Bankruptcy

Tightening the Bankruptcy Laws in the Midst of a Deep Recession

By Bob Lawless

Beginning on November 1, some people might suddenly find they are now ineligible for chapter 7 bankruptcy. Making it harder to file bankruptcy in the middle of our financial crisis may not be the best policy idea to come down the pike, but it is exactly what Congress set in motion in 2005. Here is why.

The U.S. bankruptcy law has a means test that is meant to filter "can pay" debtors into chapter 13. It's a test that was not needed--there was no evidence of widespread abuse of the bankruptcy system--and the test is not having its intended effect--the income distribution of filers has not changed. The means test begins with an inquiry that asks whether a debtor is above or below the state median income for a household of the same size in the debtor's state.

The state median income figures are periodically updated by the U.S. Census and the Executive Office for U.S. Trustees (EOUST) publishes a table that is used in the bankruptcy courts. Don't blame either the Census or the EOUST for this one. They are just doing what Congress directed. These changes happen automatically.

With the recession, incomes are going down. Thus, in half of the data points on the table, the median income that will subject a debtor to the means test has decreased. In Illinois, for example, right now a filer from a 1-person household goes through the means test if he or she has median income above $47,355. On November 1, that will change to $46,105. Also, the changes are not consistent across different sizes of households in a state. For example, in New Hampshire, the median income figures drop for 1- and 2-person households (making it harder to file chapter 7 bankruptcy) but rise for 3- and 4-person households.

Some might object that this problem is more fictitious than real. How many persons are really going to be caught out by a change of a few thousand dollars in the means test's median income figures? Well, maybe not a lot, but with us headed toward at least 1.5 million bankruptcy in 2010, also not just a few. Regardless of the number of people who are affected by the change, what concerns me more is the symbolism of making personal bankruptcy less available during a time of economic crisis. These sorts of changes feed the perception that the government will help out large financial institutions but the average Joe or Jane.

There is a lot of misinformation out there for persons contemplating bankruptcy, and I would not want this post to add to that problem. If you are thinking about filing bankruptcy and found this post, there is no reason to panic. If you are well below the state median income, this change will not affect you. Even debtors who are above the state median income often are eligible for chapter 7 because the expenses are high enough to qualify. But, if you have an income near your state's median, you might want to visit an attorney before this change goes into effect. You can find the post-November 1 median income figures here.

And a hat tip to the Credit Slips reader who wrote me and reminded me that these changes were coming.

Full post as published by Credit Slips on October 14, 2009 (boomark / email).