Thursday, February 17, 2005

Bad Arguments for Bankruptcy Reform

As the debate over bankruptcy reform has evolved, defenders of the proposed legislation have begun to emerge. One of the most vocal of these defenders has been Todd Zywicki of The Volokh Conspiracy. In two separate posts (here and here) he argues that credit card companies are not responsible for increasing bankruptcy rates and that medical expenses are not responsible for 50% of bankruptcies. To address these issues, I shall employ the always entertaining "So What?" defense.

Let's proceed.

Zywicki’s discounts the role of credit cards in bankruptcy by arguing that there has been no measured increased in household indebtedness.

First, the argument doesn't make much sense from an economic perspective. Unless credit cards have somehow removed the borrowing constraint on individual credit (and no one has provided any evidence that it has), there would be no reason to believe that credit cards would increase overall household indebtedness.

Instead, economic theory would predict that the primary effect of the introduction of credit cars would be to shift around patterns of consumer credit use, by substituting credit card debt for other less-attractive forms of credit, such as pawn shops, personal finance companies, and retail store credit (such as from appliance and furniture stores). In fact, this is what the evidence indicates has actually happened.
He continues by suggesting that the measured correlation between high credit card debt and bankruptcy is explained by the credit cards role as the credit line of last resort and the strategic debt repayment employed by those intending to file bankruptcy.

First, the correlation between credit cards and bankruptcy may reflect the unique role of credit card borrowing in the downward spiral of a defaulting borrower. Credit cards provide an open line of unsecured credit to be tapped at the discretion of the borrower. Thus, for many debtors credit cards are a "credit line of last resort" to stay afloat to avoid defaulting on other bills…

Second, a debtor's increased use of credit cards preceding bankruptcy also may reflect strategic behavior taken in anticipation of filing bankruptcy… Given the choice between defaulting on secured or nondischargeable obligations on one hand versus dischargeable credit card debt on the other, the incentive is to use credit cards to finance payment of nondischargeable and secured debt.
To these arguments, I respond So What? The crux of these arguments is that individuals, for various reasons, are shifting debt so that it might be dischargeable through a Chapter 7 filing. This offers no proof that individuals are being financially irresponsible. In fact, it's quite the opposite. People who are deeply in debt are transferring as much of that debt as possible to dischargeable credit lines, thus putting themselves into the best possible financial position post bankruptcy. It would be foolish to do anything less.

Moreover, the credit card industry has been knowingly handing out dischargeable credit lines of their own accord. Surely, they must have realized that their clients might choose to use this credit in such a fashion. And if they didn't, So What? Why is their recklessness cause for systemic reform?

Zywicki then moves on to the role of medical expenses in bankruptcy. To challenge the often cited 50% figure, Zywicki questions the methodology used in the supporting research.

In fact, the "finding" in this article of a massive rise in medical bankruptcies appears to actually be a result in the way in which medical bankruptcies are counted, rather than an actual change in the numbers. They draw their data from two sources. First, self-identified bankruptcy filers who say that some medical event "caused" their bankruptcy. [Emphasis in original]



Among the self-identified factors that are listed as "medical" causes of bankruptcy in Exhibit 2 of the article are the following: illness or injury, birth/addition of new family member, death in family, alcohol or drug addiction, uncontrolled gambling. First, it is surely open to question whether uncontrolled gambling or a death in the family really should count as a "medical" problem. More generally, the category "illness or injury" is very broadly defined in the study, and there is no apparent limit on the time frame over which the illness or injury occurred, or the severity. So classifying all of these factors as medical problems that have "caused" bankruptcy certainly seems open to question. [Emphasis added]
First, I'm a little puzzled by his assertion that it is "open to question" whether or not "death" should count as a serious medical problem. I mean, if there is a medical problem more serious than death I'd like to hear about it. But, in a more general sense, I'm not certain how valuable the opinion of a bankruptcy specialist is in establishing the seriousness of various medical conditions.

However, in the spirit of fairness, I will grant him that the study possibly overstates the role of medical expenses in bankruptcy. Likewise, I will stipulate that the causal relationship between medical expenses and bankruptcy is not established by the study and that media claims to the contrary are misleading.

Which brings me to my core argument -- So What? Even if medical expenses aren't causing bankruptcy directly, they are unquestionably a significant contributing factor in many cases. Given that fact, what matters is not the number of medical expense related bankruptcies, but the manner in which those bankruptcies are handled by bankruptcy law. David Welker of Ex Parte (which is managed by the Harvard Federalist Society, if you can believe that) backs me up on this point.

I am skeptical of the 50% number, but on the other hand, the whole debate is irrelevant. Does the analysis change if a mere 40% of bankruptcies are "caused" by medical problems. How about 30%? What if it is a mere 10%? Regardless of the number, any reform legislation should deal with such cases appropriately. Even a 10% number would be over 150,000 people a year. Zywicki concedes that some bankruptcies are caused by medical conditions and claims that the bankruptcy legislation deals with these appropriately. But whether these cases are dealt with appropriately or not, that is the real question! If the legislation deals with these cases appropriately, then it would not matter if the number were even much higher than 50%. After all, those cases are resolved appropriately. On the other hand, if these cases are not handled appropriately, you are going to be dealing with tens (maybe hundreds) of thousands of people a year in an unfair and innappropriate manner.
And so Zywicki may have caught the opposition playing politics with the numbers on this issue. To that I say "Touché!" However, I fail to see how this advances the argument for bankruptcy law reform.

Approximately 1.5 million people file Chapter 7 bankruptcy every year. Some of those are high interest earners who could repay at least some portion of their debts. I would happily support reforms designed to eliminate that sort of abuse. However, if those reforms prevent legitimate use of bankruptcy protections, I'm out. Given the enormous profitability that is ubiquitous to the industry, I'm willing to accept abuse to provide protections to the truly vulnerable (besides, all systems have noise). Until there is an affirmative demonstration of the need for reform and the ability to employ it effectively, I cannot support this endeavor.

I'm still waiting.
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