Picking Up the Pieces on Bankruptcy Reform A Roundtable
GERDANO: We are joined here by four Capitol Hill insiders who can provide insight as to what happened on bankruptcy reform in the last Congress and what might happen in the new Congress. The most significant bankruptcy reform bill in the last 20 years made it all the way to the two-yard line before dying at the end of the last session. Let me start by asking, with both bill sponsors coming back in the next session, with Republicans still controlling the committees, with an earlier start, and accepting the fact that the bills in their various forms all passed by relatively wide margins, does that mean that consumer bankruptcy reform is inevitable in the next Congress?
CORWIN: I would never curse this project by saying that it's inevitable. The Republicans thought that a 10- to 20-seat pick-up in the House was inevitable. Nothing is inevitable in politics. I think there will be a very strong push again by Sen. Grassley and Congressman Gekas to pass a bill, but there's obviously a lot of differences between this coming Congress and the last one. We can get into why we thought the bill got so far and died and what we think the differences are. But to me, the biggest difference can be summed in two words—Phil Gramm. ABI members may wonder why the new chairman of the Senate Banking Committee makes a major difference, but consider what just happened. If the conference report is reintroduced, and there are a lot of people who think that's going to happen, particularly in the House side where it passed by a veto-proof margin, there are Truth in Lending revisions in the conference report, which means there is going to be joint referral—not just to the Judiciary Committee, but to the Banking Committee, which has jurisdiction over Truth in Lending, and that changes things. I think the political link is already there between bankruptcy reform and some type of consumer credit changes. And Phil Gramm is a senator who just stopped a financial modernization bill from being enacted, despite the strong push of the Federal Reserve and the respective industries—banking, insurance and securities. He had strong disagreements with the Community Reinvestment Act provisions. He's generally not favorable toward consumer legislation and that's going to make a difference. And on the House side, it is going to make a difference, too. There, Truth in Lending changes go to the House Banking Subcommittee chaired by Marge Roukema, who is, very interestingly, the only Republican member of Congress who voted against the conference report. So this introduces a whole new element in the debate. I can't predict exactly how it's going to change the course of events, but it's very significant.
Roundtable participants shown above are (clockwise from left) George Wallace, Philip Corwin, Sam Gerdano, Mary Rouleau and David Lachmann.
GERDANO: Mary, the Consumer Federation of America was very supportive of the lender reforms that were in the Senate version. Do you agree or disagree with Phil's take on the impact of Sen. Gramm on these changes?
ROULEAU: I don't personally deal with banking issues, so I don't have the history that Phil does on Sen. Gramm. We are very supportive of the disclosure provisions and other provisions in the Senate bill, which, of course, got destroyed in the conference report. Members of Congress who don't necessarily have a lot of sympathy for debtors nonetheless understand how important disclosures are to consumers and will certainly understand if we get serious here about doing two things: preventing abuse of the bankruptcy system, by both debtors and creditors, and trying to prevent people from ending up in bankruptcy. As to the latter point—how do you get there through laws? There are limits, granted. But one of the ways to do that is give consumers the tools to make better decisions, like disclosures. These are key provisions.
GERDANO: Given the political numbers, given the earlier start on a bill, answer the inevitability question.
ROULEAU: Absolutely, there will be reform. The question is, will it be balanced? What happened last year clearly wasn't. I think if people are serious about their intent, we will have a bill. But if people are using this as an excuse to brow-beat a certain class of debtors, then we probably won't.
GERDANO: George, is the credit industry you represent gearing up for this fight? Is there evidence that they're going to put the same kind of resources into it that they did in the last Congress?
WALLACE: I think that at this point we're in the process of evaluating where we are and the effect of the election. There's obviously been a great change in the House leadership, there are some rumblings on the Senate side as well, and right now, we're in the process of evaluating whether 1999 is the year for bankruptcy reform. 1998 clearly was the best year for it; it didn't happen that year, so we're looking at 1999 and whether, after the leadership elections in the House, the pieces can be put together.
GERDANO: So you don't think that it's automatic that we pick up where we left off?
WALLACE: I think that it will be difficult to pick up where we left off. Certainly, we'll push hard for that. I run into people all the time who want to put more things in the bill, take more things out of the bill. Everybody has a wish list. I'm not sure that we'll start at the conference report. It would be a good start. But whether we start at all is very much a question.
GERDANO: David, what about timing? There was some suggestion at the end of the last session that the six-month time frame that is attached to the extension of chapter 12 somehow is the trigger for when some action will occur. I happen to think six months is too soon for any first session of Congress to pass something major. What are your thoughts on when the process might start? What do you expect the majority to do on your committee?
LACHMANN: Well, I share Phil's superstition, and I'm certainly not a believer in inevitability. The chapter 12 sunset was an important signal. The fact is both houses of Congress, in separate legislation, agreed to make it permanent. Our ranking democrat, Rep. Nadler, had even introduced the legislation with Rep. Nick Smith to extend it. Members of the majority were willing to hold that farming constituency hostage for a set of controversial and radical changes to the Code. I think that the recent elections do change the calculus somewhat. The conference report was plainly a reflection of the view of some folks in Congress that after the election there would be 60 or more Republican senators and the kind of give-and-take that you had in the Senate in terms of trying to work toward a balanced bill would not be necessary: "Why bother to settle for a bill which includes things we don't like when we can avoid it next year?" That clearly is not going to happen. The fact that a more balanced Senate bill went into a conference but came out after basically breaking every deal made among Senate members will, I think, change the dynamic when those members sit down to talk about what might happen now. The bill in this last Congress was loaded down—not only with special interest provisions, but special interest provisions which were really in conflict. I think that sort of free-for-all gave people pause and I hope will provide an opening for more reasoned and careful analysis of what it is we're meaning to do, and how different portions of the legislation interact with each other and the rest of the Code.
CORWIN: Let me just follow up on some of this. George talked about the folks he represents. They tend to be the non-bank financials. I represent the commercial banks. Bankruptcy reform remains a major priority for them in that the conditions in the bankruptcy system that cause the industry to seek reform are not changing; there is still a rising number of cases and a perception of substantial abuse. Frankly, the credit industry doesn't control the legislative debate anyway. The chapter 12 provision is going to bring the bills back up. I think Sen. Grassley is still after reform. I don't know where Congressman Gekas is. I think there are commercial issues that have to be addressed; certainly the financial derivatives issue is a major concern. You see things that need to be done and look at a Congress that may not be less favorable than in 1998, but is certainly not more favorable, as some folks would have thought a few weeks ago. But the problems aren't going away; the need for some reform isn't going away. And looking past this Congress, you have to say anyone would admit that the House of Representatives is a complete toss-up in the year 2000 election and could switch back to the democrats. While we try to keep this as non-partisan as possible, it's no secret that Jerry Nadler is not going to be as sympathetic to creditors' viewpoints as George Gekas is. So it may be less favorable than in 1998 but it still looks a lot better than what might be in 2001.
WALLACE: Let me pop in here. We certainly agree that the problems are there—the bankruptcy system is broken, it's been broken for years; an attempt was made in 1978 to repair it. That attempt, it has been shown over the last 20 years, just hasn't worked out right and it needs to be readjusted to a fairer system—fairer to consumers, fairer to debtors, fairer to creditors. I thought we were talking about whether Congress would do something about it. That's an entirely different question. The need is crucial. But Congress has not dealt with things before when there were critical needs and my response was in terms of that.
GERDANO: Let me ask you about strategy and how the issues get framed. Lenders need to keep the focus off their conduct and the kinds of changes that were in the Senate bill that Mary was talking about, especially in an environment where there was another major attorney general settlement of a class action suit involving the May Department Stores retail chain on reaffirmation problems and the recent story in The Wall Street Journal on the aggressive lending practices toward the mentally ill. Stories like this pop up all the time and in a political environment where there are people obviously trying to change the subject. How do you deal with these issues?
WALLACE: Well, let's remember that the subject continues to be the approximately 15 percent of debtors going through bankruptcy in the consumer credit system who have the ability to pay. There are two stories here. You wanted to focus upon allegations of isolated instances of creditor misconduct. What we have is widespread debtor misconduct. But I don't really call it "debtor misconduct."' The debtors are simply taking advantage of the system, which the government permits them to do. The government provides them with a consumer bankruptcy remedy, and they go ahead and sensibly take it. But it raises a moral issue, a social issue and an economic issue, and that's what needs to be addressed here. People are paying too much for credit because of the bankruptcy system and the moral fiber or moral principles on which the credit system is based are being undercut. That's how we respond to that question. The way I see it is that you have a real problem here and that problem needs to be addressed.
ROULEAU: I really think the answer to your question is that they can't respond because of the body of evidence there. The stories that The Wall Street Journal has done about credit practices speak for themselves. These are not stories being generated by Mother Jones, after all. If we're going to talk about morals and economics, I would love to have that discussion on the practices of the credit industry. On the economic side, they've made a lot of money off consumers. We know that. What is the morality of that? Marketing cards to people where they clearly know that their income doesn't sustain the level of debt load that they are willing to extend. There are a lot of people, including me, who do not understand the fine points of the Bankruptcy Code, but we definitely understand the big picture that is presented here. These are not isolated instances where credit card companies are extending credit irresponsibly. These are not isolated instances of reaffirmation abuses. To respond to Mr. Wallace on the 15 percent of people who abuse they system, I don't think anybody really knows what the number is, but I think that it's fair to say that based on what I've read in terms of the evidence that's been presented over the course of the past year, people dispute that there's substantial abuse going on in the system, including the bankruptcy bench.
LACHMANN: If I could just pick up on that. There was a lot of skepticism on the part of members of the Judiciary Committee and in the House in general as to how widespread the problem of debtor abuse in the Code is.
GERDANO: But the conference report still got 300 votes though.
LACHMANN: The conference report did get 300 votes, absolutely. I think members do want to make sure they are able to remove from the system people who are abusing the system. People who do have the ability to repay should repay. That is not a controversial point. How widespread is the problem? That is what is controversial. The industry sunk a lot of money into commissioning studies that purportedly demonstrated that this was a widespread pattern of abuse. Basically, the underlying premise of these studies is that lots of American families are crooks—just walking away from their debts, doing it as a matter of financial convenience, and having them discharged in bankruptcy. There will be continued debate in the next Congress about the extent to which that is true. Nobody will argue that some people do in fact abuse the system. What was interesting about the legislation is that while it was focused on middle-to-lower income debtors, the fact is that some of the major loopholes for wealthy debtors were left virtually intact, including unlimited homestead exemptions. If ABI members look at Judge Eugene Wedoff's analysis [online at ABI World] of the House and Senate bills and the conference report, he does a good job of pointing out that in terms of the rigid formulas in both the House bill and the conference report, people with larger debts sometimes fare much better. By the way, in the conference report, if one owed less than $1,000 to a particular creditor, that creditor would not be subject to penalties if he or she brought a §707(b) motion against the debtor, even if it was for the purpose of coercing the debtor into giving up his or her rights in bankruptcy. And that is really targeted at the kind of Sears case that you see.
WALLACE: Wait a minute. Rule 9011 is there. If you have a case where a creditor brings an action under $1,000 and it's shown the creditor has no basis for that action, Rule 9011 sits there and we're all subject to that in bankruptcy.
LACHMANN: Why wouldn't a subsequent legislative enactment overcome that?
WALLACE: Because the subsequent enactment you reflect does not directly address Rule 9011 concerns—the appropriate conduct of counsel before the court.
CORWIN: We're going to be talking past each other to some extent. I think when we talk about our issues, we get a good bipartisan consensus on such basic questions as, "Should there be some objective look at income to determine at what point someone is abusing chapter 7?" "Should the system have some documentation requirements—some auditing?" Beyond that debate, the other side, which is going to be much better organized than it was this past year, is talking about causation. And I think there are so many causative factors in a given bankruptcy, and I don't know how you can ever pin that down. So far as are there stupid decisions made by lenders, the best check on that is that if they make really stupid decisions, they lose their money if they are unsecured lenders. I just want to say that regarding the The Wall Street Journal article, for those reading this transcript who haven't seen it, there's no organized effort by consumer lenders to market to the retarded or the mentally disabled. But these people participate in society—it doesn't say on their credit report what their mental status is—and I think the article made a good point that (1) most of the lenders cited had just forgiven the debts once they found out the situation—not all but most—and (2) there's this whole panoply of laws—the Americans with Disabilities Act, the Equal Credit Opportunity Act and other acts which to a large extent tell the credit industry you can't discriminate. In fact the Community Reinvestment Act states that you have an affirmative duty to market credit to lower- and middle-income individuals. So the lenders to some extent feel like they're caught between a rock and a hard place because of the public policy that says you should be marketing and reaching out to everyone and not discriminating against any class, and then when we market to those people and lose money, we get attacked for it.
ROULEAU: Obviously it's a question of degree. I think any reasonable person understands that there's a limit here. And no one is saying that people shouldn't be marketed to, although our side has been accused of that. CFA called for voluntary industry limits on the extension of credit. I think most people in the debate understand this. It's not a question of marketing or not marketing or extending credit—it's a question of reasonableness.
LACHMANN: It's also a question of where you stand in the pecking order of creditors. Generally, the Code now rewards people who make more conservative loans by giving them a higher status. The question is whether unsecured non-priority creditors who have every reason to know that they're making highly risky loans should have their status improved by making those debts non-dischargeable when they are not now. It is not just a question of whether a debtor should or should not be able to discharge a particular debt, but where those creditors stand in opposition to other creditors. So it's not just a question of whether people should be able to get credit. But I wanted to get back to something Phil said earlier, he made an important point. There are a number of very important changes to the Code on which there is very little disagreement: implementation of the UNCITRAL Model Law on cross-border insolvencies; increasing the number of bankruptcy judges, especially if the global financial crisis comes home; the extension of chapter 12; and portions of the financial netting bill that were not controversial, especially in light of recent events in which members of both the Judiciary and Banking committees are very interested. There are a lot of things that we need to do, but one of the problems last time was that the less-controversial but highly important reforms of the Code were really held hostage by the high-profile issues. One hedge fund going under wipes out profits on a lot of consumer loans; that's something we're going to have to look at. At least on those issues where there are not strong disagreements on the basic facts or, in many cases, on the policy, we can move forward on these issues and not have them held hostage to the issues where we disagree about the underlying facts.
GERDANO: I want to move to some of the elements that are going to be front-and-center in the consumer debate. The first is obviously the means test—whether we move to a formula approach or to a judicial discretion approach. The formula matters because of how many people it might capture. There are some other studies that are coming out very soon—one from the Executive Office for U.S. Trustees and one that ABI commissioned—that will show that the number of debtors captured by the means test formulated in the House bill is much smaller than 15 percent and maybe even less than 10 percent. Does it matter? Should we change the entire system of entry to the bankruptcy system just for 7, 6 or 5 percent of the population?
WALLACE: I think that Mary will perhaps disagree with me but nonetheless, we need to have a bankruptcy system that does not give a discharge as a matter of right—that asks the question of whether a person has the ability to pay. That is necessary in order to serve the credit system, and it is, to me, a very straightforward and reasonable approach.
GERDANO: No matter what it costs the system?
WALLACE: That's where Phil's point comes back in here. We're never going to get to the bottom line here on a cost-benefit analysis, although I think at some point you've got to draw the line morally. But there's always going to be the argument, even at 7 percent, on whether the cost is worth it. The other side of the table here today will argue that the cost isn't worth it. The cost, as far as we know, is quite minimal, and all the estimates I've seen are quite minimal.
LACHMANN: Not all the estimates. The Congressional Budget Office, for example, costed it out at a very high level. In the House bill, the fact is that after going through the formula, creditors get another bite of the apple through a modified §707(b) test. The House chose not to create a safe harbor from creditor motions—that really changes the dynamic on that. So whatever you believe in terms of people discharging debt that they could or should pay, the fact is that even after you get through the means test, at least in certain versions of this bill, the honest but unfortunate debtor is not immune to all sorts of motions.
WALLACE: I would disagree with that, obviously. I think there's plenty in the bill against improper creditor motions. But to return to the basic point of cost-benefit analysis, I think there's a fundamental problem: Nobody in this room and nobody in Washington will agree on what the facts are. There's just an awful lot of hot air on this issue. I haven't seen the two studies that you mentioned, but I'd be interested in the methodology that they used, the database and so forth. On the other side of the aisle on this issue, there was a great deal of scrutiny on the studies produced by Barron and Staten and Ernst & Young. As far as I can see, this is an issue where, unfortunately, folks won't stand back and actually call the shots where they are, but instead, insist on making up the facts as they go along. Therefore I'm not optimistic about this being resolved on a pure cost-benefit basis.
LACHMANN: Maybe you're making up the facts as you go along. We're certainly not. What we've been relying on is the Congressional Budget Office, and the General Accounting Office, which works for Congress and is independent.
WALLACE: The basis of that study was an estimate done by the bankruptcy judges, who, on the whole at that time, were strongly opposed to the bill. It was also done on the basis of a proposal which was in the House and is not in the conference report. So let's be fair here.
ROULEAU: I just want to make sure that we don't get lost in this cost-benefits issue. As a taxpayer, of course I would argue that it's not a good use of taxpayer funds. I also think ultimately it is a political issue on the cost. But let me just take a different perspective. These are folks in our justice system with a legal right to be in the bankruptcy system. And the means test unfairly applies to people if it doesn't take into account people's individual circumstances. Second, it's taking away discretion from judges, and I personally have a problem with that. I suspect the bench does, too. The third point is that when you start introducing different types of means tests into the system, you do introduce the ability to circumvent those tests. So there's a fairness problem. So if I'm generally better off and can afford the advice I need, I can circumvent those tests. I think you need to keep the focus on fairness.
WALLACE: But too much judicial discretion gives non-uniform results, and that's not fair either. Since 1984, the provision in the Code, §707(b), which has allowed judges to control this problem, has not been used. It is entirely discretionary. If the judges had been trying hard to make that provision work, if the U.S. Trustee's Office had been pushing for enforcement, we would not be here today. Judges haven't taken the initiative that they have shown, for example, to enforce the Sears case—where they have on their own motions audited cases in order to find out whether reaffirmation agreements were being filed improperly.
CORWIN: I have a couple of responses to what's been said. First, Mary says we have a right to bankruptcy, and there is a right to seek protection under the bankruptcy laws, but there are legal rights for creditors, too. I think we have to remember that bankruptcy is an extraordinary remedy. It's the only place in the legal system where you can just file a paper, without any of the other usual burdens you have to bear, and you get this extraordinary injunction called the "automatic stay," which stops in its tracks the legal rights of creditors. It's the only place in the legal system that does not uphold contracts but rather voids contracts. Now we need this so that people who fall on hard times can get back on their feet, and so that companies can reorganize. But to say that there shouldn't be any controls on that, I think, is the wrong policy. I haven't seen these new studies. I would assume that the estimates are based on the statements of income in the bankruptcy filings. The NBRC had extensive testimony that there's a lot of fiction in those schedules that are filed, and I think that there are things in this bill that would improve the accuracy and veracity of the schedules. But even 7 percent of current chapter 7 levels is 60,000 households a year taking advantage of the system, discharging hundreds of millions of dollars worth of debt that they should be asked to perform on, and that's a significant abuse. And again—the point George made—we've had "substantial abuse" in the Code for 14 years. It's not breaking new ground to say that at some point you're not entitled to a chapter 7 discharge. The policy question is, "Should there be some more objective fleshing-out of substantial abuse to give some guidance to the system as to when that exists, based on the ratio of unsecured debts to remaining income after other obligations are fulfilled?" I think that there's strong bipartisan consensus that the answer to that question is "Yes."
LACHMANN: That's really where the debate comes back to your question, Sam, and that is, "How do we ensure fairness in the system to debtors and creditors?" I would just differ with you on one point, Phil, and that is that the automatic stay does not just protect debtors, it also protects other creditors from an aggressive creditor lawyer who would win the race to the courthouse. The automatic stay exists to keep the estate intact so it can be fairly distributed among creditors. We ran into this during debate in the Judiciary Committee when it was proposed that debtors go into consumer credit counseling before they can file for bankruptcy. Mr. Nadler in that debate pointed out that if you have a debtor sitting in credit counseling for 90 days without the automatic stay, there will be no estate left to distribute after the 90 days and we might as well repeal chapters 7 and 13 on the spot. I still don't think it makes sense to compel people who are in no-asset cases with no real income to sit in credit counseling, but that's a separate issue. The fact is, the stay exists to protect the rights of the debtor but it's also an extraordinary remedy to protect the rights of the creditors. And here I would say that in addition to the moral dimension, it is about money. Bankruptcy is about money. It's about dividing up a limited pot among creditors and giving the honest but unfortunate debtor a fresh start.
WALLACE: It's not just a money issue. It's a moral issue—the question of whether people feel that they need to be responsible when they take out credit or whether they're going to be irresponsible. So I disagree with you on that. Also, with regard to the automatic stay, one of the things that confuses this debate a great deal is that consumer bankruptcy works a lot differently than business bankruptcy. The automatic stay does stop, in a business bankruptcy, both sides from moving. There are assets to preserve. In consumer bankruptcy cases, you're in a situation where, as you know, 95 percent of bankruptcy cases are no-asset cases. The stay, if you look at it from a social policy perspective, is something which stops the creditors cold. The unsecured creditors aren't going to get anything in a chapter 7. Period. And the secured creditors are either going to get their collateral back, which is the remedy under law absent bankruptcy, or else they're going to get continuation of payment or some form of reaffirmation. So the consumer bankruptcy situation works differently with regard to the automatic stay. In a no-asset chapter 7, the automatic stay is essentially a tool to protect the debtor, and frankly, I happen to support that policy.
LACHMANN: Well, if indeed we're going to have people make payments to creditors out of future income, then we would need to preserve, for example, the debtor's ability to get to his or her job—to keep the car, to stay in a home or apartment. Limitations on the automatic stay to the extent that they impair the debtor's ability to earn income in the future would create problems just as in a business.
WALLACE: The automatic stay is over in three months in the vast majority of chapter 7 cases. So then what's the obligation to continue to pay the creditors? It just doesn't work the same way as you're saying it does.
GERDANO: I want to get to an intramural creditor issue, because it goes to the heart of what assets are available to repay creditors. This bill's entire premise is there can be a greater percentage of repayment to unsecured creditors. But there's a struggle between the secured creditors and the unsecured creditors. The conference report and the Senate bill both seem to resolve that issue in favor of the secured creditors by forbidding lien-stripping. How is this compatible with greater returns to unsecured creditors? How are they going to get anything if in the typical chapter 13 case, you can't lien-strip a car? What money is going to be left over to make those payments from future income?
WALLACE: The hope is to have a bankruptcy system that on the one hand, gives the honest debtor relief promptly, quickly and effectively and, at the same time, separates out the debtor who has some ability to pay and says, you also get that relief. But you do have to contribute what you can. That's the social policy we are trying to accomplish.
GERDANO: I'm trying to understand this as a practical matter.
WALLACE: I understand that. I just wanted to stress that this is the social policy we're trying to get at. Then you're asking the question, "How does that social policy affect the secured and unsecured creditor?" I don't see a conflict in the conference report between secured and unsecured creditors. The basic policy of secured credit, which has been the policy in this country since at least World War II, has been to say secured credit should be available at the lowest possible price to the American consumer. In order to do that, we're going to put secured credit first in insolvency distribution. That principle, which was undercut in 1978 with the importation of cramdown into consumer bankruptcy, is substantially changed in the conference report. I think that's a good change. The unsecured creditors are helped in a different way. In so far as debtors have the ability to pay, then they will have to pay what they can afford to the unsecured creditors. Today, unsecured creditors are not being paid in chapter 7s, but there are debtors in chapter 7 that have the ability to pay. Under the conference report, that money will go to unsecured creditors. That's a fair, honest system that is built upon social policy. It's saying to debtors, "You'll get relief if you're honest, and if you have no ability to pay, you'll get a chapter 7 discharge. If you have some ability to pay, you're going to chapter 13. You'll get relief either way."
GERDANO: What money is going to be available as a practical matter to unsecured creditors? Let's also assume there's some hypothetical debtor in chapter 13 who decides he wants to start tithing. So 15 percent comes off the top from potential distribution to unsecureds.
CORWIN: So they've found religion?
GERDANO: Well, the law permits that.
ROULEAU: No time like the present.
GERDANO: But what kind of money is going to be left over to pay these unsecured creditors?
WALLACE: Your study indicates that there's 10 percent. Our studies indicate that there's a little bit more. That's the money that's left over to pay unsecured creditors. That's money that's left on the table today that's going back to the debtor's pocket and is not being paid to the creditors.
LACHMANN: George, you've made an extraordinary point. I just want to get the perspective from Phil of the banking industry: Do you believe that the portion of a secured debt that is underwater should be treated as a secured debt?
CORWIN: Let me start out by saying that the banking industry has members who make secured loans and unsecured loans and we support all of them. Let's talk about what really happened here, and the policy question. Everyone knows what happened here. The auto finance arms of the "Big Three" in Detroit were very concerned that a system where there were more people in chapter 13 would subject them to substantially more cramdowns. They've been seeing more of this anyway, as debtors get more sophisticated legal advice and find out it's not a bad thing to buy a new car fairly close to the time you file bankruptcy. Suddenly, you can pay thousands of dollars less to keep it after filing. So the Senate Judiciary Committee, with very little debate or dissent, adopted the no-cramdown-ever amendment—not even a five-year limit. It wound up in the conference report as a five-year limit, I believe, based on the fact that five years is the maximum term of auto loans.
GERDANO: So five years is really no limit. We can agree on that.
CORWIN: Obviously, in individual cases, at the margins...
WALLACE: Have you seen boat financing these days?
LACHMANN: I work for the federal government. That's really not something that comes up in my daily life, but I'll take your word for it.
CORWIN: In some cases, obviously, some people who might trigger the means test—whatever it is—won't be told they have to go to chapter 13 with that change. So I don't know how the debtors feel—if they're better or worse off—when they get to stay in chapter 7 but pay a few thousand dollars more on the car than they would have otherwise. There may be less to be distributed to unsecured creditors, at the margin.
WALLACE: With $40 billion discharged each year, the estimates are that $2.4 billion to $5 billion is available to be paid to unsecured creditors. That's real money.
GERDANO: Even if fewer than 5 percent are covered?
CORWIN: Well, nobody knows what the exact percentage is. I'm sure in the end, all the estimates will be wrong no matter how well they're done. But the policy question is, "Should people, as they can under the present Code, be permitted to buy a new car, file for bankruptcy just a few months later, and be excused by the law from paying thousands of dollars on that car?" Everyone knows that the maximum depreciation occurs in that first year on a vehicle. Cracking down on that abuse is the right policy, overall, and there's no hue and cry from unsecured creditors to stop the bill due to that provision. I think, again, there's going to be some limits on cramdowns, in any bill that is passed, in order to address that abuse.
LACHMANN: Sam, you really highlighted a non-ideological but highly significant issue in this legislative debate, which is the competing rights of creditors, and the extent to which you can get an unsecured non-priority debt raised in status in the bankruptcy system. To the extent that you disallow cramdown, that money is going to come from somewhere. Maybe there's this pot of gold at the end of the rainbow that all the debtors are sitting on—obviously you're going to have dueling studies about how big the pot of gold is. We hear from the shopping centers, the household goods manufacturers, the banking industry—there's a lot of jockeying going on among creditors seeking greater advantage in the bankruptcy system and that will continue. And Congress really does have an obligation to make sure that the different pieces mesh in a fair and balanced way. That is an aspect of the debate, but it was sorely lacking in the last Congress.
WALLACE: I don't think it was lacking at all. I think it was discussed quite thoroughly, at least, in the conversations in which I participated. I articulated earlier today what our philosophy was in urging the accommodations that came out in the conference report.
GERDANO: The last question—and I promise I'll stop beating this horse—are the five years on secured loans negotiable? Can that be three years? Two years? Recognizing, as you said, Phil, that the biggest depreciation occurs in a car right out of the box—the firs
t year to 18 months. Wouldn't this recognize current value for the secured creditor, but at the same time leave more left over in this zero-sum game for distribution to the unsecured creditor?
WALLACE: You're starting with the premise of the 1978 Code, and I don't think that's where you should start. I don't think you should start with the premise that the cramdown is somehow written in the Holy Grail.
GERDANO: It's just an attempt to recognize economic reality. The car is not worth what the payment book says it is. It's the nature of the product. If the debtor gave you back the car and forced you to resell it, you wouldn't get what the payment book says.
CORWIN: Sam, it's not worth it because the debtor purchased it and has been driving it for three months. If it was still sitting on the lot, a new car would be worth that amount. It's not worth it because they would have been using it, and a few months later, they would file for bankruptcy and then expect to have the amount of money that they owe reduced substantially. What the auto lenders see appears to be, in a lot of cases, a pretty calculated decision by people to buy that car in contemplation of the cramdown.
GERDANO: Okay—enough. That's the last time I take up the fight for the unsecured creditors.
WALLACE: We fought a good bit for the unsecured creditors and strongly support provisions in the conference report that try to deal with the unsecured creditors. We may be wrong, but we see a significant pot of gold here. It's money that's not in the system right now. That money should be in the system—it's a social policy that encourages personal responsibility. We think it's good economic policy because it lowers the overall cost of credit.
LACHMANN: Wait a minute. Let's get to this issue because it's an important one: the overall cost of credit. We've heard the figure bandied about for some time now, that the current bankruptcy system costs every household $400. Somebody in an ad agency even thought you could keep a kid in Pampers for $400 year—they obviously haven't had kids recently. Nonetheless, the fact is that, as real interest rates, the cost of funds, has dropped, consumers have not reaped the rewards. They have gone into the profits of lenders; it has not come back to consumers and there is no empirical reason to believe that if we squeeze distressed families even more...
CORWIN: That's just not true. For the vast bulk of consumer credit, which is mortgages and auto loans, the rates are very low. They've come down, too, for unsecured credit such as credit cards. There's more disclosure, there's more competition. Credit cards haven't come down as much because (1) the cost of funding a credit card is a much smaller proportion of the cost of offering that product than a mortgage or auto loan; (2) losses in the industry have been going up because of bankruptcy; and (3) more than a third of customers are convenience users who generate no interest income. The margins of the credit card industry have gone down substantially over the last few years. To the extent there were very attractive profits in the industry, that was in the early 1990s. They've all disappeared.
ROULEAU: I think it's probably a fair statement that the margins have been reduced, but I think it's on a relative basis. If you look at the studies the CFA has done on the ramp-up in consumer credit, a lot of the damage has been done. People are going to live with the consequences for 20 or 30 years if they continue to pay those minimums.
GERDANO: Let me move to a practical question. I started off by talking about the inevitability of the bill moving ahead, given the momentum from this past year. David, what strategy might you deploy to try to amend, block or delay, knowing that this train is out of the station? What can you do, once the leadership decides they're going to move something?
LACHMANN: Well, politics, like bankruptcy, is all about arithmetic. To a large extent, that question is better posed to the majority. Bankruptcy professionals have become more engaged—we have heard from the bench, we have heard from ABI's members, we've heard from the turnaround people, we've heard from the trustees, and the question is, "Can we now sit down and do this legislation the way it was drafted in the past, when you were up on the Hill, Sam? Can we sit down with bankruptcy professionals and hammer out a bill in which there can be some consensus?" That's an open question and, to a large extent the ball is in the majority's court. The dynamic is very different, as you know, in the Senate, where a minority of Senators who have genuine concerns can at least be heard—and that's the function of the Senate.
CORWIN: It's going to be very difficult to run the majority with a six-vote margin. The goal on every bill is for the Republicans to find conservative Democrats in marginal districts who will vote their way. And the Democrats will try to find moderate Republicans from marginal districts to come over their side because they're worried about the 2000 elections. Having said that, I don't think it's going to apply that much to this bill in the House because (1) the Judiciary Committee is more polarized—there are not a lot of people in the middle. I don't see the majority, assuming that Mr. Gekas and Mr. Hyde want to go forward on this, having a lot of trouble finding the votes to report a bill out. And given a 300-vote margin for the conference report, I don't foresee a major problem in the House in getting the votes to pass something like the conference report. I think the real play is going to be in the Senate, where it's much harder to find a majority—and you need 60 votes to agree to turn the lights on. I'd be surprised if there was a Grassley-Durbin bipartisan bill, given what happened in the end game. I think Sen. Durbin will probably be pushing his own proposal to counter what Sen. Grassley does. I think we're going to have a very vigorous, comprehensive debate. I think the arguments to be made by our side for some fundamental reforms are quite sound and will get bipartisan support, but getting to final passage is never easy. I think we're going to see one or more extensions of chapter 12 before we get to final passage of anything in the next Congress.
GERDANO: What's the likely input from the White House? They had almost disproportionate power in the end game, as they always do, in terms of leverage to make some changes. But with a bill that has a 300-person majority in the House, with an earlier start, how is the White House likely to respond? They said repeatedly that they're for bankruptcy reform. How do you see them playing this—co-opting the issue? Taking an active role? An inactive role?
LACHMANN: Well, the President and First Lady have been very engaged in this debate. They have strong interest in particular parts of the legislation. I think they'll continue to be engaged. A missing factor here is the leadership. Bankruptcy was not just a committee-driven process during the last Congress. It was also a leadership-driven process. We don't know what that's going to look like in the next Congress.
GERDANO: Could the White House be part of brokering some big deal?
LACHMANN: Potentially.
CORWIN: I think what happened in the end game in the Senate was pure politics. When Trent Lott was unable to bring the bill up in June or July and the Senate went home for the August recess without floor action, I thought that the game was over. I expected the situation to get completely political, having very little to do with the merits of the legislation. We saw the White House and Tom Daschle, both of whom had indicated they were pretty copacetic about the bill that passed the Senate Judiciary Committee, suddenly show up with a list of 45 new changes they wanted in the bill, and insisting on at least half of them to get any kind of time agreement to bring the bill to the Senate floor. That guaranteed we were going to have a train wreck. The First Lady has continued to make speeches on the women and children issue. We in the credit industry don't know what else to offer on the subject of women and children. I think every idea that was thrown out by the other side wound up in the conference report.
ROULEAU: Well, maybe because they really weren't modest changes and maybe because these were issues that really do impact people, that's why it became of such great concern to the White House, as it should have, and to the women's community and children's groups. These are not modest revisions.
WALLACE: The bill has a number of very strong provisions strengthening the positions of women and children.
ROULEAU: Only on paper.
WALLACE: I think in substance.
LACHMANN: Wait a minute. Some of the changes, in substance, were really laughable and clearly intended as window dressing. For example, subordinating administrative expenses to child support—that is not a serious proposal. It would not in any way deal with problems of non-dischargeability and the impact in the post-bankruptcy environment of those non-dischargeable debts on the ability of parents to collect support. It would certainly interfere with the administration of cases. That was not a serious proposal. It was held out as an answer to the problem and, quite frankly, I don't think there's a single bankruptcy professional out there who takes it seriously.
WALLACE: The most significant provision on the child support issue is that the automatic stay is lifted so that the child support payments can continue to be collected by the state. That's an important change. We find that child support payments as a condition of discharge in chapter 13 is important. There's a book out by Mr. James Caher, an ABI member, I believe, on how to use bankruptcy as a way to interfere with the ex-spouse's obligations to pay child support and other marital obligations. Bankruptcy is in fact used to defeat the payment of such obligations. That should be stopped. The bill, I think, goes a very long way in stopping it. Those are real changes and we're proud to support them.
GERDANO: We talked about what happened at the end of the last Congress, and I would like each of you to predict what will happen in the next Congress. Specifically, is a bill going to pass? If it does, will it look more like the original House bill that passed, the conference report or the Senate version? Which of those three will it most likely resemble?
CORWIN: I would have to say that it is more likely to be somewhere between the conference report and the Senate-passed bill, at least on these disclosure issues. We need to look at other factors. There probably is not going to be a bipartisan bill in the Senate, the opposition is better organized than it has been. Having said that, I still think it could be a bill that makes very worthwhile changes, that improves the administration of the bankruptcy system and the substance of the Bankruptcy Code. I think it's important to move quickly. I think the two political parties will be working on some issues where they can reach bipartisan agreement, and enact some things in 1999 to show the public that they really can work together. But let's face it—maybe the Senate, but certainly the White House and the House are going to be totally up for grabs in the 2000 election, and the year 2000 is going to be a very politicized year. Any legislation is going to be more difficult to enact in 2000 than it will be in 1999. A lot of it comes down to timing and the commitment of principal at the committees with the jurisdiction, and the leadership, to put this in front of the queue.
GERDANO: Mary, bottom line: How confident are you that you will get some of the lender reforms into the final bill?
ROULEAU: I am confident that we will get some of the reforms in, in order for a bill to pass and be signed by the President. I think without those things, it really throws the whole thing seriously into question. Obviously, it needs to look much more like the Senate bill. I don't consider a compromise between the conference report and the Senate bill an acceptable, because I consider the conference report to have been very extreme. Certainly there have been proposals put out by our side, ABI, the National Bankruptcy Conference, good faith proposals that if people are serious about bankruptcy reform, the tools are there. I just think it's a question of whether people are serious or not and what the real agenda is here.
[Wallace flipping quarter.]
GERDANO: George has his coin out. Do you really think it's a toss-up?
WALLACE: I flipped my coin and it came up "heads," so that means that I'm going to take the strong affirmative position that we'll come out somewhere between the House bill and the conference report. There are one or two things in the House bill that are not in the conference report that I think are good and certainly deserve additional thought. One of them is §102 of the House bill, which is an attempt to make chapter 13 work better for debtors by making it more flexible—once you're in chapter 13, you get to stay in chapter 13, regardless of income fluctuation, without having to do a modification of a plan. I think that's a good reform, one that works well. The disposable income test is another area of discretion. The judges have been unable to develop uniform standards on disposable income. We need national standards for that because we need a national and uniform bankruptcy system. I think that's a very important objective. There are also some things in the conference report that we don't like, just as I'm sure that the other side feels strongly about some things in the bill.
LACHMANN: I'm going to have to agree largely with Phil. The House bill, which was much like the conference report, is a non-starter with the Senate and the administration. That cannot be the product. When we saw the conference report, it was very clear there was an intent to move into the next Congress, where it was hoped that conditions would be more favorable for that type of legislation. That did not happen. We're going to have a lively debate over how to balance the rights of competing creditors, how to be fair and balanced in eliminating abuse in the system, and how to do it in a cost-effective, rational manner. But there will also be other issues where we can either deadlock again or move forward with bipartisan agreement. The question on those important reforms—appointing bankruptcy judges, dealing with some of the netting issues, dealing with direct appeals, dealing with international insolvencies, dealing with chapter 12, dealing with the technical corrections of the 1994 Act that are still pending—is whether we can do what needs to be done for the bankruptcy system where we agree, while we continue to hash out the more controversial issues.
GERDANO: Now that David has agreed with Phil, it's time to stop. Thank you all for participating in this lively and informative discussion.
 |
Journal Date: Tuesday, December 1, 1998 |