In order to limit "abusive" bankruptcy filings, the 2005 Bankruptcy Abuse and Consumer Protection Act (BAPCPA) placed income restrictions on Chapter 7 filings, made credit counseling mandatory, and placed certain restrictions on bankruptcy lawyers. Ultimately, Chapter 7 personal bankruptcy filings were expected to drop dramatically.

According to commentator David Weidner of MarketWatch, the law did not have that result. Instead, Chapter 7 filings are back up to pre-BAPCPA levels -- and the BAPCPA actually appears to have played a key role in the foreclosure crisis.

In part because of the economy, the disquieting reality has been a sharp increase in Chapter 7 filings. Worse, a November 2008 study by the Federal Reserve Bank of New York showed that the BAPCPA encouraged reckless lending by banks.

Why Chapter 7 Filings Continue to Rise
Because the BAPCPA limits access to Chapter 7 to debtors making less than the median income in their states or who pass a strict "means test", the fact that Chapter 7 filings are back to pre-BAPCPA levels d is disturbing, argues Weidner.

It means either that the economy has caused people to fall beneath their states' median income levels or that their levels of debt are so high that they qualify under the means test.

How the BAPCPA Incentives Reckless Lending by Banks
Weidner cites the Federal Reserve Bank of New York study in describing the perverse outcomes allowed by the BAPCPA.

Under the old bankruptcy system, struggling homeowners could free up money to pay their mortgages by having their credit card debt discharged through Chapter 7. Although banks benefitted from the re-stabilization of the mortgages, they lost money on the credit card discharges.

  • After the BAPCPA, banks inundated consumers with easy or unlimited credit card offers, jumbo no-down payment ARMs and home equity lines of credit -- and reaped record fees.
    Because of the new barriers to filing bankruptcy, many borrowers do not attempt it. Instead, they simply default on their credit cards in order to make their mortgage payments.
  • Banks are increasingly garnishing wages outside of bankruptcy to collect on credit card debt.
  • When borrowers do attempt bankruptcy, the BAPCPA forces most of them into Chapter 13. As a result, they are required to pay at least a portion of their credit card debt, which tends to increase the difficulty of making the mortgage payments.
  • Most mortgage payments are front-loaded with interest, so banks come out ahead as long as borrowers are required to make some payments -- even if the increased burden ultimately causes the homeowner to default.

Related Resources

  • "How we became small enough to fail," (David Weidner, "Writing on the Wall," MarketWatch, April 6, 2010)
  • "Seismic Effects of the Bankruptcy Reform," Donald P. Morgan, Benjamin Iverson, and Matthew Botsch, Federal Reserve Bank of New York, Number 358 (November 2008, Revised February 2009)