Over the past 30 years, mortgage costs have leapt 70 percent, and health care costs 90 percent. As a result, today’s family spends 75 percent of its income just to cover basic necessities, compared to 54 percent a generation ago. Despite widespread allegations of “affluenza,” or careless spending on luxuries, American families spend 21 percent less on clothing, 22 percent less on food, and 44 percent less on major appliances than 30 years ago.

Summer 2006

Going for Broke

BY ELAINE McARDLE     |     PHOTOGRAPHS BY STEPHEN WEBSTER

The new bankruptcy reform act that went into effect last October was heralded by many as a long overdue solution to a costly societal problem: millions of deadbeat Americans who willfully lived beyond their means, then refused to pay their bills and exploited the bankruptcy option to get away with it.

But the alleged abuse was grossly exaggerated, the new law is poorly written and the only real winners are the credit card companies, who were making record profits anyway, say bankruptcy lawyers and judges, including lawyers who represent creditors. While the bar and bench say they will adjust to the changes, they believe that the existing law worked very well and that these reforms were not only unnecessary but ill-conceived and poorly drafted.

“This law is very badly rendered,” said Judge William Hillman, a member of the Boston bankruptcy bench who teaches at the School of Law, at a recent symposium on the reform act. “You wonder, who was Congress mad at?”

“It’s more time-consuming and frustrating,” laments Susan Grossberg ’92, a solo practitioner in Boston who con-centrates in bankruptcy for consumers. “Under the new law, the same relief is generally available, but it’s more restrictive in lots of ways and much more expensive.”

DIVIDE AND CONQUER

American bankruptcy law was designed to provide a safety net so well-intentioned people could get a “fresh start” when circumstances beyond their control such as job loss or major illness led to fiscal ruin. Under a court’s supervision, a debtor could divide up his eligible assets among his creditors and have his debts wiped clean, under a Chapter 7 petition, or use his income to slowly pay off creditors a percentage of what he owed, through a Chapter 13 filing. During the Great Depression of the 1930s, national bankruptcy policy was refocused to help struggling businesses get back on their feet and keep people employed, under Chapter 11 of the code.

For the most part, the system worked well, with few bad-faith filings, according to bankruptcy experts. But last year, spurred by a credit card company-fueled perception that gleeful spendthrifts were abusing the process, Congress passed its first significant reform of bankruptcy law since 1978. Signed in April by President Bush, the law makes it more expensive and difficult for most people to file for bankruptcy. It also requires more work from bankruptcy lawyers, who in response must charge higher fees to clients.

While these changes may seem reasonable, those who work within the bankruptcy system say the underlying premise —that many people abused the former law in order to dodge their financial obligations — simply isn’t true. The credit card industry spent tens of millions of dollars over eight years to garner support for the law, and, once it was passed, encouraged frightened consumers to believe the changes were more extreme than they are in order to dissuade them from filing for bankruptcy. As a result, there was a sharp spike in bankruptcy filings before the law went into effect last fall, and a commensurate drop for a few months afterwards.

Today, while bankruptcy judges and lawyers may not be fans of reforms they view as unnecessary, they are adjusting.

“The bar, parties, judges, we must do the best we can no matter what we see in terms of a lack of need to change the law,” says Judge Robert Somma ’76, who sits on the US Bankruptcy Court bench in Boston. “Congress gives you statutes, and you have to work with them, and I think these are workable. I don’t think we have any choice.”

If the credit card company view isn’t accurate, as critics of the new law insist, then what was the reality of the bankruptcy landscape?

“I have never had anyone come in who woke up one day and said, ‘I don’t feel like paying my debts,’” says Grossberg. “Never. I’ve seen a lot of tears.”

Chris Parker ’76, a Boston lawyer who’s represented as many creditors as debtors in 30 years of practice, agrees.

“I think the overwhelming number of people who filed for bankruptcy did not abuse the law or attempt to hide assets,” he says. “I think there was a misconception that there was a need to crack down on a huge wave of bankrupts.”

The view from the bench is the same. “In my 16 months on the bench, I’ve observed a great deal about consumers in bankruptcy, and I would say that the incidence of abuse — I don’t want to say it’s negligible because it does exist — but it really is statistically minor,” says Somma.

SCRAPING BY

These anecdotal impressions are supported by numerous studies. In close to 90 percent of bankruptcies, financial misfortune isn’t born of carefree spending but rather one of three things: divorce, medical problems or job loss, according to Elizabeth Warren, a bankruptcy expert and coauthor of the best-selling book The Two-Income Trap: Why Middle-Class Parents are Going Broke. Over the past 30 years, mortgage costs have leapt 70 percent, and health care costs 90 percent, Warren says. As a result, today’s family spends 75 percent of its income just to cover basic necessities, compared to 54 percent a generation ago. Despite widespread allegations of “affluenza,” or careless spending on luxuries, American families spend 21 percent less on clothing, 22 percent less on food, and 44 percent less on major appliances than 30 years ago, Warren points out.

With three-quarters of their income devoted to essentials, there’s little left over in the family budget to put money away to cushion a disaster, such as job loss or illness. At the same time, credit card companies have freely offered enormous amounts of credit at rates, sometimes as high as 28 percent APR, that once were illegal. Strapped consumers have come to rely more heavily on easily obtainable credit cards, but when they fall behind on payments, find it almost impossible to catch up. And that’s the reason — not personal irresponsibility — that bankruptcies have soared since 1980, Warren says.

Bankruptcy is rarely an option chosen gladly or easily, experts say, but rather is a last choice for desperate consumers. Most people are deeply embarrassed by having to consider bankruptcy but see no alternative, lawyers say. Indeed, most Chapter 13 petitions are filed for the single purpose of avoiding foreclosure on a family home by forcing the creditor to work out a longer or different payment plan.

Ken Lindauer ’74 has practiced bankruptcy law for consumers for more than three decades, with offices in Salem and Haverhill, Mass., and in Woodstock, Vt. “Most bankruptcy involves unsecured credit card debt, and credit card companies are traditionally not sympathetic to the plight of borrowers when they get into trouble,” he says. “When that happens, the companies make it harder for them to pay back the debt. A lot of my clients live week to week, and once they’re behind, it’s almost impossible to catch up.”

Many of his clients are elderly people eking by on Social Security, who use credit cards for food or clothing. “If they get a little behind, the credit card companies raise rates so they can’t pay them at all, and then call and threaten to secure their Social Security payments,” which, in fact, is illegal, he says.

Often, his clients believe the threats and hand over their protected assets to their creditors.

The idea that most petitioners find bankruptcy a trouble-free and attractive option simply isn’t true, he insists. “In 30 years of doing this, I’ve never had a client who’s done this happily,” Lindauer says. “I know that’s the presumption of the new bankruptcy law. But not my clients.”

The married couple that recently came into Grossberg’s Boston law office is typical of her client base. They’d worked hard all their lives at well-paying jobs to buy a house and take care of their children. They weren’t careless with money, yet had little in savings, what with the cost of living so high. And they figured they’d be fine, so long as nothing unexpected happened.

But it did.

The husband developed macular degeneration, an incurable eye disease that’s the leading cause of blindness for people over 55. As he slowly lost his eyesight, his employer cut back his hours, then laid him off, and his wife lost time at her job to drive him to doctors’ appointments. As their income declined, their living costs began to soar: medical bills, co-pays, prescription drugs not covered by insurance. They had scant fat in their budget but tightened their belts anyway, and started charging groceries on their credit cards. But there were many expenses they couldn’t reduce, including their mortgage and car payments. They fell further and further behind, with no hope of ever catching up.

“There was nothing they could do,” sighs Grossberg, who assisted the couple in their bankruptcy petition.

Then there was another recent client, a single mom who worked hard at a blue collar job that netted in the mid-$20,000 range. Every penny went to support herself and her teenage daughter in Boston, and they were making it — until the daughter announced she was pregnant. The baby’s father, a high school student, couldn’t offer any financial support, and the woman’s salary suddenly had to stretch to cover three people, including an infant.

“She was able to manage her expenses before the new arrival. But with a lot of people, the cost of living here is so high that just that one extra thing” can jettison them into financial ruin, says Grossberg. “Situations like that happen a lot.”

Still, there has been the occasional attempt at exploiting the law, and those examples were heralded by pro-reform lobbyists.

Andy Henderson ’02, who divides his Boston practice among bankruptcy, intellectual property and transactional work, recalls a couple that owned a Hummer and an enormous home who filed for bankruptcy believing they could get rid of their credit card debt without losing their other assets. “They thought they would get to keep the Hummer,” recalls Henderson, who served as counsel to the bankruptcy trustee in investigating the couple’s petition.

But the former law had a safeguard against such bad-faith attempts. When Henderson scheduled a hearing to investigate the couple’s extensive holdings, they realized they wouldn’t be able to cherry-pick what they kept and what they had to give up. “We never saw them again,” he says.

UNCHARTERED TERRITORY

Just how severely the new law will affect people remains unclear, although the American Bankruptcy Institute predicts that 4 to 20 percent of people who could have dissolved their debts under Chapter 7 will no longer be eligible to do so due to new income limits. These people may instead have to file for Chapter 13 relief, in which they agree to use “excess income” to gradually pay off their debts. But the idea of “excess income” may be mythical in many cases, says Parker.

“Honestly, some people aren’t going to be able to maintain payments under Chapter 13, or some are just not going to bother to file, and creditors will pursue them,” he says. “So it’s severe. It’s probably not the end of the world, but it’s severe.”

Since the rush of filings last fall and the subsequent fallow period of a few months, the bankruptcy clerk’s office in Boston now reports that the levels of filings gradually have returned to their normal flow, says Somma. Meanwhile, he and other judges are trying to interpret the new law to the best of their abilities, despite its obvious shortcomings. “Some of the language of the statute is so inept you can read it as you want; for example, where it says ‘and’ instead of ‘or,’” noted Hillman at the recent conference.

But in the Boston area at least, the transition has been pretty smooth, for which Somma credits his colleagues on the bench, the local bankruptcy trustee and the savvy and collegial bankruptcy bar, where lawyers for creditors and debtors are known for working cooperatively with each other. And there is hope for reform of the reforms, many believe. Judges Hillman and Somma both predict that as application of the law goes forward, there may be an acknowledgement of its shortcomings and a movement to make yet another series of changes to cure these problems.

“There may be a recognition congressionally that some of the provisions were unnecessarily harsh, or that they just don’t work,” says Somma. “That could lead to something beyond just technical amendments, but a real look” at the substance and meaning of the reforms.

Both bar and bench are banking on it.

Elaine McArdle is a freelance writer and regular contributor to Northeastern Law Magazine.