Tuesday, October 15, 2019

Let's Bring Back Bankruptcy!


Bankruptcy laws have changed in recent years - tilting the playing field in favor of the banks.

Let's bring back bankruptcy - the real kind.   Back when I was a kid, in the 1960's, if you went bankrupt, it was a shameful thing - and you often "lost everything" as a result of declaring bankruptcy.   As a result, it was a last-ditch thing to do, when all else failed.  It was the answer to the debtor's prisons of Dickens' England.   You called a time-out, everyone lost a lot of money, and you started over.

But since then, times have changed and bankruptcy laws have changed.  Bankruptcy no longer has a stigma for businesses or individuals.  It is merely a strategy that companies use to get out of debt.   For individuals, though, it isn't the get-out-of-jail-free card that it used to be.

Back in the day, I used to read Reader's Digest, when visiting my Grandmother (the non-racist one).  She kept a stack of them on the toilet tank, and in addition to Life in these United States and Humor in Uniform, there were often alarmist articles about how "other people" (probably some sort race of some kind or another) were scamming the government, the banks, or all of us, or whatever.   More than one story would tell of some clever individual who declared bankruptcy and walked away with tons of money and screwed those poor helpless banks.  We need bankruptcy reform!   Banks are hurting, and all those losses are passed on to us helpless consumers.

So since those glory days, a few things have changed.   Student loans now survive bankruptcy, in most cases, as many clever students (mostly law students) figured out you could duck out on these obligations by declaring bankruptcy immediately after graduation - when your income and assets were essentially zero, and your debt load staggering.    They closed that loophole, and opened an abyss.

Even ordinary bankruptcy laws were changed to prevent "abuses" of the process.  No longer were debts utterly wiped out, but in many instances would be "worked out" over a period of years.   You could borrow $10,000 on a credit card, make years of interest payments totaling $10,000, and then be forced to pay back the $10,000 debt over five years in a bankruptcy workout.   The banks loved this - they made huge profits, and customers found it harder to duck out on the debt.

How did banks survive before these laws were changed?   Well, for starters, it was a lot harder to get loans back then.   Since the bank was "on the hook" for the debt if it went bad, they scrutinized loan applicants more closely.  And yea, this resulted in a lot of discrimination and "red-lining" as banks didn't want to lend to minorities who they felt were a greater credit risk (and sadly, statistics backed this up at the time).  Yea, that was unfair, and redlining was outlawed - although cases of it have been reported even in recent times.

But back then, too, lending was a local matter, with the local bank holding deposits of local customers and paying 3% "bank interest" and then loaning it out at 6% "mortgage interest" and pocketing the difference.   If a borrower defaulted, the debt was on the local bank's books and this made them even more skittish about lending to people.

Today, loans are bundled and resold as investment vehicles. Banks - and increasingly mortgage brokers and online companies - now are just loan originators.  Even credit card debt, student loans, and car loans are bundled and resold with regularity.  The guy making the loan gets a commission for completing the application - but no bonus when the loan is paid back in full.   A disconnect appears between the nominal lender and the borrower.  As a result, too, lenders encourage more borrowing by "sub-prime" lenders, instead of turning them away for bad credit, as in the past.

In theory, this sounds like a plus for customers traditionally shunned by the banks - minorities and women, for example.  They can now borrow money and buy a home or a car or start a business!  This is progress, right?

Sadly, no.   Since bankruptcy laws were changed, and borrowers have a harder time ducking out on their obligations, many banks and lenders have discovered an odd thing: You don't make much money from the guy who borrows money and pays it back.  On the other hand, if you utterly ruin someone there is a lot of profit to be had.   Once they fall behind on their loan payments, you can tack on penalties and fees.  With credit cards, the possibilities are endless, with late fees, punishment interest rates (higher than loan shark rates!) and overdraft fees and whatnot. By the time the customer finally throws in the towel and tries to call it quits, you've gotten all your money back and then some and now get a workout in bankruptcy court as well.  You've turned a human being into a  perpetual debt slave.

And it doesn't end there.  Once they've pulled the trigger on bankruptcy, it doesn't mean you stop loaning them money.  Far from it - now they cannot declare bankruptcy for another seven years, making them the ideal patsy for more borrowing.   Pretty soon, half their income is going to service debts and you're laughing all the way to the bank - the bank which you own.  Once they are out of bankruptcy and seven years have past, you offer them yet more credit - on onerous terms - on the premise that it will "repair their credit rating" and the whole process continues.   You've utterly ruined a human being, tearing them down from the middle-class or at least working-class, to utter poverty, in the world's wealthiest country.

Nice work if you can get it - and a lot of institutions are doing just that.

Meanwhile, who is getting the brunt of this treatment?  Yup - minorities and women.   Maybe in the past, they were denied loans, but as I have noted before, being turned down for a loan can sometime be a blessing.   Whenever I am turned down for a loan, I take this as a sign from God (or at least my banker) that I need to get my shit together - not borrow more money.   But few people see it that way.  Rather, they run off to the payday loan shop or some other odious lender with staggeringly high interest rates, thinking they are "lucky" to get a loan, when in fact, it is the lender who is lucky to get all those interest payments from you.

Sadly, this trend has extended to the middle-class, with student loans and mortgages.  Granted, the worst victims of the student loan problem are minorities who are often lured to "for-profit" colleges with "private" student loans, with the promise of riches if they only get a college degree "online" - which is to say, obtained through their cellphone.  A college degree cannot be phoned-in, literally.  And colleges which promise high-paying careers are usually phony-baloney deals (pardon the pun).

But many young people in the middle-class are ensnared in this deal as well.   Their parents want them to succeed in life and they think that the way to succeed in 2019 is the way you did it in 1969 - go to college and get a degree.   But back in 1969, college was a lot cheaper, and companies actually hired people with liberal arts degrees.   A lot has changed since then.   But nevertheless, it is harder to feel sorry for these kids, often living the high life (quite literally) in college, when they are smart enough to read a newspaper and hear all the sob stories of the last two decades about how spending inordinate amounts of money on college can cripple you for life - or at least for a decade or two.

Again, back in the day, student loans weren't even available.  The government got into the act, "guaranteeing" student loans, which enticed lenders to lend.  But the amounts lent were pretty small.  When I was at S.U., I borrowed the princely sum of $8500 or so (for two year's of school, basically) as that was the maximum I could borrow to pay for tuition and tuition only.  I was on my own for a place to live, food on the table, clothes on my back, and gas in my car and beer in the fridge (hey, college, right?).   And I worked a number of jobs to pay for these things.

But in graduate school - law school - all these limitations evaporated.   I would take my student loan check to the Bursar's office and they would give me money back to spend as I saw fit.  I used some to remodel my kitchen.   Why not?    The money was flowing freely, and paying it back was "tomorrow" me, and let's face it, that guy is an asshole.

I did pay the loans back, over a period of a decade or more.   It wasn't easy, and the total amount owed would be the equivalent of about eighty grand, today.    So, no more angry e-mails about "how lucky I had it" from students who never had to deliver a pizza to drunk frat houses at two in the morning.  College was the best 14 years of my life - from 1978 until 1992.   Actually, not the best years, but it was fun, in a way, working my way through.   Probably more fun that doing the four-year bit.  What's the point of that, anyway?

I digress, but one thing that pissed me off about President Obama is that he started a program to encourage people to graduate in five years or less, somehow thinking it was a "problem" that some folks like me don't like to rush things.  I found what I wanted to do in life, over those 14 years, and they were an education I never would have had, racing through school in a mere four to seven.  I think instead, they should encourage people who maybe dropped out, to go back to school.  And encourage working people - if they want to - to attend night classes and work on a degree, at a pace of their choosing.  It would be a lot easier to pay for and probably negate the need for so many student loans.  But I digress.  No doubt President Obama cannot fathom an education like mine.   But he's a lot smarter than I am, in some regards.

Student loans were guaranteed by the government, and they took off.   Private loans were harder to come by, though.  As you might expect, bankers were skeptical of lending money to an 18-year-old with no job and no job prospects.   Suppose he drops out of school?  How does he pay the loan back?   Indeed, this is a burning question today - for former students who dropped out and now have no career and debts to pay back.

Since people, in the past, ditched student loans right after college, the laws were changed to make them survive bankruptcy.   No problem - the amount lent in federally guaranteed student loans was pretty small, at the time, at least for undergraduate studies.  But then private lenders got in on the action, and encouraged Congress to extend this protection to their loans as well, making the argument that minorities would have better access to college, if they could only borrow the money.   Of course, no one asked whether this was really fair - even if a minority student graduates with a useful degree and gets a good-paying job as a result, he is tens of thousands of dollars behind his co-workers, who don't have to pay back such onerous loans.

But then a funny - actually a very un-funny - thing happened.  Some unscrupulous people - including our current President of the United States - looked at this situation and realized they could make a lot of money from it.  Set up a "college" of sorts, convince people to attend it, and then get them to sign up for student loans, and then pocket the "tuition" money, which was often higher in cost that some ivy league schools.   The students, who you claimed you were trying to help, often ended up with intractable debts they could not escape for the rest of their lives.

Pretty sick.   But there are a lot of sick people out there these days.   The best thing about it, is that unlike defrauding other government programs (for example, creating phantom billings for Medicare or Medicaid), the odds of going to jail are slim.   After all, you are now the "Dean" of a college, and not just some ex-con who found a lucrative loophole in the law. They can't really say you did anything illegal, or at least it is damn hard to prove.   Like with Invention Brokers, the con is so complex, that you will put a judge or jury to sleep trying to explain it.  We are a nation with a short attention span.

Even "legitimate" colleges and universities cashed-in on this deal.  Since kids today had so much loan money to spend, they raised tuition and fees to accommodate them - often luring kids to colleges with amenities like luxury student housing, and rock climbing walls in the student center.   Colleges stared to act more like cruise lines than anything, competing for "customers" who would pay.  And the students - at an age when the reasoning and wisdom parts of the brain are not yet matured - fell for this.  Hey, this looks like a good time, and everyone else is doing it, so why not?   It is sad.

Worse yet, when these loans - of all types - go bad, the banks go hat-in-hand to the government and ask for a bailout.   Bad mortgage debt?  Get a bailout!  Even some homeowners (very few, though) got "adjustments" or reductions in the balance or interest rates on their mortgages.  Some students may qualify for "loan forgiveness" but I suspect damn few will qualify.   The banks, on the other hand, don't seem to have as much trouble - it pays to have better lobbyists.

What is the worst part of all of this, is that often these changes to the laws are predicated on them helping the disadvantaged or minorities or the poor, but in effect, they end up exploiting these very same groups of people.

So how do you fix this?

Well, one way is to go back to the old ways - bring back real bankruptcy, and allow people to duck out on their debts - entirely - by declaring Chapter 7 bankruptcy - without a "means test" or debts surviving bankruptcy, and let them bail on the debt.   This would allow people a chance to start over, debt-free.

But it would also mean that banks would not lend money!  What would minorities and other disadvantaged people do?  How would they afford college?

Well, let me ask you this:  How's the current system working out?   It was designed to protect or help minorities and the poor, but ended up screwing them, perhaps by design. We have created a generational underclass as a result of these "reforms".   Lending money to insolvent people turned out to be a bad idea, particularly for them, when they are forced to pay it back, with no recourse or get-out-of-jail free card.

If we went back to the good old days of bankruptcy, a lot of this specious lending would dry up.  The immediate result would be anarchy, of course.   Many poor people and minorities would not be able to attend college - or the college of their choice - due to the staggering cost.  More colleges would go bankrupt (than already have) and those that don't would be forced, for the first time in several decades, to tighten their belts, cut salaries for overpaid Deans and janitors, and bring down tuition rates to make them affordable.

Banks would stop lending money to insolvent people - and ruining them with loans.   Since the bank would be on the hook for bad debt, they wouldn't try to entice a poor person with a 25% interest rate credit card.   And payday loan places would evaporate overnight.

Once a person declared bankruptcy, no one would lend to them in the future, as they have shown themselves to be foolish with money and also of poor moral character.  They would have to live a cash lifestyle, which in turn, would mean more cash in their pocket, as they would not be paying interest on onerous loans.

People would once again look at bankruptcy as a shameful thing, and try to avoid it, by not taking out sketchy loans that they couldn't pay back. People would be forced to make more hard choices, knowing the consequences - being locked out of any future lending - are so dear.

Maybe it would work.  Maybe not.  But that was the way things were when I was a kid.  You didn't borrow such huge sums of money, because no bank in their right mind would lend it to you.  And since there was less "funny money" floating around, a lot of things were cheaper - including college, cars, and houses.   The expansion of mortgages from short-term loans in the 1920's to 10-15 year loans in the 1930's to 30-year loans in the 1950's didn't bring down the cost of houses, it just made them seem more affordable by stretching out the payment terms longer.     The same is true for cars - you can't sell $70,000 pickup trucks without 7-year loans.    Prices go up, when money is more easily obtained through loans.   It is a basic law of nature.

Pissed off about high housing prices?   Blame low interest rates.   A 3% mortgage buys more house than a 6% one - and housing prices go up accordingly, because people buy based on what they can afford to pay per month.  This is not rocket science.

Of course, like anything else, if we went "cold turkey" back to the old bankruptcy laws, the economy would be severely disrupted.   It would be like eliminating the home mortgage interest deduction - it would put some people out on the street, or at least force them to move to a less expensive house.  We are already seeing this with Trump's tax bill, which reduced deductions for taxes and mortgage interest in some high-cost markets.   But it is kind of hard to feel sorry for Tony Soprano struggling to pay taxes on his New Jersey mansion.

So, obviously, the idea doesn't have legs.  And I am being a bit facetious for even suggesting it.   But the discussion illustrates how we got to be where we are today.

And the one sure way to avoid this mess, of course, is to not step into it in the first place.  Maybe some folks not as smart as you are (hey you read this far, you are not a complete moron, right?) and get snookered into consumer debt or student loan debt or a risky mortgage.    But smart people really have no excuse, do they?