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The Debt Resisters’ Operations Manual

Chapter Ten

Bankruptcy: It’s Better Than Nothing

If you happen to find yourself way out in the deep waters of debt, you should know that bankruptcy may be an option for rescuing yourself and getting a fresh start. Think of it as consumer protection for debtors, a lifeline in a financial contest that is generally rigged against you. As with many sets of legal codes, it reflects the society that created it and an economic system predicated on maximizing profit regardless of the human consequences. The protections offered by bankruptcy are anything but clear or straightforward. But bankruptcy can be more desirable than pursuing private negotiations with uncooperative creditors, going through sketchy debt management schemes, or refusing to pay and trying to go completely off-grid, especially if you can find a trustworthy legal representative to guide you through the process.

This chapter will recount some of the historical developments in this avenue of debt forgiveness, explain the two most common options for filing individual bankruptcy in the United States (Chapter 7 and Chapter 13), and clarify what possibilities bankruptcy may offer to you and where you can learn more about it. Bankruptcy as a form of debt relief is not just for big corporations like Enron, WorldCom, and Lehman Brothers; it’s a legal and legitimate form of debt relief that all debt resisters should be aware of.

Disclaimer

The information contained in this chapter is an attempt to present general information about bankruptcy, its background in the United States, as well as a basic understanding of bankruptcy’s current legal provisions. We are not lawyers and cannot offer personal legal counsel on how to make bankruptcy work in your case. While it is possible to file for bankruptcy without a lawyer, there is no substitute for a trusted financial advisor or legal counsel who will act in your interests, although such people are few and far between.

A Short History of Debt Forgiveness

Debt forgiveness has a long history. The Bible is full of passages about jubilees and other cancellations of debt. The Qur’an also advocates debt forgiveness for those who cannot pay: “If the debtor is in difficulty, grant him time till it is easy for him to repay. But if ye remit it by way of charity, that is best for you if ye only knew” (2:280). Of course not every society has protected its citizen debtors—in ancient Greece, debtors unable to pay often lost their entire families to debt slavery.

On the whole, bankruptcy in the United States has been used by businesses more than individuals. Bankruptcy laws in favor of businesses were repeatedly passed and repealed throughout the nineteenth century. The first truly modern bankruptcy laws in the United States appeared during periods of “economic downturn” in the 1890s and 1930s. These laws were largely about saving companies and businesses deeply in debt. Businesses in the United States have consistently taken advantage of bankruptcy, especially in recent years, as companies have used it as a pretext to get out of pension obligations and to break union contracts.

But starting in 1978, the United States passed a law that made it significantly easier for individuals and families to get similar benefits and protections. In the 1980s, people increasingly took advantage of this potential liberation from debt. In the 1970s, just over one in a thousand Americans filed for bankruptcy every year. That number began to rise dramatically over the course of the next decade. By 1990, the rate had tripled to three in a thousand; by the late 1990s, it was up to five.

A Tale of Two Chapters

There are two chapters under which you can file for bankruptcy as an individual in the United States, named after relevant sections of the federal bankruptcy code.

Chapter 7 bankruptcy: Wipe out all of your debts

Chapter 7, often called “straight bankruptcy,” is the simplest and quickest form of bankruptcy available. It discharges or wipes away all consumer and medical debt, as well as other unsecured debts such as payday loans. However, student loans and some tax debts cannot be discharged in bankruptcy.

Filing for Chapter 7 does not mean that you must give up your home or car, if you can continue paying the debts on them or claim them as exempt property when you file. Exempt property includes home, car, retirement accounts, and household furnishing, although the maximum value of any exemption depends on the exemption law of the state in which you file. Generally, you cannot claim an exemption for property that is security for a loan (unless you successfully remove the lien on the property). Consider the following details of the major federal exemptions:

  • Home: You can claim the federal homestead exemption for up to $22,975 of equity in your home per owner, after taking into account the cost of sale (generally 10%). You can also claim state exemptions, which are more favorable in some states than others (for example, in New York, you can protect up to $150,000 per owner, and in Florida, your home is exempt without limit).
  • Car: You can claim a federal exemption of up to $3,675 of equity in your car.
  • Retirement accounts: Retirement accounts (401ks, IRAs, and Roth IRAs) are, for all practical purposes, fully exempt.
  • Household goods: You can claim a federal exemption of up to $12,250 per owner of household goods, furnishings and appliances, clothes, and other material possessions.
  • Wild card: You can claim a federal exemption of $1,225 plus $11,500 of any unused portion of your homestead exemption for anything you own.

(Federal bankruptcy exemptions are adjusted every three years; the information above is accurate until March 31, 2016.) Any property that does not fit under these exemptions is sold off to pay the creditors. Filing for Chapter 7 gives you a way of becoming debt-free without becoming penniless.

Chapter 13 bankruptcy: Repay a portion of your debts

With a Chapter 13 bankruptcy, disparate debts are consolidated into a single sum owed to the bankruptcy court, and a rigorous payment plan is set up—usually lasting three to five years. This can be thought of as a “wage earner bankruptcy.” It is intended for a situation where you have a home or a car and you have fallen behind on the payments—not where you couldn’t afford the home or car in the first place prior to filing. In short, Chapter 13 strips away your unsecured debts in order to direct your income toward saving the home or car that you need in order to go on with life. It also requires that all creditor efforts to collect your debt (both secured and unsecured) must stop. Foreclosure actions are also suspended (though they can be resumed once the case is completed). Historically, many debtors in Chapter 13 fail to comply with their payment plan during the payback period, which tragically leads to more debt. But in the best-case scenario, filing for Chapter 13 can offer some much needed breathing room from other debts while you catch up on payments for your necessary property.

The creditors fight back

The credit industry was alarmed by the boom in bankruptcies over the last thirty years, and it began a vast lobbying and propaganda campaign to tighten up the bankruptcy code. A “moral rot” was said to be spreading throughout the culture, and the old moral line about paying your debts was falling by the wayside along with other “traditional values.”

Industry lobbying to cut back bankruptcies came up short at first. During the Clinton years, bankruptcy overhaul bills were introduced but never made it all the way through Congress. The efforts finally paid off in 2005, when George W. Bush signed the preposterously named Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), a heavily pro-creditor piece of legislation that made it harder and more expensive to file for bankruptcy.

The reform has been very good for creditors. Although there was a spike in bankruptcy filings in the year or two leading up to the passage of the bill—nearly seven out of every thousand Americans filed in 2005, an all-time record—filings then collapsed to just two per thousand in 2006. Filings soon began rising again, but even during the Great Recession of 2008, the filing rate never broke above five per thousand, essentially where it was in the late 1990s, when both the unemployment rate and debt levels were well below where they’ve been in recent years. A study by the Federal Reserve Bank of New York suggests that tightening up the bankruptcy code increased the number of foreclosures because many debtors were denied this avenue of relief.

The battle over Chapter 13

Before BAPCPA, you had the option of choosing which chapter to file under. Under the guise of “abuse prevention,” however, the new law requires that you pass a “means test” if your household is above your state’s median income and you wish to file for Chapter 7. The means test is a formula based on your disposable income after certain expenses. (Means test calculators are available on the internet.) State medians run from about $37,000 in Mississippi to $66,000 in Connecticut, with the national median around $50,000. Of course, you could have an above-median income in an expensive region like New York or San Francisco and not be living large at all. Despite the restrictions on Chapter 7 filings, they still account for about 70% of all bankruptcy cases, which isn’t very different than the pre-reform share.

The 2005 reform also increased the amount of documentation required to file: tax returns, pay stubs, household budget information, and so on. Because of that, and the increased amount of time that lawyers now have to devote to a bankruptcy filing, fees have risen dramatically. The new law also requires you to complete a counseling course offered by a government-certified provider. All of this has contributed to lower filing rates than there would have been otherwise.

It is clear that in the name of “abuse prevention,” the creditors and the government are forcing people to either not file for bankruptcy at all, or if they do, to file for Chapter 13. And it is not hard to see why. Unlike Chapter 7, creditors often recover up to 30% of the original loan with Chapter 13. Many of those who file for Chapter 13 end up completely failing: the rate of discharge (getting one’s debts forgiven) is around one-third of cases according to many studies, and about one-half according to others. If your Chapter 13 filing fails, you are left in a worse situation than where you started.

And from here it only gets worse. One detailed law study found that bankruptcy laws, specifically Chapter 13, implicitly favor a certain profile, an “ideal debtor,” who is usually White and married. Most bankruptcy laws tend to favor wealth over income, ownership over renting, formal dependents over informal dependents, and straight married couples, all of which have significantly higher rates among Whites. Before 2005, Black people who filed for bankruptcy filed for Chapter 13 nearly 50% of the time, compared to less than 25% by Whites. A study found that when all other factors are equalized (identical financial cases), lawyers are twice as likely to steer Black clients toward Chapter 13 than they are White clients. The study could find no other cause besides racism in all forms: conscious, unconscious, structural, and institutional. This push toward Chapter 13—where one’s race is far more often a determining factor as compared to Chapter 7—compounds the effect of the already racist terrain of bankruptcy law.

Black people are also 20% more likely to have their Chapter 13 cases dismissed by a judge. This discrimination has had a major impact on many Black debtors—they often avoid the option of bankruptcy altogether and seek other solutions: hiding, adopting aliases, refusing to pay, or relying on highly predatory fringe financial services. It may appear at first glance that BAPCPA actually began to equalize the playing field across race and gender by introducing the fairly objective “means test,” but it has, on the contrary, continued the trend of favoring wealth over income and made the whole process more intimidating and more expensive.

Who Files for Bankruptcy? And Why?

The banks, government, and media would have you believe that people file for bankruptcy to scam the system, or because they are financially irresponsible. This is, of course, nonsense. Elizabeth Warren made her career by clarifying these myths around bankruptcy: most bankruptcies are simply not caused by financial carelessness but by life’s misfortunes such as unexpected joblessness, illness, or divorce. The major social reason for the rise in bankruptcy over the decades has been the rise in consumer debt burdens, and the major reasons for the rise in these debts are wage stagnation, the elimination of caps on interest, and massive public sector service cuts. The line of argument advanced by the credit industry ignores the source of the debt to begin with: in a time of vulnerable work markets and mass cuts in basic social services, most people have no choice but to accrue debt to simply survive.

There has been a lot of talk about the role of medical debt in bankruptcies in the past few years—and for good reason. A whopping 62% of personal bankruptcies are traceable to medical debt. But it is not the only factor. Bankruptcy is not “caused” by any one type of debt. Most individuals and families filing for bankruptcy have auto debt, credit card debt, mortgage debt, student debt, and medical debt. The debt burden that households have been forced to take on is getting harder and harder to bear, such that mass bankruptcies and default in this system seem to be structurally inevitable, especially if bankers continue to force us to take loans that we cannot pay.

It would be a mistake to think that the U.S. bankruptcy laws and proceedings are fair across lines of gender, race, and class. In terms of gender, it’s a complicated story. While the rates of bankruptcy filings are far higher for women, especially single and divorced mothers, they also benefit from the structure of bankruptcy laws. Individuals with child support obligations (usually men) who declare Chapter 7 are freed up to then satisfy these obligations, since consumer debt can be discharged but child support cannot. However, after the 2005 Act, bankruptcy became more difficult for everyone, including both single mothers and those with child support obligations. All of this raises the question: why are so many single mothers (especially women of color) declaring bankruptcy? And instead of looking for policy solutions or resorting to moral chiding, how can we avoid these situations of indebtedness in the first place? We haven’t seen these questions asked in any serious public forum.

In addition, there have been several reports in the last decade about the connection between race and bankruptcy. Anyone connecting the dots between race, predatory lending, and the 2008 financial crisis shouldn’t be surprised by these results. Neil Ellington, executive vice president of a credit counseling agency in Raleigh, North Carolina, had this to say on the matter of race and bankruptcy: “The same underlying issues that created the problem in mortgage lending, with minorities paying higher interest rates than their white counterparts having the same loan qualifications, are present in all financial fields.”

So how bad is it? One study, focused on a neighborhood in Chicago, found that the rate of filings by Blacks is triple that of their White counterparts. The underlying cause isn’t well documented, but it’s not hard to guess: Black people have been systematically targeted by financial predators. Beyond predatory lending, people of color are targeted by fierce debt reduction schemes, rescue scams, and shady financial products promising to save them from their debt burdens.

In This Society, Everyone Wants Your Money

Anyone contemplating bankruptcy or struggling with debt is likely to confront dubious operators. Worst of all are the characters who advertise on late-night TV or on the web offering debt-relief schemes. Google the term “debt relief” for examples. In the words of a Manhattan-based attorney who handles many bankruptcy cases, “I’ve never seen one that was legitimate.” Avoid them at all costs.

But there are also more legitimate groups and financial advisors who will offer you still-dubious advice against filing for bankruptcy. The standard claim is that bankruptcy is an emotionally wrenching experience that will ruin your credit for years. According to these sources, you’ll find it difficult or impossible to get a credit card or a mortgage after filing for bankruptcy. You might even find that it “carries a stigma in your community,” according to the National Foundation for Credit Counseling (NFCC), a trade association for the advice industry. Better to tighten your belt and negotiate repayment plans with your creditors, they say. For example, one advocate, Dave Ramsey, who dispenses advice from the perspective of the religious right, suggests selling everything but the bare necessities to placate the creditors.

And they are right in one sense; bankruptcy is no picnic. But neither is private debt negotiation or settlement. Few people have the time and energy to fight with creditors for months, especially without a lawyer. Groups like the NFCC have been silent about releasing data showing success rates in private negotiations, debt settlement plans, and other alternatives to bankruptcy. It’s hard to know whom to trust when everyone wants your money. Organizations like the NFCC will say terrible things about bankruptcy because they’re funded by the financial industry and other private sector interests. While they divulge few exact details about their funders, the program for its most recent conference had sponsors such as Bank of America, Chase, Citi, MasterCard, and Experian (the credit rating agency). The conference also featured “breakout sessions” for creditors and a Creditors’ Day (as if all the other days of the year weren’t creditors’ days, too).

NFCC’s ideals are personified by the winners of their 2011 Client of the Year Award, Jerry and Sue Bailey of Jackson, Michigan. The Baileys “refused” the temptation of “walking away” from $92,000 in credit card debt, opting instead for a repayment program engineered by NFCC member firm GreenPath. They admit that paying off their debt was a struggle, but it was one “worth making.” GreenPath (which, incidentally, paid its CEO about $600,000 in 2010) and other NFCC member firms are precisely the ones who run the counseling programs filers are required to attend.

So who can you trust? Bankruptcy lawyers? Let’s not forget that they make money off of debtors too. Every situation is different, and you should research the options that make the most sense for your situation.

So, should I file for bankruptcy or not?

Many of us are afflicted with a deep sense of guilt about not servicing our debt—it feels immoral. Worse still is the common myth that filing for bankruptcy means losing everything. In Chapter 7 you can avail yourself of exemptions for key assets, and Chapter 13 is designed so that you can save some non-exempt assets. We recommend you research all of this carefully. In the end, filing for bankruptcy can be a tremendous relief.

There is no minimum amount of debt that must be owed before it is reasonable to file for bankruptcy; ultimately, it is based on the situation of the individual. Before filing, we highly recommend speaking to an attorney who specializes in bankruptcy. Many offer free initial consultations. For a referral, contact your state or local bar association and consider seeking free (pro bono) bankruptcy services in your area.

Contrary to claims by the credit industry (and the academics and counselors on their payroll), the rise in bankruptcy filings over the last couple of decades is not the result of spreading moral rot and a growing indifference to debt. Most people are close to their credit limit or behind on their payments—at a time when banks can raise the money they lend you for close to 0%—and getting rid of that rapidly compounding debt can be deliverance for many.

Compound interest can feel like endless sacrifice with no reward. If you have a $5,000 balance at 18% interest and make only the minimum payment, it will take you almost twenty-three years to pay off the debt and will cost you nearly $7,000 in interest (more than the original principal). Bankruptcy can reduce your credit card balance to zero in a matter of months—and put an end to calls from collection agents. There are consequences, of course, for your future ability to borrow, but being informed and doing it right makes it worth the risk.

The biggest relief bankruptcy offers is the “automatic stay,” which means that creditors and collectors have to stop harassing you until the bankruptcy filing is completed and the court has ruled. In Chapter 13, your case is monitored so that you no longer have to deal with creditors as you pay back your debt for those three to five years (again, only if you are in the minority that successfully completes your plan).

It can cost as much as $3,000 to file for bankruptcy these days (Chapter 13 is more expensive), which, for people who are barely getting by, is a lot of money. You may be able to find a relatively cheap lawyer or get free legal representation by contacting your local bar association. It is possible to do it yourself using manuals and forms from online sources, but it can be a complicated process. The failure rate without a lawyer for Chapter 13s is at an astonishing 97%! So, we recommend getting a lawyer before filing; research carefully how to find a good one. And it can’t hurt to know the law a bit before you go—the study mentioned above about lawyers’ tendency to provide Black debtors with questionable advice shows the importance of this clearly.

What about my credit? And other risks?

The consensus in the credit counseling industry seems to be that, for many people, bankruptcy can actually be good for your credit score in the long run. How so? If you’re considering bankruptcy, you’ve probably missed a few payments and are dealing with delinquency and default—which will wreck most people’s scores. Also, before you file for bankruptcy, you have some income but a lot of debt; after filing, you will have the same income but no debt, which leads to a lower debt-to-income ratio. This ratio, in turn, is used as a factor in obtaining loans. Counterintuitively, debt management programs or similar plans don’t seem to do much for your credit, so at some point, you’ll want to make a decision about bankruptcy.

It seems that Chapter 7 and Chapter 13 have an equivalent impact on credit scores. Either way, scores take a nosedive in the short term, and you may not have access to cheap or fair credit for a while. But it won’t be long before you receive more credit card applications (sometimes as little as thirty days after filing). Why? Banks are not stupid: they know that you probably have income (or potential for it) and also that, due to your recently filed bankruptcy, you can’t file another bankruptcy for eight years. To the bank, that means you’ll have to pay back what you owe plus interest for the entire time.

Lenders will be more likely to lend to you after a Chapter 7. Few lenders will do any lending during the payback period of a Chapter 13, so it will take an extra three to five years to rebuild your credit. Notably, while a bankruptcy can stay on your credit score for seven to ten years, you can still qualify for a Federal Housing Administration-backed mortgage approximately two and a half years after filing a Chapter 7.

After bankruptcy, you will be an ideal target for the predatory loan sharks in the industry; they love people who are struggling. They will tempt you with low interest rates to start with, but then jack up rates and fees the minute that balances rise and payments fall behind. Be careful. The best strategy after bankruptcy is to accept a couple of cards. Study their terms and conditions and use them very carefully. Read up about how to build your credit (carrying a small balance, making regular payments, etc). Although a bankruptcy filing can stay on your credit report for a decade, even just six months after a filing, it’s possible to get a credit score in the 700s. That being said, it can be disastrous to declare bankruptcy a second time; few credit scores can recover from that (except patiently waiting seven to ten years).

Lastly, the biggest risk in filing for bankruptcy is that your case will be dismissed, in which case you’ve wasted time and money, accrued more debt (the interest accrues retroactively to the time of filing), and gained nothing. And, your bankruptcy would still be on your credit report. Though this is the worst-case scenario, remember that this happens for nearly 50% of those filing for Chapter 13.

Collective Solutions

Unfortunately, for the most part bankruptcy offers only individual means of fighting the creditors. It is hard to imagine how to use the bankruptcy laws in order to organize mass direct action that would seriously disrupt the debt system. In terms of the racist nature of the existing bankruptcy mechanisms, informational campaigns in communities to clear up the myths and disinformation surrounding bankruptcy would be an important first step. And, although not ideal for many, there are other options for debtors: debt negotiation or settlement, refusal, living off the grid, leaving the country, etc. One form of collective action is to help each other and build networks of mutual support for those struggling with debt.

With every bankruptcy, a bank or lender loses a certain amount of money—they have rigged the game, so they are probably recovering it in other places. Nonetheless, their books are slightly shaken. One possible action would be a simultaneous mass bankruptcy of those eligible for Chapter 7. This could be organized so that a mass of debtors with debt toward a certain bank declares bankruptcy all at once. We don’t know enough about the industry to know what effects this could have. The organizers would need serious legal counseling: bankruptcy laws are laden with fraud protections, which would have to be carefully combed through before taking action. Another possibility would be to organize a critical mass to declare bankruptcy on student loans all at once—knowing they will be dismissed, but defiantly insisting in court that the debts are illegitimate and unpayable. These actions, of course, would need years of planning, preparation, and organization.

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