It’s been a roller-coaster decade, to say the least, for the financial industry and the consumers and businesspeople who rely on it: an anxiety-stirring climb, a terrifying fall, and a painfully slow recovery.
Today, let’s focus on one of this year’s less-noted anniversaries: 2005’s rewrite of federal bankruptcy law. That law played a largely unrecognized role in the economic crash that followed, so it’s a reminder of the danger of unintended consequences and of the importance of financial reform — particularly, of getting reform right.
And, hey, we can thank Donald Trump himself for reminding us of it — a feat the Donald accomplished during a recent Republican presidential debate, when he blithely dismissed questions about his four business bankruptcies.
“Four times, I’ve taken advantage of the laws. And frankly, so has everybody else in my position,” Trump said, calling the lenders he dealt with “total killers. These are not the nice, sweet little people that you think, OK?”
Hark back a decade, to when the economy was booming, the housing bubble was inflating, and the finance industry was complaining — as it had since the 1990s — about the rise in personal bankruptcies. After years of lobbying, it won bipartisan backing for 2005’s Bankruptcy Abuse Prevention and Consumer Protection Act.
The finance industry urged lawmakers to ignore factors such as overly easy and tricky credit or lagging middle-class incomes. It achieved its key goal — making it harder and costlier for consumers to go to court to escape debt — largely by arguing that bankruptcy was booming because it had “lost its stigma.”
The evidence supporting that claim was weak, and countered by advocates such as Elizabeth Warren, then a Harvard law professor known for her research on bankruptcy and books such as 2000’s The Fragile Middle Class. Warren argued that the vast majority of bankruptcies were caused by a personal or financial shock such as job loss, divorce, major illness, or accident.
“The problem is not that people won’t pay,” she told me then. “It’s that they can’t pay.”
I caught up last week with Warren, now a U.S. senator busily urging her colleagues to address “the unfinished business of financial reform,” to ask about Trump’s remarks and also about the ‘05 law’s rarely acknowledged role in the Crash of 2008 — a role documented in a 2012 study by New York Fed economists.
In many years of writing about debt issues, I told her, I’ve almost never encountered a consumer who wasn’t mortified by even the prospect of a bankruptcy. Few ever agreed to be quoted by name, even those trapped by practices eventually outlawed, such as retroactive penalty rates. One young couple drowning in debt from credit cards first pitched to them as they began college told me they had been “deeply shamed” by a chart showing the rates, some nearing 30 percent, at which their balances piled up.
On the other hand, Trump’s comments point to one place where bankruptcy’s stigma does seem all but vanished: corporate bankruptcy.
Warren sees a basic divide: Consumers and small-business owners almost always view bankruptcy as a last, desperate resort, she says. Many corporations see it differently.
“Unlike Donald Trump, when families go into bankruptcy the humiliation runs deep. But when a business executive makes the decision, he shrugs and says, ‘Hey, it’s just business.’ No shame at all.”
Our law has long recognized a broad, societal value to the “fresh start” of both corporate and personal bankruptcy, balancing the duty to repay debts against the risk of wider, collateral damage if those debts are always treated as inviolable. That makes it especially ironic that, by partly closing a safety valve that allowed debtors to write off unsecured debt, the 2005 law helped cause the mother of all collateral damage: As the New York Fed showed, many debtors who couldn’t file for bankruptcy wound up defaulting on subprime mortgages, helping to trigger the ‘08 crash.
Warren says the law continues to hurt the economy in other ways, such as by making private student loans unrelievable in bankruptcy, just like federal student loans but without the same justification. Today’s $1.2 trillion in student debt, often for worthless classes at for-profit schools, is slowing the recovery.
“The government never concentrated on the debt overhang. The recovery has been much more sluggish than it would have been if families had been able to get back on their feet faster,” she says.
Warren’s priorities today include protecting the new Consumer Financial Protection Bureau and ending “too big to fail,” in part by reinstating the Glass-Steagall Act, the wall between commercial and investment banking repealed in 1999, when deregulatory orthodoxy ruled both parties.
Though Warren has GOP allies, the fight she leads is often painted in partisan hues. But it’s not — or shouldn’t be — a fight between D’s and R’s. It’s a fight between blind adherence to ideology and a belief that government has a role to play in setting the rules. Sometimes, that means admitting it took a wrong turn.
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