted and the list of creditors is longer than before. Where the courts have strayed from Congressional intent Congress must establish clear limitations and definitions to redirect not only the ''rogue'' judges but the majority of our judges who are intelligent and well meaning, but often are lacking adequate guidance because the Code is vague.
The Constitution states that Congress shall ''establish uniform laws on the subject of bankruptcies throughout the United States''—that bankruptcy law will be federal law to achieve uniformity as a part of the regulation of commerce—and to prevent fraud where debtors may have relocated property in other states.(see footnote 1) Public respect for the law is an attribute that must be fostered and protected. Where bankruptcy law, or any law, strays far beyond the founders' intent and creates special rights for a few, whether motivated by a true sense of altruism or a desire to fulfill the vision of a few, this respect is lost and we all suffer. Thus, where bankruptcy becomes too appealing or grants relief to those who are undeserving, those who simply don't want to pay their debts but have the ability to do so, the law must be changed.
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Where taxpayers have cheated on their returns, for instance, but are relieved of the obligation to pay, when they are otherwise not entitled to relief, the law must be changed. Where bankruptcy becomes the highly profitable playground of a few who are able to manipulate the law and the system to obtain unintended benefits, the use of ''stealth provisions,''for instance, designed to obtain relief for nondebtors not otherwise permitted under law by obfuscating the language in Chapter 11 plans, the law must be changed. Where the law and the rules are overly complex or vague and inconsistently applied and the costs of participation in the process become prohibitive it must be changed. And where the costs of bankruptcy to the public, whether in increased interest rates, increased restrictions on credit, increased costs of goods, or increased costs of government, whether because of loss of revenue or the expenses of protecting the public interests, become excessive, the law must be changed. One county property tax assessor said, ''Just tell me how much and we can adjust the rates to make up the difference.'' The loopholes and ''gotcha'' provisions which prevent parties from protecting their legitimate interests must be eliminated.
C. How We Got Here.
During the two plus years of its existence, the prior Commission, the Commission on the Bankruptcy Laws of the United States, conducted four public hearings over only eight days and 21 executive sessions over 44 days and filed its report with the President, the Chief Justice and the Congress on July 30, 1973. By remarkable coincidence, due to the preoccupation of Congress with the hearings regarding the possible impeachment of President Richard Nixon the law which became the Bankruptcy Code was not introduced until January 4, 1977. The Bankruptcy Code became law as title 11, United States Code, on the enactment of the Bankruptcy Reform Act of 1978; the much amended Bankruptcy Act of 1898 was our bankruptcy law until the Bankruptcy Code became law in 1979.
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The prior Commission was faced with the daunting task of evaluating and revising a law which had served the country for 90 years without a major change since the promulgation of consumer bankruptcy laws in the Chandler Act of 1938, during the depression. That Commission had to determine whether to discard the Act of 1898 entirely and start all over or to pick and chose which parts of the existing bankruptcy law should be saved, which should be revised and which should be discarded. The charge to the prior Commission was to ''study, analyze, evaluate, and recommend changes'' in the Bankruptcy Act of 1898. The prior Commission conducted it's business in a collegial fashion, for the most part out of the public view, and was given the freedom to examine bankruptcy law in a more global fashion. The prior Commission devoted over a quarter of the $705,500 dollars it spent on seven commissioned studies, including a study by the Rand Corporation at a cost of $150,000.
In comparison, the National Bankruptcy Review Commission, established under the Bankruptcy Reform Act of 1994, was given a more limited charge, it was told that Congress was ''generally satisfied with the basic framework established in the current Bankruptcy Code.'' The Review Commission began its work when it first met in October of 1995 and held virtually no executive sessions. It held, instead, 21 national and regional public hearings over 35 days, attended by more than 2,600 people, devoting almost half of its entire budget to public meetings, communication and outreach. The Review Commission conducted its business largely in the public eye. Thus the need for an extensive airing of the Commission's report and the reasons for reform is not nearly as great; those with a direct interest in bankruptcy laws have been heard from.
D. The Reasons for Reform.
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The Bankruptcy Code, while attempting to adhere to prior law, in large part, made sweeping, untested changes in many areas. The expansion of chapter 13 for consumer bankruptcies, greater protection under the section 362 stay of proceedings for debtors in general, the promulgation of the rules for business reorganizations, and the greater restriction on the ability of government to function, for instance, were new to the Code. We have now had twenty years to learn how the new concepts and procedures work and how the courts interpret and apply the new Code; twenty years to experiment with various attempts to ''tweak'' the Code to try to alleviate some of its shortcomings. The Code has been tested and, while adjusted periodically, has been found to be lacking. The public and many individuals have been adversely affected in many ways.
Perhaps of greater importance, the world is a much different place than it was twenty years ago. At the time of the enactment of the Code, there were a little more than 182,000 consumer bankruptcy filings, both straight liquidations and repayment plans. In 1998 there were just short of 1.4 million personal bankruptcy filings, an increase of more than 750 %. In the same time, the population has grown only a little more than 21 %. Twenty years ago there were some 32,000 business filings. In 1998, although business filings have been on a decline, thanks to the healthy economy, there were still more than 44,000 business filings.
We are celebrating a robust economy which has continued to expand longer than thought possible. When considering bankruptcy reform the affect of an overly generous bankruptcy system must be kept in mind. Without question, credit and lending policies have changed and more people have access to credit than was seriously considered twenty years ago. One of the factors contributing to the robust economy is consumer spending, financed to a large degree with consumer debt. There are those that attribute the record breaking number of consumer filings to what they perceive as ''irresponsible lending.'' But the current methods of extending credit to the borrowers who were not considered credit worthy twenty years ago are not susceptible to the ''fixes'' suggested by the debtors' advocates. If the availability of credit were curtailed, to eliminate the abuses of the irresponsible borrowers, those borrowers who are responsible and pay their debts, but do not have sufficient assets to collateralize a loan, as was required twenty years ago, would be denied access to credit—it was difficult to obtain credit without having credit.
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The law should not make it too easy to file bankruptcy but should demand personal responsibility of those that file. The law cannot allow any of the parties to ignore the rules and abuse the system. Where consumers are able to incur debt and spend irresponsibly and then be relieved of the obligation to repay, the public attitude towards the virtue of paying one's debts is lost, to the ultimate damage to our economy. A column recently appearing in the San Francisco Examiner,''(see footnote 2) first noted the interrelationship between consumer consumption, consumer marketing, excessive consumer debt, particularly due to irresponsible spending, and the soaring rate of consumer bankruptcies, then asked, ''When debt is checked, through either tighter credit or the wake-up call many consumers will have, will our economic expansion slow?'' Bankruptcy reform will encourage responsible use of credit.
In the case of business bankruptcies, the vision guiding promulgation of the rules for chapter 11 reorganizations has not been fulfilled. In the majority of chapter 11 cases, generally all but the largest cases, the present rules have been found woefully inadequate in keeping cases moving towards successful reorganization. In spite of the favorable business economy fewer than one in four debtors confirm a plan and an even smaller number successfully complete a plan. Quoting from a respected bankruptcy treatise(see footnote 3) the Bankruptcy Review Commission's report states:
Far too [frequently], counsel file a Chapter 11 petition for a debtor, the business of which is in such straits and so incapable of recovery that the Chapter 11 case is nothing more than a holding pattern before an inevitable conversion to Chapter 7 or dismissal. Such a case serves no useful purpose and instead merely prolongs a painful process. Clients would be far better served if counsel examined the economic potential of the business before filing a petition to ''rehabilitate'' a moribund debtor.(see footnote 4)
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The principal weaknesses in the chapter 11 provisions of the Code are a lack of supervision of the debtor, particularly in the vast majority of cases where there is no active creditors' committee, the lack of clear deadlines for filing and confirming a plan of reorganization, cumbersome requirements for disclosure statements, the lack of significant reporting requirements, and inadequate control of serial filers. All of these problems are addressed in H.R. 833, the Bankruptcy Reform Act of 1999.
Similar weaknesses in other areas of the Code have developed over the past twenty years, many of which are addressed in H.R. 833.
E. The Commission's Process.
When the Bankruptcy Review Commission was first formed it was thought that it would be an opportunity for a collegial, objective study of the Code and its problems. Unfortunately, events proved that such would not be the case. The Commission quickly became politicized and, thus, very polarized; in some cases the personal agenda of a few individuals, rather than objective, scholarly study by the group, was the driving force in promulgating the Commission's recommendations. There was no effort to forge a compromise where the members were deeply split on important topics, such as the consumer recommendations and the General Chapter 11 Issues.
The depth of the chasm in the Commissioners' views and the disagreeable manner in which the report was written are reflected in the Commissioners' dissents to the report, particularly the Dissent From the Process of Writing the Commission's Report.(see footnote 5) The dissent of Commissioners John A. Gose and Jeffrey H. Hartley, concurring with the Recommendations for Consumer Bankruptcy Law submitted by the Honorable Edith H. Jones, observed that the report's consumer ''Framework'' was unacceptable , that it was presented on a ''take ir or leave it'' basis. The discrete problems and complaints about consumer bankruptcy law were not presented in a manner which permitted their separate consideration.
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The Commission began under the chairmanship of former Congressman Mike Synar of Oklahoma. His unfortunate and untimely death early in its work deprived the Commission of his ability to forge a consensus, an attribute for which he was well known. Not all of the Commission's recommendations suffer from the lack of compromise. Remarkable exceptions are the Small Business Proposals, which are the product of much objective study and compromise and the very capable guidance of Stephen Case, Senior Advisor to the Small Business Committee, and the tax proposals, which were guided by Professor Jack Williams.
F. Conclusion.
Bankruptcy reform is clearly necessary. Twenty years of experience with the Code has revealed significant shortcomings, many of which are addressed in H.R. 833, the Bankruptcy Reform Act of 1999. There are those who argue that the reform process is moving too fast, those that advocate maintaining the status quo. Many of those who work within the bankruptcy industry and who have profited by the system argue against change, whether because of genuine belief that current law is best, because of the inconvenience in being required to learn new rules and procedures, or because of a potential loss of revenue. Those who have the advantage created by loopholes and shortcoming in the Code do not want the system changed. During the Commission's hearings, the debtors' lawyers quickly came to sound like a ''broken record,'' time and again repeating the overused saw, ''if it ain't broke don't fix it.'' But principally those who argue that further delay is required simply do not like the bill; it does not meet their personal vision of what bankruptcy should be and they hope that additional time will give them the opportunity to derail reform.
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In my testimony at an earlier Congressional hearing, I observed that one of the Commission's greatest failures was in ''studying the fish from inside the fish bowl when it should have been looking at the broader perspective from outside the tank.'' Solely relying on the statements, testimony and submissions of those who work within the bankruptcy industry, those who presented their views which are reflected in the Commission's report, presents the views of those with a vested interest in the bankruptcy process. The opinions of those within the bankruptcy industry do not always represent the best interests of the public.
Thus, it becomes the duty of Congress to consider the rights and interests of the public, not just the players in the system. Bankruptcy law must be kept in its proper perspective. Congress and the United States Government must serve all the citizens of this country, not just the debtors and creditors, but, more importantly, the 260 million people who did not file bankruptcy in 1998 and yet are required to bear the burden of the system. It must be remembered that the Bankruptcy process is but one function of government, a substructure within the panoply of governments, state, federal and local, which must provide for all citizens.
Mr. GEKAS. We thank the gentleman.
We turn to Professor Posner for the allotted 5 minutes.
STATEMENT OF ERIC A. POSNER, PROFESSOR, UNIVERSITY OF CHICAGO LAW SCHOOL, CHICAGO, IL
Mr. POSNER. Thank you, Mr. Chairman.
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The current Bankruptcy Code was motivated, in part, by a report issued in 1973 by a Commission that had been created by Congress to evaluate American bankruptcy law.
Of the reasons for bankruptcy reform listed in the report two stand out to modern eyes.
The first reason for reform was the rapid increase in the number of bankruptcies, which had gone from about 10,000 in 1946 to about 200,000 in 1967. The second reason was that the fresh start was ''insufficiently generous.'' You get no sense from the report that there is any contradiction in saying that both the rapid increase in bankruptcies and the insufficient generosity of the fresh start are problems.
The Commission's main recommendation with respect to consumer bankruptcy was to create a uniform system of Federal exemptions to replace the bankruptcy law's incorporation of State exemptions. The final law, as you know, created Federal exemptions that served as a de facto floor in those States that did not subsequently exercise their right to opt out of the Federal exemption system.
After the Bankruptcy Code was enacted in 1978, the number of bankruptcy filings shot up and is now about 1.4 million in 1998. Almost all of the growth has been driven by the increase in consumer bankruptcy filings, and because of this, some people have naturally assumed that the exemption rules and other consumer bankruptcy provisions of the 1978 Code are responsible for the increased filing rate.
However, the effect of the enactment of the Bankruptcy Code on consumer bankruptcy filings is hard to gauge. There are some reasons for believing that the Code is the culprit. It is true that the Federal exemptions created in 1978 were more generous than the exemptions in most States at that time and so people in the less generous States could now do better by filing for bankruptcy. However, empirical studies have come to conflicting results, and analysis has been confounded by the occurrence of other events that probably had an influence on bankruptcy filings. Perhaps the most important, in my view, was the de facto deregulation of State interest rate ceilings in 1978.
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Since 1978, Congress's attempts at bankruptcy reform have been motivated, in part, by concern about the rapid increase in bankruptcy filings. In 1984, it introduced the substantial abuse test in Section 707(b), which attempted to force high-income debtors into Chapter 13, although it is not clear how much effect this law has had. Yet in 1994, Congress increased the generosity of exemptions. It increased the homestead exemption, for example, from $7,500 to $15,000. A married couple could exempt $30,000 of home equity. Taken together, it seems that the net result of post-1978 bankruptcy reform was an increase in the generosity of the bankruptcy system.
So we have a strange repetition of history. The Bankruptcy Code was motivated, in part, by concern about the number of bankruptcy filings, yet resulted in a more generous bankruptcy system. Bankruptcy reform has been motivated by concern about the number of bankruptcy filings and yet has also resulted in a more generous bankruptcy system.
Why has this occurred? Well, it is hard to say, but it seems that the answer lies, in part, in the influence of interest groups. As I have argued recently, the people with the most at stake and with the most influence on bankruptcy reform in 1978 were bankruptcy lawyers, bankruptcy judges, consumer groups of various sorts and creditors. Lawyers, judges and consumer groups lobbied hard for a more generous bankruptcy system, and it appears they got one. The creditors did not have as much influence as one might expect, perhaps because their interests conflicted. Bankers seem to care most about the treatment of mortgages, for example, not about exemptions, while other commercial lenders cared about a variety of issues, like reaffirmation agreements, the right to redemption, as well as exemptions.
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The people least-well represented in the hearings leading up to the 1978 Code were the ordinary members of the public, the people who borrow money routinely. Although lawyers and consumer groups claimed to represent the public, it is more plausible that they were interested in helping people who have already incurred a great deal of debt and so might need the services of a bankruptcy lawyer. In addition, the legislative process lasted over a decade and received little attention from the media. Bankruptcy law was then a backwater; no one predicted that bankruptcy reform would change this, so no one alerted the public to what was happening.
These considerations suggest that we should not be complacent about the status quo. The status quo bankruptcy system probably reflects the interests of lawyers and maybe certain kinds of creditors as well. We should be cautious about assuming that the current generosity of the bankruptcy system reflects the public's interest and that the public would be opposed to reform.
Does the public have an interest in means testing? It is hard to see why it wouldn't. The public has always objected to welfare benefits, for example, going to the undeserving poor, and it would seem that for similar reasons the public would object to bankruptcy protection going to higher income individuals.
The people who would be most harmed by means testing would not be the public in general; they would be the bankruptcy lawyers. Bankruptcy lawyers would most likely see a decline in business from those people who, I assume, are their most lucrative clients; namely, the higher income people seeking to escape their debts.
[The prepared statement of Mr. Posner follows:]
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PREPARED STATEMENT OF ERIC A. POSNER, PROFESSOR, UNIVERSITY OF CHICAGO LAW SCHOOL, CHICAGO, IL
The current Bankruptcy Code was motivated in part by a report issued in 1973 by a Commission that had been created by Congress to evaluate American bankruptcy law. Of the reasons for bankruptcy reform listed in the report, two stand out to modern eyes. The first reason for reform was the rapid increase in the number of bankruptcies, which had gone from 10,196 in 1946, to 208,329 in 1967.(see footnote 6) The second reason was that the fresh start was ''insufficiently generous.'' You get no sense from the report that there is any contradiction in saying that both the rapid increase in bankruptcies and the insufficient generosity of the fresh start are problems. But it seems clear that if the fresh start is made more generous, more people will file for bankruptcy; and if you want fewer people to file for bankruptcy, then you have to make the fresh start less generous.
The Commission's main recommendation with respect to consumer bankruptcy was to create a uniform system of federal exemptions, to replace the bankruptcy law's incorporation of state exemptions. It did not explain this recommendation in any detail, but it may have believed that incorporation of state exemptions was unfair to people who lived in states with miserly exemptions. (State exemptions, then as now, ranged from the extremely miserly to the extremely generous.) The amounts chosen—for example, $5000 homestead—were also not explained. Subsequently, the House sought a more generous federal floor (for example, $10,000 homestead), while the Senate sought to retain incorporation of state exemptions. The final law contained an odd compromise—intermediate exemptions (for example, $7500 homestead) as a de facto floor in those states that did not opt out of the federal exemptions.
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After the Bankruptcy Code was enacted in 1978, the number of bankruptcy filings shot up, and has risen almost every year. In 1998, there was a new record: about 1.4 million. Almost all of the growth has been driven by the increase in consumer bankruptcy filings. Because of this, people have naturally assumed that the exemption rules and other consumer bankruptcy provisions of the Code are responsible for the increased filing rate.
However, the effect of the enactment of the Bankruptcy Code on consumer bankruptcy filings is hard to gauge. There are some reasons for believing that the Code is the culprit. The federal exemptions created in 1978 were more generous than the exemptions in most states at that time, and so people in the less generous states could now do better by filing for bankruptcy. And although most states opted out of the federal system, many states increased the generosity of their own exemptions quite substantially over the 1980s and 1990s. As a result, some academics believe that the Bankruptcy Code caused the increase in consumer bankruptcies. However, empirical studies have come to conflicting results, and analysis has been confounded by the occurrence of other events that probably had an influence on bankruptcy filings. Perhaps the most important was the de facto deregulation of state interest rate ceilings in 1978.(see footnote 7) This, and related factors, enabled creditors to issue credit to higher-risk debtors than they had in the past, and these are the very debtors who are most likely to be unable to repay their debts.
Since 1978, Congress' attempts at bankruptcy reform have been motivated in part by concern about the rapid increase in bankruptcy filings. In 1984, it introduced section 707(b)'s substantial abuse test, which attempted to force high-income debtors into Chapter 13, although it is not clear how much effect this law has had. Yet in 1994, Congress increased the generosity of exemptions. It increased the homestead exemption, for example, from $7500 to $15,000. A married couple can exempt $30,000 of home equity. Taken together, it seems that the net result of post-1978 bankruptcy reform was an increase in the generosity of the bankruptcy system.
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So we have a strange repetition of history. The Bankruptcy Code was motivated in part by concern about the number of bankruptcy filings, yet resulted in a more generous bankruptcy system. Bankruptcy reform has been motivated by concern about the number of bankruptcy filings, and yet has also resulted in a more generous bankruptcy system. Why has this occurred?
The legislative history of the Bankruptcy Code illustrates the widely held view that legislation will reflect the interests with the most at stake, and not necessarily the interests of the diffuse and unorganized public. As I argued in a recent article, the people with the most at stake, and with the most influence on bankruptcy reform in 1978, consisted of bankruptcy lawyers, bankruptcy judges, consumer groups, and creditors. Lawyers, judges, and consumer groups lobbied hard for a more generous bankruptcy system, and they got one. The creditors did not have as much influence as one might expect, perhaps because their interests conflicted. Bankers seemed to care most about the treatment of mortgages, while unsecured lenders cared more about reaffirmation agreements, the right to redemption, and exemptions. Complicating these matters was the question of whether exemptions should be controlled by the states or by Congress, a question that has so far been resolved in favor of the states.
The people least well represented in the hearings leading up to the 1978 Code were the ordinary members of the public who need to borrow money. Although lawyers and consumer groups claimed to represent debtors, it is more plausible that they were interested in helping people who have already incurred a great deal of debt, and so might need the services of a bankruptcy lawyer. In addition, the legislative process lasted over a decade and received little attention from the media. Bankruptcy law was a backwater; no one predicted that bankruptcy reform would change this, so no one alerted the public to what was happening.
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These considerations suggest that we should not be complacent about the status quo. The status quo bankruptcy system probably reflects the interests of lawyers and certain kinds of creditors. We should be cautious about assuming that the current generosity of the bankruptcy system reflects the public's interest, and that the public would be opposed to reform. Does the public have an interest in means testing? It is hard to see why it would not. The public has always objected to welfare benefits going to the undeserving poor; it would seem that for similar reasons the public would object to bankruptcy protection going to higher-income individuals. The people who would be most harmed by means testing would not be the public in general; they probably would be bankruptcy lawyers. Bankruptcy lawyers would see a decline in business from those people who are likely to be their most lucrative clients—wealthy people seeking to escape their debts.
ARTICLE: THE POLITICAL ECONOMY OF THE BANKRUPTCY REFORM ACT OF 1978
ERIC A. POSNER*
Copyright (c) 1997 Michigan Law Review
96 Mich. L. Rev. 47
*Assistant Professor of Law, University of Pennsylvania. B.A. 1988, Yale; J.D. 1991, Harvard.—Ed. Thanks to Barry Adler, Jack Ayer, Douglas Baird, Lucian Bebchuk, Frank Easterbrook, Bob Feidler, Rich Hynes, Ed Kitch, Ken Klee, Kevin Kordana, Richard Levin, Harvey Miller, Randy Picker, Ed Rock, David Skeel, Stephen Williams, and participants at a talk at the University of Virginia Law School and at a conference sponsored by the Institute for Law and Economics, University of Pennsylvania. Special thanks to Alan Schwartz and Ron Trost, who prepared formal comments for the talk at Penn, and to Andrew Gallo, for valuable research assistance.
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INTRODUCTION
Why do we have a bankruptcy law? The conventional story is that bankruptcy law reflects two requirements of a modern commercial economy: a method for the orderly payment of debts owed to multiple creditors and a means to ensure that individual debtors retain sufficient assets and rights to maintain a dignified or at least nonpenurious existence. No doubt this story contains elements of the truth, but it also has many limitations. The story does not explain many significant attributes of the Bankruptcy Code, including the administrative structure it establishes, its reliance on a mixture of federal- and state-determined rights, and its balancing of interests between creditors and debtors.
When commentators try to explain these aspects of the Bankruptcy Code, they generally describe them as the result of conflicts between debtor interests, on the one hand, and creditor interests, on the other. The outcome is explained as just a compromise reflecting the relative political power of each group. On reflection, however, this explanation is not satisfactory. It does not take account of the following factors: (1) different kinds of creditors have different, and often conflicting, interests; (2) other actors have a strong interest in the Bankruptcy Code, including lawyers, judges, agency officials, managers and shareholders of corporations, and politicians; and, perhaps most significantly, (3) debtors, considered as the class of people who are potential beneficiaries of bankruptcy law, do not compose an organized and politically influential group. A satisfactory explanation of the Bankruptcy Code must take into account the interests of all relevant parties and the extent of their political power.
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An understanding of the political influences on the origin of the Bankruptcy Code is of considerable importance at the present time. In 1994 Congress created a National Bankruptcy Review Commission for the purpose of evaluating the bankruptcy system and proposing amendments.(see footnote 8) The Commission has held hearings, has voted on a variety of proposals, and is expected to issue a report in October, 1997.(see footnote 9) One question that has not received much attention concerns the extent to which political realities constrain the Commission's behavior and the extent to which they will affect Congress's reception of its report. One way to approach this question is to look back at the political background of the Bankruptcy Reform Act of 1978, develop a political theory of its origin, and use this theory to shed light on the political determinants of the bankruptcy amendment process.
These are the goals of this article. In particular, this article analyzes the legislative history of the Bankruptcy Reform Act of 1978(see footnote 10) and related materials, in the hope of describing the influence of interest groups on the final statute. It has, of course, long been assumed that certain narrow provisions of the 1978 Act reflect the influence of interest groups—for example, the section that gives special protection to security and lease interests in aircraft.(see footnote 11) This article goes farther and argues that fundamental elements of the 1978 Act reflect political compromises among competing interest groups. In particular, I claim (1) that the allocation of powers to bankruptcy judges and trustees resulted from efforts by Congress to increase its patronage opportunities, (2) that the provisions on exemptions resulted from a conflict between federal and state officials over the power to make transfers to local interest groups, and (3) that the provisions on business reorganization resulted from efforts by managers' lawyers and large creditors to maximize their influence on the reorganization of distressed firms, at the expense of other interests, such as equity and small debt. I make similar claims about the provisions on reaffirmation, student loans, and the fraud exception to the right to discharge.
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These conclusions grow from the application of ideas from public choice theory to the legislative history of the Bankruptcy Code. The use of this methodology represents a departure from most bankruptcy scholarship, which is normative, doctrinal, or empirical. This article, in contrast, analyzes the political determinants of bankruptcy law: its contribution is its description of the ways in which the political process resulted in a particular kind of bankruptcy system.(see footnote 12)
Because of the length of the article, a brief overview will be helpful to the reader. The argument begins in Part I with a general discussion of the features that are generally believed to characterize a socially desirable bankruptcy law. This discussion provides a baseline for identifying distortions caused by the influence of interest groups. To clarify the nature of these political interests, Part II contains a stylized cast of characters, categorized into debtors, creditors, elected and unelected federal authorities, state authorities, and lawyers, and analyzes their interests in bankruptcy reform. After some methodological notes in Part III, Part IV describes the legal and political background of the Code. It describes the 1898 Act, as amended, that prevailed prior to the enactment of the Bankruptcy Reform Act in 1978; it discusses the sources of dissatisfaction with the 1898 Act; and it summarizes the legislative history of the 1978 Act.
Next come the arguments about the influence of interest groups on the final statute. Part V analyzes the administrative structure created by the 1978 Act. Part VI analyzes the exemption rules. Part VII analyzes the provisions relating to corporate reorganization. Part VIII analyzes three less significant issues that nonetheless generated a great deal of controversy: the dischargeability of educational loans, the reaffirmation of debts, and the fraud exception to discharge. The conclusion, Part IX, draws out the implications of the arguments for bankruptcy reform and discusses some of the proposals currently before the National Bankruptcy Review Commission.
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I. NORMATIVE THEORIES OF BANKRUPTCY LAW
In public choice studies it is standard to describe the optimal version of the law in question and use interest group theory to explain the observed deviations. This approach raises difficulties because the optimal version of a particular law may be controversial. Bankruptcy law is no exception. Nevertheless, a few comments on the academic debate concerning optimal bankruptcy law may provide a useful, if rough, baseline for the political analysis.
A. Procedures for the Satisfaction of Multiple Claims
The optimal bankruptcy law solves a collective action problem that arises when a debtor defaults on loans from several creditors. Default frequently occurs when a debtor borrows from multiple creditors and has too few assets to pay back all of them. In the absence of a bankruptcy system, the creditors would have an incentive to race to the courthouse and obtain a judgment before the other creditors realized that the debtor is insolvent. The reason is that under state law the first creditor to obtain a judgment against a debtor has a better chance to seize the debtor's assets than later creditors do. The race to the courthouse creates several costs, including the cost of monitoring the debtor closely in order to be the first to detect an impending default and the loss of the going-concern or relationship-specific value of assets that occurs when solvent debtors with temporary cash-flow problems are driven into insolvency because creditors prefer seizing assets immediately to maximizing the value of all the debtor's assets. Bankruptcy law reduces these costs by providing for an orderly collection procedure, including (1) an automatic stay that prevents creditors from pressing a claim unless it would be destroyed by the delay, and (2) a distribution system that for the most part respects prebankruptcy entitlements.(see footnote 13)
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In theory, the collective action problem could be mitigated through bargaining. Ex ante, creditors can protect themselves with security interests, debt covenants, and other contractual provisions; in the absence of the Bankruptcy Code's restrictions on waivers they could contractually provide for a post-insolvency division of assets.(see footnote 14) Because the rules designed to ensure an orderly collection procedure also affect such bargaining, and the influence of rules on bargaining can be analyzed only with great difficulty, the optimal design of the collection procedure in bankruptcy remains poorly understood.
B. Discharge
The bankruptcy policy of discharge for consumer debtors does not have as clear an explanation. The puzzle is that debtors, like creditors, want to minimize the cost of credit. The right to discharge, however, increases the cost of credit, because it prevents creditors from collecting some of their debts, and they must pass on their costs to debtors in the form of higher interest rates. Although debtors who face unanticipated costs ex post should be delighted with the chance of discharging their debts, the policy injures the interests of debtors as a class. Another way of putting this is that people who already have a lot of debt may support discharge; but the vast majority of people, who, whether or not they already have debt, expect to continue taking on debt into the future, should object to the (nonwaivable) right to discharge.(see footnote 15)
There are two possible solutions to this puzzle.(see footnote 16) The first assumes that most people see poverty as an evil and are willing to pay, through taxes, to see it reduced. The nonwaivable right to discharge supplements the welfare system in two useful ways. First, it discourages debtors from contracting out of the welfare system by using as collateral assets that are necessary to minimal well-being. Welfare laws prohibit the use of welfare payments as collateral; discharge law (along with exemption law) renders valueless ''necessary'' assets, however defined, and future income as collateral by barring creditors from collecting from them. Second, the right to discharge discourages high-risk behavior that would otherwise be an unavoidable side effect of welfare. Because the welfare system protects people from some of the downside risk of investments, it encourages people to take on too much risk. The right to discharge, however, forces creditors to raise interest rates, discouraging some debtors from engaging in risky investments whose cost is externalized on the taxpayer.
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On another view, discharge is justified because debtors frequently take on more debt than they really want to. They do so because they are misinformed about the law or about their future resources, or because cognitive error prevents them from recognizing the risks that accompany debt. There may be elements of truth in this argument, but no one has shown that these problems are pervasive enough to justify a departure from the norm of freedom of contract, and no one has shown that the nonwaivable right to discharge—rather than waiting periods, mandatory disclosure statements, and similar laws—is the most appropriate response to them.
These arguments raise the issue of the optimal level of government for determining the value and kind of property that should be shielded from creditors by exemption laws. Most welfare law is determined by the states, rather than by the federal government, and one justification is that states have more information about local attitudes toward risk and poverty and a stronger incentive to respect them. This justification suggests that exemption law should be left in the hands of the states. A criticism of local control of welfare, however, is that states externalize the costs of poverty on other states.(see footnote 17) This criticism suggests that local control of exemption law may also have social costs because of spillovers.(see footnote 18) But the direction of the spillover is unclear. On the one hand, it is well known that some states, especially Texas in the nineteenth century, have chosen generous exemptions laws for the purpose of encouraging immigration. Competition for immigrants could lead to suboptimally generous exemption laws. On the other hand, it is also possible that states would choose suboptimally stingy exemption laws in order to drive impoverished debtors to other states. We will return to these issues in Part VI.
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C. Reorganization
The purpose of reorganization is to preserve the going concern value of firms. A firm that enters bankruptcy and emerges intact but with a new capital structure may satisfy creditors' claims more effectively than a firm that is liquidated. There is controversy, however, over how reorganization should proceed. One question is whether the managers of the debtor should retain control over the debtor, on the theory that they alone possess the necessary expertise, or whether an independent trustee should control the firm during reorganization, on the theory that the managers have perverse incentives. Related questions include how much power different kinds of creditors should have over the plan, the court's role in approving the plan, and the protections given the creditors who vote against a plan.(see footnote 19)
A more complex issue is whether reorganization law should be concerned solely with maximizing the ex ante value of firms or should serve more general social functions, such as minimizing the dislocation that employees would experience if a firm were liquidated, or spreading risk among various kinds of equity and debt investors.(see footnote 20) Either view is theoretically possible, but the first view is more plausible. One problem with the second view is that no one has presented evidence showing that fewer jobs are lost when a firm reorganizes than when a firm is liquidated. In fact, reorganizations often involve the firing of employees, and liquidations often involve the selling off of entire components of a business without resulting in a substantial loss of employment. In addition, one must take account of the decline in the demand for labor outside the firm that results from keeping alive an inefficient firm. Another problem with the second view is that no one has provided a rigorous explanation of how reorganization mitigates dislocation. Such an explanation would show, among other things, that unemployment insurance, job-training programs, and other elements of the welfare system would fail to soften the transition more effectively than reorganization law does.
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D. Administration
A final issue concerns the administration of the optimal bankruptcy law. Little can be said at a high level of generality about the optimal form of administration, but the important issues can be identified. These issues include: (a) the allocation of powers among the bankruptcy judge and the trustee; (b) the allocation of powers among bankruptcy judges and district judges; (c) appointment and tenure of bankruptcy judges, including the question of which level of government should have the appointment power (state or federal) and which branch of government (executive or judicial); and (d) similar questions with respect to the appointment and tenure of trustees.
II. CAST OF CHARACTERS
A. Debtors
The first category of players consists of debtors. Among consumer debtors it is useful to distinguish between ''continuing debtors'' and ''overburdened debtors.'' Overburdened debtors are those debtors that gain more from the one-time transfer of wealth from creditors to debtors that occurs when discharge rules are made more generous than they lose from the higher interest rates that they will have to pay for loans in the future. Continuing debtors are those for whom this is not true. Overburdened debtors seek the expansion of their right to discharge; they also prefer a smooth administrative system if discharge is sufficiently generous. Continuing debtors presumably prefer the law of discharge and exemption that properly balances their desire for low interest rates and their desire for protection if they default on their loans, a balance that may (or may not) best be achieved through private contracting. Overburdened debtors may have a strong incentive to organize, particularly during economic downturns when their financial difficulties are most acute; continuing debtors have little incentive to organize.
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It is also important to distinguish actual debtors, whether overburdened or continuing, from those who purport to represent them. The National Consumer Law Center, for example, claims to represent consumer debtors, but its members have distinct interests that conflict with the interests of debtors. For example, the members might prefer laws that generate business for themselves even though such laws might injure debtors in general and continuing debtors in particular.
In addition, the managers of corporate debtors have interests that conflict with the interests of the corporations or their shareholders. Managers have an interest in retaining control of the corporation even when new management would increase the value of the corporation.
Debtors as a class are not represented in the legislative history. Individual debtors—whether continuing or overburdened—do not give testimony. Corporate debtors are dumb and must speak through their putative representatives, the managers. Shareholders also do not make an appearance. The main debtor-related witnesses are lawyer groups, such as the National Consumer Law Center, and some individual lawyers who mainly represent debtors.
B. Creditors
Although creditors as a group have many similar interests, they tend to specialize, and as a result creditors often came into conflict in the legislative history. Banks, represented by the American Bankers Association, issue mostly low-risk debt, both secured and unsecured. Credit unions, represented by the National Credit Union Association, issue low-risk debt that can be collected easily through payroll deductions. Finance companies, represented by the National Consumer Finance Association, issue high-risk debt, often secured by household goods and often collected through wage garnishment.(see footnote 21) The National Association of Credit Management and the National Commercial Finance Conference represent a variety of businesses that extend credit to commercial debtors. Trade creditors are not represented, except in a diluted fashion by general institutions like the Commercial Law League. Involuntary or unsophisticated creditors, such as tort creditors and employees, are not directly represented, except that (some) union members are represented by (some) unions. Different creditors have different amounts of power at the state level and at the federal level.
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Because creditors as a group have an interest in minimizing the cost of credit, they should support low exemptions, preserving prebankruptcy entitlements in bankruptcy, and efficient reorganization schemes.(see footnote 22) But each kind of creditor has an interest in raising the costs of other creditors when doing so drives the customers of the latter into the arms of the former. For example, banks and other issuers of low-risk credit may favor exemptions for household goods in order to eliminate finance companies' means for ensuring repayment of their high-risk loans. Credit unions might prefer high priority for employees' wage claims against a bankrupt employer in order to reduce the chance that employees who lose wage claims will default on loans from credit unions. Another conflict arises because some creditors, such as banks, have many long-term loans in their portfolios, while other creditors, like finance companies, have many short-term loans in their portfolios. The first group would care more about the effect of bankruptcy reform on their existing assets than would the latter, which can more easily pass on additional costs to its customers.(see footnote 23)
C. Elected Federal Officials
The most important elected federal officials in the legislative history were members of Congress (the various presidents do not appear to have taken much of an interest in bankruptcy policy). Members of Congress played two roles in the legislative history. First, they testified in favor of or against certain provisions, for example, the proposed nondischargeability of educational loans. Second, they voted. Members of Congress had an interest in using the opportunity of bankruptcy reform to effect self-serving structural changes in the government. As we shall see, they had an interest in creating new patronage positions and seizing the power to make patronage appointments from different levels of government (the states and localities) and from different branches of the federal government (the courts), and they had an interest in gaining control over areas of policy traditionally in the hands of the states, such as exemption policy. To be sure, the extent to which Congress could seize power from other elements of the government was limited by the independent political power of those elements. In addition, the goals of the House and the Senate did not always converge: the conventional wisdom is that the Senate is more sensitive to the interests of states with small, rural populations.
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D. Unelected Federal Officials
Unelected federal officials included bankruptcy judges, federal judges, trustees, and agency officials. As we shall see, bankruptcy judges had a strong interest in elevating their status to something like that of the federal judges, and the federal judges had an equally strong interest in resisting this elevation lest it dilute their status. Existing trustees may have feared a weakening of their positions. A few federal agencies also had an interest in the legislation. The most important were the Securities & Exchange Commission, which under old law had an important role in the reorganization of public corporations, and the Justice Department, which had a role in the nomination of judges.
E. Lawyers
Different kinds of lawyers had different attitudes toward bankruptcy reform. We distinguish among (a) lawyers who specialized in bankruptcy law and who were represented by the National Bankruptcy Conference, (b) lawyers who specialized in commercial law and were represented by the Commercial Law League, and (c) lawyers generally, who were represented by the American Bar Association. We will also see lawyer groups with a local tilt, such as the Dallas Bar Association and the California Bar Association, and other specialty groups, such as the American College of Trial Lawyers. Lawyers as a class had an interest in ensuring that bankruptcy reform would not diminish their role in bankruptcy proceedings, and we shall see them rally against a proposal to give a government agency the role of counseling consumer debtors. They also had an interest in enhancing the ''judicial''—as opposed to the ''administrative''—character of bankruptcy, because judicial proceedings require the services of people with legal training. But the interests of creditors' lawyers and debtors' lawyers clashed over the extent to which bankruptcy law should serve the interests of creditors or debtors, and the interests of local organizations and national organizations clashed over the extent to which bankruptcy law should be determined by state law or federal law.(see footnote 24)
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F. State and Local Authorities
Local authorities, including governors and state legislators, resist ceding authority to the federal government. One reason for this resistance is that they cannot make transfers to their supporters if they have no control over the law. Another reason is that some states can enact laws that externalize costs on other states. A third reason is simply that state officials enjoy the prestige that comes with power. Consequently, local officials often resist federal efforts to preempt state law. With respect to bankruptcy law, however, local officials are constrained by Congress' constitutional authority to enact a bankruptcy law.(see footnote 25) Because Congress has all the bargaining power, local officials can retain local control only when they can give more to Congress in the form of payoffs than Congress could obtain itself through direct regulation. As we shall see, this is a possible explanation for the outcome of the battle over control of exemption policy.
G. Academics
Academics should be mentioned, since they testified frequently. It is not clear that they should be categorized as a separate interest group, however, since they appeared usually as lawyers representing various constituencies. Sometimes they simply provided information, such as statistics on bankruptcy filings and the history of bankruptcy law.
III. METHODOLOGICAL NOTES
To analyze a phenomenon as complicated as the legislative history of the Bankruptcy Code, one must make simplifying methodological assumptions. Ideally, we would like to make some assumptions about how political actors behave, on the basis of which we could make ''predictions'' about the content of the final law, which could be confirmed or falsified by looking at actual events. In practice, we find that the predictions are rough and the events used to test them are messy. Materials available to the researcher, like legislative history, does not necessarily reveal what happened in back rooms and over lunch. Nonetheless, the materials do allow one to adjudicate among the claims of rival hypotheses.
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We assume that agents maximize utility. Creditors, debtors, lawyers, and other citizens seek legislation that transfers wealth to them. Judges and other government officials seek prestige, either for its own sake or for its effect on future income. We adopt the standard public choice view that a relatively small number of people with similar interests and a lot at stake will have more of an incentive to organize into politically effective interest groups, while larger numbers of people will have less of an incentive to form such groups. Interest groups have a disproportionate influence on the outcome of legislation, because politicians depend on their financial support for reelection and because politicians depend on the information supplied by interest groups with respect to legislative proposals.(see footnote 26)
But if interest group influence is disproportionate, it is not complete. Legislators maximize their utility by supporting legislation that increases their chances of reelection, but this does not imply that legislators vote only for legislation supported by the most powerful interest groups. Citizens pay attention to some issues and will vote against politicians who frequently support an interest group at the expense of the public. Politicians may need money from the interest groups, but they also need to be able to make a credible claim to voters that they vote consistently with their constituents' interests. The pressure to pay off an interest group while not alienating voters sometimes results in attempts to disguise transfers to interest groups so they cannot be easily identified as such by the voters.(see footnote 27)
These assumptions produce several hypotheses at a general level: (1) when the public has little interest in an area of legislation, the legislative outcome will transfer resources from the public to interest groups; (2) when powerful interest groups conflict, the legislative outcome will reflect a compromise between them; (3) House and Senate bills will differ according to the influence of different interest groups in the jurisdictions from which members obtain their political power; (4) interest groups will seek the placement of legislative power in the level of government in a federal system in which they have the most influence; and (5) as noted above, legislators will disguise transfers when the transfers would otherwise injure the public in a visible way. These hypotheses will guide the discussion below, and will be refined in light of the evidence.
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For the most part, the analysis will ignore institutional issues, such as the committee structure in Congress. Although committees are important,(see footnote 28) their influence on legislation is not well understood, and the likely gain from examining their role in bankruptcy reform does not justify the increase in the complexity and length of the discussion that would be necessary.
Public-choice analysis frequently ignores ideology, arguing that interest groups seek to acquire wealth rather than vindicate ideological commitments, and members of the public, whether or not ideologically motivated, rarely have the resources or inclination to oppose the efforts of the interest groups. The assumption is useful in some contexts, but it is clearly not always true.(see footnote 29) For example, as Mark Roe shows, the ideology of populism—characterized by a suspicion of concentrated economic and political power—accounts at least partly for the laws that fragment ownership of public corporations.(see footnote 30) If populism has influenced corporate law, it seems likely that it also has influenced bankruptcy law.
Ideology, however, played only a minor role in the legislative history of the 1978 Bankruptcy Act. As one would expect, creditors invoked the traditions of laissez faire in this country, and certain debtor and lawyer groups invoked the tradition of providing protection to the poor. But everyone seems to have acknowledged both that credit plays an important role in the economy and should not be overly restricted, and that bankruptcy law serves as a safety net. Much of the debate was about the proper tradeoff: a technical decision made against an unquestioned ideology of welfare-state capitalism. Populist arguments did not appear in the legislative history, though no doubt they played an indirect role through their influence on the development of prior legislation.(see footnote 31) There were a few desultory appeals to states' rights. It is possible that populism, states' rights, and other ideologies, such as New Deal liberalism, played a powerful role in shaping perceptions, even if they were not clearly expressed in the debates; we consider this possibility below.
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IV. LEGAL BACKGROUND OF THE 1978 ACT
A. The 1898 Act as Amended
On the eve of the passage of the 1978 Act bankruptcy law was a complicated and arcane field. The complexity was due to many factors. The 1898 Act was itself complicated and vague, and it reflected needs produced by economic and social conditions, including a severe depression, that no longer existed in the second half of the twentieth century. Moreover, Congress had amended the 1898 Act many times, and courts had interpreted the 1898 Act and its amendments in an aggressive way, resulting in a law of bankruptcy that often bore little relation to the statutory text. By the 1960s observers were expressing a great deal of dissatisfaction with the bankruptcy system. The following sections describe the old law and the criticisms most frequently raised against it.
1. Administrative Structure
The two main players under the old bankruptcy law were the bankruptcy judge and the trustee. The bankruptcy judge—prior to 1973 officially known as the ''referee'' and sometimes unofficially so called up until 1978(see footnote 32)—decided the disputes that arose in connection with bankruptcy cases. The referee system was controlled by the Judicial Conference of the United States and administered by the Administrative Office of the United States Courts.(see footnote 33) The bankruptcy judge was appointed by panels of district judges for six-year terms. Originally, the bankruptcy judge had been considered to be a kind of clerk or ''adjunct'' of the district court. The district court had jurisdiction over the bankruptcy case, and although it delegated most of the decision-making functions to the bankruptcy judge, appeal from the bankruptcy judge's order was to the district court. In practice, the bankruptcy judge had a great deal of power over the day-to-day operation of the bankruptcy proceeding. The district courts would rarely conduct bankruptcy hearings themselves. The bankruptcy judge made routine decisions regarding the property in the bankruptcy estate (summary jurisdiction) and made decisions regarding property in the possession of third parties when all consented (plenary jurisdiction).(see footnote 34) Some commentators argued that the bankruptcy judges did not have sufficient jurisdictional and remedial powers to decide cases in an expeditious way—they would have to refer issues outside their power to the supervising district court—and that bankruptcy judges' subordinate status weakened their authority with litigants.
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The trustee was a private individual, usually a lawyer, who would represent and administer the debtor's estate. When, as frequently happened, the creditors did not elect the trustee, the trustee would be appointed by the bankruptcy judge. The trustee performed many of the functions associated with the trustee today, including those of rejecting executory contracts, operating the debtor's business, pursuing people against whom the debtor had a claim, and arguing the estate's case before the court. However, the pre-1978 bankruptcy judge often engaged in activities within the domain of the post-1978 trustee. The bankruptcy judge would, along with the trustee, attend the first creditor's meetings. As a result, the judge would hear evidence that would not be admissible at trial. The bankruptcy judge and the trustee would have frequent ex parte contact. Sometimes a bankruptcy judge would persuade a trustee to pursue a particular course of action, such as going after property, then rule on the trustee's behavior at a later hearing. Sometimes, a bankruptcy judge would actually negotiate contracts with interested parties—such as between union and management—and give business advice to a debtor in possession. The close contact between the bankruptcy judge and the trustee raised concerns that bankruptcy judges biased their decisions in favor of trustees.(see footnote 35)
2. Exemptions
The 1898 Act incorporated state exemptions by reference.(see footnote 36) State exemptions were rules that prevented creditors in state actions from collecting debts from debtors by seizing and selling off the exempt assets. These laws exhibited striking diversity in their generosity and in the kind of property protected. The Maryland statute in 1960, for example, provided for a $100 exemption in real property, $100 in wages, insurance proceeds, and various other streams of income, and all wearing apparel, books, and tools of the trade. The Texas statute provided an exemption for a rural homestead of 200 acres of unlimited value or an urban residential and business homestead worth up to $5,000 exclusive of improvements, all furniture, wearing apparel, a large quantity of livestock, and similar items. According to one study, the average exemption claim in Maryland was $188 and in Florida was $7,427, with a national average of $943. The exemption laws differed in a variety of other ways. Many exemption statutes were archaic, singling out bibles, guns, crops, or farm animals. They reflected the rural origins of states that had since become highly urbanized. Some allowed debtors to waive the exemptions in a contract, others did not. Some allowed debtors to avoid liens, others did not. Some exemption laws had been aggressively modified through common law development, others had not. The lack of uniformity among the statutes, the obsolescence of many of them, and the unintelligibility of some of them led commentators to call for the creation of a uniform system of federal exemptions.(see footnote 37)
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3. Business Reorganization
On the eve of the 1978 Act, there were three forms of business reorganization—Chapters X, XI, and XII. Chapter XII was specialized and rarely used, so it will not be discussed. Chapters X and XI emerged in a loose way from two common law forms of reorganization: the equity receivership (Chapter X) and the composition (Chapter XI). Simplifying greatly, the equity receivership was a process by which the major creditors of a debtor would, often with the consent of the debtor, obtain a foreclosure and purchase its assets using a newly formed corporation of which all creditors received a share (of equity or debt). A court would appoint a receiver, usually chosen by the major creditors, and creditors could enforce their claims through this receiver. In theory, dissenting creditors were protected by the ''absolute priority rule,'' which held that senior creditors must be paid in full before junior creditors receive any value.(see footnote 38) In practice, courts circumvented this rule in order to avoid defeating reorganizations. There was generally little judicial review of the process or the plan eventually agreed to, anyway, and, as a result, creditors and commentators frequently accused managers and senior creditors of conspiring to squeeze out intermediate debt and nonmanagement equity.(see footnote 39)
Compositions occurred when all creditors consented to a reorganization of the debtor's capital structure. The problem with compositions was that if any creditor declined to cooperate, that creditor either had to be paid off or the composition could not occur. Compositions generally involved the reorganization of small, closely held firms, rather than public corporations.(see footnote 40)
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Dissatisfaction with the common law of reorganization resulted in calls for reform and eventually in legislative amendment in the 1930s. Initial proposals were resisted by the bankruptcy bar apparently because (1) its members would lose the benefit of years of experience with the old law, and (2) the proposals would have created a centralized bureaucracy that would take business from the lawyers.(see footnote 41) When the dust settled in 1938, Chapters X and XI had been created.
Chapter X, the successor of the equity receivership, created additional procedural protections. A Chapter X petition could be filed either by the creditors or by the debtors. If the judge approved the petition, he or she would appoint a trustee, who was supposed to operate the debtor's business. The trustee and the creditors could propose plans, but they had to meet elaborate requirements for disclosure of information concerning the relationships of the parties. Thanks to some aggressive interpretation by the Supreme Court, the absolute priority rule prevailed.(see footnote 42) The judge was required to dismiss Chapter X petitions if adequate relief existed under Chapter XI. The SEC had the duty to evaluate the plan and in practice had an important role in the proceedings.(see footnote 43)
Chapter XI, the successor of the composition, was intended to be used by small, closely held firms. It applied to cases in which all the debt is unsecured; the plan could not affect secured debt. The debtor alone had the power to commence proceedings in Chapter XI, and it alone could make a proposal. Judicial approval of the petition was not necessary. Creditors were supposed to be represented by a creditors' committee, but the latter was often dominated by the more powerful creditors. The plan did not have to satisfy the absolute priority rule; it could be confirmed as long as creditors would receive no less under the plan than they would receive from liquidation. The SEC had no role in Chapter XI.(see footnote 44)
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Chapter X and XI proceedings evolved in ways not foreseen by the drafters. Although, as noted, the drafters intended Chapter XI for close corporations and Chapter X for public corporations, they did not put rules reflecting these intentions in the statute. Debtors of both kinds preferred Chapter XI, and helped along by a controversial Supreme Court case,(see footnote 45) usually succeeded in reorganizing under Chapter XI, despite the SEC's time-consuming efforts to convert to Chapter X. By the eve of the 1978 Act, Chapter XI had become the dominant form of reorganization.
The benign interpretation of this development is that Chapter XI proved to be more flexible than Chapter X; the skeptical interpretation, as we will see, is that Chapter XI gave certain powerful interests—managers, managers' lawyers, large creditors—advantages during reorganization. One's choice between the two interpretations would probably depend on how one judged the performance of the SEC. The SEC routinely exercised its right to intervene and be heard on Chapter X matters, participated in meetings and conferences, challenged the qualifications of trustees, attacked the representation of interests on creditors' committees, scrutinized the trustee's administration of the estate, challenged attempts to sell the debtor's property, opposed plans of reorganization that did not adhere to the absolute priority rule, and criticized compensation arrangements.(see footnote 46) These interventions were time consuming, and they were considered a nuisance by those who sought to push through a reorganization plan. But they may also have protected bondholders and equityholders who did not have a large enough stake to participate in the reorganization. The main disadvantage of Chapter XI—that debtors could not modify the rights of secured creditors—was overcome through common law development. A stay would prevent secured creditors from repossessing collateral until the debtor had negotiated a plan with the unsecured creditors, after which the debtor could pay off the secured creditor. The debtor did not have to compensate the secured creditor for the lost opportunity to use the collateral and so had leverage with which to extract concessions from the secured creditor.
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There were other problems with Chapters X and XI, including most prominently the lengthy litigation that was necessary to resolve the question of which chapter was appropriate. After a debtor filed under Chapter XI, the SEC would sometimes raise this question by moving for conversion to Chapter X. Determining which chapter applied was difficult because of the vague ''as needed'' test created by the Supreme Court.(see footnote 47) This benefited the debtor and its management, because they could use the threat of delay and the consequent diminution in the value of assets that could satisfy the creditors' claims to obtain concessions from the creditors. Dissatisfaction with the complexity and manipulability of reorganization law led to calls for reform.
4. Miscellaneous
Under the ''miscellaneous'' category we gather several issues that were not as important as administrative structure, exemption policy, and reorganization but that nonetheless received a great deal of attention during the legislative history of the 1978 Act. The first issue concerned whether debtors could too easily discharge educational loans, in effect converting the federal loan programs into tuition subsidies. The second issue concerned the practice of reaffirmation. Debtors frequently promised to pay prebankruptcy debts in return for postbankruptcy credit from the same creditor. Commentators argued that this practice undermined bankruptcy's fresh-start goal. The third issue was whether shady creditors manipulated the fraud exception to discharge—under which discharge was denied if the debtor had made a fraudulent statement to creditors—with the result that many debtors could not obtain the fresh start they deserved. The argument was that creditors would have debtors fill out confusing forms with the intention of causing debtors to fail to list all their assets and liabilities. This would constitute fraud, resulting in a denial of discharge.
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B. Legislative History of the 1978 Act
The legislative history of the Bankruptcy Reform Act is complex.(see footnote 48) It consists of thousands of pages of hearings, reports, and debates spanning a decade. To simplify the analysis, we divide the legislative history into three stages. The first stage extends from the enactment of the law creating a bankruptcy commission in 1968 to the commission's release of a report and proposed bill in 1973. The second stage extends from the House and Senate hearings on the commission's bill and on an alternative proposed by a group of bankruptcy judges, mainly in 1975 and 1976, to the passage of House Bill 8200 and Senate Bill 2266 in 1978. The third stage covers the resolution of the conflicts between House Bill 8200 and Senate Bill 2266, leading to enactment of the Bankruptcy Reform Act in November, 1978. A brief description of these events sets the stage for the analysis and foreshadows many of its themes.
1. Stage 1
Growing dissatisfaction with the bankruptcy laws in the 1960s persuaded first a subcommittee of the Senate Judiciary Committee and then the full Congress to create a commission to evaluate the bankruptcy laws. The original Senate bill provided that the commission would consist of representatives from the House and Senate, three bankruptcy judges, and three businessmen.(see footnote 49) Apparently in response to objections from the federal judiciary to the presence of bankruptcy judges and the absence of Article III judges,(see footnote 50) the House version of the bill provided for three presidential appointees, two representatives from the House, two representatives from the Senate, and two appointees of the Chief Justice of the Supreme Court. This version passed the full Congress in 1968.(see footnote 51)
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The Commission on the Bankruptcy Laws of the United States was formed in 1971 and met over the next two years. In 1973 the Commission issued a report criticizing the existing bankruptcy laws and proposing a legislative replacement known as the Commission's Bill, or CB.(see footnote 52) The Commission listed the following complaints about the bankruptcy laws:
1. The rapid increase of bankruptcies from 10,196 in 1946 to 208,329 in 1967, and especially of consumer bankruptcies.(see footnote 53)
2. Administrative waste. For example, in 1972 $6.7 million of the $17 million spent on the operation of bankruptcy courts was spent on no-asset cases.(see footnote 54)
3. Insufficiently generous fresh start for debtors, and inadequate incentives for creditors to collect in bankruptcy.(see footnote 55)
4. Lack of uniformity in the treatment of debtors.(see footnote 56)
5. Abusive or negligent practices by bankruptcy judges, trustees, and bankruptcy lawyers.(see footnote 57)
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The CB contained many modifications of the bankruptcy system, but three stood out. First, it provided for a sharper distinction between bankruptcy judges and trustees, elevating the status of the bankruptcy judges and placing the trustees in a new, centralized bankruptcy agency in the executive branch.(see footnote 58) Second, it provided for a system of uniform federal exemptions.(see footnote 59) Third, its reorganization provisions consolidated Chapters X, XI, and XII and modified the procedural and substantive rules of confirmation.(see footnote 60)
Infuriated by their exclusion from the Commission and suspicious of its capacity to produce an adequate bill, the bankruptcy judges created their own bill, known as the Judges' Bill, or JB. The CB and the JB had many similarities but several important differences.(see footnote 61) The bankruptcy judge under the JB was to have more power and status than the bankruptcy judge under the CB, and the JB did not provide for a bankruptcy agency. The JB provided for minimum, rather than uniform, federal exemptions. Although both bills had special provisions for publicly held corporations, the JB, unlike the CB, would have maintained separate tracks for close corporations and public corporations.
2. Stage 2
Representatives Don Edwards and Charles Wiggins introduced the CB in 1973, but little was accomplished that year. In 1974 Edwards and Wiggins reintroduced the CB as House Bill 31 and the JB as House Bill 32 and during 1975 and 1976 held lengthy and detailed hearings on them before the Judiciary Committee's Subcommittee on Civil and Constitutional Rights.(see footnote 62) These hearings culminated in House Bill 6, which was introduced in 1977. The Subcommittee held meetings on House Bill 6, which resulted in a new version, House Bill 7330, and after further discussions yet another version, House Bill 8200. The Judiciary Committee amended House Bill 8200 and issued a new version, along with a committee report.(see footnote 63) Meanwhile, the Subcommittee also prepared a report on the constitutionality of the proposed bankruptcy courts.(see footnote 64) The House debated and amended House Bill 8200 in October 1977, but because the legislative managers did not approve of this amendment—a similar one had been rejected by the Subcommittee—they removed the bill from the calendar. The Subcommittee held further hearings(see footnote 65) and released a new report.(see footnote 66) The House debated House Bill 8200 again in February 1978, reversed the earlier amendment, and passed the bill by a voice vote.(see footnote 67)
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The 1977 House Report identified three major problems with the bankruptcy system: (1) impaired adjudication of cases resulting from judges' lack of independence and low status; (2) insufficient relief to consumer debtors; and (3) excessive vagueness.(see footnote 68) To address these and other problems, House Bill 8200 proposed the following changes to the law.
Administrative structure. House Bill 8200 would have abolished the old referee system. It would have given the new bankruptcy judges full powers of law, equity, and admiralty, including injunctive powers, the power to hold jury trials, contempt power, and jurisdiction over all matters arising in connection with a bankruptcy case, with appeal to the circuit courts. The bill also would have given bankruptcy judges more control over local rulemaking, finances, and so on, so they would not have to defer to district judges, which was considered demeaning. Bankruptcy judges would have become Article III judges, with full tenure and advice-and-consent presidential appointment.(see footnote 69) In addition, the bill would have created a system of U.S. Trustees, modeled on the U.S. Attorney system. Trustees would have been autonomous but under the loose supervision of the Department of Justice. They would have had administrative authority over bankruptcy cases.(see footnote 70)
Exemptions. House Bill 8200 provided for a $10,000 exemption for the homestead and $5,000 for personal property, among other things, but would have given the debtor the right to choose between the federal and state exemptions—effectively making the federal exemptions a floor. House Bill 8200 would also have given the debtor the right to waive judicial liens on exempt property and nonpurchase money security interests in household-related exempt property.(see footnote 71) House Bill 8200 would have allowed consumer debtors to redeem collateral.(see footnote 72)
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Business reorganizations. House Bill 8200 provided for the consolidation of the old Chapters X and XI, and it chose as the standard for approval of confirmations a substantially more liberal rule than the one that prevailed under Chapter X. The debtor would have had an exclusive 120-day right to propose a plan. The management would presumptively have retained control as the debtor in possession. The CB, in contrast, made the trustee presumptive for large, public corporations. Creditors' committees would have been appointed by the courts.(see footnote 73)
Miscellaneous. House Bill 8200 retained the discharge exception for false financial statements. Because it was believed that creditors sometimes manipulate debtors, however, if a creditor made this charge but then lost, it had to pay debtors' costs and attorneys' fees.(see footnote 74) Over significant objections,(see footnote 75) the bill retained the discharge for educational loans.(see footnote 76) The bill would have prohibited reaffirmations.(see footnote 77)
Meanwhile, in the Senate the CB and the JB had been introduced as Senate Bill 236 and Senate Bill 235 in 1975. The Senate Judiciary Committee's Subcommittee on Improvements in Judicial Machinery conducted hearings.(see footnote 78) No further activity occurred until 1977, when a new bill, Senate Bill 2266, was proposed and hearings were held.(see footnote 79) After the House passed House Bill 8200, the Subcommittee revised Senate Bill 2266 and reported it out to the Judiciary Committee. The Judiciary Committee voted in favor of the new Senate Bill 2266 after amending it, and a report was filed.(see footnote 80) After Senate Bill 2266 traveled through several committees, it came before the full Senate, which amended it and passed it by a voice vote as an amendment in the nature of a substitute to House Bill 8200. Senate Bill 2266 included the following provisions.
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Administrative structure. Senate Bill 2266 would have created less powerful and prestigious bankruptcy judges than House Bill 8200. Bankruptcy judges would have continued as adjuncts of the district courts. Bankruptcy judges would have been appointed by the court of appeals for each circuit, rather than by the President, and would have had a twelve-year term.(see footnote 81) Senate Bill 2266 also would not have created a bankruptcy agency in the executive branch, instead keeping the trustee system in the judicial branch.(see footnote 82)
Exemptions. Senate Bill 2266 followed old law and provided for the incorporation of state exemptions.(see footnote 83)
Business reorganization. Senate Bill 2266 would have consolidated Chapters X, XI, and XII, but it left a separate track for public corporations. Among other things, it provided for mandatory appointment of a trustee in the case of public corporations. It would have retained the old, strict standard for reorganization of public corporations, while providing for a standard similar to the House's for the reorganization of private corporations.
Miscellaneous. Senate Bill 2266 would have retained the fraud exception to discharge but provided that the debtor is entitled to attorneys' fees and costs if the creditors' claim of fraud is not brought in good faith.(see footnote 84) Student loans would have been nondischargeable for five years after they were due.(see footnote 85) Debtors would have had thirty days to rescind a reaffirmation, but after the expiration of that period reaffirmations would have been enforceable.(see footnote 86)
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3. Stage 3
Stage 3 began with an impasse. Congress faced two bills, House Bill 8200 as originally passed by the House and Senate Bill 2266, though the latter was now known as House Bill 8200 as amended by the Senate (''first Senate amendment''). Instead of holding a joint conference, the managers of the legislation conducted negotiations and hammered out a deal. The compromise was reflected in the House's amendment to House Bill 8200, passed in September 1978. In October the Senate passed the House amendment by a voice vote after adding several of its own amendments (''second Senate amendment''). The House concurred, also by a voice vote, and the President signed the bill in early November.
The House amendment split the differences between House Bill 8200 and Senate Bill 2266 in several ways. The House prevailed on the transfer of new powers to the bankruptcy judge, but the bankruptcy judge would not be an Article III judge. The Senate prevailed in its efforts to prevent the creation of a bankruptcy agency in the executive branch, but agreed to a limited pilot program to test the idea. The compromise created a uniform system of federal exemptions—for example, a $7,500 homestead exemption—but gave the states the right to opt out. It adopted the House's version of reorganization law, with two concessions to the Senate: it included vague provisions designed to create some special protections for cases involving public corporations, and it provided for the automatic appointment of an examiner in such cases, though not of an independent trustee as the Senate had preferred. Reaffirmations were to be permitted, but they had to meet disclosure and related requirements. Numerous other compromises occurred, but we need not detail them.(see footnote 87)
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The provisions of the second Senate amendment are strikingly trivial, but their triviality makes them all the more interesting. The amendment reduced the bankruptcy judges' authority to hire clerks, gave the Judicial Council the power to issue ''recommendations'' of candidates for the appointment of bankruptcy judges, eliminated the bankruptcy judges' retirement plan, gave the chief judge of a circuit the power to evaluate certain incumbent bankruptcy judges, and even possibly, obscurely, took away the bankruptcy judges' hard-won right to be called ''judge'' rather than ''referee.''(see footnote 88) Because of the lateness of the date, the House passed the second Senate amendment without making further changes.
The second Senate amendment is surprising not only because its provisions were trivial, but also because it seems to have violated the deal made between the House and the Senate. As we shall see, the evidence suggests that Senator DeConcini unilaterally made these changes and told the House that they were non-negotiable. Rep. Edwards was distressed about these changes but could not oppose them at the late date. The House passed the second Senate amendment in early October; the President signed the bill in early November.(see footnote 89)
V. ADMINISTRATIVE STRUCTURE
Participants in the hearings came into conflict over two major issues of administrative structure. The first issue concerned the power and status of the bankruptcy court. Some participants believed that bankruptcy judges should have broader powers than those they enjoyed under the old law and that they should have greater status; other participants preferred the old law. Because the status of a judge depends in part on the extent of his powers, the questions of power and status were intertwined. The second issue concerned the nature of the administrative apparatus that would control the appointment of trustees. Some participants wanted to create a ''bankruptcy agency'' in the executive branch; other participants wanted to keep the appointment of trustees in the judicial branch.
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Recall that the Senate bill to create a Bankruptcy Commission contemplated that bankruptcy judges would serve on the Commission, but that the final law created slots only for appointments from the executive branch, the Senate, the House, and the federal judiciary. The bankruptcy judges' exclusion from the Commission resulted from the objections of the federal judiciary. During the initial hearings before the Senate in 1968 Judge Weinfeld, speaking for the Judicial Conference of the United States, said:
Here the proposal is that referees be included as well as lawyers, but the fact is that the ultimate judgment with respect to bankruptcy matters is made by judges of the court who review the various actions of referees when petitions for review are presented.
. . . You must bear in mind that the experts [i.e., referees] have points of view reflecting at times their separate interest—I don't mean this special interest in any invidious sense—but men sometimes become wedded to their particular ideas. It would seem to me that the Commission that we propose [i.e., without referees] would be more concerned with broad-gaged policies. . . .(see footnote 90)
Weinfeld's argument was flimsy. No doubt bankruptcy judges had a ''separate interest,'' but so did everyone else involved in bankruptcy reform. Bankruptcy judges knew more than anyone else about the bankruptcy system, and the oddity of excluding them from the Commission was obvious enough to others—no testifying party outside the federal judiciary seconded Weinfeld's views.(see footnote 91) But his views nonetheless prevailed.(see footnote 92)
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The most likely reason that the federal judiciary opposed the participation of bankruptcy judges on the Commission is that it feared that bankruptcy judges would use their influence on the Commission to press for a bankruptcy law that would transfer power and status from the federal judiciary to the bankruptcy judges. Bankruptcy judges had long made clear to the federal judiciary their dissatisfaction with their subordinate status, lobbying the federal judges for more autonomy, fancier titles, greater privileges, and the right to participate in judicial policymaking and administration. They felt most keenly their exclusion from the Judicial Conference, the judicial branch's policymaking body. Judge Weinfeld did not admit the motives of the federal judges, of course; but we will see shortly evidence that the federal judiciary's most passionate concern about bankruptcy reform was that the status of federal judges would be diluted by an increase in the power of bankruptcy judges. The House and Senate yielded to the federal judges' objections to the participation of bankruptcy judges on the Commission,(see footnote 93) probably because they believed that the success of any legislative deal would depend on the judges' cooperation both during legislation and when the statute entered litigation.
The federal judges' victory was short lived. The Commission argued that bankruptcy judges' low status hampered their efforts to adjudicate bankruptcy disputes in a fair and expeditious manner. The solution to this problem was ''to enhance the real and apparent judicial independence of bankruptcy judges.''(see footnote 94) One route to enhancement would occur through modification of appointment, tenure, and compensation. The CB would have made bankruptcy judges subject to presidential appointment with the advice and consent of the Senate, increased their tenure from six to fifteen years, and increased their compensation. The other route to enhancement of status would occur through modification of the role of the bankruptcy judge, so that the judge would have fewer ''administrative'' and more ''judicial'' responsibilities—the theory being that administrative actions dissipated the cloud of impartiality that otherwise enhanced the prestige of the judge. In pursuit of these aims the CB would have reduced bankruptcy judges' administrative responsibilities, expanded their jurisdiction, and increased their remedial powers.(see footnote 95)
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Judge Weinfeld—now on the Commission—rejected the Commission's argument in a separate statement and maintained that the existing system worked adequately, that bankruptcy judges' powers should not be changed, and that the appointment process should remain in the hands of the district judges, although perhaps tenure should be increased to twelve years.(see footnote 96) He lost on all these issues. However, he and the other judge on the Commission, Hubert Will, prevailed on the other members of the Commission not to propose that the bankruptcy judgeship be made an Article III position.(see footnote 97)
Before identifying the sources of this conflict, let me mention the Commission's second major proposal regarding administrative reform. The Commission proposed the establishment of an entirely new independent agency in the executive branch, to be called ''The United States Bankruptcy Administration.'' The Administrator would be a presidential appointee, with the advice and consent of the Senate, and would have a seven-year term. The Administration would take over the functions of the trustee and the administrative functions of the bankruptcy judge, and it would offer counseling services to debtors in consumer cases.(see footnote 98) Judge Weinfeld did not object to this proposal in his statement, but later, during the hearings, the federal judges and the bankruptcy judges would object to it.
Why did the majority of the Commission support the enhancement of the independence and prestige of the bankruptcy courts, while Judge Weinfeld opposed it? Why did the Commission support the creation of a bankruptcy agency while the bankruptcy judges opposed it? Looking beyond the parties' statements and at their interests, it appears that the proposed administrative structure reflected concerns about maintaining and expanding power, especially the power of patronage.
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Seven of the nine members of the Commission came from the executive and legislative branches, both of which had an interest in creating new patronage opportunities. The bankruptcy courts described in the CB would have served this interest by (1) transferring the appointment power from the judicial branch to the legislative and executive branches, and (2) making the position of bankruptcy judge more attractive to candidates and thus a more valuable currency for repaying political debts. The creation of a bankruptcy agency would have served the executive and legislative branches' interest in patronage opportunities by creating one advice-and-consent position and countless subsidiary positions, to be filled by political allies.
The federal judges opposed the creation of more independent bankruptcy courts, because (1) they would lose their appointment power over bankruptcy judges, and thus one of their main patronage opportunities, and (2) their status would be diluted through the vast increase in the number of federal judicial positions. The federal judges also opposed the creation of the bankruptcy agency, because to the extent that the agency would deprive bankruptcy judges of the power to appoint trustees and to the extent to which the bankruptcy judges were within the control of the federal judges, the creation of the bankruptcy agency would reduce the power and independence of the judiciary.
The bankruptcy judges supported the enhancement of the power and prestige of the bankruptcy courts, because they would gain power, status, and possibly pecuniary compensation. Bankruptcy judges had for a long time complained about what they saw as their low status,(see footnote 99) and they saw bankruptcy reform as an opportunity to solve this problem. Said one observer about the JB: ''I think the Judges' bill is the result of the fact that these are judges and they want to be judges and judges' judges and this accounts for what is in the Judges' bill, the need for status.''(see footnote 100) Although the CB would not have enhanced the bankruptcy judges' status and power as much as the JB—in particular, the latter would have made appeal to the circuit court, bypassing the district court, in effect treating bankruptcy courts and district courts as equals(see footnote 101)—it did enough to garner the bankruptcy judges' support in this respect.
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We think that it is demeaning and unbecoming for a district judge to enact a local rule requiring that any fee in excess of a rather minimal amount, $200, must be passed before the district judge for approval before it can be allowed, remembering that he has had nothing whatsoever to do with this case.
. . . If there is a major, serious contempt that involves something more and requiring something more than a fine of $200, it has got to be transferred and certified to a district judge. We feel that is totally inappropriate and tends to weaken the respect that litigants and lawyers should entertain for the bankruptcy court.
1975–76 House Hearings, supra note 54, at 153 (testimony of Bankruptcy Judge Robert B. Morton, President, National Conference of Bankruptcy Judges). Here is another:
While H.R. 31, the Commission Bill, strongly favors the elevation and independence of the new court there is one aspect of their proposal that is seriously flawed and, in fact, works against their own goal of enhancing the status and dignity of the new court. I refer to the H.R. 31 provision that clerks of the bankruptcy court be appointed from among the clerks of the district court with the concurrence of the district judges. That kind of hybridization would be as damaging as it is unnecessary and inconsistent. Any independent court worthy of the name must have a clear, unblurred line of authority to its own clerks.
Id. at 513 (statement of Bankruptcy Judge Robert B. Morton) (footnote omitted). Here is a third:
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[T]he bankruptcy referees were certainly regarded at a different level from district judges [during the early post-World War II years]. In my early visits for meetings at Foley Square, the referees did not sit at tables with the district judges and, I believe, did not ride the same elevators. My recollection is that the referees didn't even have their names on their doors, but I'm not positive about that.
KENNEDY, supra note 45, at 32–33.
The bankruptcy judges, however, opposed the creation of the bankruptcy agency. One judge testified:
My view is that a national corporate trustee will be the framework for another huge bureaucracy with tentacles reaching into every area of the country and marked with all the weaknesses of inept officialism, expensive red tape and corruption inducing proliferation [sic]. This last consideration is vital for the temptation and the opportunity for corruption will be unlimited.(see footnote 102)
A more plausible explanation for the bankruptcy judges' opposition to the bankruptcy agency is that the latter would have deprived them of their main source of patronage—the power to appoint trustees from their acquaintances in the local bankruptcy bar.(see footnote 103) As a bankruptcy judge (and his clerk) wrote after the enactment of the bankruptcy bill, ''Judicial appointment of a trustee is common, particularly in nominal asset cases filed by individual debtors. The court-appointed trustee is often understandably a personal friend of the judge who serves in a number of cases before that judge at a given time.''(see footnote 104) The bonds of friendship are strong indeed.
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If the patronage motives were half hidden in the Commission Report and related documents, they became clearer during the hearings in Stage 2. The federal judges, who had earlier resisted the bankruptcy judges' efforts to have their title changed from ''referee'' to ''bankruptcy judge,'' apparently on the grounds that such a change would dilute the prestige of the title ''judge,''(see footnote 105) reiterated their opposition to elevation of the bankruptcy judges and to the creation of a bankruptcy agency.(see footnote 106) Again, the federal judges could not admit that their motive was a fear of a loss of prestige, but a former judge made this rationale explicit:
[A] significant increase in the number of Article III judges, contemplated by [House Bill 8200], would dilute the significance, and prestige, of district judgeships. Prestige is a very important factor in [*80] attracting highly qualified men and women to the federal bench, from more lucrative pursuits.
. . . .
. . . The benefits which might flow from increasing the prestige of that post [of bankruptcy judge] would be far outweighed by the dangers brought by a loss of prestige of federal district judgeships.(see footnote 107)
In addition to the evidence that the judges feared losing status, there emerged evidence that they feared losing the patronage power to appoint bankruptcy judges.(see footnote 108) One must admit the possibility that the federal judges were right on policy grounds, but if they had been, one would have expected some support for their views from outside the judicial branch. Almost no one—creditors, debtors, or lawyers—expressed such support.(see footnote 109)
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Mr. McClory. One very good reason why district judges don't want to change the system, I think we must recognize, is that they enjoy appointing the referees, and they enjoy appointing special masters, too.
Judge Rifkind. Maybe they do.
1977 House Supp. Hearings, supra note 58, at 50; see also 1977 Senate Hearings, supra note 72, at 514–15 (testimony of Stanford Lerch, former Trustee).
Stage 2 also saw the bankruptcy judges reiterating their support for higher status bankruptcy courts and their opposition to the creation of a federal bankruptcy agency.(see footnote 110) Evidence of the bankruptcy judges' practice of appointing cronies to the position of trustee supports the hypothesis that the bankruptcy judges opposed the bankruptcy agency because they feared losing their patronage power. Some observers suggested the existence of a ''bankruptcy ring,'' consisting of the local bankruptcy bar and bankruptcy judges who favored each other over outsiders.(see footnote 111) The bankruptcy judges denied these allegations, arguing that defects in the system resulted from their lack of power, not from their abuse of it. They reiterated their view that their powers should be broadened, that an agency should not be created, and that they should continue to have the power to appoint trustees.(see footnote 112)
As a result of the nature of the system itself, there exists a relationship between the Bankruptcy Judges, the trustees and the counsel for the trustees which many people, including many involved in the system, consider unhealthy from the point of view of proper judicial and governmental administration. The judges by and large appoint the trustees and thereby in effect select the counsel. They do not generally appoint persons who are total strangers to them, and it would be entirely unrealistic to expect that they would or should. These same trustees and lawyers then deal on a day-to-day basis with the judge regarding the routine conduct of the proceeding, and finally these same trustees and lawyers appear before the judge as litigants and counsel when a controversy arises.
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As a result of the conditions discussed above, and I am sure for other reasons, there grew up over the years an isolation of the bankruptcy bench and bar from the mainstream of American jurisprudence and from the judiciary and the legal fraternity generally. Persons practicing in the bankruptcy field tended to confine their activities exclusively to that area, and the Bankruptcy Court, of course, did so from necessity. Therefore, a relatively small group of lawyers controlled the bankruptcy field. Those not within this group tended to regard them with suspicion and distrust.
1975–76 House Hearings, supra note 54, at 538 (statement of Harold Marsh, Jr., former chairman of the Bankruptcy Commission), reprinted in H.R. REP. NO. 95–595, at 95–96 (1977); see also id. at 25 (testimony of H. Kent Presson, Assistant Chief, Bankruptcy Division, Administrative Office of the U.S. Courts); H.R. REP. NO. 95–595, at 95; KENNEDY, supra note 45, at 37 (describing the bankruptcy ring); Anne Colamosca, The Bankruptcy Hustle, THE NEW REPUBLIC, FEB. 17, 1979, AT 15.
The hypothesis that Congress saw an opportunity to increase its patronage powers by seizing appointment powers from the courts receives support from the following exchange between Representative Butler and Attorney General Bell regarding the question of who should appoint bankruptcy judges:
Mr. Butler. Selection by the President of the United States of bankruptcy judges? Would that disturb you? By the President?
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General Bell. It would not. It would be a little different from what we're doing now, I guess—we're doing it the same way. We have a lot of these appointments.
As you know, I've been having a lot of problems with U.S. attorneys. That seems to be a big problem in selecting judges. I guess it's more political.
. . . .
. . . You might be charged with giving the party in power more patronage. You have to recognize, if you have a system where the Judicial Council, or even the district judge recommending to the Judicial Council, that they be selected, you have less of a political system. Because some judges are Democrats, some are Republicans.
If you want to give it all to Democrats, we'd—we, being in power right now, I guess I couldn't object to it.
Mr. Butler. Patronage is a ''burden'' of power, I think, in my observation.
[Laughter.]
General Bell. It is a burden, I think. It really is that. I wouldn't quarrel with you if you think that's the way to do it.(see footnote 113)
Bell's initial point was that appointments by the executive and legislative branches are seen as political, because all of the appointments are made by the party in power. Appointments by the judicial branch are not as controversial, because judges belong to different parties. Bell apparently had disliked the political controversies that engulfed the Justice Department because of its role in the appointment of U.S. Attorneys, and, as we shall see, probably feared having to deal with similar controversies if the President were given the power to appoint bankruptcy judges because the Justice Department would have a role in those appointments as well. But he was forced to concede Butler's point which, though sarcastically made, must have been clear to everyone in the room (hence the laughter): the creation of opportunities for patronage benefits the party in power.
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Lawyers, as noted, generally supported the creation of the higher status bankruptcy courts and opposed the creation of a bankruptcy agency, but they were divided in some respects. Commercial lawyers and bankruptcy lawyers strongly supported the creation of independent bankruptcy courts.(see footnote 114) One reason for their support was that in districts where the bankruptcy judge did not use the trustee position as a source of patronage, the bankruptcy lawyers used it as a source of profit:
Frequently, an attorney that has represented a creditor in past cases will notify him of the bankruptcy of one of the creditor's current debtors. The attorney then obtains a proxy from the creditor to vote the creditor's interest in the case. An attorney may obtain numerous proxies in a particular case in this manner. When the trustee is to be elected, the attorney votes all of his proxies for a colleague. The colleague thus elected then hires the attorney to serve as counsel to the trustee in the case, assuring a fee for these services. The fee for counsel is usually substantially higher than the fee for the trustee, because it is not limited to a specified percentage under the Bankruptcy Act. In a subsequent case, the colleague and the attorney will switch places.(see footnote 115)
By electing each other as the trustee and hiring each other as the trustee's counsel, bankruptcy lawyers assured themselves a steady source of business and a steady source of profit.
Another reason that commercial and bankruptcy lawyers supported the enhancement of the status of bankruptcy courts is that lawyers, like bankruptcy judges, care about prestige; just as it is more prestigious to argue in front of federal courts than to argue in front of state courts, so would it be more prestigious to argue in front of high-status bankruptcy courts than to argue in front of low-status bankruptcy courts. Shortly after World War II ''bankruptcy lawyers were generally regarded as second-class members of the profession, they were not regarded with the same respect as civil lawyers.''(see footnote 116) Frank Kennedy, the drafter of the CB, ingenuously describes how he and the National Bankruptcy Commission worked to enhance the stature of the bankruptcy bar by trying to effect changes in the law—for example, merging the bankruptcy rules and the federal rules of civil procedure in order to make civil cases in the district court and civil cases in the bankruptcy court as similar as possible.(see footnote 117) So deeply ingrained was their desire for respect, the bankruptcy lawyers did not see the enhancement of the prestige of the bankruptcy court as a controversial project, or that changing the law to that end might actually make the law worse.
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Lawyers as a class were less enthusiastic about the proposed administrative changes but were generally supportive.(see footnote 118) They, like the federal judges, may have feared that an increase in the power of bankruptcy judges would lead to a general dilution of the status of the federal courts and thus a dilution of the status of lawyers practicing in federal courts. To the members of the American Bar Association this danger must have seemed minimal: they probably believed sensibly that an increase in the status of bankruptcy judges would not dilute the status of federal judges by much. But even so, this loss would hit hardest lawyers who specialized in nonbankruptcy trial work and who thus depended to an unusual degree on the status of the federal courts for their own status. These lawyers did oppose the creation of independent bankruptcy courts.(see footnote 119)
Lawyers unanimously opposed the creation of a bankruptcy agency, particularly the proposal that it have the role of counseling consumer debtors. The lawyers argued that the agency would ''destroy the private consumer bankruptcy bar'' and create a ''monopoly of lay counselors.''(see footnote 120) The talk of ''monopoly'' is, of course, just talk: the lay counselors would be government agents, not employees of a single private enterprise. The lawyers objected to the proposal to give the bankruptcy agency the role of counseling consumer debtors because that role threatened a source of business for the lawyers. In addition, the federalization of the trustee system would have reduced the ability of locally influential bankruptcy lawyers to use their connections to obtain the position of trustee or to get themselves hired by the trustee. Lawyers who frequently acted as trustees supported the elevation of the status of bankruptcy courts while opposing the establishment of a bankruptcy agency(see footnote 121)—in both cases consistently with their interests, narrowly understood.
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The creditors generally supported increasing the independence of bankruptcy courts, just because they hoped that higher-status courts would attract better judges and that more powerful bankruptcy courts would be less vulnerable to reversal by higher courts and attendant delays.(see footnote 122) They opposed the creation of the bankruptcy agency, at least partly because they feared that such an agency would encourage consumers to enter bankruptcy.(see footnote 123)
The Department of Justice opposed the creation of independent bankruptcy judges and a bankruptcy agency. Attorney General Bell argued that bankruptcy judges should remain adjuncts of the district court, and that, although an official trustee was a good idea, he or she should be placed in the judicial branch.(see footnote 124) Bell opposed a proposal that the trustees be placed in the Department of Justice rather than in a separate bankruptcy agency, arguing that if the trustees were in the Justice Department, this would create conflict of interest problems, because in many cases the Justice Department would then both represent a creditor (the United States) and participate in the administration of the debtor's estate.(see footnote 125) Bell also argued that the existing bankruptcy system worked well, and that as long as bankruptcy judges were given sufficient resources, it was not necessary to confer more status on them. Both of Bell's arguments were reasonable, and possibly candid,(see footnote 126) but other statements he made suggest that the Justice Department, which already managed the President's appointment of federal judges, did not want the additional burden of managing the President's appointment of bankruptcy judges.(see footnote 127) This was the tenor of the passage quoted above, in which Bell lamented his involvement in political controversies over the appointment of U.S. Attorneys.(see footnote 128) If this conjecture is correct, he would probably not have wanted the additional burden of managing the trustee system, either. The Justice Department opposed the proposed changes most likely because it would have had to bear the administrative and political costs arising from its role in appointments while gaining no benefits or benefits of uncertain value.
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The House Hearings led to a bill that greatly expanded the patronage powers of the executive and legislative branches of the federal government. House Bill 8200 endorsed the idea of the stronger bankruptcy courts, indeed in many respects going beyond the provisions of the JB and the CB. Most significant, House Bill 8200 would have created Article III bankruptcy judges, with life tenure. The House Report argued that it was necessary as a matter of policy to increase the power and status of bankruptcy judges, but this could not be done under Article III of the Constitution unless the judges were given life tenure. This argument was plausible but not decisive, given the state of constitutional theory at the time.(see footnote 129) The House Report rejected proposals to leave bankruptcy judges as adjuncts of the district court, and it rejected proposals to turn them into Article I judges. In addition, House Bill 8200 gave the bankruptcy judges broad jurisdictional and remedial powers and provided that appeal from a bankruptcy order would be to the circuit court.(see footnote 130) This last provision was particularly unattractive to the federal judges, because it seemed to put the bankruptcy courts on par with the district courts. House Bill 8200 also followed the Commission's recommendation and created a federal bankruptcy agency, but put the agency in the Department of Justice. The administrator would be an appointment of the Attorney General.(see footnote 131)
Although Senate Bill 2266 gave bankruptcy judges new powers, duties, and privileges (including the right to appoint their own clerks), it did not go so far as the House bill. Senate Bill 2266 did not turn bankruptcy judges into Article III judges, but it did increase their terms from six to twelve years. The power to appoint bankruptcy judges was transferred from district courts to courts of appeal. Administrative functions remained in the judicial branch. No federal bankruptcy agency was to be created.(see footnote 132) The overall effect was to raise the independence and status of the bankruptcy judges slightly, but not by nearly as much as under House Bill 8200, and to prevent the shift of patronage power from the judiciary to the legislative and executive branches and from the local level to the national level.
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The hypothesis that the House's bill(see footnote 133) was motivated by concerns about patronage should be examined in greater detail.(see footnote 134) It is, of course, possible that the House believed that increasing the prestige of bankruptcy judges served the public interest, or, more likely, federal judges did not have as much influence on House members as did all the interest groups—creditors, lawyers, bankruptcy judges—that supported the enhancement of the bankruptcy court's prestige. The patronage hypothesis, however, receives support from a recent article, which provides evidence that expansion of the federal judiciary is likely to occur only when the Presidency, the House, and the Senate are controlled by a single political party at the time that the authorizing legislation is passed, and the Presidency and the Senate are controlled by the same party when the nominations and confirmations occur.(see footnote 135) The authors argue that expansion of the federal judiciary occurs during political alignment because expansion offers the controlling party an opportunity to appoint judges who share its political views and to dilute the influence of the sitting judges who do not.(see footnote 136) Although this argument is a plausible explanation for the subject of the study—the appointment of Supreme Court justices and federal appellate judges—it is unlikely that Congress cares much about the political views of bankruptcy judges. An alternative hypothesis is that when political alignment exists, Congress creates new judicial positions in part because these new positions can be used for patronage. When House Bill 8200 reached the floor, the Democrats had captured the Presidency as well as the House and the Senate, so the conditions were ripe for judicial expansion. Indeed, in the same year that the 1978 Act was passed Congress also passed the Omnibus Judgeship Act of 1978, which created 35 federal appellate positions and 117 district court positions, considerably more than Congress had ever created before, and the first new positions since the last political alignment in the late 1960s.(see footnote 137) One commentator called the Omnibus Judgeship Act a transfer to the President of ''the largest block of judicial patronage in the nation's history.''(see footnote 138)
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ECON. 435 (1996). THE ARTICLE SHOWS THAT FOR SUPREME COURT JUSTICES AND FEDERAL APPELLATE JUDGES, POLITICAL ALIGNMENT IS A SIGNIFICANT FACTOR IN THE TIMING OF EXPANSIONS, AND THAT BOTH POLITICAL ALIGNMENT AND CASELOAD PRESSURES ARE SIGNIFICANT FACTORS IN THE SIZE OF THE EXPANSIONS. OTHER VARIABLES—increasing caseloads, requests from within the judiciary, budgetary growth—are not correlated with the timing of judicial expansion at a statistically significant level.
It is true that new bankruptcy positions were created in 1984, when government had become divided; so were appellate court positions. But this is just one counterexample: the authors claim statistically significant, not perfect, correlation.
One might object that Congress did not so much create new bankruptcy court positions as improve old ones; but because existing bankruptcy judges had no right to reappointment after their terms expired, Congress would have the opportunity to exercise its new patronage power. The crucial points are that Congress shifted the appointment power to the executive and legislative branches, and it increased the desirability of the positions, making them more valuable as currency for paying off political debts. If constitutional considerations required Article III status for bankruptcy judges, as further hearings suggested,(see footnote 139) then so be it. Recall that the Commission members other than the judges sought to create Article III positions.(see footnote 140)
A similar argument can be made about the bankruptcy agency. The agency would require appointments, and these appointments could be used for patronage purposes. Detailed reasons for putting the bankruptcy agency in the Department of Justice are not given in the House Report—there was only a vague reference to the similar functions of trustees and U.S. Attorneys.(see footnote 141) One possibility is that this proposal retains most of the patronage opportunities created by the Commission proposal, but the agency, buried in the Department of Justice rather than standing on its own, would not be quite as obviously an expansion of the executive branch.(see footnote 142) In fact, the drafters of the compromise legislation providing for the pilot program chose districts in states represented by influential senators on the Judiciary Committee precisely for the purpose of giving them a patronage interest in the new appointments, and thus a motive for supporting an expansion of the pilot program into a permanent program at a later date.(see footnote 143) We will see that the U.S. Trustee system would be used for patronage purposes almost immediately after its creation.
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But if these arguments were true, one would expect the Senate to have supported these proposals. After all, under the House bill the Senate retained advice and consent powers over the appointment of bankruptcy judges, and one would expect the Senate's patronage privileges with respect to federal judges would have extended to bankruptcy judges. One possible source of the Senate's resistance is that senators believed that they would have to share some of this patronage power with House members, and the value of patronage appointments to the federal bench—a power enjoyed by senators, not by representatives—would have diminished as a result of the dilution of the federal judiciary.(see footnote 144) Another reason for the Senate's objections to House Bill 8200 may have been that the Senate feared a transfer of power from the states, from which senators draw their power, to the President. This is consistent with the view that the Senate tends to support the interests of smaller states, which have disproportionate power in the Senate, over the larger states, which have more power in the House and the Presidency. A third and related reason is that many senators were ideologically committed to states' rights and populism, both of which opposed further centralization of authority in the federal government. A fourth reason is that most federal judges have powerful connections in the Senate, but not in the House: these connections are indeed the source of their appointments. An old political debt may not be fully discharged by an appointment to the federal judiciary—that is the problem with a barter economy. A sense of obligation may thus linger. Justice Burger had powerful connections in the Senate—in particular, Strom Thurmond—but did not have such connections in the House.(see footnote 145) Moreover, the urban interest groups that had so much influence in the House—creditors and lawyers, especially—had less influence in the Senate. So although the Senate supported some increase in the status of bankruptcy judges, it had many reasons for objecting to an increase large enough to injure their federal judiciary franchise; and the Senate opposed the creation of a bankruptcy agency, because this proposal would have transferred a great deal of local power to the federal government.
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But given that expansion of patronage served the interests of Democrats in both chambers, it is no surprise that a compromise was hammered out. The bankruptcy judges would acquire significant new powers and independence, but they would become Article I judges rather than Article III judges. They would become presidential appointments, but their terms were limited to fourteen years, and appeal from their orders would be to district courts. Constitutional concerns(see footnote 146) were met with assurances from the Chief Justice that the Supreme Court would uphold the new bankruptcy positions.(see footnote 147) The bankruptcy agency would be put on a hold, but a pilot program would be initiated. The Democratic Party as a whole would benefit from the elevation of the status of bankruptcy judges, and because the party controlled the Senate, the Senate Democrats could be expected to consent as long as suitably compensated for any political disadvantage.
But one problem remained. The compromise may have satisfied the Senate Democrats' fear that they would lose patronage power vis-a-vis the House Democrats. It did not, however, address the federal judges' own desire not to lose any status at all. Hence, the dramatic intervention of Chief Justice Burger. Burger, who had earlier opposed the elevation of bankruptcy judges in a letter to Senator DeConcini(see footnote 148) and through the Administrative Office of the United States Courts, telephoned DeConcini and other senators, after the House passed the compromise bill, and complained about presidential appointment of bankruptcy judges, their retirement benefits, and their status as adjuncts to the circuit courts.(see footnote 149) ''Burger 'not only lobbied, but pressured and attempted to be intimidating,' DeConcini said. He said the Chief Justice was 'very, very irate and rude.' ''(see footnote 150) Nevertheless, the second Senate amendment threw some crumbs to Burger in the form of remarkably petty reductions in the independence and status of the bankruptcy judges.(see footnote 151) First, the Senate made it more difficult for bankruptcy judges to acquire clerks, adding a requirement that acquisition be ''based on need'' rather than based on right.(see footnote 152) Second, the Senate added to the appointment provision the requirement that the ''President shall give due consideration to the recommended nominees of the Judicial Council of the Circuit within which an appointment is to be made.''(see footnote 153) Third, the Senate eliminated the retirement plan of future bankruptcy judges and reduced the retirement benefits enjoyed by incumbents. Fourth, the Senate gave the chief judge of each circuit the power to evaluate the qualifications of incumbent bankruptcy judges who were to continue in the office during the transition. Finally, there is even an ambiguous provision that led Congressman Edwards to raise, but then dismiss, the possibility that the Senate sought to prevent incumbent bankruptcy judges from referring to themselves as ''judges,'' rather than referees.(see footnote 154)
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Why did DeConcini make these concessions to Burger? There are two possible explanations. First, the vehemence of the federal judges' protest may have led DeConcini to reconsider his judgment that under the compromise bill the Senate would not lose too much patronage power. If federal judges were upset about the bill, that must mean that they expected to lose a great deal of status. If that was so and the position of federal judge would therefore become less attractive, the Senate had lost more patronage power than it had first thought. Second, DeConcini may have worried that the Supreme Court would undo the legislative deal, either by interpreting the statute in a strict way or even by striking down the already constitutionally suspect provisions dealing with bankruptcy judges. The House, in going along with the Senate's unilateral amendment, may have shared this concern. As mentioned earlier, the legislative managers understood the constitutional complications raised by the proposed Article I status of the bankruptcy judges and doubtless feared that an offended Supreme Court could seize upon these complications and undo ten years of legislative work.
Before ending this story, we need to tie two loose ends. First, one might wonder why the Republicans went along with the Democrats' efforts to create patronage positions that only the Democrats would fill. The answer to this question is probably that resistance was futile given the Democrats' large majorities in each house; that little political gain could be achieved from resistance, because the subject was complex and the public uninterested; and that the Republicans may not have objected to the increase in federal patronage opportunities that would benefit them if and when they returned to political power. Note that when the House Democrats split over the question of elevating the status of bankruptcy judges and creating a bankruptcy agency, the Republicans sided with the dissenters—an indication that they opposed the increase in patronage that would benefit Democrats.(see footnote 155)
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Second, we noted earlier that the more sophisticated public choice models give some role to the electorate. Politicians do not make transfers to special interests when voters observe these transfers, disapprove of them, and respond to them by voting against the politicians when they run for reelection. One hypothesis is that politicians will choose an inefficient form of a transfer in order to conceal it from the voters.(see footnote 156) This hypothesis sheds light on some features of the legislative history of the Code. It seems likely that Congress modified the role of the bankruptcy judge in such a way that increased status, rather than simply increasing salary, because voters would more likely observe and object to the increase in salary. Thus did the 1977 House Report quote approvingly from a Justice Department report: ''We will never pay the incomes to judges that they could earn in other pursuits and we must not create conditions that require us to settle for second best in the federal courts.''(see footnote 157) The reason that judges cannot be paid their market value may be that voters do not want to spend that much on judges, or (more likely) judges' salaries are linked to Congressional salaries and voters do not want to spend too much on members of Congress.(see footnote 158) In either case, payment in status is a disguised transfer, designed to circumvent the political restrictions on payment in money. In addition, we saw that the House decided to put the bankruptcy agency within the Justice Department rather than creating a new federal agency along the lines proposed by the Commission. In doing so, the House lost the opportunity to create a valuable presidential appointment; but it also reduced the likelihood of accusations of patronage. Voters and their watchdogs are more likely to object to the addition of a new agency to the federal bureaucracy than to some tinkering with the internal structure of an existing agency.(see footnote 159)
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Although our story ends in 1978, the reader may be interested in subsequent events. In 1982 the Supreme Court struck down the provisions in the 1978 Act relating to the position of bankruptcy judges.(see footnote 160) The Court held that the Act violated the Constitution by giving Article III powers to judges who do not have lifetime tenure and independent salaries. Justice Burger joined the dissent, which argued that the bankruptcy courts could be considered limited Article I courts. House members felt that Burger had broken a promise to deliver Supreme Court approval of the 1978 Act.(see footnote 161) Brennan, Marshall, and Blackmun, joined by Powell, formed the plurality. The outcome is probably attributable to their commitment to the independence of the federal judiciary, and not to the fact that much of the patronage power in the federal government had shifted to the Republicans in 1981. Rehnquist and O'Connor concurred on narrower grounds. Congress responded in 1984 by placing the bankruptcy judges more solidly under the authority of the district courts.(see footnote 162) The way in which constitutional constraints interfered with attempts by the relevant political agents to strike a deal, one that gave bankruptcy judges more power but not too much more power, is worth some thought. They forced the participants either to keep the bankruptcy judges completely subordinate to the district courts or to make them Article III judges, as the House sought, and denied them an important route of compromise.
In 1986, the U.S. Trustee program was made permanent and expanded to cover every state, except Alabama and North Carolina.(see footnote 163) But in the meantime the patronage hypothesis—at least in outcome if not necessarily in intent—was confirmed. According to the first director of the Executive Office for U.S. Trustees, in the early 1980s ''the Department of Justice expressly said the [U.S. Trustee] program would get more support if politicians were invited to make U.S. Trustee appointments. They actually solicited various senators for their views as to who the U.S. Trustee should be.''(see footnote 164) In doing so, the Justice Department merely followed the plan of the drafters.(see footnote 165) Similar, albeit not quite as credible, claims were made about the trustees appointed by the U.S. Trustees. One bankruptcy judge said:
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When the pilot project started, I thought, ''Maybe this is a good idea. Perhaps it will take some of the politics and favoritism out of the system,'' . . . I quickly realized that it didn't. It just switched whose ox was being gored by whom. It was the U.S. Trustees' friends who were now being appointed as panel trustees.(see footnote 166)
Aside from patronage concerns, there is a general view that the U.S. Trustee system has not worked well; this view will be discussed in the conclusion.
VI. EXEMPTIONS
Federal and state interests divided even more sharply over exemption policy than they did over administrative structure. States had controlled exemption policy since the United States had come into existence. On the eve of the 1978 Act, federal bankruptcy law incorporated state exemptions, and although federal law supplemented state exemptions with a handful of federal exemptions (for foreign service workers, fishermen, seamen, longshoremen, railroad workers, and veterans(see footnote 167)), the federal exemptions did not play a significant role in bankruptcy cases. The legislative history of the 1978 Act displays an effort by federal authorities once again to wrest control of exemption policy from the states.
To understand the conflict over exemption policy, one must distinguish the issue of federalism and the issue of the proper content of exemption law. The issue of federalism concerns whether the federal government or the states will have control over exemption policy. The issue of content concerns the proper level of generosity of exemption law, including both the monetary value of protected property and the kind of protected property. If politicians can gain political rewards by changing exemption law (in whichever direction), then one should expect a conflict between federal and local authorities over the power to control exemption law. If some interest groups have more power at the federal level while others have more power at the state level, then one should expect the former to prefer federal control of exemption policy and the latter to prefer state control of exemption policy. But whether control of exemption policy lies in the hands of state politicians or in the hands of federal politicians, interest groups will lobby the appropriate government for the exemption rules they prefer.
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These observations raise the question whether the politicians involved in bankruptcy reform during the 1960s and 1970s actually believed that having control over exemption law was valuable. At first sight, one might think not. As noted earlier, many of the states' exemptions were archaic, providing protection for participants in an economy that no longer existed. Many states had not amended their exemption laws in dozens of years. If control of exemption law provided a fruitful means of making political payoffs, one might expect the kind of constant tinkering with it that one sees in tax law. The dominant view of commentators writing before the enactment of the Bankruptcy Code was that state legislatures did not care about exemption law.(see footnote 168)
This view, however, was wrong. Control over exemption policy had proved its value to state politicians in many ways. First, control over exemption law had allowed state authorities to respond to the demands of newly powerful classes of overburdened debtors during times of economic depression. Again and again during the nineteenth and twentieth centuries, states increased the generosity of exemption laws when an economic downturn caused default by debtors in large numbers.(see footnote 169) This legislation interfered with efforts by creditors to seize property to satisfy unpaid debts. The enactment of such laws must have been a straightforward and effective way for politicians to earn the gratitude of a large number of highly interested voters, the overburdened debtors, without alienating continuing debtors, who were probably sympathetic to the plight of overburdened debtors, and without risking much retaliation from the creditors, whose political power ebbed during economic downturns. Second, a glance at the current state exemption laws reveals the fingerprints of traditional interest groups. The exemption laws of virtually every state single out for favorable treatment groups of well-known political influence, such as insurance companies, farmers, teachers, veterans, and charitable organizations.(see footnote 170) Third, at least one state (Texas) and possibly others that sought to expand their population in the nineteenth century used exemption laws to encourage immigration from other states. By prohibiting creditors from collecting from the assets of residents, a state's generous exemption law encourages overburdened debtors to immigrate—a practice that continues to this day.(see footnote 171) Although it is true that many of the exemption laws on the books go back more than a hundred years, most states did modify their exemption laws from time to time, and they continue to do so even today.(see footnote 172)
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If control over exemption policy was valuable to state politicians, then it must have appeared valuable to federal politicians as well. Control over exemption policy would have given federal authorities the power to provide relief to debtors in times of economic distress. More immediately, Congress would have the power to create exemptions that benefited insurance companies, banks, farmers, and other groups that could provide the greatest political support. To the extent that local control of exemption law created spillovers, control over exemption policy would allow the federal government to eliminate those spillovers and gain the support of those whom they injured. These considerations no doubt motivated the unsuccessful efforts of Congress to seize control of exemption policy in the nineteenth century and its successful efforts to create exemptions for particular categories of workers. And the same motivations would cause some members of Congress to use the widespread belief in the need for bankruptcy reform in the 1960s and 1970s as an excuse for the federal government to seize control of exemption policy from the states yet again.
The normative case for federal control of exemption policy, however, was weak. The academic critics in the 1950s and 1960s argued that Congress should enact a system of uniform federal exemptions on the grounds that the state exemptions were too often archaic, too variable, and too generous or too mean;(see footnote 173) but they never explained why control of exemption policy should lie with the federal government rather than with the states.(see footnote 174) The variability of exemption law suggested, if anything, that tastes about credit risk and protection against default differed greatly from locality to locality and that therefore uniformity imposed at the national level would have served no purpose.
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The strongest case for uniform federal exemptions arises from the problem of spillovers. When states enact inconsistent laws, there sometimes results a ''race to the bottom,'' in which all states become worse off as a result of their competition for resources. A common example is that of pollution: in the absence of federal pollution laws, states would enact suboptimal pollution laws because the cost of pollution is partly born by downwind or downstream states, while the benefits of weak pollution laws, in the form of jobs and industry, accrue to the state that enacts the law. But if all states follow this logic, the aggregate costs will exceed the aggregate benefits. Uniform federal environmental laws would solve this prisoner's dilemma.
One analogy with respect to exemption laws concerns their effect on migration. As noted above, Texas originally created generous exemption laws to encourage migration from other states. Texas may correctly have calculated that the benefits of an increased population would exceed the higher cost of credit incurred by its citizens; but if all states had enacted generous exemption laws for this purpose, the migration gains would have disappeared while the cost of credit would have remained high everywhere. By preventing states from competing for migrants through exemptions, a uniform federal exemption law would prevent the race to the bottom. The problem with this argument, however, is that whatever the truth about Texas' motives in the nineteenth century, it is doubtful that modern states use exemption law to encourage migration, because people probably do not take exemption laws into account when deciding whether to migrate.(see footnote 175)
Another possible source of spillovers might be efforts by states to externalize the cost of default. If one state's exemption regime is more generous than those of other states, perhaps national creditors would spread the increased cost of collection in the high-exemption state among debtors in all the other states. All debtors would pay the same higher interest rate, but debtors in the high-exemption state would, in effect, pay less in interest charges for their right to keep more assets in case of default. But if the other states responded by increasing their exemptions, this benefit would be lost, while debtors in all states would pay the high interest rates—in effect, paying for more protection in case of default than they want. The problem with this argument, however, is that national creditors (to say nothing of local creditors) can adjust interest rates by state, charging the debtors in high-exemption states higher interest rates than they charge debtors in low-exemption states.(see footnote 176)
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A third possible source of spillovers might be efforts by states to externalize the cost of poverty. Citizens in each state might believe that exemption laws should cushion people against bad luck or improvidence but fear that generous exemption laws would attract poor people from other states. Uniform exemptions would resolve this fear. The problem, again, is that no evidence suggests that generous exemption laws attract migrants in large numbers.
If spillovers caused significant losses, one would expect efforts by the states to produce a uniform law, because the reciprocity of the supposed harm means that uniformity would have produced mutual gains.(see footnote 177) Yet the uniform exemptions law recommended in 1976 by the National Conference of Commissioners on Uniform State Laws was enacted by just one state!(see footnote 178)
Despite the shaky normative foundations for nationalizing exemption law, that idea made it onto the agenda of bankruptcy reform in the 1970s. The Commission endorsed the idea of uniform federal exemptions without justifying its position. It simply referred to the great diversity of state exemption laws.(see footnote 179) The particular exemptions contained in the CB—for example, $5,000 homestead plus $500 per dependent and $1,000 for general personal property—were also not explained. In addition, the CB provided that the exemptions would be nonwaivable and gave the debtor the right to avoid judicial liens in exempt property and nonpurchase money security interests in household goods. The JB provided for a set of minimum federal exemptions—including $6,000 plus $600 per dependent for the homestead and $3,000 for general personal property—and allowed the states to choose higher exemptions so long as they did not in the aggregate exceed $25,000.(see footnote 180)
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It may seem facile to argue that the Commission favored uniform federal exemptions because they would transfer power over exemption policy from the states to the federal government. But recall that four of the nine members were members of Congress—including Burdick and Edwards, the legislative managers for the Senate and House—and three were presidential appointees.(see footnote 181) The two federal judges on the Commission also probably had no objections—political or philosophical—to federal exemption law.(see footnote 182) The entire membership of the Commission comprised people whose position, influence, and interest were connected with the federal government; seven of the nine members either would directly benefit from a transfer of the power over exemption law from the states to the federal government or were appointed to the Commission by someone who would benefit from such a transfer. As agents of the federal government, they sought an expansion of its power. Against this, one might object that the Commission members simply did not realize that state authority over exemptions could be justified on normative grounds. They failed to provide a rationale for federal exemptions because the rationale was, in their minds, obvious. But this theory overlooks the fact that the reporter for the Commission, Frank Kennedy, had written an article defending the old law's incorporation of state exemptions just 13 years before the release of the Commission's report.(see footnote 183)
Although bankruptcy judges were officials of the federal government, their power was local. Unlike the Commission members, they did not have an interest in transferring power over exemption law from the states to the federal government. Indeed, if they had any interest at all in the subject of exemption law, it was either to simplify it, in order to make their jobs easier, or not to change it, in order to avoid having to learn new law. The JB's endorsement of minimum federal exemptions may have been a compromise between these impulses. It may also have been designed to appeal to Congress, in order to give the bill legitimacy and plausibility. The $25,000 ceiling is hard to explain; perhaps the bankruptcy judges thought that bankruptcy law would seem illegitimate if wealthy people could obtain protection from it. At any rate, this idea would have no influence on subsequent events. Because the bankruptcy judges did not share the Commission members' interest in federalizing exemption policy, they preferred to leave some of exemption policy under local control.
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Rather than choosing between the CB and the JB, House Bill 8200 established a set of federal exemptions but gave the debtor the right to choose between the federal exemptions and the state exemptions. This approach effectively meant that the federal exemptions provided a floor. These exemptions included $10,000 for the homestead and $5,000 for miscellaneous personal property. In addition, House Bill 8200 followed the CB in making the exemptions nonwaivable and giving the debtor the right to void a judicial lien in exempt property and a nonpurchase money security interest in household goods and related property. Senate Bill 2266 followed the 1898 Act and left exemption policy to the states. Although it added a right to redeem, it did not create rights to void any liens.
Why did the House retreat from uniformity and propose instead a federal floor? There is little evidence bearing on this question, but it is possible to make some conjectures. One conjecture is that state officials made their influence felt behind the scenes. Although state officials' first choice would have been to retain complete control over exemption policy, their influence may have been strong enough only to effect a compromise in which they retained control over the ceiling, the Congress over the floor.
Another conjecture emerges from the conflicting behavior of creditors. One might believe that creditors would, as a group, prefer a federal ceiling to a federal floor and that House Bill 8200 represented a defeat. In fact, the story is more complicated. The American Bankers Association supported minimum federal exemptions,(see footnote 184) while the National Consumer Finance Association and the National Credit Union Association favored uniform federal exemptions.(see footnote 185) Insurance companies(see footnote 186) and the National Association of Credit Management(see footnote 187) favored state control over exemption policy. To explain this distribution of positions, observe that creditor groups whose members were locally powerful—banks, insurance companies, and local businesses—preferred either complete state control or some state control.(see footnote 188) Creditor groups whose members were not locally powerful—credit unions, finance companies(see footnote 189)—preferred more federal control. Because their power was greater at the federal than at the local level, the credit unions and finance companies believed that their influence could ensure that only federal, not local, exemptions would be sufficiently low. Whatever the content of exemption law, creditors likely preferred authority over exemption policy at that level of government over which they had the most influence.(see footnote 190)
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Creditors may also have tried to use the opportunity of exemption reform to gain competitive advantages in the credit market. Banks issued lower risk credit, either secured or unsecured, and apparently, because of fear of bad publicity, usually avoided pursuing debtors too aggressively—for example, by taking household goods as collateral or seizing them from defaulting debtors.(see footnote 191) Consumer finance companies issued higher risk credit, both secured and unsecured, and did take household goods as collateral.(see footnote 192) If typical bank credit—especially, mortgage loans and loans secured by personal property—and finance company credit were close enough substitutes that an increase in the price of one would increase the demand for the other, then banks may have supported minimum federal exemptions in the hope that the higher effective exemption level that would result in states that had stingier exemptions would reduce the amount of collateral available to consumer finance companies without affecting the amount of collateral available to banks. (see footnote 193)
This conjecture is supported by evidence of two related conflicts between banks and consumer finance companies. The first conflict occurred over the right of redemption. Creditors generally dislike the right of redemption because it gives debtors the capacity to impose delay and litigation costs on the creditors, and debtors use the threat of delay to obtain some loan forgiveness. A limited right to redemption, however, would have a differential impact on creditors. Consider the right to redeem limited to goods, not real property, and excluding goods subject to purchase money security interests. This limited right to redeem injures the consumer finance companies, which depend heavily on nonpurchase money security interests in household goods; but it does not injure banks, because they depend mostly on real estate mortgages and purchase money security interests. The limited right to redeem thus might force the consumer finance companies to raise interest rates, driving their customers into the arms of the banks, whose interest rates would be unaffected. This may explain why in the legislative history banks supported a right to redemption of collateral except that used for purchase money security interests,(see footnote 194) while the consumer finance companies' opposed the right of redemption.(see footnote 195) The banks prevailed.
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The second conflict occurred outside of the context of bankruptcy. When the FTC proposed rules restricting wage assignments and security interests in household goods, the consumer finance industry responded by challenging them through political and legal channels, whereas the banks remained mostly passive. An empirical study shows that legal restrictions on wage assignments reduced the amount of credit issued by consumer finance companies while not affecting the amount of credit issued by banks (and improving the position of credit unions).(see footnote 196) Although this study does not show that legal restrictions on security interests in household goods produced similar results, the logic is similar and so banks may have thought this result likely. The banks' passivity suggests that they saw in the proposed rules a competitive advantage.(see footnote 197)
Finally, insurance companies had done well at the state level. The exemption of insurance proceeds in many states encouraged debtors who anticipated bankruptcy to sell off nonexempt property and purchase insurance. The insurance industry likely supported state control of exemption policy, because it did not want to risk losing its favorable position.
The national lawyer groups, such as the National Consumer Law Center(see footnote 198) and the Commercial Law League, supported federal control of exemption law, and their influence on Congress was greater than that of the local bar associations, which generally supported state control. Presumably, each group preferred seeing exemption policy in control of the level of government over which it had the most influence, but since it was Congress that was making the decision, the national groups did better than the local groups.
We can summarize the argument so far in the following way. Consider the biggest winners and losers from the federal exemption floor. In the stingy states the continuing debtors and creditors as a group would lose, but the lawyers, the overburdened debtors, and possibly certain powerful classes of creditors, such as the banks, would win. The losers had less political power at the national level than the winners did, especially because, as we saw, the creditors were divided by their interests. In the generous states a federal exemption floor would have had no effect.
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Now consider the winners and losers from uniform federal exemptions. The story is the same for the stingy states, but in the generous states, now the lawyers, possibly the overburdened debtors, and certain creditors would lose, while the continuing debtors and creditors as a group would gain. In other words, the politically weak would prevail.
Minimum federal exemptions benefited some politically powerful groups without offending any other politically powerful groups, so they were preferred to uniform federal exemptions, which offended the politically powerful groups in the more generous states.
This argument raises the question why the Senate sought to leave exemption policy to the states. If the House would have gained from enacting a minimum exemption law because it would transfer payoffs from the state governments to the federal government, why wouldn't the Senate have gained as well? To answer this question, we must consider in more detail the relationship between local and national authorities.
We have been assuming so far that the federal government would seize political power from state governments whenever it could, but this assumption conflicts with observed behavior. In fact, there are two reasons why the federal government might leave certain areas of the law to the states, even though it has the constitutional power to legislate in these areas itself.(see footnote 199) First, when local interests have invested resources in understanding existing state legislation, they stand to lose their valuable legislation-specific expertise if Congress enacts superseding law. Recall that bankruptcy lawyers resisted the Chandler Act apparently because of the fear that it would eliminate the relevance of their expertise.(see footnote 200) To avoid this kind of loss, lawyers will pay off the federal government, either by giving support directly to federal politicians or by using their local influence to cause state politicians to pay off federal politicians.
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It is true that bankruptcy lawyers and judges had valuable expertise regarding the nuances of state exemption law—the complexity of which cannot be exaggerated—and would have been reluctant to lose it. Indeed, the bankruptcy judges and many lawyers—and particularly local organizations, like state bar associations—opposed uniform federal exemptions and supported either state control or no more than a federal floor.(see footnote 201) Still, this story is not very satisfying. Exemption law composed a small portion of the bankruptcy lawyers' and judges' expertise, and with respect to other areas of bankruptcy law, far from opposing reform out of a desire to maintain the relevance of their expertise, they enthusiastically supported it.
The second reason why the federal government leaves legislative power with state governments is that state governments have greater information about local interests than the federal government does and can therefore satisfy them more successfully; either the state governments or these local interests can take enough of the surplus from more efficient state regulation to be able to ''pay'' the federal government more than the latter would obtain through direct regulation. It is plausible that state politicians had quicker and more accurate access to information about the optimal level of exemption for the interests that benefited from it than did federal politicians. As a result, state officials had a greater ability to tailor exemption policy to the idiosyncracies of their state.(see footnote 202) In one state, for example, insurance companies are powerful and would pay a lot for exemptions for insurance proceeds; in another state, the farmers have all the power. If state officials could earn more political support from controlling exemption policy than federal officials could, then the parties had an incentive to make a deal in which the federal officials leave exemption control in state hands in return for some kind of ''payment.'' The form of ''payment'' could, of course, vary. State officials might promise to supply patronage to federal officials or to support them in elections. In addition, interest groups with both local and national power could deter a federal takeover of exemption policy from the states by threatening to withhold support.
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These stories suggest two reasons why the Senate and the House came into conflict over the level of government control of exemptions. First, senators owed more of their political power to state political organizations than representatives did. Exemption policy does not interest people at the district level; it does at the state level, since the state, not the district, is the source of state law. Second, the Senate was disproportionately influenced by the less populous, more rural states.(see footnote 203) The powerful farming lobbies in those states care deeply about a transfer of control over exemption policy from the states, where their influence is strong, to the federal government, where their influence is diluted. Since their influence at the federal level is stronger in the Senate than in the House, however, they can use their national influence to block the transfer.
Another reason for the difference may have been personal or ideological. Senator Wallop was a believer in state's rights and had recently been involved, as a state politician, in the amendment of Wyoming's exemption laws. As chairman of the Judiciary Committee, he had disproportionate control over the legislation, and apparently he cared only about this issue. Many senators had similar views about states' rights, whereas the House was dominated by believers in New Deal liberalism and centralized government.(see footnote 204) It remains an open question, however, whether members cared enough about these ideological commitments to resist pressures from interest groups.
The compromise bill in Stage 3 provided still another variation on exemption law: a set of uniform federal exemptions, including the power to avoid certain liens, with a state right to opt out. The compromise meant that a state could, by legislative direction, force debtors to use exemptions that are lower than the federal exemptions; or it could force debtors to use exemptions that are higher than the federal exemptions; or it could leave the debtor the choice of using federal or state exemptions. The opt-out idea ingeniously gave the federal government control over exemption policy in all the states for which the interest in exemption policy was low, but not from the states that had a powerful interest in control of exemption policy. As a result, the federal government picked up some power without offending those with the most to lose. Most states did, in fact, opt out, showing again that the states did care about controlling exemption policy. Nevertheless, Congress gained some control over exemption policy.
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There is one last question. Why was it never proposed that Congress create nonuniform exemptions—that is, exemptions that vary from state to state? After all, Congress had often enacted legislation that affected states differentially—for example, laws relating to building projects. Such a proposal would have allowed Congress to give each state the exemption law that maximized value to local interests and to gain in return the maximum amount of political support. The answer may be that Congress could obtain creditor support for federal exemption law only by promising to make exemption law uniform or at least more uniform than it had been. Creditors disliked the ability of debtors to change residences under the old law in order to escape collection.(see footnote 205) Another possible answer is that because one of the most powerful justifications for bankruptcy reform was the complexity of the old bankruptcy law, federal differential exemptions would have appeared to be a step backwards. A final answer, consistent with the theory presented above, is that determining the optimal exemption on a state-by-state basis would have been too complicated for Congress, and it did better by, in effect, franchising exemption policy to the states.
VII. BUSINESS REORGANIZATIONS
The legislative history of the Code contains a number of interesting conflicts over the law of corporate reorganization. It might surprise some people to learn that an argument that did not have much prominence is an argument currently used by many scholars to justify Chapter 11, namely that reorganization protects employees from the dislocation caused by economic and organizational transitions. A few parties raised this point in hearings in a desultory way,(see footnote 206) and the 1977 House Report mentioned it briefly,(see footnote 207) but it did not receive much attention or analysis, despite its populist appeal.(see footnote 208)
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An important issue in the legislative history, by contrast, concerned the question whether the streamlined, pro-management procedures of Chapter XI should govern reorganization of large, publicly held corporations. Recall that between the late 1930s and the enactment of the Code in 1978, Chapter XI had become the preferred means of reorganization even for the public corporations for which Chapter X had been intended. Creditors supported the debtors' Chapter XI filings, and courts generally went along, resisting the SEC's efforts to convert to Chapter X. Managers preferred Chapter XI because Chapter XI left them in control of the firm during reorganization and gave them the exclusive right to propose the plan of reorganization.(see footnote 209) Chapter X required the replacement of the managers with a trustee. Managers could use their Chapter XI powers to keep the firm alive while hoping for a change in market conditions. To be sure, managers did not necessarily exercise their powers under Chapter XI. Studies of recent corporate bankruptcies show that managers rarely keep their positions after a firm enters bankruptcy,(see footnote 210) and this was likely the case prior to 1978. But managers probably could use their Chapter XI powers to extract concessions from the creditors, such as pecuniary compensation or an equity interest in the reorganized firm.(see footnote 211) Managers also probably liked Chapter XI's ''best interests'' standard, which guaranteed creditors only the liquidation value of their claims. If any going concern value remained, this could, in principle, be distributed to equityholders such as the managers. In contrast, Chapter X's absolute priority rule distributed going concern value to interests with the highest priority.
The managers' preference for Chapter XI might lead one to believe that the creditors preferred Chapter X. Although creditors could buy off managers in a Chapter XI proceeding and have a receiver appointed who would be more sensitive to the creditors' interests, surely creditors would have preferred Chapter X, because under Chapter X they did not have to pay the management to resign and they were entitled to the going concern value of the firm.
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There are several reasons why creditors—or, at least, some creditors—nonetheless preferred Chapter XI to Chapter X.(see footnote 212) First, Chapter X proceedings always took a long time, whereas Chapter XI proceedings were usually brief. Chapter X required a large number of formal hearings and reports. Chapter XI proceedings were informal. Chapter X required that the SEC review the plan of reorganization—a process that took a long time—and it permitted it a thousand other interferences. One source of irritation was the SEC's position that equityholders with fraud claims had a right to rescission and refund of the purchase price, giving them priority over creditors.(see footnote 213) Creditors believed that the formal requirements of Chapter X and SEC participation produced delay, during which costs mounted and assets dwindled, without creating any offsetting benefits.
Second, participating creditors had more influence in Chapter XI than they did in Chapter X. The creditors could elect their own receiver to operate the firm under the procedures of Chapter XI—once they had obtained resignations from the managers—whereas they had to submit to the appointment of a trustee by the bankruptcy court under the procedures of Chapter X.(see footnote 214) In Chapter X the SEC challenged trustees who had connections with management, monitored their administration of the estate, and opposed any procedures and arrangements that did not meet its standard of fairness.(see footnote 215) Because the SEC and the bankruptcy court exercised greater supervision over Chapter X cases than over Chapter XI cases, participating creditors in Chapter X had less influence over the outcome of reorganization than they did in Chapter XI.
Third, the practical distinction between the best interests standard and the fair and equitable standard was small. At first sight, one might think that creditors would prefer Chapter X, because the absolute priority rule gave creditors the going concern value of the firm; in Chapter XI the creditors were guaranteed only the liquidation value of the firm. When, however, a firm had no going concern value, which was often the case, the different standards led to the same outcome. When going concern value existed, the lower standard of Chapter XI did not injure the participating creditors, because it was only a floor and they could use their influence to negotiate a larger distribution. It could hurt only the nonparticipating creditors. Finally, the requirement that plans be ''fair and equitable,'' under Case v. Los Angeles Lumber Products Co.,(see footnote 216) could not be avoided by consent, and this of course meant that creditors could not pay off insiders in Chapter X even when the latter could offer ''new value.''(see footnote 217)
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These latter points are crucial. The procedural differences between Chapter X and Chapter XI had a significant effect on the ability of parties to engage in opportunistic behavior. Chapter XI favored those parties who participated in the reorganization—namely, the managers and the large creditors. Shareholders and small creditors—such as consumers, employees, and trade creditors—would generally not participate, because when one's claim is small the cost of participation exceeds the expected gains.(see footnote 218) Thus, in Chapter XI managers and large creditors could conspire to create a plan that transferred value to them from the small creditors and, if the firm was not insolvent, the nonmanagement shareholders.(see footnote 219) Chapter X favored the small creditors and the nonmanagement shareholders, because the court and the SEC would guard their interests. To be sure, large creditors could potentially do better in Chapter X because of the absolute priority rule, but it appears that they did better by paying off managers, and freezing out nonmanagement equity and small debt under the quick and informal procedures of Chapter XI,(see footnote 220) than by sharing with small debt and possibly with equity and enduring delay under the cumbersome procedures of Chapter X.
This view receives support from the legislative history. The large creditors participated vigorously, arguing that the new bankruptcy law should follow Chapter XI, not Chapter X, and have informal, flexible procedures even for bankruptcies of large, public corporations.(see footnote 221) Small creditors were not organized, did not testify, and probably had little influence.
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Besides the creditors, the most important groups to testify on reorganization were the lawyers' groups. Creditors' lawyers supported the Chapter XI-type procedures, probably in part because their clients supported them. But the lawyers—particularly lawyers for corporate debtors—had an additional reason to prefer Chapter XI to Chapter X:
Unfortunately, by filing a chapter XI case not only does the debtor remain in possession, but the lawyer also remains in control. The lawyer can really control the progress of the proceedings. The lawyer has an awful lot to do with what happens in that chapter XI proceeding, and the lawyer for the debtor will be appointed the lawyer for the debtor in possession, and so he will remain, throughout, in a very active capacity in a chapter XI case. In a chapter X case that does not ordinarily follow.(see footnote 222)
In Chapter X a trustee was appointed, and the lawyer would not earn a very large fee. So lucrative were the positions open to lawyers in reorganizations in Chapter XI that lawyers apparently engaged in misbehavior under the procedures of Chapter XI, particularly in their attempts to obtain control of creditors' committees.(see footnote 223)
It is unclear whether Chapter X or Chapter XI better served the interests of shareholders, considered from an ex ante perspective. Chapter XI's ''best interests'' test gave them a better chance of obtaining some value from the reorganization than did Chapter X's requirement of a ''fair and equitable'' plan; but, as mentioned before, shareholders were unlikely to receive value under either test, since managers and creditors do not usually enter a solvent firm into bankruptcy. Shareholders may have feared, however, that managers would enter a solvent firm into bankruptcy in order to justify a capital restructuring that transferred wealth away from existing shareholders. If the speed of Chapter XI's procedures resulted in a lower cost of reorganization when reorganization was warranted, then shareholders would have preferred Chapter XI; but if the informality of Chapter XI's procedures enabled management to manipulate the process in its favor, then the shareholders could well have preferred Chapter X. That Chapter XI allowed management to have an interest in the reorganized entity was unlikely to benefit shareholders; as the SEC argued, there were more straightforward ways to pay for participation of management if such participation was necessary.(see footnote 224) It seems likely that the optimal reorganization law for shareholders would have given less power to management than Chapter XI did—instead, giving power to an independent trustee, perhaps—while using less cumbersome procedures than those found under Chapter X. Whatever the case, shareholders did not have a sufficient stake to organize and played no role in the legislative history.(see footnote 225)
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As noted, managers would prefer Chapter XI procedures to Chapter X procedures, because the former allowed them to remain in control of the corporate debtor for a certain amount of time. Despite these benefits, managers did not testify.(see footnote 226) One possible reason is that managers do not generally believe that their firms will ever go bankrupt; another possibility is that testimony in favor of pro-management provisions in bankruptcy would have been bad public relations.(see footnote 227) The latter point suggests that managers might have exercised their influence behind the scenes.(see footnote 228) However, corporations have never been shy about lobbying state legislators for protection from takeovers despite the risk of bad public relations.(see footnote 229) Another possible reason is that the gain to managers from favorable reorganization law was just not that much relative to the cost of lobbying; in this sense, they may have been an unorganized and uninfluential group like the shareholders. But even if this were so, their interests and the interests of commercial bankruptcy lawyers converged, because the lawyers would want their clients—the managers—to find reorganization attractive so that they would enter reorganization as much as possible. The managers' interest in Chapter XI procedures for the reorganization of public corporations under the new bankruptcy law was thus reflected in the behavior of the lawyers, who vigorously lobbied for such provisions.(see footnote 230)
The cleavage between the approaches of Chapter X and Chapter XI persisted throughout the legislative history of the Bankruptcy Code, and at every stage participants testified in conformity with their interests, as described above. Most observers agreed that reorganization of small, closely-held corporations should follow the informal approach of Chapter XI, because such corporations do not suffer from the distortions caused by the separation of management and equity. The chief dispute concerned whether the approach used for close corporations should also govern large, public corporations. This dispute was often unhelpfully phrased as the question of whether Chapters X and XI should be consolidated into a single chapter or should remain separate, but the real issue—the power to be given to managers of public corporations—is clearly discernable. Most of those who sought consolidation believed that Chapter XI procedures should control in cases involving public corporations. Everyone who resisted consolidation believed that rigorous procedures like those in Chapter X should control in cases involving public corporations. The consolidation language was rhetorically powerful, because a plea for simplification of the law always has resonance, but it did not affect the substance of the debate. Some participants advocated consolidation of the chapters but wanted the law to treat public corporations differently from close corporations; so they advocated consolidation of Chapters X and XI but with an exception for public corporations in the (single) chapter that would result.
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The CB is a product of the last strategy. The Commission proposed consolidating the two chapters but creating special provisions for public corporations, albeit in a rather obscure way. Instead of the absolute priority doctrine implied by Chapter X's requirement of a ''fair and equitable'' plan and instead of the liquidation standard implied by Chapter XI's ''best interests'' test, the CB created a ''fairness test'' which had, according to the Commission, the following characteristics. The absolute priority rule would continue to be applied, but it would be softened by allowing ''another look after the facts are in'' (whatever that means) and by allowing equity to obtain some value if its future contributions, especially in the form of management, were thought essential to a successful reorganization. In addition, the court would not make the valuation necessary for this test if a public corporation was not involved and the parties, after full disclosure, negotiated a settlement.(see footnote 231) The idea behind this odd evidentiary provision was that the protection of the absolute priority rule would drop away when everyone consented to a reorganization, but again only in the case of close corporations. The absolute priority rule with a new value exception would apply when public securities were involved. In addition, an independent trustee would be discretionary but presumptive for public corporations, and although the SEC's role would be eliminated, its functions would be performed by the bankruptcy agency. The Commission thus recognized the possibility of a greater conflict in public corporations between the interests of management, on the one hand, and creditors and shareholders, on the other, than in private corporations. This difference justified greater procedural protections for reorganization of public corporations than for reorganization of private corporations. Behind the rhetoric of consolidation, the two-track system prevailed.(see footnote 232)
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House Bill 8200 followed the CB in emphasizing the importance of consolidation and in providing for a modified absolute priority rule that allowed consenting senior creditors to give up some value to equity in return for cooperation. This idea is uncontroversial when applied to close corporations, where ownership and control are undivided, but its application to public corporations raised serious difficulties. The problem is that the modified absolute priority rule allows management of public corporations to extract value from creditors by threatening to delay reorganization and to extract value from small creditors by conspiring with large ones. Indeed, the Supreme Court had made this point repeatedly in its opinions on equity receiverships,(see footnote 233) and again when it rejected an argument that the ''fair and equitable test'' of Chapter X permitted senior creditors to transfer value to managers in return for cooperation.(see footnote 234) But House Bill 8200 did not, unlike the CB, provide the ''evidentiary'' restriction on reorganization of public corporations. House Bill 8200 did not differentiate public and private corporations at all. Moreover, House Bill 8200 further weakened the absolute priority rule by applying it to classes of creditors, rather than to every creditor, so a senior creditor would lose value to junior creditors if outvoted by other creditors in its class. House Bill 8200 also did not provide for an automatic trustee, and it denied standing to the SEC. In these ways, House Bill 8200's treatment of reorganization of public corporations followed the informal route of Chapter XI, even more so than did the CB, and in contradiction to prior law.
Senate Bill 2266, which maintained separate rules for public and private corporations, differed crucially from House Bill 8200 by forbidding management and creditors of public corporations to agree to a reorganization that locks out the shareholders and small creditors. Senate Bill 2266 endorsed the absolute priority rule in all its rigor. In particular, Senate Bill 2266 would have made confirmation of the plan depend on the court's finding that objecting classes (including equity) received adequate value. Senate Bill 2266 also provided for the automatic appointment of trustees for bankruptcies of public corporations, for standing for the SEC as the representative of unorganized shareholders and bondholders, and for a larger judicial role in valuing the business and assuring that the plan is fair. Whereas the House argued that shareholders were more sophisticated than they were when the Chandler Act was passed and could protect themselves as long as sufficient disclosure is made,(see footnote 235) the Senate insisted that shareholders in public corporations had to be protected from attempts by managers and large creditors to freeze them out.(see footnote 236)
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What explains the House's and Senate's divergence over the formality of procedures for the reorganization of public corporations? One explanation draws on the observation that lawyers and large creditors supported informal procedures. The House's constituency consisted of the populous urban areas where large corporations, with many employees and vast financial resources, exercised their greatest influence. The corporations exercised their influence through their managers, and these managers had strong incentives to preserve their power, even at the expense of the shareholders they represented. When a firm enters bankruptcy, the managers would like to retain control as long as possible and to have as much leverage as possible with respect to the creditors. The reader will be reminded of the recent successful efforts of entrenched management to lobby state legislatures for takeover protection that benefited the management at the expense of the shareholders.(see footnote 237) If managers exercised influence behind the scenes, they would have more influence over the House than over the Senate.
Also in the populous urban areas were the powerful banks and other large creditors, which, expecting to have large enough claims to find it worthwhile to participate in reorganizations, preferred rules that maximized the influence of participants over proceedings; and the lawyers, who preferred the informal procedures of Chapter XI, which maximized their business and their control over the proceedings. The Senate, by contrast, was disproportionately controlled by smaller, less populous states, where managers of big businesses, large creditors, and lawyers(see footnote 238) existed in smaller numbers and had less influence.(see footnote 239) Lacking influential constituents with a strong interest in management and big credit, senators may have been open to the influence of the SEC,(see footnote 240) which supported stricter procedures and standards for reorganization of public corporations(see footnote 241)—probably to protect its turf but probably also to protect public investors. Another possible explanation is that senators believed that protection of shareholders and junior debtholders was in the public interest,(see footnote 242) though this hardly explains why members of the House did not take a similar view. More plausible, given the disproportionate influence of rural states in the Senate, is that the Senate's position reflected the populist fear of the power of vast public corporations, the same fear that produced Chapter X forty years earlier.(see footnote 243)
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The support for special protections in the case of public corporations was thus awfully thin, and it is not surprising that the Senate conceded almost completely to the House on these issues during the final negotiations. The final bill did not contain special distribution rules for public corporations, and it kept the House's watered-down absolute priority rule. Although the final language was not explicit on this issue, it appeared to contain the new value exception sought by the House.(see footnote 244) The face-saving concessions to the Senate were meager: most notable, permission for the SEC to appear in bankruptcy court but not to appeal adverse orders, the automatic appointment of an examiner for the bankruptcy of public corporations, and the prohibition on issuing nonvoting stock.(see footnote 245) The examiner could perform an investigation and issue a report on the debtor, but it did not have the standing or the coercive powers of the trustee. The interests of large creditors, the lawyers, and managers had prevailed over those of the shareholders and the small creditors, a result consistent with what appears to have been the distribution of political power.
VIII. MISCELLANEOUS
A. Student Loans
The Commission Report recommended that educational loans not be dischargeable in bankruptcy.(see footnote 246) The recommendation apparently grew out of a concern that the increasing frequency of such discharges would undermine the student loan system. During the House and Senate hearings banks and other creditors, academic institutions, bankruptcy lawyers, bankruptcy judges, and several members of Congress testified in support of dischargeability.(see footnote 247) No major interest groups opposed dischargeability, but several members of Congress testified in opposition to dischargeability. House Bill 8200 provided that educational loans would be dischargeable, as under the prior law.(see footnote 248) Senate Bill 2266 provided that educational loans would not be dischargeable within five years of maturity. The final bill reflected the Senate's version.
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Academic institutions benefited from dischargeability, because it transferred the burden of paying tuition from students to the government, artificially inflating the demand for education. Creditors benefited, because they earned interest on the loans but incurred no risk, because the government guaranteed the loans. Lawyers benefited, because recent graduates' main liabilities consisted of their student loans, and they had to hire lawyers in order to have them discharged. The victim of the dischargeability rule was the diffuse and unorganized public. However, the abuse of the system and the cost and unfairness to the taxpayer were clear enough that politicians could score points with voters by taking a public stand against dischargeability. The apparently opportunistic failure to pay debts, at the taxpayer's expense, was doubtless more readily comprehended and condemned by the average voter than the esoteric details of corporate reorganization and judicial administration. This may explain the unusually frequent testimony of members of Congress during the hearings. By testifying (and, of course, voting) in favor of nondischargeability, they created a record that would help them during their next election.(see footnote 249) Members of Congress not directly influenced by constituents on this issue may also have feared the budgetary implications of the government's increasing liability for discharged student loans.(see footnote 250)
B. The Fraud Exception To Discharge
The House and Senate agreed to retain the 1898 Act's exception to discharge for debts issued after debtors had filed false financial statements with creditors. As one might expect, creditors and their lawyers generally testified in favor of the exception; debtors' lawyers testified in opposition of the exception.(see footnote 251) The latter argued that creditors abused the fraud exception in two ways. Some creditors would give consumer debtors highly complex financial forms to fill out in the hope that the complexity would lead to mistakes, the mistakes could be represented as intentional misrepresentation, and thus the debt would be made nondischargeable. Creditors would also threaten to sue debtors for fraud in the hope of extracting from them a reaffirmation of their debts.(see footnote 252) The Commission had taken these claims seriously and recommended that the exception be eliminated.(see footnote 253) However, Congress compromised between the interests by adding some fee-shifting provisions designed to compensate debtors who litigate false claims of fraud.
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C. Reaffirmation
Under the 1898 Act a debtor could reaffirm any debts dischargeable in bankruptcy. Debtors' lawyers, the FTC, and many academics opposed the right to reaffirm, arguing that creditors obtained reaffirmations through bullying and deception, thus depriving the debtor of a fresh start.(see footnote 254) Creditors and creditors' lawyers supported reaffirmation, no doubt because it reduced their bankruptcy losses a great deal. But they also made the plausible argument that the debtors themselves benefited from the right to reaffirm, as it enabled them to acquire new credit and to retain valued collateral.(see footnote 255) No one has noticed that a prohibition on reaffirmation would discourage debtors from filing for bankruptcy: by reducing their ability to obtain credit after bankruptcy, such a prohibition would make bankruptcy less attractive. The final law permitted reaffirmation, but also required approval by the bankruptcy court and established a thirty-day cooling-off period during which the debtor could unilaterally rescind the reaffirmation.
CONCLUSION
The dominant academic view of the Bankruptcy Code is that it works well. This view is not hard to understand. The Bankruptcy Code is in many respects an elegant and sophisticated piece of legislation. The 1898 Act had become intolerably ambiguous and archaic, really quite horrible, and the 1978 Act swept away the years of doctrinal cobwebs and incrustations, replacing them with a lucid, simple, and apparently humane system for dealing with overburdened debtors and helpless corporations.
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The academic view, however, makes a typical lawyerly mistake: it confuses improvement in doctrine with improvement in policy. That post-1978 doctrine is clearer and simpler than pre-1978 doctrine does not mean that it better serves the public interest. Indeed, measured by the standards set for itself by the 1973 Commission, the Bankruptcy Code must be considered a failure.
Recall that the Commission listed the following complaints with the old system: (1) the rapid increase in the rate of bankruptcy filings (208,329 filings in 1967); (2) administrative waste; (3) insufficient generosity for debtors and failure by creditors to collect in bankruptcy; (4) lack of uniformity in the treatment of debtors; and (5) negligence and abuse on the part of bankruptcy professionals.(see footnote 256) The 1978 Act has not solved these problems. First, as discussed in more detail below, since 1978 bankruptcy rates have skyrocketed to over one million per year. Second, the efficiency of the current bankruptcy system is doubtful. From July 1, 1990, to June 30, 1992, for example, the total cost of the 1.2 million consumer chapter 7 cases exceeded gross receipts in these cases by almost $100 million and distributions to creditors by about $250 million.(see footnote 257) Third, exemption laws are more generous today than they were before 1978, but the generosity of exemptions is mostly a matter of state law. There are no statistics on the extent to which creditors use the bankruptcy system rather than swallowing losses from unpaid loans. Fourth, because of the role of state exemption law in the Bankruptcy Code, debtors continue to be treated nonuniformly. Fifth, although anecdotal evidence suggests that negligence and abuse are less widespread today than prior to 1978, the lack of systematic evidence of this behavior both now and then makes generalization hazardous.
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Now, it is doubtful that the 1973 Commission's rather haphazard list of complaints about the old law should be the standard for evaluating the Bankruptcy Code, and the statistics should be read carefully. One might criticize a private company that spent almost twice as much money to collect from debtors than it received from them, but the Bankruptcy Code's goals are more complicated. The pertinent question is whether, supposing the goals are proper, some other system would achieve them more cheaply. The answer to this question would take us beyond the scope of this paper. A more modest approach to bankruptcy reform draws on this article's conclusions about the political history of the 1978 Act. We can use these conclusions to evaluate complaints recently directed at that law and ask about the nature and likelihood of reform.
Consumer bankruptcy filings and exemptions. Many commentators worry about the rapid growth of consumer bankruptcies since 1978. Recall that the 1973 Commission had mentioned as a reason for bankruptcy reform the growth of bankruptcy filings from 10,196 in 1946 to 208,329 in 1967.(see footnote 258) In 1996 bankruptcy filings exceeded 1 million. One can obtain a more accurate sense of the trend by observing that from 1920 to 1960, between about 1 in 2000 and 1 in 4000 people filed for bankruptcy, with no clear trend up or down. There was an anomalous dip in the mid-1940s, probably as a result of post-war prosperity. From 1960 to 1978, there was a gradual upward trend in filings, from about 1 in 2000, to about 1 in 1000. From 1978 to 1996, filings increased from 1 in 1000 to about 1 in 270.(see footnote 259) A recent study suggests that a considerably larger portion of the population, ranging from fifteen percent to twenty-three percent, would benefit financially from filing for bankruptcy, and even larger portions would benefit if individuals engaged in sophisticated prebankruptcy planning.(see footnote 260) Although academics disagree about the extent to which the increase in filings reflect the influence of the Bankruptcy Code,(see footnote 261) it is clear that if the quantity of bankruptcy filings was a problem in the 1960s, the Code has not solved it.
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One explanation for the increase in the filing rate is the rise in the generosity of state exemptions. There is, however, little evidence for this view. But even if the view were correct, Congress can do little about exemptions, as they are determined by state law. Although some creditors and commentators advocate uniform federal exemptions, it is no more likely that Congress can preempt state exemption laws today than it could in 1978. Indeed, given recent trends in the devolution of power from the federal government to the states, a system of uniform federal exemptions appears more unlikely now that it did in the 1970s. A further irony should be observed. Most of the states that opted out of the federal exemptions in 1979 and the early 1980s did so in order to force debtors to use stingier state exemptions;(see footnote 262) but now many—possibly most—of the opt-out states provide for exemptions that are more generous than federal exemptions. The National Bankruptcy Review Commission will recommend a system of uniform federal exemptions for some property and floors and ceilings on state exemptions with respect to other property.(see footnote 263)
Double appeals. Bankruptcy litigants must appeal adverse rulings to the district court, and from there to the circuit court and the Supreme Court. Commentators criticize this rule, seeing little reason to believe that bankruptcy disputes need three levels of appeal when ordinary civil disputes need only two. We have seen that this system is an artifact of the federal judiciary's attempt to maintain their prestige prior to 1978. The double appeal system was a concession to the federal judges, a symbol of the subordination of the bankruptcy court to the district court. Assuming that the federal judiciary no longer would exert political pressure on this issue (as seems plausible), the system will probably be abolished, as it should be. The NBRC has voted to eliminate the double appeals system.(see footnote 264)
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Article III standing for bankruptcy courts. The NBRC will recommend that bankruptcy courts be given Article III status.(see footnote 265) It will be interesting to see whether the federal judiciary will raise objections again. Because the bankruptcy judiciary has become more respectable, the federal judiciary might see in its elevation less of a threat to its status than in 1978. Even if federal judges raise objections to the elevation of bankruptcy judges, jurisdictional confusion and other difficulties raised by the bankruptcy courts' awkward position in the judiciary may cause Congress to ignore such objections.
The U.S. Trustee System. In a recent survey of the members of the American Bankruptcy Institute, the U.S. Trustee System was most frequently listed in response to a question asking for the three most important problems in the bankruptcy system.(see footnote 266) Although the survey does not supply the reasons for the respondents' dissatisfaction, other sources suggest that bankruptcy lawyers think that the U.S. Trustees do not appoint trustees in a fair way, possibly engaging in cronyism; intervene in cases on the basis of their publicity, rather than on the basis of the merit of the intervention; object to reasonable legal practices; do not perform adequate supervision; issue inappropriate guidelines that do not take account of local variations in legal culture and practice; and have little influence over bankruptcy judges.(see footnote 267) Accusations (and admissions) of patronage in the system were mentioned earlier. Many of these problems can be traced to the centralization of an institution whose purpose is inherently local. The political history of the 1978 Act gives reason to doubt that the current system is desirable. It is possible that bankruptcy judges who hold office today would appoint trustees more honestly than the pre-1978 judges and than the current Trustees.(see footnote 268)
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The bankruptcy judge's administrative powers. Some commentators have argued that bankruptcy judges should have greater administrative powers than they do under the 1978 Act.(see footnote 269) Recall that the elimination of the bankruptcy judges' administrative powers under the 1898 Act may have been motivated by the desire to enhance their status. It was thought that because an administratively engaged judge would look like a participant, he or she would appear to take sides and not to have the dignified cloak of impartiality. Whether or not this is true, the political motivation behind the separation of administrative powers and the normative justification should be kept separate, and the legal distinction rethought.
The debtor-in-possession model and the absolute priority rule. Many commentators believe that managers have too much control over the corporate debtor during reorganization.(see footnote 270) Some object to the difficulty of replacing incompetent managers with trustees;(see footnote 271) others object to the exclusivity period.(see footnote 272) We saw that large creditors prefer to deal with managers rather than trustees, that lawyers also prefer to keep managers in control during reorganization, and that these groups made their influence felt during negotiations over the new bankruptcy law. Because the amount of authority given to managers during reorganization reflected the balance of political power and not necessarily the public interest, modification of the debtor-in-possession rules may be justified. A similar point can be made about the current version of the absolute priority rule: it more likely reflects the interests of the creditors and lawyers who lobbied Congress in the 1970s than the interest of the public.
Reaffirmation. There still exists a conflict between those who support and those who oppose the right to reaffirm debts. The 1978 Act's compromise—the cooling-off period and the requirement of judicial approval—appears to be routinely circumvented. Debtors reaffirm their debts outside the bankruptcy proceeding, and state courts enforce the reaffirmation when debtors breach the contract.(see footnote 273) It is unsurprising that a last-minute political compromise would not take into account this difficulty of coordination in a federal system. If circumvention is in fact routine, the restrictions on reaffirmation should either be dropped or strengthened, depending on one's view about the value of reaffirmations.
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* * *
Some readers might take this political history of the 1978 Act as an indication of the futility of legislative reform. If politics determines legislative outcomes, what is the purpose of reform? But such pessimism is unjustified. The lessons of the analysis are concrete and practical. Because of the indeterminacy of the normative arguments for and against various kinds of bankruptcy reform, one must rely on experience and history. The experience of lawyers and courts tells us which parts of the law create practical difficulties. History tells us which parts of the law reflect political compromises rather than normative goals. Because the political forces that led to unsatisfactory compromises in 1978 have changed, there is hope that proper amendments can now be made. But it must also be acknowledged that reformers face a new set of political forces in 1997, and these forces will limit the extent to which improvement can be achieved.
Mr. CHABOT [presiding]. Thank you very much.
Professor Skeel?
STATEMENT OF DAVID A. SKEEL, JR., PROFESSOR, UNIVERSITY OF PENNSYLVANIA LAW SCHOOL, PHILADELPHIA, PA
Mr. SKEEL. Thank you, Mr. Congressman.
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I would like to give a very brief overview of the history of bankruptcy law over the last 100 years. I will focus in particular on the influence that bankruptcy lawyers have had on bankruptcy law, and on its implications for the current deliberations.
Although Congress passed several bankruptcy laws during the 19th Century, America did not have a permanent bankruptcy law until 1898. The driving force behind the 1898 Act was creditors. Business organizations, such as chambers of commerce and local boards of trade had begun to form in the late 19th Century, and under the auspices of an umbrella group they called the National Convention of Commercial Bodies of the United States, creditors pushed for a Federal bankruptcy law throughout the 1880's and 1890's. Business groups wanted a Federal bankruptcy law because they believed that State laws enabled debtors to discriminate against out-of-state creditors.
Creditors were fiercely opposed by a group of lawmakers, many of whom represented southern and western States, who feared that Federal bankruptcy laws would hurt farmers and that the administration of bankruptcy would require a vast new Federal bureaucracy. The 1898 Bankruptcy Act represented a compromise between these two perspectives. The law was passed, but the law also made it relatively easy for debtors to discharge their debts and pared down the administrative structure to an absolute minimum.
Perhaps the most important effect of the 1898 Act was that its scaled down administrative structure created an enormous need for a bankruptcy bar. In striking contrast to English bankruptcy law, the U.S. system was run by the parties rather than a governmental official. The judges, for instance, called referees, were part-time officials and had only limited powers, and each of the parties themselves relied on lawyers.
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The next major movement to reform bankruptcy law commenced in 1929 with an extensive investigation that led to the Donovan Report in 1931 and to proposed legislation the following year. The report expressed concern with the behavior of bankruptcy lawyers, and in terms that sound much like the current debate, worried that bankruptcy law did not do enough to encourage debtors to pay their debts.
To remedy these concerns, the investigators called for Congress to appoint administrators to examine debtors, as in England, and suggested that discharge should be postponed in some cases; in effect, an earlier version of means testing.
The most strident opposition to these proposals came from bankruptcy lawyers. Speaking on behalf of groups such as the Commercial Law League and the Bankruptcy Committee of the American Bar Association, bankruptcy lawyers attacked the proposals claiming that there was no need to overhaul existing practice. Their opposition appears to have been an important reason that the principal reforms were abandoned. The influence of the general bankruptcy bar was further evidenced several years later in the most important New Deal bankruptcy reform, the Chandler Act of 1938.
Although the Chandler Act completely reformed the reorganization procedures for large corporations, the reformers deferred to the proposals of the general bankruptcy bar with respect to the rest of bankruptcy practice.
Bankruptcy lawyers are only one of the many groups with an interest in bankruptcy law, of course. Creditors continue to vigorously promote their interests as we have also seen in recent years, but bankruptcy lawyers have proven disproportionately influential for several reasons.
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First, bankruptcy lawyers have an ongoing interest in bankruptcy law that is as great or greater than that of any other constituency. Creditors, for instance, can pass on some of the costs of bankruptcy to their customers.
Second, bankruptcy is extraordinarily complicated. Some might even say dull. Bankruptcy lawyers are the experts, and this expertise gives them substantial influence over the shape of the technical details of bankruptcy.
Many of the amendments that bankruptcy lawyers have supported over the years seem quite desirable, but bankruptcy lawyers, even those who represent creditors, have a strong interest that there be many bankruptcies rather than few. The two most striking trends in bankruptcy over the course of this century are that the scope of the bankruptcy laws has continually expanded, and that proposals that would reduce the need for bankruptcy lawyers often fail.
[The prepared statement of Mr. Skeel follows:]
PREPARED STATEMENT OF DAVID A. SKEEL, JR., PROFESSOR, UNIVERSITY OF PENNSYLVANIA LAW SCHOOL, PHILADELPHIA, PA
BANKRUPTCY IN U.S. HISTORY: THE PAST AND ITS IMPLICATIONS
I would like to give a very brief overview of the history of bankruptcy law over the last one hundred years. I will focus in particular on the influence that bankruptcy lawyers have had on bankruptcy law, and its implications for the current deliberations.
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Although Congress passed several bankruptcy laws during the nineteenth century, America did not have a permanent bankruptcy law until 1898. The driving force behind the 1898 Act was creditors. Business organizations such as chambers of commerce and local boards had begun to form in the late 19th century and, under the auspices of an umbrella group they called the ''National Convention of Commercial Bodies of the United States,'' creditors pushed for a federal bankruptcy law throughout the 1880s and 1890s. Business groups wanted a federal bankruptcy law because they believed that state laws enabled debtors to discriminate against out-of-state creditors.
Creditors were fiercely opposed by a group of lawmakers, many of whom represented southern and western states, who feared that federal bankruptcy laws would hurt farmers, and that the administration of bankruptcy would require a vast new federal bureaucracy. The 1898 Bankruptcy Act represented a compromise between these two perspectives. The law was passed, but the law also made it relatively easy for debtors to discharge their debts; and pared down the administrative structure to an absolute minimum.
Perhaps the most important effect of the 1898 Act was that its scaled down administrative structure created an enormous need for a bankruptcy bar. In striking contrast to English bankruptcy law, the U.S. system was run by the parties rather than a governmental official (the judges, called ''referees'' were part-time officials and had only limited powers), and each of the parties relied on lawyers.
The next major movement to reform bankruptcy law commenced in 1929, with an extensive investigation that led to the Donovan Report in 1931, and to proposed legislation the following year. The Report expressed concern with the behavior of bankruptcy lawyers and—in terms that sound much like the current debate—worried that bankruptcy law did not do enough to encourage debtors to pay their debts. To remedy these concerns, the investigators called for Congress to appoint administrators to examine debtors, as in England, and suggested that discharge should be postponed in some cases—in effect, an earlier version of means testing.
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The most strident opposition to these proposals came from bankruptcy lawyers. Speaking on behalf of groups such as the Commercial Law League and the Bankruptcy Committee of the American Bar Association, bankruptcy lawyers attacked the proposals, claiming that there was no need to overhaul existing practice. Their opposition appears to have been an important reason that the principal reforms were abandoned. The influence of the general bankruptcy bar was further evident several years later, in the most important New Deal bankruptcy reform, the Chandler Act of 1938. Although the Chandler Act completely reformed the reorganization procedures for large corporations, the reformers deferred to the proposals of the bankruptcy bar with respect to the rest of bankruptcy practice.
Bankruptcy lawyers are only one of the many groups with an interest in bankruptcy law, of course. Creditors continue to vigorously promote their interests, as we have also seen in recent years. But bankruptcy lawyers have proven disproportionately influential for several reasons. First, bankruptcy lawyers have an ongoing interest in bankruptcy law that is as great, or greater, than that of any other constituency. Creditors, for instance, can pass on some of the costs of bankruptcy to their customers. Second, bankruptcy is extraordinarily complicated—some might even say boring. Bankruptcy lawyers are the experts, and this expertise gives them substantial influence over the shape of the technical details of bankruptcy.
Many of the amendments that bankruptcy lawyers have supported over the years seem quite desirable. But bankruptcy lawyers (even those who represent creditors) have a strong interest that there be many bankruptcies rather than few. The two most striking trends in bankruptcy over the course of this century are that the scope of the bankruptcy laws has continually expanded, and that proposals that would reduce the need for bankruptcy lawyers often fail.
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I provide a more detailed discussion of each of the issues I have mentioned in two articles that I would more than happy to submit for the record: ''Bankruptcy Lawyers and the Shape of American Bankruptcy Law,'' 67 Fordham Law Review 497 (1998); and ''The Genius of the 1898 Bankruptcy Act,'' Bankruptcy Developments Journal (forthcoming, 1999).
BIO
David Skeel is a Professor of Law at the University of Pennsylvania. Professor Skeel graduated in 1987 from the University of Virginia School of Law, where he was an editor of the Virginia Law Review and a member of Order of the Coif. Thereafter, he clerked for the Honorable Walter K. Stapleton on the U.S. Court of Appeals for the Third Circuit, and practiced bankruptcy for several years at Duane, Morris & Heckscher in Philadelphia. Before joining the faculty of the University of Pennsylvania Law School, he taught at Temple University School of Law from 1990–1998. Professor Skeel also has held visiting appointments at the University of Wisconsin Law School and University of Virginia School of Law. Professor Skeel's recent articles include ''Bankruptcy Lawyers and the Shape of American Bankruptcy Law,—67 Fordham Law Review 497 (1998) and ''The Genius of the 1898 Bankruptcy Act,'' Bankruptcy Developments Journal (forthcoming 1999).
Mr. CHABOT. Thank you, Professor.
Professor King?
STATEMENT OF LAWRENCE P. KING, CHARLES SELIGSON PROFESSOR OF LAW, NEW YORK UNIVERSITY SCHOOL OF LAW, NEW YORK, NY
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Mr. KING. Thank you very much, and I thank the committee for the invitation to appear here today.
Since part of what I was going to talk about had also to do with some historical aspects of the bankruptcy law, I will pick up from what the good professor to my right was just talking about, except that I will limit my remarks more to the evolvement, if you will, of the discharge under the bankruptcy system that we have in the United States.
Of course, as everybody knows, we have what is called the unconditional discharge in the Bankruptcy Code, and that first came into existence, in its present form in the Bankruptcy Act of 1898. Until that time, even though Congress had the constitutional authority to enact the bankruptcy law, it really did not exercise that authority basically until 1898.
It did exercise it by enacting three laws prior to 1898, but these laws had very short existence. In 1800, it lasted for about 2 years. In 1841, it lasted for another couple of years, and the Act of 1867 lasted about 11 years. Throughout that process, too, the discharge itself evolved.
The first Act, for example, in 1800, was not even open to what we would call today consumers. It was available to traders and merchants only, and it was available only by means of involuntary petitions filed by creditors against the merchants and traders. In essence, it followed the English system that existed at that time. It was not possible to get a discharge at that time unless a certain percentage of creditors agreed to give it.
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In 1841, for the first time, the bankruptcy law was open to what we would call consumers. That is all individuals, not just traders and merchants, and also it was available by means of a voluntary petition.
The discharge at that point was turned around somewhat. Instead of a percentage of creditors having to consent to the discharge, the creditors or a percentage of them in order to bar a discharge had to vote against it, which, of course, turned things around. So it was almost like an unconditional discharge at that time.
The Act of 1867 was still different with respect to the discharge and, in that Act, discharge became available only if a certain percentage of the debt was paid, or if a certain percentage of creditors agreed to it. So, as I say, until 1898, actually there was not the unconditional discharge that we have today.
Now, during this period of time, the law was evolving in England as well, and in England, the law that started then and exists to this day is what we would call the conditional discharge. That is, the judge has the discretion to suspend the discharge or to condition it, that is, for a period of time while payments are being made, or to condition it on the payment of a certain amount of debt over a period of time.
As mentioned, Congress did not opt for the English system in respect to the Act of 1898, even though back at that time, some of the same importuning by creditors was existing, and it is funny to say in a way, as exists today. There is not really a change in substance of the arguments that are being made.
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One of the interesting factors, I think, that one ought to keep in mind, too, I just came across it very recently as a matter of fact, and it is a recent development. Germany had a law similar to England, that is, the conditional discharge. Interestingly, that law was abolished. On January 1st of 1999, with respect to the new German bankruptcy or insolvency law, they have adopted, as a model, the U.S. law. They have adopted the unconditional discharge and done away completely with what was considered to be the conditional discharge.
A problem existed in England, at least so I was told, I unfortunately cannot document it, and in Germany, of which I certainly have been told because I dealt a little bit with some of the legislators there. One of the aspects of having a conditional discharge meant that many, many people could not afford to make the payments, parenthesis, Chapter 13—could not afford to make the payments in order to get the discharge. How do they continue to live? The way they continue to live and to earn a living for their families was to move. In effect, it was to adopt a new identity, not to leave the country.
There are countries in the world where people leave the country because they cannot get a discharge. In others they would move to other parts of the country and in effect adopt another identification, another ID card, as we would call it, perhaps, another Social Security card, to get benefits and the like. I do not know if that is the kind of system that one would want to have here.
As I say, the importuning with respect to changing the unconditional discharge that we have and to go to a means-testing or to make Chapter 13 mandatory started back in the 1920's. It went through the 1930's, through the 1940's, through the 1960's, through the 1970's, through the 1980's.
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I see my time is up, and let me just add one point. Back in the early 1920's and in the 1970's, there was this statement in the Congress and by Congressmen. One of the problems with the Bankruptcy Act is that the stigma of bankruptcy is decreasing.
Well, my goodness, if it has been decreasing since 1920 and here we are in 1999, how come there is any stigma left? I think there really is a major stigma left.
[The prepared statement of Mr. King follows:]
PREPARED STATEMENT OF LAWRENCE P. KING, CHARLES SELIGSON PROFESSOR OF LAW, NEW YORK UNIVERSITY SCHOOL OF LAW, NEW YORK, NY
PART I: NEEDS BASED BANKRUPTCY RELIEF: AN HISTORICAL PERSPECTIVE.
It is not clear what ''Needs based bankruptcy relief'' means, particularly in a historical context. In this Congress, the term is associated with the consumer credit industry's means testing proposal allowing an individual debtor to obtain relief under chapter 7 of the Bankruptcy Code only if the debtor cannot pay a portion of his debts under a set formula. Our current bankruptcy law offers a different interpretation of ''needs based bankruptcy relief:'' a system granting an unconditional discharge to nearly all honest individuals who forfeit their nonexempt property and accept the often painful consequences of declaring themselves bankrupt. This unconditional discharge concept evolved during the 19th century through Congressional acts exercising the bankruptcy power in the Constitution, which has culminated in bankruptcy laws considered the most progressive in the world. My testimony will review the history of both interpretations of needs based bankruptcy, but in reverse order. First, I will trace the development of the unconditional discharge. Second, I will provide an overview of requests made by the consumer credit industry and others throughout this century for a conditional discharge or means testing.
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PART II: THE HISTORICAL DEVELOPMENT OF THE UNCONDITIONAL DISCHARGE, THE CURRENT SYSTEM'S VERSION OF ''NEEDS BASED BANKRUPTCY RELIEF.''
Throughout the history of bankruptcy legislation in the United States, bankruptcy law gradually changed from punishment and a creditor remedy, complete even with imprisonment for debt in the various States, to a more balanced approach that recognized not only that honest debtors deserve relief from the burden of oppressive indebtedness, but that providing a discharge for such individuals was sound public policy. See Hanover Nat'l Bank. v. Moyses, 186 U.S. 192 (1902)(''determination of the status of the honest and unfortunate debtor by his liberation from encumbrance on future exertion is a matter of public concern'').
Although the Constitution authorizes Congress to enact uniform laws of bankruptcy, our early national bankruptcy laws were short-lived and responsive to financial crises. The first bankruptcy law enacted by Congress was the Act of 1800, which was to expire of its own accord in 1805 but, in fact, was repealed in 1803. It resembled the English bankruptcy law at that time, applied only to traders and merchants, and had no provision for a voluntary petition, permitting only creditors to institute proceedings. A discharge was available only if two-thirds in number and value of the creditors consented. 1 Collier on Bankruptcy 0.04 (14th ed. 1974).
The next Act was passed in 1841. Under this Act, voluntary proceedings were possible for both merchants and nonmerchants. Discharge was available unless a majority in number and amount of creditors affirmatively dissented. See Vern Countryman, ''A History of American Bankruptcy Law,'' Comm. L.J. 226, 229 (June/July 1976). The 1841 Act was repealed in 1843.
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Economic difficulties after the Civil War produced the Act of 1867. Under this Act, discharge was available if a 50% dividend was paid or if a majority of creditors consented. See Collier, supra at 9; Countryman, supra, at 231; Charles Jordan Tabb, ''The History of the Bankruptcy Laws in the United States,'' 3 ABI L. Rev. 5, 20 (1995). The Act of 1867 was repealed in 1878.
While Congress was enacting and repealing bankruptcy laws, English law also was evolving, particularly in the late 1800s. Like the Bankruptcy Act of 1898 in the United States, an English law revision in 1883 established the bankruptcy system there for many decades. English law gave the court discretion to grant or deny the discharge, and, most importantly, enabled the court to condition or suspend the discharge until a certain percentage of the debt was repaid out of future income. Our Bankruptcy Act of 1898 took a different approach and permitted the bankrupt to apply for an unconditional discharge, which would be denied on objection if the bankrupt had committed an act warranting the denial of a discharge, similar to section 727 of the current Bankruptcy Code. The 1898 Act was the first bankruptcy legislation to become a permanent law in the United States and remained in existence until superseded by the Bankruptcy Code, which became effective in 1979.
As part of the Chandler Amendments of 1938, Chapter XIII (''Wage Earners' Plans''), the predecessor to today's chapter 13, was added to the Bankruptcy Act of 1898. An individual wage earner filing under Chapter XIII could propose a plan to pay creditors out of future wages, salary or commissions. Chapter XIII, like the English system, generally withheld the debtor's discharge until completion of the repayment plan. Unlike the English system, the choice between Chapter XIII and the liquidation provisions of our 1898 Act (now chapter 7) was completely voluntary.
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Although the bankruptcy system had offered an unconditional discharge since 1898, it was not until 1970 that Congress made the discharge self-executing for specific types of debts, particularly those incurred by means of an alleged false financial statement instead of an affirmative defense in subsequent litigation.
The suspended or conditional discharge remains the rule in England and was the rule in Germany until January 1, 1999. Until that date, discharge was not available without consent of 50% of creditors and 75% of the claims. Germ. KO §182. See Peltzer, German Insolvency Laws (1975). As of January 1, 1999, the German law eliminated the conditional discharge and adopted the U.S. law of unconditioned discharge. Germ. Insol.L. §286, 290 (1999). The English rule is not the general rule in the United States under the Bankruptcy Code, which superseded the Bankruptcy Act in 1979 but continued its policy of unconditional discharge. A 1934 ruling of the United States Supreme Court offers a possible rationale for the American system of unconditional discharge:
The power of the individual to earn a living for himself and those dependent upon him is in the nature of a personal liberty quite as much if not more than it is a property right. To preserve its free exercise is of the utmost importance, not only because it is a fundamental private necessity, but because it is a matter of great public concern. From the viewpoint of the wage-earner, there is little difference between not earning at all and earning wholly for a creditor. Pauperism may be the necessary result of either.
Local Loan Co. v. Hunt, 292 U.S. 234, 245 (1934). Although section 707(b), which was added to the Bankruptcy Code in 1984, is sometimes used to deny chapter 7 relief to debtors who are able to pay some or all of their debts, see Part III, infra., our needs based bankruptcy system, for the most part, requires only current assets, and not future income, in exchange for a discharge of overwhelming debts.
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PART III: BARRING CHAPTER 7 RELIEF IF CERTAIN PORTION OF DEBT CAN BE REPAID, E.G., THE CONSUMER CREDIT INDUSTRY'S VERSION OF ''NEEDS-BASED BANKRUPTCY RELIEF.''
Although some observers inaccurately blame the Bankruptcy Code of 1978 for increases in filings and abuse of the system, criticism of our bankruptcy laws far preceded the enactment of the new Bankruptcy Code. The unconditional discharge has always had its critics, even in the early 1900s, and representatives of the consumer credit industry importuned Congress or Congressional Commissions during the 1920s, 1930s, 1960s, 1970s, 1980s, and 1990s, to adopt, in effect, a conditional discharge system described in terms of a means test. See Charles Jordan Tabb, ''The History of the Bankruptcy Laws of the United States,'' 3 ABI L. Rev. 5, 27(1995); Joint Hearings before Subcommittees of the House and Senate Judiciary Committees on S. 3863, 73rd Cong., 1st Sess., pp. 546, 641, 753 (1932)(proposing adoption of English system of conditional discharge).
In tracing the history of Congress' rejection of the consumer credit industry's needs-based bankruptcy proposals, it is useful to start with the rationale of the Congress that enacted the Bankruptcy Act of 1898. As stated in the 1897 House Report:
This vast number constitutes an army of men crippled financially—most of them active, aggressive, honest men who have met with misfortune in the struggle of life, and who, if relieved from the burden of debt, would reenter the struggle with fresh hope and vigor and become active and useful members of society. . . . [T]he passage of a bankrupt law . . . will lift these terrible and hopeless burdens and restore to the business and commercial circles of the country the active and aggressive elements that have met with misfortune and are now practically disabled for the battle of life . . . when an honest man is hopelessly down financially, nothing is gained for the public by keeping him down, but, on the contrary, the public good will be promoted by having his assets distributed ratably as far as they will go among his creditors and letting him start anew. . . . The granting or withholding of it is dependent upon the honesty of the man, not upon the value of his estate.
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H.R. Rep. No. 65, 55th Cong., 2d Sess. 30, 43 (1897).
Advocates of limiting bankruptcy relief for consumers had a friend in President Herbert Hoover, who recommended adoption of the English conditional discharge in his message to Congress in 1932:
The discretion of the courts in granting or refusing discharge should be broadened, and they should be authorized to postpone discharges for a time and require bankrupts, during the period of suspension to make some satisfaction out of after-acquired property as a condition to the granting of a full discharge.
1 Collier, supra, at 14. While other of President Hoover's recommendations were enacted as part of the 1938 amendments, this conditional discharge recommendation was not.
Throughout the 1960s, the consumer credit industry engaged in efforts to gain enactment of its version of needs based bankruptcy, albeit unsuccessfully. See Statement of Frank R. Kennedy before the Subcommittee on Monopolies and Commercial Law of the House Committee on the Judiciary, ''Antecedents of H.R. 4786'' (March 25, 1982). See also Hearings on H.R. 1057 and H.R. 5771 before Subcommittee No. 4 of the House Committee on the Judiciary, 90th Cong., 1st Sess. (1967).
As in the 105th and 106th Congresses, prior consumer credit industry requests for a conditional discharge/means based system have been accompanied by claims of unprecedented numbers of bankruptcy filings, abuse of the system by unneedy debtors, and predictions of adverse changes in the consumer credit market if Congress fails to adopt the industry's request. See, e.g., Statement of Robert B. Evans on behalf of the National Coalition for Bankruptcy Reform, before the Subcommittee on Courts of the Senate Committee on Judiciary (January 24, 1983).
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''The number of bankruptcies in the United States has increased more than 1,000 percent annually in the last 20 years.'' Preamble to Senate Joint Resolution 88, a bill to establish a bankruptcy study commission in 1968.
. . . [T]he crises that is now developing occurs to a large extent in the area of so-called consumer bankruptcies. In short, in our modern economy of credit cards and charge accounts, it is the wage earners and the heads of families who are coming more and more into the bankruptcy courts. Under the circumstances, it is essential that the bankruptcy system be overhauled and modernized.
Congressman Rogers, Chairman of Subcommittee No. 4, Congressional Record H6215 (June 30, 1970) on Senate Joint Resolution 88, to create a bankruptcy commission. Interestingly, there was no new bankruptcy law that could be blamed for such crises.
In 1970, Congress created a Commission on the Bankruptcy Laws of the United States to make recommendations in light of the social and economic changes that had occurred since 1898. The Commission filed its final report in 1973, including a draft bankruptcy statute. One of its major recommendations was to reject means testing proposals and to retain the unconditional discharge. The Report explained:
[P]roposals have been made to Congress from time to time that a debtor able to obtain relief under Chapter XIII should be denied relief in straight bankruptcy. . . . The Commission has considered the arguments made for conditioning the availability of bankruptcy relief, including the discharge, on a showing by the debtor that he cannot obtain adequate relief from his condition of financial distress by proposing a plan for payment of his debts out of his future earnings. The Commission has concluded that forced participation by a debtor in a plan requiring contributions out of future income has so little prospect for success that it should not be adopted as a feature of the bankruptcy system.
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Report of the Commission on the Bankruptcy Laws of the United States, H. Doc. No. 93–137, Pt. I, p. 159, 93d Cong., 1st Sess., Cong. (1973). In the House Report on the Bankruptcy Reform Act of 1978, the House of Representatives reiterated the 1973 Commission's position and rejected the notion of a mandatory chapter 13. Report of the House Committee on the Judiciary to Accompany H.R. 8200, H.R. Rep. No. 95–595, 95th Cong., 1st Sess. (1977).
The issue of means testing arose again only several years later, when critics opined that the 1978 Bankruptcy Code was responsible for a significant increase in the bankruptcy filing rate. The consumer credit industry embarked on a media and lobbying campaign and released industry funded studies to show that many chapter 7 debtors could pay their debts if they were obliged to do so. See Statement of Philip Shuchman, Rutgers School of Law, submitted for the American Bankruptcy Institute Panel Discussion on Consumer Finance and Other Substantive Amendments (January 31, 1984). Various pieces of legislation were introduced requiring that a determination of the debtor's earning potential be made before allowing chapter 7 relief or permitting creditors to bring objections to chapter 7 cases based on debtors' ability to pay. S. 2000, 97th Cong., 2d Sess.; see also H.R. 1800, H.R. 4786. In endorsing legislation that would permit consideration of future income, representatives of the credit industry testified that ''about one person out of every four taking straight bankruptcy [chapter 7] walks away from debts he could pay, transferring $1.5 billion in affordable debts to other consumers in the form of higher prices and interest costs. Even worse for some lower income consumers, it means curtailed access to credit.'' Statement of Robert B. Evans, Senior Vice President and General Counsel, National Consumer Finance Association, on behalf of the National Coalition for Bankruptcy Reform, before the Subcommittee on Courts of the Senate Committee on Judiciary (January 24, 1983). Like today, the industry also reported a new phenomenon: surprise bankruptcy filings by borrowers with little or no previous history of delinquency and additional credit available, leading lenders to be doubtful that those filings were a last resort. See, e.g., Statement of Raymond W. Klein representing the National Retail Merchants Association and the American Retail Federation before the Senate Judiciary Committee Subcommittee on Courts (January 24, 1983). During hearings before the Subcommittee on Monopolies and Commercial Law, House Committee on the Judiciary (March 25, 1982), both Professor Vern Countryman of Harvard Law School and Professor Frank Kennedy explained to the Subcommittee that the consumer credit industry's means testing proposals, and its justifications, were not new. Professor Countryman explained that ''the consumer credit industry's current proposal is not inspired by the new Bankruptcy Code of 1978, although it may be inspired by the belief that the political climate is now more favorable to that proposal than it was in 1978. The industry has been pushing essentially the same proposal since 1964.'' Professor Countryman also reported separately that some of these means testing proposals had been attacked by witnesses as being ''Un-American,'' see Vern Countryman, ''Bankruptcy and the Individual Debtor—And a Modest Proposal to Return to the Seventeenth Century,'' 32 Cath. U.L. Rev. 809, 821 (1983), perhaps due to the fact that the unconditional discharge has sometimes been perceived as a safety valve integral to America's free market economy.
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Although the consumer credit industry had garnered support in Congress for its means testing legislation in the early 1980s, means testing ultimately was rejected. The Senate report explained that ''Crushing debt burdens and severe financial problems place enormous strains on borrowers and their families. Family life, personal emotional health, or work productivity often suffers. By enabling individuals who cannot meet their debts to start a new life, unburdened with debts they cannot pay, the bankruptcy laws allow troubled debtors to become productive members of their communities.'' S. Rep. No. 65, 98th Cong., 1st Sess. 2, 53 (1983).
The amendments that resulted in 1984 were quite favorable to the consumer credit industry, even without means testing. One such amendment was section 707(b), which permits the court to dismiss a chapter 7 case if obtaining chapter 7 relief would be a substantial abuse of the provisions of chapter 7. Although reasonable people may differ on the wisdom of section 707(b) and its intended function, many courts and United States trustees use the provision to dismiss chapter 7 cases for the ability to pay debts or for specific bad acts.
Congress again made a variety of amendments to the Bankruptcy Code in the Bankruptcy Reform Act of 1994, and again retained unfettered access to chapter 7 for the honest individual. However, the 1994 Act created another Commission to study the bankruptcy system. The Commission submitted a report to Congress in October, 1997. Seven out of nine members of this Commission were unwilling to recommend that Congress consider a means testing system, but two members submitted a statement recommending that Congress consider means testing proposals. See Report of the National Bankruptcy Review Commission (October 20, 1997).
A historical perspective on the consumer credit industry's needs based bankruptcy proposal ends with the current legislative endeavor, the Bankruptcy Reform Act of 1999 (H.R. 833). H.R. 833 proposes that chapter 7 relief be denied to any individual or family able to pay a portion of their debts according to a set formula set forth in section 102 of the bill. The means testing formula applies to all individual debtors who seek recourse in chapter 7, regardless of their income level. Although my historical perspective has focused primarily on needs based bankruptcy and means testing as they affect the unconditional discharge, the means testing provision is only one of hundreds of significant amendments in H.R. 833, all of which should be considered with care and many of which should be summarily discarded.
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CONCLUSION.
Throughout the past century, Congress has decidedly disavowed any inclination to mitigate the unconditional discharge for honest debtors. It may appear to Congress that there is now widespread support for the consumer credit industry proposal to reject the unconditional discharge in favor of means testing. However, most people familiar with the workings of the current bankruptcy system probably do not believe that the credit industry means testing proposal is necessary or cost-justified, even if they generally support bankruptcy reform. The reasons supporting past rejections of means testing throughout the past Century—maintenance of employment incentives, family stability, logistical difficulties in predicting future income and expenses, consistency with our market economy, efficiency, and basic humanitarianism—still exist today.
LAWRENCE P. KING
Charles Seligson Professor of Law, New York University School of Law; counsel, Wachtell, Lipton, Rosen & Katz, New York City.
B.SS., City College of New York (1950); LL.B., New York University (1953); LL.M., University of Michigan (1957).
Member, Advisory Committee on Bankruptcy Rules, Judicial Conference of the United States (1983–1992); Reporter to the Advisory Committee (1979–1983); Associate Reporter to the Advisory Committee (1968–1976); Consultant, Commission on the Bankruptcy Laws of the United States (1972–1973); Senior Advisor, National Bankruptcy Review Commission (1996–1997).
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Member:
National Bankruptcy Conference;
American College of Bankruptcy;
American Law Institute;
American Bar Association, Committee on Commercial Bankruptcy;
New York Sate Bar Association;
Association of the Bar of the City of New York.
Editor-in-Chief, Collier on Bankruptcy (15th ed.), (15th ed. rev.);
Co-Editor-in-Chief, Collier Bankruptcy Practice Guide;
Co-author, King & Cook, Creditors' Rights, Debtors' Protection and Bankruptcy (3d ed. 1996);
Co-author, Duesenberg & King, Sales and Bulk Transfers Under the Uniform Commercial Code.
I have not received any federal grant, contract or subcontract during the current and preceding two fiscal years.
Mr. CHABOT. Thank you very much, Professor.
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Mr. Mabey?
STATEMENT OF RALPH R. MABEY, LeBOEUF, LAMB, GREENE AND MacRAE, SALT LAKE CITY, UT
Mr. MABEY. Thank you.
I would like to just touch on what Professor King said with respect to the decline of the stigma of bankruptcy. I think it is a very interesting question, and indeed, I recall that the Solicitor General of the United States in 1930 made similar arguments that the stigma of bankruptcy was dying.
It has had a very long and slow death, this stigma, it would appear, and the facts, I think, today demonstrate that it is not dead.
Today's debtors in bankruptcy have at least as much debt as compared to their income as they did in 1981. In 1991, debtors who filed bankruptcy generally earned less than those who filed bankruptcy in 1981.
In other words, in general, in 1991, the real median family income of those who filed bankruptcy was only $18,000. In 1981, it was over $22,000.
These facts, I think taken together, suggest that the stigma of bankruptcy or its lack does not explain the skyrocketing rise in bankruptcies. People try to stay out of bankruptcy just as long until they are just as bad off today as they did, say, 10 years ago.
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So I ask, then, why in our national prosperity are so many consumers bad off when you look at their balance sheets? An overriding reason, I believe, is America's staggering consumer debt, which approaches $800 billion. I submit that it is the stigma of borrowing on our credit cards, for instance, that is dead as a doornail, and not the stigma of bankruptcy.
Just look at the numbers, and I am reliant on Moss and Johnson's Harvard Business School working paper. Between 1983 and 1992, those earning less than $10,000 increased their consumer debt 49 percent. Those earning only between 10- and $20,000 increased their consumer debt 82 percent. All of those earning less than $50,00 taken together increased their consumer debt 56 percent.
In a nutshell, poor Americans are borrowing much more on their credit cards, and they are borrowing it much faster.
These people, as the data I earlier cited show, are the ones who are filing bankruptcy, and it follows. They have less ability to avoid the bumps in the road.
It has followed, then, in America as night follows day that as poorer Americans have increased their consumer debt, our bankruptcies have skyrocketed. Why has credit card debt exploded among poorer Americans? Among other reasons, because of the effective elimination of the usury laws under the Marquette decision, which according to Diane Ellis of the FDIC fundamentally altered the market for credit card loans in a way that significantly expanded the availability of credit and increased the average risk profile of borrowers.
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The result was a substantial expansion of credit card availability, and a reduction in the average credit quality and an increase in bankruptcies.
I know that consumption is a powerful engine that drives our economy, but I do not believe that high levels of consumer debt are healthy for Americans, especially when new credit card borrowing is sold increasingly to those who can least afford it.
In conclusion, I say that it is not healthy for our body politic or for our souls in the long run to have high consumer debt, and it is not in the interest of our individual well-being and our prosperity as a Nation.
Accordingly, I think that we must be very careful what we do with the bankruptcy laws. If we tighten them, Mr. Chairman, by, for instance, making more credit card debt nondischargeable, as H.R. 883 does, we will make credit card lending more profitable, resulting in more consumer debt and more problems for Americans.
When we tightened the laws in 1984, that was the result. I ask this committee to act cautiously with respect to the bankruptcy laws so as not to increase profitability for credit card lending to poorer Americans such as to increase credit card debt which I submit is the real problem that this country faces.
Thank you.
[The prepared statement of Mr. Mabey follows:]
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PREPARED STATEMENT OF RALPH R. MABEY, LEBOEUF, LAMB, GREENE AND MACRAE, SALT LAKE CITY, UT
I. HISTORICAL SETTING: WHY DO WE SOMETIMES FORGIVE OUR DEBTORS?
''If I can once get square, I will never contract another debt.''
—Robert Morris, Debtor and Patriot.
When the neighbors file bankruptcy, should we deliver sympathy and a casserole—or warn our kids against playing with their kids to avoid the taint of shame and irresponsibility?
Should the government allow creditors to hold the debtor up to public ridicule for three days and then divide the debtor's body into pieces in satisfaction of their debts—as in Rome?(see footnote 274)
Or command forgiveness of debt and grant a fresh start to debtors after every seventh year, as required in the Bible at Deuteronomy Chapter 15, which further admonishes: ''See that you do not harbor iniquitous thoughts when you find that the seventh year, the year of remission, is near and look askance at your needy countryman and give him nothing. If you do, he will appeal to the Lord against you, and you will be found guilty of sin.''(see footnote 275)
In answer to these questions, by fits and starts, with much impassioned soul searching, debate and recrimination, the United States has for two centuries moved inexorably toward greater relief and respect for individual debtors.
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Before our independence, we were a country of debtors. A large number of early European settlers came here under indenture.(see footnote 276)
One of the precipitating factors of the Declaration of Independence was the British invalidation of debtor relief laws in Massachusetts and Virginia. In justifying its actions, the British Board of Trade noted that nine out of every 10 creditors resided in Great Britain—the Americans were the debtors.(see footnote 277) Following the War of Independence, on August 31, 1786, debtor farmers marched on Boston during Shays' Rebellion, mobbing the court to prevent it from imprisoning fellow farmers for their debts.(see footnote 278)
As he argued before the Supreme Court in Ogden v. Saunders, and later in Congress for the Bankruptcy Act of 1841, the Massachusetts statesman Daniel Webster remarked of the post-Revolutionary crisis:
''The relation between debtor and creditors, always delicate, and always dangerous, whenever it divides society, and draws out the respective parties into different ranks and classes, was in such condition in the years 1787, 1788, and 1789 as to threaten the overthrow of all government; and a revolution was menaced, much more critical and alarming than that through which the country had recently passed.''(see footnote 279)
As a result of the gravity of these issues around the time of the Constitutional Convention, in 1789, the U.S. Constitution was adopted with explicit bankruptcy authority granted to Congress.
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Soon thereafter, the crash of 1792 and the panic of 1797 resulted in the imprisonment under state law of thousands of debtors.(see footnote 280) In fact, debtors' prison persisted under state law until the 1830s(see footnote 281); during some periods, there were in Pennsylvania, New York, Massachusetts and Maryland three to five times more debtors in prison than criminals.(see footnote 282)
The Bankruptcy Act of 1800
Congress responded with the Bankruptcy Act of 1800, which was similar to the English law in effect at the time of independence.(see footnote 283) The 1800 Act was repealed in 1803.
One of the lamentable stories from this period is that of Robert Morris, who had the honor to sign the Declaration of Independence, the Articles of Confederacy and the U.S. Constitution. After master-minding the financing of the early American government and the Yorktown campaign, he experienced considerable misfortune speculating on land out West, incurring debts that landed him in Philadelphia's Prune Street Jail from 1798 to 1801.(see footnote 284) Morris was eventually relieved by the Bankruptcy Act of 1800.(see footnote 285)
The Bankruptcy Act of 1841
Following the devastating panic of 1837, the trail-blazing, and controversial, Bankruptcy Act of 1841 became law; it was repealed 18 months later. The 1841 Act was the first enactment in Anglo-American law to provide for voluntary bankruptcy and to eliminate the restriction of bankruptcy eligibility to merchants. In other words, for the first time, the debtor could file bankruptcy—until the 1841 Act only creditors could put a debtor into bankruptcy, action which they took to make it easier to collect their debts. And for the first time ordinary citizens, consumers as we say today, could file bankruptcy.(see footnote 286) Although the Supreme Court did not address the 1841 Act before it was repealed in 1843 due to political resistance, its constitutionality was upheld at the circuit level, bringing voluntary bankruptcy by non-merchants within the ambit of Congress's bankruptcy power.(see footnote 287)
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During the brief period governed by the 1841 Act, 33,739 debtors were adjudicated bankrupt, of whom only 765 were denied a discharge.(see footnote 288) Seventy-seven debtors, from 25 Illinois counties, had the honor of being represented by Abraham Lincoln or his firm, Logan & Lincoln, which handled more bankruptcies than any other firm in Springfield, Illinois.(see footnote 289)
The Bankruptcy Act of 1867
The panic of 1857 and the cataclysm of the Civil War brought enactment of the Bankruptcy Act of 1867, repealed in 1878.(see footnote 290) The Act of 1867 allowed the debtor to retain increased exempt property under state or federal exemptions and required a 50% distribution to creditors and creditor consent as preconditions to a discharge (the 50% requirement was later reduced by Congress to 30%; the creditor-consent requirement would later be discarded entirely in the 1898 Act).(see footnote 291) However, the 1867 Act contained so many grounds for denying discharge that fewer than 1/3 of the debtors filing under the Act ever received a discharge.(see footnote 292)
These three laws were born and died amid controversy. But taken together they contained dramatic American innovations, favorable to ordinary American debtors: Individual debtors were given voluntary access to bankruptcy relief, to broader state exemptions, and to the discharge of their debts with less creditor approval.(see footnote 293)
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The Bankruptcy Act of 1898
The Bankruptcy Act of 1898, largely with us today in concept although superseded by the 1978 Bankruptcy Reform Act and subsequent amendments, consolidated and improved many of these innovations for the benefit of debtors while also enacting many credit industry initiatives governing the distribution of assets and payment of creditors.(see footnote 294)
In 1934 the United States Supreme Court encapsulated the American view toward the discharge of individual debtors through bankruptcy as follows:
One of the primary purposes of the Bankruptcy Act is to ''relieve the honest debtor from the weight of oppressive indebtedness and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes.'' (Citation omitted.) This purpose of the act has been again and again emphasized by the courts as being of public as well as private interest, in that it gives to the honest but unfortunate debtor who surrenders for distribution the property which he owns at the time of bankruptcy, a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt. (Citations omitted). . . .
When a person assigns future wages, he, in effect, pledges his future earning power. The power of the individual to earn a living for himself and those dependent upon him is in the nature of a personal liberty quite as much if not more than it is a property right. To preserve its free exercise is of the utmost importance, not only because it is a fundamental private necessity, but because it is a matter of great public concern. From the viewpoint of the wage-earner there is little difference between not earning at all and earning wholly for a creditor. Pauperism may be the necessary result of either. The amount of the indebtedness, or the proportion of wages assigned, may here be small, but the principle, once established, will equally apply where both are very great. The new opportunity in life and the clear field for future effort, which it is the purpose of the Bankruptcy Act to afford the emancipated debtor, would be of little value to the wage-earner if he were obliged to face the necessity of devoting the whole or a considerable portion of his earnings for an indefinite time in the future to the payment of indebtedness incurred prior to his bankruptcy. . . .(see footnote 295)
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Conclusions
With this historical context in mind, I suggest the following reasons why, for a century and more, United States law favors a fresh start for honest debtors—with relatively few strings attached:
(1) We have a tradition of an independent, creative, entrepreneurial, and risk-taking citizenry.(see footnote 296)
(2) We have long-since abandoned Blackstone's view that ''the law holds it to be an unjustifiable practice, for any person but a trader to encumber himself with debts of any considerable value''.(see footnote 297) As early as the latter part of the 1920's, it has been estimated that installment sales as a percentage of total sales reached 38% for furniture stores, 50% for household appliance stores, and between 60 and 65% for new and used automobiles.(see footnote 298) Today, household debt (including house and car loans) approaches $4 trillion, nearly a fourth of which is pure consumer debt.(see footnote 299) Consumer debt is an exceedingly powerful engine driving our economy. As early as 1931, the existence and increase in consumer debt was linked to the need for bankruptcy and a fresh start.(see footnote 300)
3. We have a relatively free market economy which imposes relatively great risks (and opportunities) on our citizens and provides relatively meager safety nets. The fresh start is one of those safety nets.
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II. THE IMPACT OF THE 1978 BANKRUPTCY REFORM ACT: DID IT LEAD TO INCREASED FILINGS? IF NOT, WHAT HAS?
Consumer Debt Precipitates Consumer Bankruptcies
Generally speaking, as one might suppose, the level of consumer debt influences the level of consumer bankruptcies. A recent analysis(see footnote 301) of the incidence of consumer bankruptcies strongly indicates that, from approximately 1920 to 1985, the gradual rise in consumer bankruptcy filings was probably caused by the rise in consumer debt (with additional bankruptcy hills and valleys explained by episodes of pronounced recession and prosperity). In other words, for about 65 years, from 1920 to about 1985, for every billion dollars of real consumer debt outstanding (in 1967 dollars) the annual number of bankruptcy filings was usually not far from the long-term average of 1,735.(see footnote 302) I believe, therefore, that until 1985 the rise in consumer bankruptcy filings is best explained by the rise in consumer debt—in the main, when consumer debt rose, consumer bankruptcy filings rose. Since 1985, however, this has changed—consumer filings have not simply kept pace with the increase in real consumer debt, but instead, consumer filings per billion dollars of debt have soared.
With the enactment of the 1978 Bankruptcy Reform Act, bankruptcy filings rose faster than consumer debt for a couple of years, but bankruptcy filings, as a function of consumer debt, declined in 1983 and 1984. Then, notwithstanding the pro-creditor bankruptcy reforms adopted in 1984, bankruptcy filings as a function of total consumer debt again surged upward.
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The 1978 Act
What explains that, following adoption of the 1978 Bankruptcy Reform Act, bankruptcy filings per billion dollars of consumer debt shot up for a couple of years, then declined for a couple of years, only to shoot up again after the stricter 1984 reform act was adopted? It does not make sense to me to lay these trends at the feet of the law; if the law caused the bankruptcies, bankruptcy filings, in relation to consumer debt, would not have declined in 1983 and 1984, and then shot up again after stricter laws were passed in 1984. The law's operation does not explain these variations. The explanations are elsewhere. I am inclined to put substantial credence in the following analysis of Moss and Johnson:
There are several other reasons why one might be skeptical of those who blame the 1978 reforms for the subsequent explosion of consumer filings. First, the changes in the law were not actually all that dramatic. As Vukowich has noted, 'These slight changes [involving discharge provisions under Chapter 13 as well as a minimum federal exemption] hardly account for the large increase in bankruptcy filings or for all the 'abuses' alleged to occur under the new law.' Second, the Bankruptcy Reform Act was not the only contextual change that might have affected filing rates in the late 1970s and early 1980s. Advertising by bankruptcy lawyers, for example, appears to have increased substantially after the Supreme Court ruled in 1977 that lawyer advertising represents commercial speech and is thus protected under the First Amendment. The early 1980s were also a period of considerable macroeconomic distress. The unemployment rate had reached its trough level of 5.8 percent in 1979 and then commenced a steep ascent to a peak of 9.7 percent in 1982. In fact, the rise in the consumer bankruptcy multiplier from 1979 to 1982 coincides rather neatly with the rise in the national unemployment rate. Third, and perhaps most damning for those who attribute the rapid growth of consumer filings to the pro-debtor provisions of the 1978 Act, is the fact that the multiplier did not slow down or reverse course when Congress enacted a set of pro-creditor bankruptcy reforms in 1984. On the contrary, this was precisely the moment when the multiplier commenced its most rapid, sustained, and unprecedented ascent. It may be that consumer debtors are simply not as sensitive to changes in the bankruptcy law as some analysts apparently believe.''(see footnote 303)
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The Bankruptcy Skyrocket Was Launched in About 1985—Not by New Laws, But by Dramatic Increases in Consumer Lending to Poorer Americans
The radical increase in consumer filings began after the enactment of the stricter 1984 bankruptcy laws.(see footnote 304) From 1985, bankruptcy filings, as a function of outstanding consumer debt, have shot to levels unknown even in the Great Depression.(see footnote 305) In 1935, 3,468 bankruptcies were filed for every billion dollars of consumer debt outstanding (in 1967 dollars). In 1997, 5,380 consumer bankruptcies were filed for every billion dollars of consumer debt!(see footnote 306)
I believe the bankruptcy ''crisis'' is found not in the absolute number of consumer filings, but in the unprecedented number of bankruptcies per billion dollars of consumer debt, which has risen every year since 1985.
I believe a credible explanation for this crisis is found in the Federal Reserve's data on the distribution of consumer debt: between 1983 and 1992 poorer Americans increased their consumer debt-to-income ratios at a dramatic and unprecedented rate that parallels the surge upward in consumer bankruptcy filings. Whereas the bottom 45% of American households, as measured by income, carried only 42% of all consumer debt in 1983, by 1992, the bottom 36% of American households, as measured by income, carried 56% of all consumer debt(see footnote 307). The dramatic increase in consumer debt for the average low income household is illustrated as follows:
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Why has there been such a startling increase in consumer borrowing by poorer Americans? A number of reasons have been suggested. Interest rate deregulation(see footnote 308) and the general lowering of prime interest rates(see footnote 309) allowed credit card issuers to give credit cards (by the millions) to low-income borrowers who constituted sub-prime risks. Lenders were free to hedge their lending risks by charging interest rates without fear of usury laws. All of us know, at least anecdotally, that consumer credit opportunities have been aggressively, and successfully, sold to low-income America.
Why, since 1985, when low-income Americans began to take on so much additional consumer debt relative to their capacities to pay, have bankruptcies risen? Because these Americans are, taken together, less able to pay their debts and therefore, more likely in need of bankruptcy protection.(see footnote 310)
III. WHAT OF THE DEATH OF STIGMA?
In the recent debates surrounding the proposed amendments to the Bankruptcy Code, much has been said about bankruptcy's ''loss of stigma.'' In the words of Alan Greenspan, ''personal bankruptcies are soaring because Americans have lost their sense of shame.''(see footnote 311)
Mr. Greenspan's view is more than 60 years old. For example, in 1930 Thomas D. Thacher, then Solicitor General of the United States, complained that too many workers were ''accustomed to pay their debts by postal card'' (referring to the form of notice mailed upon a bankruptcy filing), and attributed this to the ''disregard of business integrity'' encouraged by the bankruptcy laws of the time.(see footnote 312) And a 1933 white paper released by the Department of Commerce in tandem with the Yale Law School said that many ''consumers appearing in the bankruptcy courts . . . consider the receipt of a legal discharge of their debts as a creditable achievement. Freedom from debt without being held accountable for his past actions encourages the unconcerned debtor to resume his wasteful and extravagant habits.'' The report noted that there was no penalty for the discharge ''other than the stigma of a bankrupt . . . [and that in] . . . recent years the significance of this penalty has been gradually diminishing.(see footnote 313)
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The stigma of bankruptcy seems to be suffering a decades-long death allowing for repeated eulogies over its surprisingly warm body.
In Fact, Studies Show That Americans Today Wait to File Bankruptcy Until They Are At Least As Bad Off as Their Predecessors Were When They Filed Bankruptcy
I believe the following facts suggest that The Bankruptcy Stigma still makes people today wait until they are at least as bad off as their predecessors were before they file bankruptcy:
1. Today's debtors who file bankruptcy have at least as much debt as compared to their income as did debtors who filed bankruptcy in 1981.(see footnote 314)
2. 1991's debtors who filed bankruptcy generally earned less than those who filed bankruptcy in 1981.(see footnote 315)
3. Out of a sample of 1,000 chapter 7 debtors recently analyzed, approximately 96 percent would not be able to pay even 20 percent of their unsecured debts out of post-bankruptcy income over five years.(see footnote 316)
The Stigma of Consumer Debt, Not Bankruptcy, Is Dead
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I believe the operative stigma which has died among Americans is the stigma of consumer debt: We (both lenders and borrowers) embrace consumer debt much more than we should and it often leads to our financial undoing. Consumers often borrow sums ''beyond their means'' (although, faced with catastrophic illnesses or sudden unemployment, they sometimes have little choice). Lenders knowingly extend credit to high-risk borrowers (although these borrowers sometimes use this credit to turn their fortunes around).
How Do We Adjust to The Death of the Stigma of Debt?
Not by tightening the bankruptcy laws without very careful thought. If we tighten the bankruptcy laws by, for instance, making more credit card debt non-dischargeable as H.R. 833 would, then we make credit card lending more profitable—probably resulting in more credit card lending, and more consumer debt, which exacerbates, not remediates, our problem.
Said again, if the markets for sub-prime lending have driven consumer lending sky high, it must be because there is great profit in lending both to the typical consumers and to the higher-risk consumers who are overextended and may not pay their debts back. If one now reduces access to bankruptcy, it will increase the profitability of consumer lending and, one should expect, that consumer debt will be driven higher.(see footnote 317)
Instead, I believe reducing the consumer debt incurred by Americans would be healthy for each of us as individuals, for our body and our soul, and in the long run, healthy for our continuing prosperity as a nation.
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But, in my experience very few persons indeed carry a high credit card balance because they intend to, or know they can and might, file bankruptcy.(see footnote 318)
I believe the answer to unwise and unwarranted consumer debt lies elsewhere—perhaps in education, perhaps in reinstituting usury laws, perhaps in other lending restrictions or warnings, perhaps in the hard lessons of a recession, perhaps best in personal humility and responsibility taught at home.
IV. NEEDS-BASED BANKRUPTCY RELIEF: WHAT ARE ITS HISTORICAL UNDERPINNINGS? WHY IS THERE SUPPORT FOR IT NOW? WHAT IS THE ANSWER?
There are aspects of needs-based bankruptcy relief in our history and our current laws.
The Bankruptcy Act of 1867, for instance, provided that, in order for the debtor to receive a discharge, creditors had to be paid 50 cents on the dollar (later reduced to 30 cents) or receive the consent of a minority of creditors.(see footnote 319)
Today our law dictates that drunk drivers and support payment obligors do not ''need'' (or deserve) a discharge of those related debts.(see footnote 320)
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And, of course, since 1984, Chapter 7 bankruptcy cases may be dismissed for ''substantial abuse.''(see footnote 321)
In effect, these needs-based bankruptcy provisions in today's law are primarily requirements of debtor honesty, with ability to repay debts also considered under the ''substantial abuse'' rubric.(see footnote 322)
As to why additional ''needs-based'', means testing, bankruptcy requirements are being advanced, I am unsure. As I have testified, I do not believe that a means test addresses the cause of increased bankruptcy filings.
Moreover, the most recent study I have seen shows that only a very small percentage of Chapter 7 debtors could pay back significant amounts of debts.(see footnote 323) This supports my earlier testimony based on other studies which show most debtors earn relatively little and have high debt to earnings ratios.(see footnote 324)
Moreover a litmus means test, akin to the ones which have recently been proposed, threatens to be impractical, inefficient and unjust.
In light of the facts as I see them, I support a more modest amendment to section 707(b) which allows the court the discretion it needs to weigh the totality of the debtor's circumstances(see footnote 325) and then to eliminate those relatively fewer cases where abuse exists. The Chapter 7 trustee should be authorized to review each case and bring appropriate section 707(b) motions before the court. Where relatively high income debtors (those earning over $60,000 a year) seek a discharge under Chapter 7, the debtor's creditors should be authorized to bring the section 707(b) motion before the court.(see footnote 326)
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V. DOES BANKRUPTCY BENEFIT OR HARM CREDITORS? WHAT OF THE CHAPTER 11 REFORM PROPOSALS?
I leave this discussion to other witnesses, except for the following.
In the beginning, bankruptcy was made for creditors.(see footnote 327)
Today, bankruptcy protects creditors from the ''snatch and grab'' laws of each state, which otherwise require creditors to fight each other over the debtor's remains to their mutual disadvantage. Bankruptcy encourages equality of creditor treatment.(see footnote 328)
In addition, through the fresh start for individuals and the reorganization of companies, bankruptcy rehabilitates persons and companies so that they may do better business with creditors in the future. In an economy driven in large part by consumption (and consumer credit), the discharge can effectively ''recycle'' consumers' economic capacity, giving them another chance to contribute, this time presumably more prudently, to the commercial economic process.(see footnote 329)
I recently shared a courtroom with creditors and management of Geneva Steel Company, one of Utah's largest employers, which was forced into Chapter 11 by foreign steel dumped in our markets.
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The events in that courtroom illustrated the importance of bankruptcy to creditors. Unsecured suppliers, owed perhaps $25 million, unsecured bondholders owed over $325 million, the secured bank lenders owed about $73 million, and Geneva's employees—all joined in supporting Geneva's Chapter 11 case and in supporting new financing for Geneva's operations even though the new financing would have a higher bankruptcy repayment priority than their own obligations.
This broad support was based, I believe, on at least three factors:
First, Chapter 11 provides a mechanism for saving Geneva's going concern value and improving its viability so that creditors and employees can be paid more than if it failed and were liquidated.
Second, Geneva's creditors knew that in Chapter 11 they would have much to say about how Geneva would be restructured. Some Government receiver wouldn't be making the decisions; they would.
Third, Geneva's creditors understood that they would be favored above shareholders and that creditors would be treated fairly as between each other.
Geneva's reorganization may succeed or fail (I believe it will succeed), but those who stand to lose and win the most, the creditors, will be empowered by the bankruptcy law to help decide the course of its reorganization.
The American system of Chapter 11 which allows creditors and owners of a troubled company to negotiate and work together to find the best solutions far outweighs, in my opinion, the government imposed restructurings and liquidations found in the bankruptcy laws of most other countries. It is my hope that Congress will not unbalance this mechanism by continuing to listen to individual creditor and interest groups who seek individual advantages under the law. To do so is to reimpose the evils of ''snatch and grab'' law and undermine the equity and equilibrium of the reorganization process.
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Mr. GEKAS [presiding]. We thank the gentleman.
We turn to Judge Lee.
STATEMENT OF JOE LEE, UNITED STATES BANKRUPTCY JUDGE, EASTERN DISTRICT OF KENTUCKY, LEXINGTON, KY
Mr. LEE. I, too, would like to say something about the stigma of bankruptcy. I think that the reason people think there is no stigma to bankruptcy these days is because they listen to the radio and television ads of automobile dealers, furniture dealers, carpet dealers saying ''bad credit, no credit, bankrupt, come on in, we will sell you goods and services.''
Hearing that, people subliminally think obviously there is no longer a stigma to bankruptcy, but I have served on the bankruptcy bench for 37 years, and 18 of those years was under the prior law when we presided over meetings of creditors and listened to the interrogation of debtors. Even under the new law for a period of several years, we had discharge hearings wherein we supervised the reaffirmation agreements by debtors and listened to their stories.
I do not find these people to be cavalier. They are all contrite, very concerned about having to take bankruptcy, and if you think about it a minute, you will understand why. These people have neighbors; they have mothers, fathers, uncles, and they have a church group that they go to. They have a place of work that they go to, and it is ridiculous to say that debtors walking in those shoes find no stigma in bankruptcy. Obviously, they are looked on by their neighbors, their fellow employees, their friends, their church group as having gone through bankruptcy, and there is a stigma to bankruptcy.
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I would end my statement by pointing out that back in 1971, the Brookings Institution did a study of bankruptcy at the request of the Administrative Office of U.S. Courts, and that study was funded by a grant and not by an industry. They asked the question whether it would be more beneficial to society to require debtors to repay their debts as opposed to having those debts discharged in bankruptcy.
Their conclusion was that it was virtually impossible to tell whether it would benefit society more to come up with a needs-based bankruptcy system such as this and require debtors to pay debts, as opposed to the decreased consumption that would occur by those debtors during the period of repayment, and they came to the conclusion that it was sort of a dog fall as far as society was concerned to require payment of debts and think that that would benefit society.
I also point out in my paper, as Judge Mabey has and others, that there was an event in 1978 that triggered an enormous increase in bankruptcy filings in subsequent years, but it was not the enactment of the Bankruptcy Reform Act of 1978. Rather, it was the decision a few months later in December 1978 in the Marquette case in which the issue was this. A National Bank in Omaha, Nebraska, had issued credit cards, BankAmericards, to citizens of Minnesota, and the Attorney General of Minnesota contested the rate on those credit cards, which was 18 percent under Nebraska law. The maximum rate available in Minnesota was 12 percent.
The Supreme Court held that under the National Bank Act, the interest rate that the National Bank could charge was the interest rate of the State in which the bank was located. In other words, the National Bank could export its interest rate to citizens of other states without running afoul of the usury laws of that State.
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Almost immediately, a couple of States, South Dakota and Delaware, enacted statutes abolishing usury laws and statutes favorable to banking, and almost immediately, Citicorp opened a credit card processing unit and a National Bank in Sioux Falls, South Dakota, and moved its credit card operations from New York City to South Dakota.
Almost immediately, four National Banks in Maryland, moved their credit card operations to Delaware, and they did that because the Maryland State legislature had refused to raise interest rates. So it was the Supreme Court, really, and not the Bankruptcy Code that opened up this Pandora's box.
I see my time has expired.
[The prepared statement of Judge Lee follows:]
PREPARED STATEMENT OF JOE LEE, UNITED STATES BANKRUPTCY JUDGE, EASTERN DISTRICT OF KENTUCKY, LEXINGTON, KY
SUMMARY
My statement is presented in three parts an incorporates exhibits and charts which are attached at the end of Part II.
Part I: The impact on the economy and society if H.R. 833 is enacted has not been fully considered. Two million families could be forced to live at the poverty level while they repay a fractions of their debt.
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Part II: There was an event in 1978 that triggered an increase in consumer bankruptcy cases, but that event was not the enactment of the Bankruptcy Reform Act of 1978. By way of comparison, personal bankruptcy filings in Canada have increased significantly since 1968—not because of any changes in the bankruptcy laws there, but because of the entry and development of the credit card industry in Canada in 1968. Deregulation of the credit card industry in the United States, which began in 1978, has resulted in an increase in the number of consumers overburdened by credit card debt seeking relief through bankruptcy.
Part III: Congress has considered and has wisely rejected compulsory chapter 13 proceedings on other occasions. As early as 1937 Congress recognized that an effective and sensible debt repayment plan would have to be voluntary and of relatively short duration. Compulsory chapter 13 legislation may encourage predatory extensions of credit, just as Congress recognized in 1968 that unrestricted wage garnishments encouraged the making of predatory extensions of credit.
PART I
HISTORY AND SIGNIFICANCE OF THE ''FRESH START'' DISCHARGE UNDER AMERICAN CONSUMER BANKRUPTCY LAW: WHY DO WE LET DEBTORS ''WALK AWAY FROM THEIR DEBTS?''
The ''Fresh Start'' discharge relieves the honest debtor of the burden of overwhelming debt and restores the debtor as a productive member of society capable of supporting himself and his family.
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The belief that requiring debtors to repay some or all of their debts will bring down interest rates and prices is largely a myth.
In his book ''The Indebted Society, The Anatomy of an Ongoing Disaster,'' Little Brown and Company, 1996, Professor James Medoff, the Meyer Kestnbaum Professor of Labor and Industry at Harvard University, points out that between 1980 and 1992, when the federal funds rate (the interest that banks charge for overnight loans) fell from 13.4% to 3.5%, a drop of nearly 10 percentage points, the average credit card interest rate rose from 17.3% to 17.8%.(see footnote 330) Professor Medoff suggests that during the 1980s, when interest rates were high, lenders learned a valuable lesson; consumer debtors in general pay very little attention to interest rates.
The small reduction in the average credit card interest rate that has occurred since 1992 is due in large measure to the increased reliance by credit card issuers on ''teaser rates'' to entice more consumers to open new credit card accounts. See Chart 7 attached to my statement. In 1993, credit card banks were nearly four times as profitable as all commercial banks. Despite the slight decrease in the average credit card interest rate, credit card banks remain twice as profitable as commercial banks.(see footnote 331) While the charge-off rate on credit cards may have increased due to the marketing of cards to college and high school students and debtors with subprime (less than good) credit histories, in applications to purchase or merge banks the applicants tell regulators that such acquisitions and mergers will reduce costs and save customers money. If the latter is true, such savings should more than offset the increase in write off of credit card debt.(see footnote 332)
We are told that consumer spending is the engine that accounts for two-thirds of the expansion of our economy, and that consumer confidence is critical to consumer spending. One of the unintended consequences of this proposed legislation is that it tinkers with the engine that drives our economy.
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In 1971 the Brookings Institution published a study of the United States bankruptcy system which it had undertaken at the request of the Judicial Conference of the United States.(see footnote 333) Under the heading ''Who Bears the Cost'' the authors of this study discuss the question whether requiring debtors to repay some of their debt would be good for the economy. Their ultimate conclusion was that it was impossible to tell whether the positive effect on the economy of forcing debtors to repay old debt would outweigh the effect of reduced spending and consumption by such debtors during the period of repayment.
As I understand the bill presently under consideration, it is designed to force approximately 30% of individual debtors filing for relief under the Bankruptcy Code into debt repayment plans. These debtors and their families, including children, would be required to live at poverty level for 5 years while repaying some portion of the family debt. Based on present day filings this could mean that each year approximately 400,000 families would be relegated to living at poverty level. This would be in addition to families of low wage earners already living at poverty level. At the end of a five-year period (400,000 x 5) there could be a constant number of 2,000,000 families forced to live at poverty level in addition to the millions of minimum wage earners and their families who now exist on poverty-level wages.
However, these 2,000,000 families who are forced to live at poverty level under coerced debt repayment plans will be worse off than other low wage, poverty level families. This is because the income of these 2,000,000 families may theoretically exceed poverty level and thus they may not qualify for earned income credit tax refunds, school lunch programs, food stamps, or other subsistence provided to families with below poverty level income. These families will be worse off than other poor families because they will be living at poverty level for up to five years only due to the requirement that they repay some of the family debt.
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While mercifully we have abolished imprisonment for debt, this needs-based bankruptcy legislation may be tantamount to sentencing 2 million families to home incarceration for 3–5 years, simply because they will not be able to afford to go anywhere but church.
At a time when one of the objectives of our government is to raise all families above poverty level it seems inconsistent to force into poverty those families who for whatever reason can't pay their VISA and MasterCard bills.
Before enacting this legislation Congress should study the effect on the economy of severely restricting consumer spending of 2,000,000 families whose ability to spend will in no way be enhanced by government subsidies. Congress should also study the effect on consumer confidence of the proposed punitive treatment of these families.
Needs-based bankruptcy also may discourage entrepreneurship and affect our economy in that respect as well. Most small businesses, about 80% of which fail in two years, are started by individuals. These businesses, even those that do not survive, provide a significant number of new jobs annually. Quite a number of personal bankruptcy cases are filed by individuals to escape debt incurred in a failed business venture. Under this needs-based bankruptcy legislation, these individuals, if they subsequently have become employed, may have to live at poverty level for 3–5 years while repaying old business debt. This change in the bankruptcy laws could discourage entrepreneurs from undertaking a new business venture. And since the government professes to encourage entrepreneurship, we should think twice about enacting a bankruptcy law that does just the opposite.
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Against this background it makes no sense to project that this bill will save American families $550 per year in reduced interest and cost of goods and services. This projection apparently is based on industry-funded research of specious origin.(see footnote 334)
In another part of my statement I have pointed out that an earlier study conducted by the Credit Research Center in 1982 concluded that in the absence of bankruptcy only 1/4 of the indebtedness discharged in bankruptcy would be collectible by creditors in any event. That seems obvious because of the fees charged by collection attorneys and the unlikely possibility of collecting an account in full. Thus, the $550 figure being bandied about as a savings to American families should, at a minimum, be divided by four so that the real savings, if any, would be more in the range of $137, and this would be offset by the increased cost to the Government of administering the changes in the law mandated by H.R. 833.
This subcommittee should be cautious about enacting legislation that serves the ends of VISA and MasterCard while they are defendants in an action in the Southern District of New York in which the Justice Department is seeking to restrain them from violations of the antitrust laws. In my view a reduction in credit card rates may depend largely on the success of the Justice Department in that action. There is no good reason why this legislation shouldn't be delayed pending the outcome of that action.(see footnote 335)
PART II
THE IMPACT OF THE 1978 BANKRUPTCY REFORM ACT: DID IT LEAD TO INCREASED FILINGS? IF NOT, WHAT HAS?
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There was an event in 1978 that triggered an increase in individual bankruptcy cases, but that event was not the enactment of the Bankruptcy Reform Act of 1978.(see footnote 336)
The event in 1978, which was a catalyst for the enormous expansion of consumer debt—particularly credit card debt—as well as the accompanying increase in consumer bankruptcy filings, was the decision of the U.S. Supreme Court in what is known as the Marquette case.(see footnote 337) This benchmark decision was handed down by the U.S. Supreme Court on December 18, 1978, approximately a month and a half after the November 6, 1978 date of enactment of the Bankruptcy Reform Act.
In the Marquette case the Supreme Court held that a national bank located in Omaha, Nebraska could charge residents of Minnesota to whom it had issued Bank-Americard credit cards the rate of interest allowed by the law of the state in which the bank was located even though the rate was greater than the rate permitted by the law of Minnesota. The Minnesota Attorney General had argued that the maximum applicable rate was the 12% rate fixed by the law of Minnesota rather than the 18% rate allowed by the law of Nebraska. The Supreme Court held that under the National Bank Act the applicable rate was that permitted by the law of the state in which the national bank was located. In other words, a national bank may ''export'' the interest rate of the state in which the bank is located to its out of state customers and credit card holders without running afoul of the usury laws of the customers' home states.(see footnote 338) This decision in effect ''deregulated'' control of interest rates by individual states and emasculated state usury laws.
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Some states acted quickly to deregulate interest rates and other banking functions to attract banks and related entities. Two such states were South Dakota and Delaware.(see footnote 339)
Citicorp was one of the first lenders to take advantage of deregulation at the state level. In 1981 Citicorp established a new national bank and credit card processing center at Sioux Falls, South Dakota and moved that bank's credit card operations from New York City to Sioux Falls.
In 1982 Maryland Bank, N.A., the state's largest bank at the time, moved its credit card operations to Delaware and was followed shortly thereafter by First National Bank of Maryland, Equitable Trust Co., and Suburban Bank. These four banks moved their credit card operations to Delaware after the Maryland state legislature refused to relax the state's usury laws.(see footnote 340)
The Supreme Court had opened Pandora's box. The race was on among the states to relax usury laws to attract banks; the race was on among banks to establish affiliate national banks in states that had relaxed or abolished usury laws.
In 1987 the Bank Holding Company Act was amended by the Competitive Equality Banking Act of 1987 to permit ownership of federally-chartered credit card banks by entities other than bank holding companies. This has permitted the creation of national banks by many retailers such as Chevron, Dillards, Fingerhut, J.C. Penney, Sears, and Circuit City Stores, Inc. These retail affiliate credit card banks issue credit cards to customers for use in charging purchases at the retailer's store. The interest rate charged on these credit cards typically is four or five percentage points higher than the interest on regular credit cards. For example, the interest rate on a Circuit City credit card issued by First North American National Bank of Marietta, Georgia is 24.5%. The interest rate on a Sears credit card is 22%. By use of these credit cards retailers are able to circumvent any remaining applicable state usury laws that might otherwise control the interest rate on consumer purchases.
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Attached to my statement as Exhibit No. 2 is a list of approximately 70 credit card banks chartered by the Comptroller of the Currency, the administrator of national banks. You will note that most of these banks have been chartered since 1978.
This imaginative use of credit card banks has caused consumer credit outstanding to rise steadily since 1978 and personal bankruptcies to increase in tandem with the growth of consumer credit outstanding. See Charts 1–4 attached to my statement.
Should there be ''doubting Thomases'' about the growth of consumer credit being virtually the only real cause for the increase in personal bankruptcies we need only look at the Canadian experience.
Interest rates in Canada have been deregulated at least since 1886, but personal bankruptcies there were not a noticeable problem prior to 1968. In 1968, two years after the development of the Visa and MasterCard associations in the United States, Visa entered Canada, resulting in dramatic growth in credit card loans. As a result personal bankruptcies started rising sooner in Canada than in the United States. This cannot be blamed on changes in Canadian bankruptcy laws because Canadian bankruptcy laws had not been changed. Personal bankruptcies grew sharply and immediately after Visa association entered Canada. From 1966 to 1976, the personal bankruptcy rate in Canada grew 340 percent. Over the same period, the personal bankruptcy rate in the United States grew by only 8 percent. One explanation for this difference in rates may be that state usury laws were limiting the availability of credit in the United States during that period (which was prior to the decision in the Marquette case), while the absence of usury ceilings in Canada was permitting the expansion of credit card debt to more high risk borrowers.(see footnote 341)
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After interest rate deregulation in the United States resulting from the Marquette decision, over the next decade the personal bankruptcy rate in the United States and Canada follow a remarkably similar pattern. Between 1976 and 1986, the Canadian bankruptcy rate grew by approximately 93 percent, and the U.S. bankruptcy rate grew by 72 percent. In the decade 1986–1996, as the credit card industry underwent rapid innovation and expansion, personal bankruptcy rates in both countries grew dramatically. In Canada, the personal bankruptcy rate grew 225 percent; in the United states it grew 123 percent.(see footnote 342)
The Canadian experience indicates that changes in our federal bankruptcy laws have not been a significant factor in the rise of personal bankruptcies in the United States. During all of this period the unchanged Canadian bankruptcy laws have been far more restrictive than the U.S. bankruptcy laws, but those laws were not effective against the onslaught of unsecured credit foisted on debtors by credit card issuers. Credit card lenders may be pointing the finger at the Bankruptcy Reform Act of 1978 to detract Congressional and public attention from the fact that their credit card operations are the real source of the problem.
Between 1993 and 1998 bank credit card loans in the United States doubled from $223 billion to nearly $500 billion, and personal bankruptcy filings increased accordingly. See charts 5–6 attached to my statement. This surge in credit card debt and personal bankruptcies occurred primarily because of relaxation in banking laws and regulations.
Since the early 1990's banks increasingly have resorted to securitizing credit card accounts receivable, and banking laws and regulations have been changed to facilitate these transactions. Most are familiar with the practice of bundling home mortgage loans or even car loans and selling them as a package to investors. But the practice of bundling unsecured credit card receivables and selling them in a package to investors is a relatively new phenomenon. Congress and federal regulators have been persuaded to make changes in the law and regulations to facilitate these transactions. The proliferation of credit card-backed securities has produced hefty profits for lenders and investors but has left as its legacy a society drowning in credit card debt.
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Credit card securitizations are usually structured by the issuing bank as non-recourse sales of pools of credit card receivables to an entity such as a Master Trust. The trust in turn issues to investors securities similar to bonds. The trust uses money it receives from investors to purchase credit card receivables from banks. The banks then use the money they receive from the trust to make new loans.
The investors in credit card-backed securities are usually mutual funds, insurance companies, corporations, and other banks, foreign and domestic. Investors receive periodic interest payments over time, and receive payment of principal when the securities mature (e.g., 5–10 years). The cash flow generated as consumers repay their credit card debt is used to make interest payments to investors. To ensure there will be sufficient funds over time to make interest payments to investors, the bank issuing the credit cards which back the securities is obligated to maintain a minimum level of credit card receivables in the asset pool. In other words, as consumers repay their credit card debt, the total amount of credit card receivables held by the trust must be replenished. In effect the bank is obligated to investors to continue generating credit card receivables during the life of the security. Receivables are easily generated so long as consumers stay in debt. In the past five years competition in the credit card industry has been driven by two factors: (1) profit margins reflected by the difference between the high interest rates charged to consumers and the cost of funds to the bank (see chart 7); and (2) the need to generate credit card receivables for securitizations (see chart 6).
Apparently some banks are buying or merging with other banks in order to acquire credit card receivables, which are then sold on the secondary market for funds to facilitate the purchase or merger arrangement.
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In 1994 the President signed into law Riegle-Neal Interstate Banking and Branching Act, Pub. L. No. 103–328, 108 Stat. 2338 (1994), which significantly reduced geographic restrictions on interstate banking activity. This new law permits bank holding companies to purchase subsidiary banks across state lines without regard to restrictions on out-of-state acquisitions imposed by state law. It also permits interstate bank mergers regardless of state law. The act also permits a national bank to establish and operate a de novo branch in a state other than the bank's home state.
This act has led to acquisitions of banks by bank holding companies and to bank mergers that may result in the sale or transfer of credit card accounts of bank customers. Upon acquisition of such accounts the acquiring banks apparently are free to impose other terms on the cardholder, including an increase in the interest rate as a means of paying for the acquisition.
When home mortgages or car loans are sold, as they frequently are, the entity acquiring such mortgages or car loans cannot change the terms of payment or interest rate. This apparently is not so with respect to credit card accounts that are sold.(see footnote 343)
In any event 5 large banks now own or control 43% of all credit card debt. These 5 financial institutions, together with 45 other banks, 50 financial conglomerates in all, control 81.5% of the approximately $500 billion in credit card loans. All other banks and financial institutions in the United States control only 18.5% of outstanding credit card debts. See chart 8 attached to my statement.
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Congress and banking regulators have facilitated the enormous expansion of consumer credit and have encouraged the consumer credit industry's reliance on securitizations. When a bank securitizes its credit card receivables it is able to remove the loan from its balance sheet, thereby reducing the amount of capital it must retain. Legislation effective on September 1, 1997 was intended to facilitate the securitization of credit card receivables and other consumer debt instruments, such as home equity loans, by utilizing an entity called a Financial Asset Securitization Investment Trust (FASIT). A FASIT can issue securities that will be treated as debt for federal income taxation purposes. Any taxable income or net loss will flow through to the equity owner of the FASIT; the FASIT itself is not a taxable entity.(see footnote 344) A rule clarified by the Comptroller of the Currency on December 2, 1996 permits national banks to invest in securities backed by credit card receivables and other consumer loan receivables. This rule increased the amount of capital and surplus a federally-chartered bank may invest in asset-backed securities from 10% to 25%.(see footnote 345)
In 1996 Congress opened the door to permit savings associations, or ''thrifts,'' to engage in credit card lending. In 1997, the Office of Thrift Supervision promulgated a rule which permits thrifts to make credit card loans.(see footnote 346)
Amendments to the Fair Credit Reporting Act in 1997 made it much easier for lenders to make the familiar ''you have been pre-approved'' offers of credit through mass advertising to consumers who have not applied for loans. Lenders submit to credit reporting agencies not names but merely a profile of consumers to whom the lender may wish to extend an offer of credit. Previous to the amendments the credit reporting agency was permitted to furnish the lender the names and addresses of consumers who fit the profile only if the lender agreed to make a ''firm offer'' of credit to every consumer on the list. The recent amendment emasculates the definition of ''firm offer,'' thereby permitting creditors to offer ''pre-approved'' credit to anyone.(see footnote 347)
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It has been reported that credit card banks mailed 3 billion unsolicited offers of credit either by negotiable checks or preapproved credit cards, or home equity loans to debtors during 1997. That is approximately 30 such offers to every household in the United States, or another way of putting it, approximately eleven such offers for every man, woman and child in the United States.(see footnote 348) According to American Banker, since 1996 Fleet Financial Group has mailed out 4.5 million checks in denominations of $3,000 to $10,000 inviting prescreened debtors who had not solicited loans to simply endorse the checks (thereby acknowledging the loan) and use the money to pay taxes or spruce up their houses, etc. Other lenders, including Chase Manhattan Corp., have engaged in similar check mailings.(see footnote 349)
Some such offers are being mailed to debtors with subprime (less than good) credit ratings, of which the lenders are fully aware. These are the same lenders who want to preclude debtors from relief under chapter 7 of the Bankruptcy Code in the event of default and force such debtors into a repayment plan under chapter 13. In other words, they want to close the bankruptcy escape hatch as a hedge against losses on their risky, improvident loan procedures.
In a speech before the American Bankers Association on September 27, 1998, Julie L. Williams, Acting Comptroller of the Currency, made these points:
. . . Beginning in 1993 consumer loans overtook commercial loans as a percentage of all commercial bank assets. Although the balance of these bank assets has again recently converged, analysis shows that this is the result not of any slowdown in the pace of consumer [loan] originations. Instead, more and more banks—of all sizes—are finding it easy and advantageous to securitize consumer assets and thus take [the loans] off their books, freeing them to make more loans. . . .
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. . . Consumer lending remains one of the few places on the banking landscape where profit margins have held up in the face of growing competition. . . .
. . . .
. . . Between 1993 and 1998, consumer credit outstanding—excluding home mortgage debt—rose more than fifty percent, reaching more than one and a quarter trillion dollars. And this does not include another $2 trillion in unused credit lines—credit that consumers can tap at their convenience. Together, these numbers nearly equal the total deposits in all U.S. commercial banks.
These are staggering sums. But their true significance becomes clearer in the context of the overall performance of our economy. For while consumer credit outstanding was going up roughly 50 percent between 1993 and mid-1998, personal income has risen only half as fast during the same period. And debt service payments as a percent of disposable personal income are nearly the highest they have ever been.
. . . .
We should hardly be surprised, then, to see deterioration in the performance of some categories of consumer loans and the increase in the personal bankruptcies in recent years. . . .
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. . . .
Many American households are overextended, and there is plenty of blame to go around. . . . While some [lenders] continue to exercise restraint and common sense, other lenders have aggressively targeted those consumer groups most likely to be seduced by easy credit: college and even high school students; recent bankrupts; and people who are already overextended. Some issuers have exploited loopholes in the law to get unsolicited credit cards into customers' hands; others resort to heavy-handed and sly marketing practices, such as ''teaser'' interest rates.
A particular trouble spot is the fast-growing home equity market. In the three years between 1994 and 1997, the dollar value of commercial banks' home equity loans increased by more than 35 percent.
Home equity loans are usually marketed to, and used by, consumers as a means to consolidate credit card debt. According to a recent study, over the past 24 months 4.2 million American households have converted $26 billion of credit card debt into home equity mortgage debt. For many consumers, this makes sense. . . . But the same study also shows that only a third of the 4.2 million households that had consolidated their unsecured debt were still credit card debt-free at the end of the study period. To varying degrees, the others had ''reloaded'' their credit cards with new purchases, leaving them worse off than before in terms of their total debt burden. Worse still, they placed their homes in jeopardy.
Ms. Williams characterizes the rise of consumer banking as synonymous with the democratization of credit. But she also points out that no one wins when individuals receive too much credit or credit they cannot afford. No one wins when a consumer falls behind or declares personal bankruptcy or loses a home to foreclosure.
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Unfortunately some of the sponsors and proponents of the legislation presently under consideration have made statements suggesting the current increase in individual bankruptcy filings during good economic times is unprecedented.
Actually, an increase in individual bankruptcy filings in good economic times is not at all unusual.
In testimony before the Committee on Banking and Financial Services, U.S. House of Representatives, September 12, 1996, at pages 127–128, Ricki Helfer, Chairman of the Federal Deposit Insurance Corporation, stated:
[r]ising consumer delinquency and charge-off rates during an economic expansion—like the present rising rates—are not unusual. During the last economic expansion from 1985 to 1989, consumer delinquency and charge-off rates also rose.
In testimony before the Subcommittee on Financial Institutions and Regulatory Relief of the Senate Banking Committee, on July 24, 1996, Mr. James Chessen, the Chief Economist of the American Bankers Association stated:
It is interesting to note that bankruptcies have risen during recent periods of economic growth. In the 1980's, despite the longest postwar expansion, bankruptcies rose steadily.
. . . Consumer debt has expanded because banks are very healthy and can meet the growing consumer demands for credit.
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. . . [R]ising delinquencies should be closely monitored, but there is no reason for alarm. Banks are already becoming more cautious and have already taken steps to reduce their exposure.
In fact, the banking industry holds a lower volume of consumer loans, including credit cards, than they did at the start of the year. They have already responded to rising delinquencies.
Moreover, the potential losses are not great enough to create substantial problems for the banking industry. First, the exposure per individual customer is very small. Second, banks' loan portfolios are well diversified, and third, the industry has record levels of capital and reserves to enable it to easily handle the highest levels of consumer losses. . . .
. . .
Given the strong financial condition of the banking industry, consumer delinquencies pose no serious threat.
. . .
Prudent lending in the face of rising delinquencies is appropriate. And I have to say that we need to be sure that the regulators do not overreact and slam the brakes on consumer lending.
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Thus, when representatives of the American Bankers Association appear before the Senate Banking subcommittee that oversees their lending activities, they tell the subcommittee that potential losses on consumer loans are not great enough to create substantial problems for the banking industry; that regulators should not overreact and slam the brakes on consumer lending.
When representatives of the consumer loan segment of the American Bankers Association appear before this subcommittee they tell the subcommittee that the number of consumer bankruptcies is causing them serious problems and that the solution is to slam the door on the access of consumer debtors to relief under the Bankruptcy Code.
The consumer loan industry can't have it both ways. They can't say there is no problem, don't overreact and regulate us; there is a problem, overreact and regulate our customers.
Mr. Chessen told the Senate Banking subcommittee what is essentially the truth.
The growth of consumer debt has outstripped the growth of disposable income and pushed consumer debt burdens to historically high levels. The rising consumer delinquencies are the best evidence some consumers are reaching the limits of their debt.
This statement by a spokesman for the banking industry pretty well concedes that the reason for the rise in delinquencies and bankruptcies is historically high debt levels of consumers and not the alleged laxity of the bankruptcy laws.
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Clearly, the extraordinary and enormous ballooning of consumer credit has been made possible by actions of the courts, Congress, and regulatory agencies, through interest rate deregulation and the easing of restrictions on consumer lending. It is these actions which are responsible for the increase in individual bankruptcy filings. Those who blame the 1978 Bankruptcy Reform Act for the increase in individual bankruptcy filings are misleading the public and Congress.
PART III
NEEDS-BASED BANKRUPTCY RELIEF: WHAT ARE ITS HISTORICAL UNDERPINNINGS? WHY IS THERE SUPPORT OF IT NOW?
My colleagues on the panel have done an excellent job covering this subject. I would like to add a few thoughts and a footnote.(see footnote 350)
The Act of 1841 by its terms did not take effect until February 3, 1842. It was repealed on March 3, 1843, so the Act was in effect only 13 months. Nevertheless, during this short period 33,729 persons owing nearly $441,000,000 took advantage of the Act. The law firm of Abraham Lincoln and Judge Stephen T. Logan filed 77 of these cases in the U.S. District Court at Springfield, Illinois.
A major reason the House Judiciary Committee in the past consistently has rejected mandated chapter 13 is concern over whether involuntary chapter 13 proceedings may violate the Thirteenth Amendment, which prohibits involuntary servitude. Though it has never been tested in the chapter 13 context, it has been suggested that forcing an individual to work for creditors would violate this prohibition. See House Report No. 95–595, 95th Cong., 1st Sess., pg. 120.
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The following quote is excerpted from a statement of Professor Vern Countryman of Harvard Law School in oversight hearings on personal bankruptcy before the Subcommittee on Monopolies and Commercial Law of the House Judiciary Committee on October 22, 1981, March 23, 25, April 28, May 20, and June 16, 1982, at page 435.
(1) As was said by a witness fifty years ago, opposing a proposition that we adopt the English practice of suspending bankruptcy discharges until the debtor has paid off all, or at least a substantial part, of existing debts from future earnings (which is the essence of the proposals here), such a proposition is ''contrary to the genius of our institutions.'' Indeed, that proposal was, I believe, the only bankruptcy proposal in the history of this country to be characterized by another witness as ''Un-American.'' Joint Hearings before Subcommittees of the House and Senate Judiciary Committees on S. 3863, 72nd Cong. 1st Sess., pp. 546, 641, 753 (1932). The Thirteenth Amendment provides th