Soaked By Congress
By Donald L. Barlett and James B. Steele
Congress is about to make life a lot tougher--and more expensive--for people like the Trapp family of Plantation, Fla. As if their life isn't hard enough already. Eight-year-old Annelise, the oldest of the three Trapp children, is a bright, spunky, dark-haired wisp who suffers from a degenerative muscular condition. She lives in a wheelchair or bed, is tied to a respirator at least eight hours a day, eats mostly through a tube and requires round-the-clock nursing care. Doctors have implanted steel rods in her back to stem the curvature of her spine.
Her parents, Charles and Lisa, are staring at a medical bill for $106,373 from Miami Children's Hospital. Then there are the credit-card debts. The $10,310 they owe Bank One. The $5,537 they owe Chase Manhattan Bank. The $8,222 they owe MBNA America. The $4,925 they owe on their Citibank Preferred Visa card. The $6,838 they owe on their Discover card. The $6,458 they owe on their MasterCard. "People don't understand, unless they have a medically needy child, these kinds of circumstances," says Charles Trapp, 42, a mail carrier.
Why would Congress add to the burdens of folks like the Trapps? The family has filed for bankruptcy, and Congress wants to make it a lot more difficult for other Americans to do the same, a change that would hit especially hard at women. And poor people. And the recently jobless. And the sick.
Under legislation Congress is expected to take up soon, families like the Trapps will be required to go through a series of means tests to justify their medical and other expenses. That will cost them: more money in legal bills, more days lost from work, more mental aggravation. Even worse, in the end they still might not qualify for bankruptcy assistance.
Most members of Congress believe in what they are doing. Senator Charles Grassley, an Iowa Republican, speaks for many of his colleagues when he says, "I hope this bill does make bankruptcy more embarrassing--and more difficult. In fact, I plead guilty that that is a motive behind our legislation."
The House passed its version of the bankruptcy bill last year. The Senate enacted its bill in February. Now members of both chambers are meeting in secret to iron out differences and put their finishing touches on what they call the Bankruptcy Reform Act, which has the ostensible goal of curbing abuses.
What is the real reason Congress is doing this? Because the legislation is just what banks, credit-card companies, debt consolidators and other financial-services businesses ordered. To get it, they retained high-powered Washington lobbyists, among them Haley Barbour, former chairman of the Republican National Committee, and Lloyd Bentsen, onetime Senator and Treasury Secretary. The price tag for lobbying: more than $5 million.
At the same time, the lending industry poured contributions into the coffers of the national committees of both political parties and into the campaigns of individual lawmakers whose support was crucial. Some of the giving was appropriately timed. A $200,000 contribution to the National Republican Senatorial Committee by MBNA Corp.--which is to credit cards what Pepsi is to soft drinks--was delivered on the day of an earlier House vote on the bankruptcy bill. It passed handily, 300 to 125. The price tag for political contributions: more than $20 million. Says a Capitol Hill staff member who worked on the bankruptcy legislation: "If this were NASCAR, the members would have to have the corporate logos of their sponsors sewn to their jackets."
The Bankruptcy Reform Act is typical of legislation that Congress writes for the benefit of special-interest groups that are hefty campaign contributors--at the expense of ordinary Americans who contribute nothing. The proposed legislation would treat a bankrupt man's credit-card debt the same as his obligation to pay child support, meaning that MasterCard and an unmarried mother would compete for the same limited pool of cash. And the law would create hurdles intended to discourage or prevent people from filing for bankruptcy protection.
If, for example, a bankruptcy filer was left with more than $1,200 a year (beyond his basic expenses) over five years, that would be considered an abuse. If a mother tapped an ATM to buy necessities such as food or prescription drugs six weeks before filing for bankruptcy, the withdrawal could be considered a fraudulent transaction. If a family planned to file for bankruptcy, it would first have to undergo credit counseling, in some cases at its own expense. If a child or some other member of the family received medical treatment within 90 days before the bankruptcy filing, the bills could never be written off, no matter how poor the family.
To get into bankruptcy court, a filer would have to produce a variety of financial documents, including statements of projected monthly income and expected pay raises over the next year, and tax returns for the previous three years. No one of these requirements may look particularly onerous. But taken together, these and other provisions would impose additional burdens and legal costs on individuals and families already struggling to survive. "It's a thousand paper cuts," says Elizabeth Warren, a Harvard Law School professor and bankruptcy specialist. "And some people will bleed to death from a thousand paper cuts."
That includes people like the Trapps, who, after years of meeting their bills, were finally engulfed in a sea of debt through circumstances beyond their control. In that, they fit the classic image of a family seeking help in bankruptcy court. Contrary to the popular view of bankruptcy filers as free spenders who vacation in the Caribbean and buy expensive jewelry on their credit cards, the vast majority turn to bankruptcy court only after one of three events: loss of job, divorce or extraordinary medical expenses--in short, the kind of misfortune that can befall anyone. For the Trapps, it was two out of three. Just as the family was consumed by medical bills, Lisa Trapp had to give up her job as a mail carrier to manage her daughter's care.
Current bankruptcy law allows most individuals and families to file under Chapter 7. Here, assets--if there are any--are pulled together by a trustee and sold off. The bankruptcy filer may be able to keep his home and a few personal possessions. Retirement accounts and pensions also cannot be touched. Proceeds from the asset sale are divided among creditors. Outstanding debts, such as credit-card or medical bills, are discharged, meaning they do not have to be paid. Again there are certain exceptions: most taxes, child support, alimony and student loans cannot be discharged. Other individuals and families--those who are deemed able to pay back a larger portion of their debt--may file under Chapter 13. Here, the debtor agrees to pay a percentage of his income every month for up to five years to a trustee, who distributes the money to creditors.
During the 1990s, there were two filings under Chapter 7 for every one under Chapter 13. But the overwhelming majority of Chapter 13 bankruptcy cases ended in failure, with the debtors unable to complete the payment plan because they had insufficient income.
Under the legislation before Congress, new means tests would force more borrowers into Chapter 13--leading to still more failures--and would eliminate bankruptcy as an option for others. For this second group, life will be especially bleak. Listen to their future as described by Brady Williamson, who teaches constitutional law at the University of Wisconsin in Madison and was chairman of the former National Bankruptcy Review Commission, appointed by Congress in 1995: "A family without access to the bankruptcy system is subject to garnishment proceedings, to multiple collection actions, to repossession of personal property and to mortgage foreclosure. There is virtually no way to save their home and, for the family that does not own a home, no way to ever qualify to buy one." The wage earner will be "faced with what is essentially a life term in debtor's prison."
How did this come about? The credit-card industry seized on a sharp increase in bankruptcy filings in 1996 and 1997 to mount an intensive lobbying campaign for legislation that would make it easier to collect from borrowers who file for bankruptcy. A sophisticated public-relations blitz created the image of a bankruptcy system rife with abuse and in need of reform. That campaign told of rich people walking away from their debts, courtesy of bankruptcy court. It told of responsible families who paid their bills being forced to pick up the costs of more affluent Americans and others who were bilking the system. And it warned that bankruptcy had lost its "stigma."
The industry bankrolled studies to back its claims. In February 1998 the WEFA Group, a Philadelphia-based economics consulting firm, released a report contending that personal bankruptcies cost each American household an average of $400 a year. Paid for by MasterCard International and Visa USA, the WEFA study put the overall cost to the economy at $44 billion in 1997. Said Mark Lauritano, a WEFA senior vice president: "Clearly, the American consumer is facing a significant burden as the result of bankruptcy, both through higher prices and increased interest rates." The dollar-cost claims--which were disingenuous at best--would become the most widely quoted statistics in the campaign that produced the legislation now before Congress.
To apply pressure on lawmakers, the industry ran a series of ads in newspapers calling for bankruptcy reform. "What Do Bankruptcies Cost American Families?" asked a typical ad in the Washington Post on June 4, 1998. The answer: "A month's worth of groceries." Sponsored by a consortium of credit-industry trade associations, the ad showed a shopping cart filled with groceries. "Today's record number of personal bankruptcies costs every American family $400 a year. Now Congress has an opportunity to enact bankruptcy reform that reduces this burden and is fair to everyone...while ensuring that people who can pay their debts do so."
Other Visa- and MasterCard-financed studies asserted that many whose debts are discharged in bankruptcy could actually pay some of their bills but don't. The Credit Research Center at Georgetown University estimated that 25% of the debtors who file in Chapter 7 could repay more than 30% of their nonhousing debt over five years. The study warned that the continuing rise in bankruptcy filings would increase the cost of credit. It concluded: "Our results imply that the bankruptcy system itself is contributing to these rising costs by offering the opportunity to wipe out debt with a single signature to many borrowers that have the ability to repay."
Industry lobbyists promoted the themes. George Wallace, a lawyer representing the American Financial Services Association, contended that there is "growing statistical evidence that there's a significant group of American consumers who are using bankruptcy when they have some ability to pay. We have a system today that is broken, a system that provides a welfare benefit without a means testing."
Members of Congress echoed the industry line. Declared Representative George Gekas, the Pennsylvania Republican who shepherded the legislation through the House (and who has collected $30,000 in political contributions since 1997 from bankers and credit-card companies): "In 1997 Americans filed an all-time record of 1.33 million consumer-bankruptcy petitions, which erased an estimated $40 billion in consumer debt. Those losses are passed on to [other] consumers, resulting in a hidden tax for every American household. The only reasonable explanation is that the stigma of bankruptcy is all but dead. It is simply too easy to file."
Representative Bill McCollum, a Florida Republican who has received $225,000 from the lending industry, upped the ante: "Bankruptcy will cost consumers more than $50 billion in 1998 alone. That translates into more than $550 per household in higher costs for goods, services and credit."
Senator Robert Torricelli of New Jersey, a strong advocate of the Senate bill and head of the Democratic Senatorial Campaign Committee, last year pocketed a $150,000 contribution from MBNA. "What every American needs to understand is that somebody is paying the price," says Torricelli. "I believe this is the equivalent of an invisible tax on the American family, estimated to cost each and every American family $400 a year."
There is only one problem with all this rhetoric: it's not true. That's the finding of a TIME investigation based on interviews with those directly involved in the system--judges, lawyers, trustees, bankruptcy professors and the bankrupt themselves--along with an examination of court records across the country and an array of statistical evidence. While lenders do indeed lose money on those who fail to pay their bills, the U.S. Bankruptcy Court maintains no statistics on the types of debt written off--credit cards, medical, personal loans--or the total dollar amount discharged. But whatever that number may be, it misses the point: there is little more to be extracted from those in bankruptcy. Some people unquestionably use bankruptcy court to escape bills they could afford to pay, but their numbers are insignificant. The vast majority of bankruptcy filers have neither the income nor the assets to pay creditors. Most turn to bankruptcy as a last resort.
To understand how much at odds with the real world the bankruptcy scene imagined by Congress and the lending industry is, spend a moment with the people who have a street-level view of the system. Steven Friedman, a bankruptcy judge in West Palm Beach, Fla., describes the people who pass through his courtroom as "average citizens who have worked hard to obtain a decent standard of living and, through unfortunate circumstances such as medical problems or financial or job loss, are down on their luck." He adds, "The instances of abuse, where people who file bankruptcy are attempting to defraud their creditors or to be dishonest, are very [few]."
Says attorney Judith Swift, a former president of the bankruptcy bar in Dallas: "I keep a box of tissues in my office because people are mortified that they have to file bankruptcy. I've seen grown men break down. They take the financial crises as a sign of personal failure. A lot of people who come to my office have been holding down one full-time job and two piddly little part-time jobs, trying frantically not to have to file a bankruptcy. It's a very, very difficult decision for most people."
It was for Maxean Bowen, a single mother raising an 11-year-old daughter. A social worker in the foster-care system in New York City, Bowen helped rehabilitate parents with substance-abuse problems. In 1998 she developed a painful condition in both feet that made it difficult for her to walk. Because her job required her to make house calls, she had to give it up and go on unemployment, hoping the condition would ease up. Her take-home pay dropped from about $1,600 a month to $800. To get by, she borrowed from relatives and started using credit cards to pay for food, clothing, utilities and rent. "I thought, 'As soon as I get back to work, I'll try to pay these off,'" she says.
By 1999, when she got a job interviewing families in an office, she owed thousands of dollars to the credit-card companies--much of it in late fees. That's when the threatening calls and letters surged. "They would call me on the job," she says. "That was very embarrassing. They call you early in the morning. They call you late at night. Sometimes I get calls at 10 o'clock at night. And they are very nasty." To placate them, she sent $200 to $300 on occasion. "But when the bill came the next month, it seemed like it went higher," she says. "I was going crazy."
A co-worker suggested bankruptcy, and Bowen filed a petition in U.S. Bankruptcy Court in New York. She still gets calls demanding payment. At least now, she says, she knows her creditors can't attach her salary, no matter how ugly the conversation turns.
Bowen's discovery that she was treading water despite her partial payments--and that the outstanding balance never went down--is not unusual. A government study showed that by the time individuals and families seek bankruptcy protection, more than 20% of income before taxes is going toward paying interest and fees on their unsecured debt.
This helps underscore why the notion that debtors in bankruptcy court are sitting on many billions of dollars that they could turn over to their creditors is a figment of the imagination of lenders and lawmakers. Consider:
--A study of 1,955 Chapter 7 bankruptcy filers in 1997-98 by the Executive Office for U.S. Trustees, which monitors the bankruptcy system, concluded that "by the time they filed, they had little if any capacity to repay. In fact, most will have to increase income or reduce expenses to remain solvent after bankruptcy."
--The same study projected that the total amount that unsecured creditors, like credit-card companies, might be expected to collect from all Chapter 7 filers added up to "less than $1 billion annually."
--A study by two law professors at Creighton University, funded by the nonpartisan American Bankruptcy Institute, found that only 3.6% of Chapter 7 debtors would be able to pay more. "The vast majority belong in that chapter," the study stressed. "They have too little income after necessary expenses to repay unsecured debt. It is vital, therefore, that no undue burdens be thrust on that needy majority in order to flush out a small minority of abusers." The amount that might be collected: less than $1 billion.
--Congress's own investigative arm, the General Accounting Office, criticized two studies financed by the credit-card industry that purported to show that a substantial number of debtors could pay more. Questioning their assumptions, data and sampling procedures, the GAO said that "neither report provides reliable answers to the questions of how many debtors could make some repayment and how much debt they could repay."
As all of this suggests, there is little money to be squeezed out of those in bankruptcy, especially since trustees already collect about $4 billion from debtors each year, a sum that includes proceeds from liquidated assets. Even if they could find an additional $1 billion, the economic and emotional costs of doing so would far outweigh the return. To put it in perspective, the estimated $1 billion that might be collected would amount to two-tenths of 1 percentage point of outstanding revolving credit. If trustees were able to scare up another $4 billion--as the industry claims but few in the bankruptcy system believe possible--it would still amount to less than seven-tenths of 1 percentage point of revolving credit.
To further undercut claims by the lending industry that it needs get-tough legislation, 82 professors at 66 law schools, from Harvard to UCLA, last September signed a letter itemizing the consequences the proposed bankruptcy legislation would have on those in need of financial relief. It was sent to every U.S. Senator.
What would motivate a sizable majority of Congress to support such legislation? Money. Lots of it. In addition to the $5 million the lending industry spent on lobbyists who worked exclusively on pushing the bankruptcy bill through Congress, it shelled out $50 million that went to firms that lobbied on bankruptcy and other issues.
To be sure, some lawmakers who voted for the bill believe bankruptcy is out of control, that many filers just want to walk away from debts they can afford to pay. Some were angered by the procession of Hollywood entertainers and other wealthy prominent citizens who used the system in the 1990s. Some were annoyed by lawyers who advertised bankruptcy as an easy solution for overextended consumers. And some were troubled by what they saw as a decline in values. "We have had a general lack of shame or personal responsibility that used to be associated with paying bills or not paying bills and the filing of bankruptcy," said Senator Grassley, who has collected more than $100,000 in campaign contributions from credit-card companies and other lenders since 1997.
While the bill contains some genuine reforms, on balance the harm that it would do far outweighs the good. At the same time Congress has written legislation to make life more burdensome for low- and middle-income filers, it has declined to put any curbs on practices of the financial industry that are leading many individuals deeper and deeper into debt. Beverly Fox, a bankruptcy lawyer in Plantation, told TIME: "[You] have a family with an annual gross combined income of $35,000. I see they owe Citibank $10,700. At the time Citibank gave them that credit limit, which is almost 33% of their annual gross income, Citibank looked at their credit report, or should have, and could see that they already owed three or four other credit cards $3,000, to $4,000, to $5,000. They were already $15,000 in debt, and the banks continued to raise [the family's] credit limits because they are making the minimum payments. Once a family is over 30% debt-to-income ratio, it should stop using unsecured credit. But people don't know that. They think that because they've been approved for this higher credit limit, they can manage it." Because many people pay only the minimum amount due or a few dollars more, Fox says, they think everything is fine. But the balance on the cards "continues to grow, more as a result of the interest than the use of the cards."
Consumer advocates urged Congress to include in the legislation a provision requiring credit-card companies to spell out on each monthly statement the number of years it would take a cardholder to pay off the debt by making minimum payments, and how much that would cost overall. But that proposal went nowhere because it was opposed by the credit-card industry. The Senate version of the bill requires companies to include on monthly statements a toll-free number that cardholders can call to find out how long it would take them to pay off their loan.
Congress also turned back an amendment by Senator Paul Wellstone, a Minnesota Democrat, who proposed that lenders who charged more than 100% annual interest should be barred from collecting their debts in bankruptcy court. One-hundred percent interest? Actually, that's the bargain-basement rate. In some cases, interest rates run upwards of 1,000%.
Welcome to the world of payday lending, where annual interest rates would make Mob loan sharks of an earlier era blush in embarrassment. The business flourishes in working-class neighborhoods, where people run out of money before their next payday. The lender may charge up to $40 for a $200 loan to be repaid in two weeks. That's an annual interest rate of 521%. In exchange for the advance, the lender requires the borrower to write a check for $240, dated to coincide with his next paycheck. When the two weeks are up, the borrower may repay the loan or roll it over into a new one, further increasing the interest charges. If the borrower fails to do either, the lender cashes the postdated check. If it bounces, the lender sues and in some states collects up to three times the value of the check, plus interest.
An Illinois study found the average annual interest rate for such services in that state was 533%. One customer was charged 2,007%.
Senator Orrin Hatch, a Utah Republican who has championed the bankruptcy legislation, defended payday loans. Said Hatch: "These lenders provide a vital service to the poorest borrowers. With this check-cashing service, borrowers can get the emergency cash they need without telling the boss they need a cash advance or giving up their televisions and furniture."
The burgeoning payday-loan industry includes publicly owned companies. Ace Cash Express, Inc., of Irving, Texas, operates more than 900 stores in 28 states and the District of Columbia where it cashes checks, sells lottery tickets and provides money-transfer and bill-paying services. At a third of its stores, Ace offers payday loans. Its stock is traded on the NASDAQ.
For a fee of $30, Ace will advance cash for a $200 check for two weeks. That works out to an annual rate of 391%. Income from the company's lending operations jumped from 7% of its total revenue in 1997 to 12% in 1999.
The company's largest stockholder is Edward ("Rusty") Rose III of Dallas. Rose owns 11% of Ace's outstanding stock, according to documents filed with the U.S. Securities and Exchange Commission. Rose is the millionaire Dallas investor who helped George W. Bush turn a $600,000 investment in the Texas Rangers baseball team into $15 million--a 2,400% profit. Rose is one of the Bush Pioneers, the elite group of fund raisers who each promised to raise $100,000 for the Texas Governor's presidential race.
While Rose has done quite nicely from his investments, customers of Ace Cash Express and other payday lenders have not fared nearly so well. As you might expect, people who pay interest charges of 300% or more often end up in bankruptcy court. Says David Nixon, a lawyer in Fayetteville, Ark.: "The kinds of people who use payday loans are just barely getting by. They have jobs. They work hard. They try to pay their bills, but they come up short. Here's an easy way to get cash fast--at least it seems easy. But it's like getting on a treadmill. Once they get on it, it's impossible to get off."
Sometimes the people on the treadmill aren't those you might expect. In Greenwood, Ind., one of Ace's customers was Eva Rowings, 60, a retired high school Latin teacher. In 1995 Rowings began teaching part time at a reduced salary. "I tried to make ends meet," she says, "and I did pretty well for a couple of years, but then it all went downhill." She had four operations, including gall bladder surgery and orthoscopic procedures on both shoulders.
The debts piled up. She owed $5,800 in medical bills, $5,900 on credit cards and $8,100 in loans, plus other miscellaneous bills. Her debts matched her total annual income.
She began borrowing at two other payday-lending firms before turning to Ace, where she was "astonished at the number of senior citizens that were coming in each month." In a typical transaction, she borrowed $200 for 12 days and paid a $30 fee--an annual interest rate of 456%. If she missed a payment, she says, she would owe an additional $30. "By the end of the month," she says, "I would have no money." Finally, a distressed Rowings, who had always believed in paying her debts but was worn down by the endless dunning calls from bill collectors day and night, decided there was never going to be an end. She filed for bankruptcy. "It was humiliating," she says. "I wished I had never stopped teaching full time."
Another point should be noted. Rowings did not contribute to the election campaigns of candidates for Congress. Nor did Charles and Lisa Trapp. Nor Maxean Bowen. Their creditors, on the other hand, have contributed millions and millions of dollars to get the legislation they want--from thousands of small donations of less than $5,000 to hundreds of large ones ranging from $5,000 to more than a quarter-million dollars. Since 1997 credit-card companies and other lenders have given $2.2 million to the House and Senate Judiciary Committee members responsible for drafting the legislation, according to data compiled by the Center for Responsive Politics.
While the industry got much of what it wanted, Congress thus far has sidestepped an opportunity to enact a genuine reform and end one of the most blatant bankruptcy inequities--the homestead provision.
If you live in a $2 million home in Texas or Florida and file for bankruptcy, you are guaranteed you can keep your home. If you live in a $75,000 home in Pennsylvania or Delaware and file for bankruptcy, you may lose it. How is this possible? People who file for bankruptcy claim their exemptions under state law. In the case of the homestead law, the provision varies from state to state. Five states--Florida, Iowa, Kansas, South Dakota and Texas--have unlimited exemptions. Whether a residence is worth $10,000 or $10 million, it can't be touched by creditors. Five other states--Delaware, Maryland, New Jersey, Pennsylvania and Rhode Island--along with the District of Columbia, have no homestead provision, meaning a person can lose his home in bankruptcy. The value of the exemption in the remaining 40 states ranges from $2,500 in Arkansas to $200,000 in Minnesota.
Advocates of bankruptcy overhaul outside Congress have argued for years that federal law should be amended so that all Americans are treated alike, no matter where they live. But Congress doesn't see it that way. The reason? States' rights. Says Senator Sam Brownback, a Kansas Republican: "What is being attempted here is to take a right away from states that they've had for over a hundred years. It's contrary to states' rights."
Not exactly. The Constitution expressly gives Congress the power to establish "uniform laws on the subject of bankruptcies throughout the United States." Both the House and Senate bills contain homestead provisions. Neither deals with the basic unfairness of the exemption. The Senate bill would permit bankruptcy filers to retain up to $100,000 in equity in their home. Any amount over that would go to creditors. The House bill would allow homeowners to retain up to $250,000 in equity. But that cap would be meaningless, since any state could opt out of it under the bill. Key members of Congress are on record as saying there will be no bill that limits the exemption.
To understand how the current system works, how it would work under "reform"--most likely the same--and how it should work if Congress were crafting a law that treated all people equally, let's consider the story of two homeowners in bankruptcy. One is James Villa, a 42-year-old onetime stockbroker who lives in a $1.4 million home in Boca Raton, Fla. The other is Allen Smith, a 73-year-old retired autoworker with throat cancer who lives in a deteriorating $80,000 home in Wilmington, Del.
Let's begin with Villa. Through most of the 1990s, he was president, chief executive officer and indirect owner of 99.5% of the stock of H.J. Meyers & Co., Inc., a brokerage firm based in Rochester, N.Y., with branch offices in more than a dozen cities. H.J. Meyers was a boiler room. Its most significant feature, according to an investigation by Massachusetts securities authorities, "was the high-pressure tactics of management continually exerted on brokers, who then used high-pressure tactics on their customers." Brokers cold-called people urging them to invest in speculative securities and initial public offerings underwritten by the firm. Brokers "implied to investors that they were in possession of important nonpublic information concerning an issuer."
One investor bought stock on his credit card after being assured that he would double his $25,000 investment and that "nothing can go wrong." He didn't and it did. He lost $15,000 and was forced to take out a home equity loan to cover his losses.
Villa profited handsomely from the business. For himself, he collected cigarette speedboats and vintage autos and racing cars, from a 1957 Cadillac to a 1990 Ferrari. For his wife, he collected jewelry--a $22,000 Rolex watch, a three-carat $44,000 wedding ring and $9,000 diamond earrings.
In October 1998, Massachusetts securities authorities ruled that H.J. Meyers had engaged in fraudulent and unethical practices. They revoked the broker-dealer registrations of the firm, Villa and four of his associates. Shortly before the crackdown, H.J. Meyers closed its doors, and in November 1998 Villa packed up and headed for Florida and its generous homestead exemption. He left behind a countryside littered with investors who had lost money, including some whose retirement savings had disappeared. Some of the unlucky H.J. Meyers clients took their cases to arbitration, won awards and filed claims in Villa's bankruptcy case.
How much the creditors will eventually receive is up in the air. Charles Cohen, Villa's lawyer, says that "obviously, Mr. Villa is going to try to pay back everything he can. How much I can't tell you at this point." In the assets column, Villa's most valuable possession is his $1.4 million Boca Raton home. But it's beyond the reach of his creditors, thanks to the homestead exemption.
By contrast, 1,100 miles to the north, in Wilmington, Del., 73-year-old Allen Smith is about to lose his home in bankruptcy court. Smith was born in Birmingham, Ala., and served in the Coast Guard during World War II. After his discharge in 1945, he attended an auto-mechanics school in Detroit and then went to work as a metal finisher and body repairman for Chrysler. The company transferred him to its Delaware plant in 1959, where he worked until he was forced out after 35 years during one of the automaker's downsizings.
Smith bought his modest home in Wilmington in 1964. In 1970, at age 44, he married. His wife Carolyn worked at a neighborhood florist. "I was living good, having a good time," Smith told TIME, "giving my wife everything she needed. Tried to make her happy."
When Smith lost his job at Chrysler in 1982, he was too young to collect Social Security so he took a new job as a security guard. Two years later, his world began to unravel. "Everything just went bad at one time. It waited until I got retired. If I had been working, it would have been different, but I had retired before everything started to happen."
"Everything" began with his wife's diabetes. "She just lost her toe in 1984," he says. Then "they had to cut her leg. And they had to keep cutting it off." Finally, they amputated both legs. To accommodate her wheelchair, Smith built a ramp and made other renovations. To pay for it all and to keep up with the monthly payments on all his credit cards, he borrowed against his house, which had been paid off. "I had what they called triple-A credit," he says.
Along the way, Smith's physical condition deteriorated, and he had to quit his security job. He developed throat cancer and now speaks through a voice box. "I got sick," he says. "I got a thyroid [condition], cancer, low sugar, high blood pressure, heart murmur. I got everything. I'm lucky to be alive."
In June 1998 the Smiths filed a bankruptcy petition under Chapter 13, with the understanding they would make $100 monthly payments to a trustee who would distribute the money to creditors. By that time, the loan against their home had swelled to $64,000, and they owed $51,000 on their credit cards and charge accounts, double their annual income. That November, Carolyn Smith died. With the loss of her Social Security income, Smith struggled. His situation was further complicated by a run of misfortune. He was hospitalized after a stroke; he had cataract surgery; the friend who promised to collect his pension and Social Security checks and make his mortgage payments didn't, and the mortgage company moved to foreclose. That's when his Chapter 13 case collapsed--as happens in two-thirds of all Chapter 13 proceedings--and he was switched to Chapter 7. Now he's awaiting his discharge. He will lose his home and move to Toledo, where he will live with a niece. "I wasn't planning to move," he says. "It hurts. I don't want to be nobody's responsibility because I've always been my own man all my life."
To create a level playing field for everyone, Congress would need to enact a flat exemption that covers all assets--from home to pension. Otherwise there is the kind of inequity described by A. Jay Cristol, the chief U.S. bankruptcy judge in Miami:
"Let's assume you have two very decent, honest people and one of them has a million-dollar home and one of them has a million dollars in cash and they go into bankruptcy. The one with the million-dollar home keeps a million bucks and the one with the million dollars in cash gives all but a thousand dollars in cash to the trustee."
The same scenario applies to retirement accounts. The wealthy investor who puts $1 million into a retirement plan gets to keep the money. The middle-income family with $10,000 in a savings account loses it.
The simple solution: Establish one exemption that covers all assets, from homesteads to pensions. Says Judge Cristol: "Why not just say you can have as a fresh start $55,000 or $100,000, or whatever the legislature decides is the right amount, and it doesn't make a difference if it's equity in your home or whether it's cash in the bank. That's what you get to keep. And that would be fairer and simpler, and the poorest people would be treated the same as the wealthiest people. But as it is now, the worse off you are, the worse you're treated."
Lenders and lawmakers maintain that the bankruptcy laws need to be toughened to reverse the sharp growth in filings during the 1990s. While bankruptcy cases did indeed rise through 1998, they fell in 1999. But what Congress and credit-card companies neglected to say was that the increase was largely attributable to one group--women with modest or low incomes. For this group, reform is going to be especially bad.
Although courts do not keep data on the number of men, women and couples who file for bankruptcy, academic studies have developed estimates. Research conducted by Elizabeth Warren, a Harvard law professor, and Teresa Sullivan, dean of graduate studies at the University of Texas, shows the pattern. From 1981 to 1999, bankruptcy filings by women shot up 838%--four times as fast as for all others--jumping from 53,000 to 497,000. In contrast, filings by husbands and wives rose just 138%, from 178,000 to 423,000. Once a small minority in bankruptcy court, women now comprise the largest single bloc--39% of all personal-bankruptcy cases--more than men or couples.
Despite all the glowing economic indicators that point up--stock-market indexes, employment, corporate profits--the income gap continues to widen, and those most often found toward the bottom are women. Even women in jobs that pay solid middle-class wages find themselves in financial trouble and must seek bankruptcy protection when they are overwhelmed by debt following a breakup or a divorce.
Women such as Lucy Garcia. The 26-year-old mother of two boys, ages 9 and 6, Garcia is a payroll coordinator at the Sheraton New York, one of midtown Manhattan's largest hotels. Assigned to the food-and-beverage department, she helps compute wages, overtime payments and other payroll items for the department's 800 employees. And she balances the department's checkbook.
But in her personal life, balancing finances hasn't been easy since Garcia and her sons' father separated more than a year ago. Family finances had always been tight, and with just one paycheck, Garcia found herself using credit cards to buy the basics. "Sometimes when you don't have money and you need to buy things for your kids, like food and stuff like that, you use the credit card because it's so easy," she says.
After payroll deductions for taxes and Social Security, she had about $1,850 a month to pay her bills. After her rent of $580, a car loan of $400 and an insurance premium of $200, she was left with $670 a month to feed and clothe the boys and herself and pay for her utilities, child care, other miscellaneous expenses--and her credit-card bills.
To bring the ballooning debt under control, she stopped using credit cards and made nominal payments on her accounts. "I thought if I sent them something, $10 or $20, they would leave me alone," she says. But she only fell further behind. Even in months when she didn't use the credit cards, the amount she owed rose because of late-payment penalties and interest charges. Before long, she needed to pay at least $300 a month just to stay even.
Unable to do so, she became increasingly short of cash and unable to pay her bills--rent, car, credit cards. She began alternating payments--the rent one month, credit cards the next, making a car payment after that. That didn't work either, and soon she was getting dunning letters and phone calls. One credit-card company threatened to attach her wages.
"It is just so frustrating to know you owe this much money," she says. "I wish I had the money to pay it off and be O.K. I can't sleep at night. I have tried to not let it affect me with my children. Kids don't know. They say, 'Mommy, I want this.' 'Can we do that?' My God, if they only knew."
When she fell behind in the rent and her landlord warned that he would evict her, she knew she had to do something. She turned to a Manhattan consumer-bankruptcy lawyer, Charles Juntikka. Garcia was typical of many of his clients--embarrassed by her debts, upset over not being able to pay her bills, not knowing where to turn. "There is this image of middle-class people running up huge debts, then declaring bankruptcy and laughing at everyone," he says. "I've just never seen that. These people hurt."
Juntikka filed a petition for Garcia under Chapter 7, seeking to have her unsecured credit-card debt discharged. Garcia says she intends to give up the car to further reduce her debt load, and Juntikka is optimistic she will get a fresh start. Now, for the first time in months, Garcia says, she can sleep at night.
But if the Bankruptcy Reform Act pending in Congress were the law, Garcia would not be able to rest so easy. "Lucy wouldn't be able to obtain a discharge under this bill," says Juntikka. "Under the new standards Congress has put in the bill, she earns too much money. She could not get a discharge. She would still be stuck with some of the credit-card bills she can't pay now."
The standards referred to by Juntikka concern the means testing that allocates a fixed amount of expenses to debtors in computing their ability to pay their debts. And as Juntikka interprets them, Garcia would not be able to seek relief in Chapter 7. Even if by some chance she could prove her case in court, he says, the process would be lengthy and costly. "People aren't going to be able to deal with these draconian measures," he says. As a result, some people will be permanently indebted to credit-card companies, others will see their wages attached, some may lose their homes. "This is going to cause so much misery," he says.
Warren, the Harvard law professor and longtime student of bankruptcy, marvels at how a piece of legislation that could penalize so many people has come this far. "This is one of those things with low visibility, and therefore it's easy to give in to the interest group," says Warren. "It all flies below the radar screen. That's the best place for the lobbyists. That's where the pickings are the fattest. The only way to explain it is campaign contributions." --With reporting by Laura Karmatz and Andrew Goldstein and research by Joan Levinstein
Second in a series of Investigative Reports on campaign finance
With reporting by Laura Karmatz and Andrew Goldstein and research by Joan Levinstein