Matthew Notowidigdo: Reconsider bankruptcy reform

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Q1
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What do you think is a priority for the Biden government?

I look forward to resuming the debate on bankruptcy reform. Currently the focus is on student loans, which to my knowledge are the only debts that cannot be paid in bankruptcy. But [Massachusetts] Senator Elizabeth Warren came up with a detailed policy paper towards the end of her presidential campaign on how she would reform the bankruptcy system, and that is a template for what I believe the progressive wing of the Democratic Party would take as a starting point.

Warren, then a law professor at Harvard, and President Biden, then a Senator from Delaware, were on opposite sides of the 2005 Anti-Bankruptcy Prevention and Consumer Protection Act, which made it harder to file for bankruptcy. Filings used to be rare, but bankruptcy rates began to rise in the 1980s and 90s. By the early 2000s, about 1 percent of households reported a complaint each year, and there were a few high profile examples of abuse. Policy makers felt that the system was being used by people who didn’t need it and their concern was that the bankruptcy rate was getting out of hand. The bill made it more costly, taxing, and financially less beneficial to file for bankruptcy.

Biden supported it. Warren was a critic of this, and his passage inspired her to run for the Senate. My research with Tal Gross from Boston University, Ray Kluender from Harvard, Feng Liu from the Consumer Financial Protection Bureau, and Jialan Wang from the University of Illinois examined what the bankruptcy reform actually did – and who was right about the BAPCPA.

Both were in different ways: Biden was right that consumers benefited from it. Some of the cost savings were passed on as lower credit card rates and lower credit costs. But Warren was right about the heading of the law Abuse prevention, and it’s hard to prevent abuse.

Our research suggests that the number of filings has declined across the board, and even people who have had an adverse event like illness or injury had a much harder time filing for bankruptcy. It is unfortunate that the BAPCPA was passed in 2005 and just a few years later we had a financial crisis. Many people affected by the crisis faced bankruptcy and foreclosure. But even now, many people who we would expect to file for bankruptcy do not and are unable to make a fresh start.

I don’t think the proponents wanted that. The administration should start there and reverse parts of the law so that people can get back on their feet after negative shocks. Many people suffering from illness, injury, or divorce are unable to repay their debts.

The idea of ​​reaching out to people who abuse the system is a good one. It’s just a difficult problem to solve. Using income as a basis to determine who can submit didn’t work well. Perhaps, 15 years after that first attempt, we can find other ways of looking at this.

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