Radical Potential for Bankruptcy

Alexza, a Midwest native, struggled with credit card debt for 10 years, working multiple jobs—nanny, bartender and distillery tour guide—just to make minimum payments. Collection agencies called her constantly. She stopped responding, but that wasn’t enough to avoid financial worries. She went to inpatient therapy largely due to stress, which added to her debts. (Alexza asked to be identified by her first name only so she can speak candidly about her finances.)

She considered bankruptcy, but was afraid of what they would say about her. “You feel like a failure,” she told me. The cost of filing a lawsuit—in her case, about $1,800 to cover legal fees—was also prohibitive for someone with no savings. But in September 2021, while working in a cafe, she decided: “I can’t afford to continue barely marking time.” She borrowed money from a friend and met with a lawyer. Less than two weeks after she filed her claim, the calls from collection agencies stopped. By January, she had paid off nearly $20,000 in medical and credit card debt.

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Debt has long plagued many Americans like Alexza. People in the US today have more debt than they did a few decades ago. Household debt tripled from 1950 to 2022; As of 2020, 14 percent of Americans had so much debt that it outweighed the value of their assets. In this context, we can expect more people to seek the fresh financial start that bankruptcy can offer. However, less than 0.2 percent of American adults applied last year. Of course, not everyone with debt will benefit from bankruptcy, but many people might. At a time when so many Americans are struggling, why aren’t more people going down this path to get a second chance?

Until the early 19th century, Americans mired in debt had few mechanisms to get out of debt. But beginning in the 1810s and 1820s, political scientists Emily Zakin and Chloe N. Thurston write in Political Development of the American Debt Relief Programwhite Farmers in the southern and plains states, who sometimes had to take out loans when crops failed, began demanding that their political representatives do something to help. Thanks in part to these efforts, legislators began working to create a process by which people could take their creditors to court to have their debt erased; debtors will be able to start over. (This process was mainly aimed at helping indebted farmers keep their property; it did little for black sharecroppers, who did not own the land to begin with.)

The first federal law on voluntary bankruptcy was adopted in 1841. It was repealed two years later, but was reintroduced and expanded in 1867. As one senator who supported the 1867 expansion put it, the whole of the proposed law was that everyone should be able to “run away from their debts and become a man again.” This idea was radical: it turned the US into one of the most debtor-friendly countries on earth. Within three years of the American law’s renewal, nearly 43,000 debtors had paid off their debts.

Today, bankruptcy law in the United States looks very different. American laws remain more lenient than those of many other rich countries such as Australia and Austria. But over the past few decades, financial industry groups in the U.S. have pushed lawmakers to amend the bankruptcy system to give creditors priority over debtors. And with each regulatory update, “it gets harder and harder for consumers,” Robert H. Scott III, an economics professor at Monmouth University, told me.

In the late 1990s and early 2000s, bankruptcy was more common than it is now, and Americans successfully wrote off $4 billion in credit card debt a year. But then credit card lobbyists, worried about all that lost revenue, began promoting the idea that some debtors were abusing the system and raising the cost of credit for everyone. (“What are bankruptcies costing American families?” asked one of their newspaper ads.) They argued that mass bankruptcies were damaging the economy. However, so does the failure to help debtors: debt is one of the largest drivers of wealth inequality. In addition, many scholars argue that debtor-friendly bankruptcy laws promote entrepreneurship. But the creditors’ argument won, and after much effort, lawmakers passed the inelegantly named Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Since then, filing applications has become riskier, more burdensome and more expensive.

To file, debtors must make a down payment that can exceed $1,000—a strange catch-22 for those who can’t afford to pay their bills. The bankruptcy process can also affect your credit score. While research into exactly how filing affects scores over time is limited, bankruptcy can remain on your credit report for up to 10 years, potentially limiting your access to rental housing and bank loans. Depending on where you live and what type of bankruptcy you file, you may also need to give up your home or car to pay off your debts. People filing in some states have better luck. In states like Rhode Island, which has a generous $12,000 vehicle tax exemption, the risk of losing what may be your only way to get to work is low. Alexza, for example, was able to keep her old car. Homeowners in Texas and Florida are also lucky because their homes are virtually protected from lenders. But people living in places with less generous protections may have to suffer greater losses.

Deciding whether to file becomes more complex when you consider the different types of bankruptcy. While bankruptcy comes in many varieties, the two most common types for individuals are Chapter 7 and Chapter 13. Chapter 7, which Alexza filed for, wipes out most eligible debts, but also requires you to relinquish any property over a certain value for with some exceptions. . For the poorest Americans, this is the natural choice; 95 percent of people who file Chapter 7 keep everything they own, and 96 percent have their debts discharged.

Chapter 13, on the other hand, is essentially a long-term debt repayment plan. It has one major advantage – you can keep your assets – but overall it is much less forgiving. If you miss payments, your entire case may be dismissed and you will once again be solely responsible for paying off all of your debts. As Zakin and Thurston write in In their history of debt relief, Chapter 13 was created in the 1930s not to protect debtors, but as a way to return money to American business owners who worried that bankruptcies were costing them. One study conducted at the same time showed that few debtors could keep up with payments; today, only about half of people who file Chapter 13 end up debt-free, and some filers end up in a worse financial situation than when they started the process.

However, the legal system pushes many poor people who own little into Chapter 13. Some of the pressure is structural, since traffic tickets and other court fees that are disproportionately levied on the poor can only be forgiven through Chapter 13. 13. However, bias in legal representation also plays a role: a study published American Bankruptcy Institute Law Review found that when advising debtors with identical financial situations, lawyers were more likely to recommend Chapter 7 to white clients and Chapter 13 to Black clients.

In many other ways, bankruptcy does not benefit Americans equally. The typical applicant is likely to be a middle-income person, even though low-income Americans have the most debt relative to their income, suggesting the system may not be reaching them. This may be partly because many of the broadest exemptions are aimed at those who already own significant assets. Many states allow homeowners who file Chapter 7 to keep their home if it is worth less than a certain value, but renters may not necessarily be able to keep the property, which will likely be worth much less than the home. Meanwhile, many debts faced by former prisoners, such as restitution debts and parole fees, cannot be discharged during Chapter 7 or Chapter 13. And student loans have not become easier to discharge in bankruptcy court until 2022.

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The inequality doesn’t end there. While bankruptcy has failed to reach many Americans who need it most, it has become an escape hatch for the rich. Chapter 11 was designed specifically for wealthy individuals and corporations. This allows them to pay off creditors over the long term, sometimes in part at a lower interest rate, while their companies operate as usual in the name of protecting their employees’ jobs. Rudy Giuliani, Francis Ford Coppola and Donald Trump have filed for Chapter 11—in Trump’s case—six times. While the process is expensive and complicated, according to scientist Melissa Jacoby, it’s actually much friendlier than the bankruptcies the rest of us use.

The hassle of filing aside, perhaps the bigger barrier to bankruptcy for many Americans is stigma. Some scholars have compared this process to a kind of public repentance. During this process, the court takes a close look at your finances and choices. And because many people view debt as an individual failing, those going through bankruptcy can feel humiliated, even though in many cases debt is more accurately viewed “as a collective misfortune,” says Daniel Platt, a law professor at the University. from Illinois in Springfield, told me. In the 19th century, members of the debtors’ movement realized that their struggle was a common one. Glimpses of this thinking emerged after the 2008 financial crisis, when many people drew a clear line between corporate exploitation and individual money problems. But even in the absence of widespread economic disaster, when someone files for bankruptcy, “there is a failure,” explained Dali Jimenez, a law professor at the University of California, Irvine. “A lot of these failures are not the fault of the individual, but of the system, which has no other safety net for you.”

Of course, bankruptcy cannot save people from this systemic failure. For example, debt forgiveness cannot solve the problem of stagnant wages or rising housing costs. But for people like Alexza, it may provide some respite. At one point, she saw no way out of her debts. Then, before she knew it, they were gone.

Political Development of the American Debt Relief Program

TO Emily Zakin and Chloe N. Thurston