Corporate Research E-Letter No. 26, July-August 2002
DEBT TRAP: THE CREDIT INDUSTRY’S CAMPAIGN TO “REFORM” THE PERSONAL BANKRUPTCY LAWS
by Philip Mattera
July 2002 may be remembered as the high-water mark of anti-corporate sentiment in modern U.S. history. Yet as soon as Congress completed its work on a corporate crime bill to respond to public outrage over the likes of Enron and WorldCom, the House and Senate returned to their preferred practice: promoting legislation that satisfies the desires of business and thus generates bountiful campaign contributions.
The special interest that our solons hastened to serve was that of the purveyors of plastic—the credit industry. For years, the big credit card companies have been complaining that the personal bankruptcy laws are too lax, that they encourage profligate citizens to run up large debts and then use the courts to wipe the slate clean—to the detriment of the lenders’ bottom line.
Over the past four years, the credit industry has dished out campaign contributions by the millions and bankrolled an elaborate public relations effort to stem the number of bankruptcies and to force more of those who do file to do so under Chapter 13 of the code, which requires repayment of most or all debts, as opposed to Chapter 7, which allows filers to cancel most of their debts after liquidating some assets.
Both the House and the Senate voted for bills along these lines several times, but the legislation was repeatedly derailed for one reason or another. This year Congressional proponents are once again seeking to enact a brazenly pro-business, anti-consumer measure that critics say would turn the federal bankruptcy courts into publicly funded collection agencies for some of the world’s most powerful financial institutions.
PLASTIC FOR THE MASSES
Hand-wringing over the rising volume of personal bankruptcy filings dates back to the late 1970s, when a much less business-oriented Congress enacted debtor-friendly reforms that made it easier for individuals filing bankruptcy to hold onto their remaining assets. A surge in filings after the reforms took place opened a debate on the wisdom of the changes. That debate intensified as the volume of bankruptcies kept setting new records each year throughout the 1980s and into the early 1990s. The total soared from about 200,000 a year at the time the reforms took effect to around 900,000 in 1992. After declining for a few years, bankruptcy filings climbed sharply during the late 1990s and have remained at more than 1 million a year ever since.
The simple cause and effect relationship between the 1979 reforms and the rise in filings that the industry propounds conveniently ignores a much more complex reality. First, the years during which bankruptcies rose were also a period during which the consumer credit industry expanded enormously. Credit card usage started to spread in the late 1950s, but for quite a while it remained a privilege enjoyed by a relatively affluent minority of the population. As late as 1983, only about 15 percent of families carried any credit card debt; by the late 1990s, that figure was up to nearly 50 percent.
Many of the new customers were people with low income. Along with home mortgage lenders, credit card companies realized during the 1980s that there was good money to be made by signing up poorer people and charging them exorbitant interest rates. Predatory lending turned out to be more lucrative than redlining. Robert Manning, author of the book CREDIT CARD NATION, has estimated that the credit industry overcharged consumers some $300 billion during the 1990s.
At the same time, credit card issuers encouraged people with better credit ratings to open more accounts and take on a larger debt burden. Middle class people began receiving countless credit card solicitations, often with “preapproved” cards enclosed. Places such as supermarkets, movie theatres and physicians started to accept credit cards, making the use of plastic seem more and more routine. The credit pushers also went after the young: college students with little experience in money management were lured into the world of plastic. Many of them ended up harming their credit rating before they even entered the labor market.
Any rapid expansion of credit will increase the volume of problem loans, but the climate in which plastic was freely offered to the masses exacerbated that tendency. For one thing, the growth of consumer credit came after interest rates had been largely deregulated, meaning that the card issuers were free to demand vigorish that was often in excess of 20 percent. People who were new to the world of revolving credit did not catch on that, at those rates, it would take decades to pay off their balance if they consistently sent in only the minimum payment.
To make matters worse, many of the new holders of plastic were stuck in jobs with stagnant real wages. Running up the credit card balance was often the only way to keep their head above water. Once spending became seemingly so easy, there was little inclination to cut back, even during economic downturns. The industry encouraged this mindset. In 1995 the chief economist of Visa U.S.A. told the Wall Street Journal that, thanks to credit cards, when “consumers hit a rough spot, they don’t have to sTop spending altogether as they did ten years ago. That’s the beauty of the card as a payment vehicle.”
It may be beautiful for the credit industry, but many people could not keep up with the debt treadmill and turned to the personal bankruptcy process to survive. A study released in 2000 found that more than half of the people filing for bankruptcy did so in part because of medical bills or other consequences of illness or injury. In the absence of national health insurance to protect people from such problems, the personal bankruptcy system became a kind of social safety net for the middle class.
TARGETING THE SAFETY NET
This safety net is what the credit industry targeted when it launched its “reform” effort in the late 1990s. Thanks to its profuse campaign contributions to Republicans and Democrats alike, the credit industry’s message was heard loud and clear on Capitol Hill.
In 1998 the House voted overwhelmingly in favor of a bill to restrict bankruptcy filings, and the Senate headed in the same direction. Republican Senator Chuck Grassley of Iowa, a key Congressional promoter of the campaign, undoubtedly gave goose bumps to credit card executives when he declared, “the free ride is over.”
A June 17, 1998 article in the Wall Street Journal suggested that enactment of the bill looked good, thanks to what the newspaper described as “A multimillion-dollar public relations and lobbying blitz run largely by the companies with the most to gain: credit-card issuers and other lenders.” The Journal went on to note: “In recent months, the six-year-old National Consumer Bankruptcy Coalition, which includes Visa U.S.A., MasterCard International Inc., the American Bankers Association and the National Retail Federation, has financed much of the research concluding that bankruptcy laws are too lax, and then it has spread the results in advertisements decrying ‘bankruptcies of convenience.’ It also has underwritten opinion polls designed to show public support for industry proposals.”
This steamroller was thwarted by the unwillingness of the Clinton Administration to endorse legislation that was so blatantly anti-consumer. In 2000 the House and Senate both approved a bankruptcy overhaul bill, but Clinton pocket vetoed it near the end of his term in office.
The following year, Congress wasted no time taking up the issue again. The New York Times put the matter bluntly: “The bill’s quick resurrection after Mr. Bush’s inauguration was seen as evidence of the generous campaign contributions made to each party by the credit industry.” Since Bush had jumped on the “reform” bandwagon, the industry and its supporters assumed victory was theirs at last. Both the House and Senate again approved legislation, but there was controversy over a provision in the Senate version that put a limit on the amount of home equity that a debtor could shield from creditors during the bankruptcy process. Several states, including Florida and Texas, had laws allowing an unlimited homestead exemption, which in some cases had allowed wealthy individuals filing for bankruptcy to keep multimillion-dollar mansions out of the hands of their creditors. Bush had supported the unlimited homestead exemption while governor of Texas.
The difficulty members of Congress faced in deciding whether they owed more allegiance to rich individuals or the credit industry derailed the legislation last year, but dedicated lawmakers made sure to revive the issue again this past spring. A compromise was reached on the homestead issue (the $125,000 cap would be applied only to homes purchased within 40 months of the bankruptcy filing), but another surprise issue arose.
New York Senator Chuck Schumer arranged to have language inserted in the Senate bill that barred anti-abortion protestors from filing for bankruptcy to escape fines and civil penalties imposed on them for acts or threats of violence against abortion providers. A compromise on the abortion issue appeared to have been reached in late July, right after the corporate crime bill was completed, but it was later challenged by some hardline right-to-lifers in the House. Congressional leaders expect to take up the bill again in September.
CORPORATE FOX IN THE REFORM HENHOUSE
One of the most controversial companies in the credit card business is Providian Financial Corp., which made a specialty out of issuing high-interest cards to people with a poor credit rating. Over the past few years, the company’s dubious marketing practices have come to light, resulting in charges of consumer-protection violations brought by the Office of the Comptroller of the Currency and the San Francisco district attorney’s office. Providian had to pay $300 million to settle those charges in 2000, and later that year, the company agreed to pay another $100 million to settle a series of consumer class-action lawsuits. Providian has now been barred by regulators from issuing new subprime credit cards, and it is in the process of selling off assets amid reports of accounting irregularities.
What makes these facts more significant is that a man named Larry Thompson, who sat on Providian’s board while these problems were unfolding, is now deputy attorney general of the United States and the official named by President Bush to head the Administration’s corporate fraud task force.
Despite all the hoopla about fighting business corruption, it appears that corporate evildoers and their sympathizers may still be calling the shots in Washington.
TEN LARGEST U.S. CREDIT CARD ISSUERS
(ranked by size of managed receivables in first quarter of 2002)
3. Bank One/First USA
5. American Express
6. Discover (Morgan Stanley)
7. Capital One
8. J.P. Morgan Chase
9. Household International
10. Bank of America
Source: US Bancorp Piper Jaffray