Journalism
Big Money & Politics/Who Gets Hurt? Soaked by Congress (Part 2)
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.