Summary of Testimony of Ralph R. Mabey

Respecting Proposed Bankruptcy Reform

March 16, 1999

For two centuries, American bankruptcy law has evolved toward unconditional discharge while it promotes the fair distribution of assets for creditors. The fresh start provided for honest debtors by American bankruptcy law is quite consistent with our relatively free market economy that imposes relatively great risks (and opportunities) on our citizens and provides relatively meager safety nets.

Consumer debt, not the Bankruptcy Code, is responsible for the increase in filings

Most economists and researchers have rejected the theory that the Bankruptcy Reform Act of 1978 is responsible for the subsequent increase in the bankruptcy filing rate. Indeed, the 1984 amendments, which restricted debtors' access and rights in bankruptcy, was also followed by a sharp increase in the filing rate.

The rise in bankruptcy filings from the 1920s until 1985 is best explained by the rise in consumer debt. Since 1985, the increase in bankruptcies may be attributable to the growing distribution of consumer credit to lower income borrowers, who ultimately are more likely to default. According to the Federal Reserve, in 1983, the bottom 45% of American households (as measured by income) carried only 42% of all consumer debt; by 1992, the bottom 36% of American households carried 56% of all consumer debt. The functional deregulation of interest rates, along with the general lowering of prime interest rates, may explain the increase in poorer Americans' access to credit since the mid-1980s.

The stigma of bankruptcy: reports of its death have been greatly exaggerated

Death of stigma arguments are not new. Thomas D. Thacher, Soliciter General of the United States, suggested in 1930 that bankruptcy was losing, or had already lost, its stigma. If bankruptcy has lost its stigma, we would expect that people filing for bankruptcy today would have higher incomes and lower debts than those who had filed in the past. However, Americans who file for bankruptcy in the 1990s actually have lower incomes and higher debts than those who filed for bankruptcy in the early 1980s.

If any stigma has died, it is the stigma of indebtedness

Borrowers (and lenders) embrace consumer debt much more than they should. Perhaps education, reinstitution of usury laws, or increased disclosures in connection with consumer credit will curb such tendencies, but the proposed bankruptcy reform will not. Instead, tightening the bankruptcy laws as proposed (e.g., making more credit card debt nondischargeable) may make consumer lending even more profitable thereby increasing incentives to expand lending to low income, subprime and risky borrowers, perhaps leading to even more defaults.

Discretionary dismissal, not means testing

If consumer debt, and its distribution among low income borrowers, is driving up the bankruptcy filing rate, means testing is not the solution. Instead of implementing a potentially arbitrary means testing system, at considerable expense, increasing court discretion and oversight may be a more appropriate and efficient measure to identify and dispense with the relatively small proportion of abusive cases.

Protecting creditor benefits in bankruptcy, business and consumer

Today, bankruptcy protects creditors from the "snatch and grab" laws of each state, which otherwise require that creditors fight each other over the debtor's remains to their mutual disadvantage, destroying asset values. Special interests seeking individual benefits in bankruptcy undermine the equity and equilibrium of bankruptcy and the success of the reorganization process.