Resolved: The Time Has Come for
Means-Testing Consumer Bankruptcy

A Debate

Sponsored by the American Bankruptcy Institute
Wednesday, February 18, 1998
1:30-3:00 p.m.
Room 2237, Rayburn House Office Building
Nelson Reporting Associates, Inc.
202-434-8171

Prepared, Web posted and Copyright © February 25, 1998, American Bankruptcy Institute.


JUDGE WEDOFF: We should get started.

My name is Gene Wedoff. I'm a bankruptcy judge in Chicago and also a Director of the American Bankruptcy Institute and Co-chair of its Consumer Bankruptcy Committee. On behalf of the more than 6,000 members of ABI, I'm delighted both to welcome you to this debate on consumer bankruptcy law and to serve as moderator.

Consumer bankruptcy is very much in the news and on the minds of policymakers in Washington. Sharp increases in the number of consumer bankruptcy cases have been extensively reported and the increased filings have led some to conclude that bankruptcy has lost its stigma--that many individuals file bankruptcy not because they need to but simply because it's easier than paying their bills. In response to this perception, a major change has been proposed in the way bankruptcy relief is provided to consumers. This change, referred to by its advocates as needs-based bankruptcy, would require that individuals who have the means to do so must repay all or a portion of their debt in order to obtain bankruptcy relief.

The topic for today's debate focuses on this proposed change. Should consumer bankruptcy law be needs based, requiring means-testing of individual debtors? And if so, how should such a change be enacted into law?

We are fortunate to have some of the mostknowledgeable people in the nation to discuss this issue with us. Our principal debaters are George Wallace and Gary Klein.

George is a partner with the Washington law firm of Eckert, Seamans, Cherin and Mallot. He is counsel to the American Financial Services Association, a major supporter of needs-based bankruptcy. Gary is a staff attorney at the National Consumer Law Center in Boston, and the author of its publication Surviving Debt. He has frequently testified on bankruptcy issues before congressional committees as an advocate for consumer rights.

To present a congressional view of the issue, we have with us a member of the House Judiciary Committee who is intimately involved in the consumer bankruptcy debate. Representative Jerrold Nadler of New York is the sponsor of proposed legislation that contains a number of proposals to protect consumers. Representative Bill McCollum of Florida, a sponsor of legislation that incorporates the needs-based approach was scheduled to be with us but was required to cancel his appearance due to emergency matters arising in his district.

Last-minute emergencies also affected two professors who had planned to question our debaters. Weather kept Elizabeth Warren in Boston, and Richard Flint is ill in Texas. However, we are fortunate to be joined by twooutstanding alternative interrogators.

Since 1986, John Bernard Corr has been a professor of law at the Washington College of Law at American University. He is co-author of the "Bankruptcy Code Manual," published by West, and is a frequent recipient of outstanding professor awards based on student ballots.

Deborah Williamson is shareholder in the San Antonio, Texas firm of Cox and Smith Incorporated. She is President-elect of ABI, executive editor of the ABI journal, and a frequent author and speaker on a wide range of bankruptcy topics.

Here is the format for our debate: Mr. Wallace, supporting needs-based bankruptcy, will open with a 15-minute statement; Mr. Klein will follow with a 15-minute statement in opposition. Each debater will then be allowed a 5-minute rebuttal. Representative Nadler will present his comments and questions for 10 minutes. And then the program will conclude with questions from myself and from our two interrogators. Both the questions and answers are subject to time limits.

I am committed to enforcing all of the time limits strictly and each speaker will be signaled to show the time remaining. I must warn you all that, in my judicial capacity, I am sometimes required to cut off even the most compelling arguments, and I fully intend to honor mycommitment to the clock today.

With that, I would ask Mr. Wallace to make his opening statement.

OPENING STATEMENT OF GEORGE J. WALLACE

MR. WALLACE: Thank you, Judge Wedoff. It's always good to be under control.

As we approach the 21st century, consumer bankruptcy as we know it must be changed. First, it must be changed because it is part of the safety net that has been created to help people in need in this country, but it is part of that safety net which has never been, and is not now, needs tested. In other words, it is available both to those who are in need and those who cannot demonstrate that they are in need.

The present Bankruptcy Code is based upon a statute that was initially enacted in 1898 after two experiments during the 19th century. It is a simplistic approach to dealing with problems of overburdened debtors. It produces a simple solution to their problems. It says that if you will file bankruptcy, your unsecured debts can be discharged. They can be discharged even though you have some or considerable ability to pay.

Behind this central principle of the Bankruptcy Code is this reality: that you or I could tomorrow file bankruptcy if we wanted to, and discharge our unsecured debts. Now, there are some controls on that, but they are not controls that exist in the statute.

Since 1898, there have been two practical controls on the use of bankruptcy by those who borrow money. The first has been economic self-interest. The way bankruptcy is structured, it may not be good for me, as an individual economic matter, to file bankruptcy because I have too many assets that are not exempt. Therefore, it doesn't make economic sense for me--for example, if I have $100,000 boat free and clear of my creditors--to file bankruptcy to discharge $50,000 of unsecured debt. And I will not do so. Nobody does.

But there is an asset that is very, very important to me which bankruptcy, at least Chapter 7 bankruptcy, does not reach, and that is my future income. It has been a principle since 1898 that from the moment that I file bankruptcy, my future income is free from the claims of my unsecured creditors. Now, that produces an opportunity for abuse. And that opportunity is one which should have been, and has been in the past, controlled by a second practical limit upon the use of bankruptcy, and that's been a sense of personal responsibility amongst Americans that they will not use bankruptcy and shed their contractual, their moral obligations, to repay people that have loaned them money, unless they are in dire need. We call this bankruptcy stigma sometimes, but it is essentially a feeling of personal responsibility that has controlled the abuse of bankruptcy. The statute is vulnerable to abuse, but a sense of personal responsibility amongst Americans has controlled its use.

Now, in 1984, the statute was amended to try to impose at least some limit upon the abuse of bankruptcy in the way I'm discussing it. And that has a simple statutory phrase, it says that if you file Chapter 7 and you are substantially abusing Chapter 7, your case can be dismissed. But this provision has not been effective. Only a handful of cases have been resolved under this provision since it was enacted in 1984 despite growing statistical evidence that there's a significant group of American consumers who are using bankruptcy when they have some ability to repay.

Since 1938, there's been another form of relief available to American consumers who become overburdened with debt; it's called Chapter 13--I think many of you know about it. Chapter 13 is a repayment plan. It doesn't require you by any means to repay all of the debt you owe, only the amount of debt that you have the ability to repay. Chapter 13 has, since 1938, been entirely optional with the debtor. You can't force somebody into Chapter 13.

Now, with that structure being there, something has happened recently. In 1978, the Bankruptcy Act that was enacted in 1898, was revised by something called the Bankruptcy Code. One of the central principles of the Bankruptcy Code was that the stigma behind bankruptcy--thesense of deflated personal responsibility--should be removed. The debtors who were in need should not be burdened with that. It was an attempt to be generous to those who were in need.

Since 1978, something remarkable has started to happen. In 1978, there are approximately 172,000 consumer bankruptcy filings. By 1980, 287,000. By 1990, 718,000 consumer bankruptcy filings. In 1995, 874,000 bankruptcy filings. In 1996, 1.1 million bankruptcy filings. And by 1997, 1.35 million estimated personal bankruptcy filings. That's an extraordinarily high increase in the use of a social welfare program that is not means-tested. Certainly, that is suspicious.

Why are people using bankruptcy more and more? Are they doing it because they have more problems with debt? Perhaps that's the case. If so, there's nothing wrong with that because the bankruptcy statute is an appropriate part of our system of dealing with those who are in need. On the other hand, if it's being abused, the size of the abuse is increasing enormously. If 10 percent or 20 percent of American consumers in 1978 were abusing bankruptcy, that 10 or 20 percent would have amounted to 17,000 or 20,000 individuals. But today, 10 percent of 1.35 million filings is 135,000 people. That's a lot of people who are going through the system and who are potentially abusing.

And make no mistake about it, the person who pays for that abuse is not the creditor. The way the consumer credit system works, over the long run, the person who pays for that abuse is the American consumer--him or herself--who pays higher cost of credit for the privilege of using that credit in order to fund those people who do not repay their debts.

There are other reasons why we ought to reform the Bankruptcy Code, and that is because there is strong statistical evidence that abuse is actually occurring. That strong statistical evidence is shown most clearly by the study by Barron and Staten which, even after deduction for payment in full of all secured debts and priority debts, found that approximately 30 percent of those who are filing and using Chapter 7 would have ability to pay approximately 30 to 40 percent of their unsecured debt. Think of that for a moment. That's a lot of people. And that raises a substantial question about what this statute is doing.

Finally, change is necessary because the American public is concerned about bankruptcy. Polls have shown that the American public, when asked whether or not it is appropriate for those who have some ability to pay to file bankruptcy, the answer is firm "no" by an overwhelming majority.

This is an issue which is timely. It's an issuewhich needs to be done with. And if it is not dealt with now, if bankruptcy filings continue at the rate that they are increasing, the problem will only get larger and the American bill-paying consumer will only pay more.

Now if bankruptcy reform needs to occur, the question is: can it be done efficiently and effectively? This is an important question, of course. But this is America. And in America we have generally been able to do what needs to be done. If we have a welfare program that is not needs tested, surely we should be able to figure out a way to do that. And two bills in Congress today, H.R. 3150 and H.R. 2500 show the way in which that can be done. There are other bills, as many of you know, in Congress, but I'm going to focus on those two because they demonstrate a particular approach to how this can be done efficiently and effectively.

H.R. 2500 and H.R. 3150 set up a system in which the debtor's ability to repay in whole or in part the unsecured debt that they owe can be worked out in advance, not by the court, not by a bureaucracy, but by the debtor who is preparing the petition that they are going to file to start the bankruptcy petition. That's the simple way you do it. Already, debtors have to prepare a schedule of income and expenses in order to prepare a petition which they will file. That's done for them either by a professional--by abankruptcy petition preparer--or by themselves. The proposal is that that schedule will be revised so that a simple mathematical calculation can be made to determine that debtor's current net income, which is essentially the difference between what they're earning at the time they file the bankruptcy and what they then spend in expenses. Those expenses are limited by a template that the Internal Revenue Service now uses in working out arrangements with taxpayers to determine whether or not their expenses are excessive. And that template would be applied to the debtor's expenses, and then a quick determination would be made.

If the debtor's income is more than 75 percent of national median income, then they would have to go forward and have their net income determined for the purposes of determining eligibility for Chapter 7--not Chapter 13. They can always file Chapter 13. Bankruptcy relief is always available to them if they are in need--either Chapter 13 or Chapter 11. But, the question of whether they can get the easy discharge of Chapter 7, will be subjected to a means testing.

So the first question is whether or not they have income more than 75 percent of national medium income. Rough estimates at this time indicate that, indeed, 75 percent or so of current filers would be removed by that simple test. In other words, 75 percent of the people would not even haveto inquire into their net income. The remaining people would, and their net income would be determined. And that net income, then, if it was great enough to pay 20 percent of their unsecured debt or at least $50 a month, then they would have to use Chapter 13.

Now, that seems to be a simple, straightforward calculation. It's basically a three-step calculation--national medium income 20 percent, and the $50 a month test--and I think it can be easily handled by a simple form that is handled by the debtor.

Now, some people say: well, what happens if the debtor's expenses are unusually high. An exception is made available for extraordinary expenses. A simple exception, that, in fact, is administered entirely by the debtor. The debtor fills out the form and says: I have extraordinary expenses, for example, I have a child that is disabled; I have unusual expenses. I am on an iron-lung; I have some find of a major medical expense. They fill that out. The debtor files that paper with the court. That then is determinative unless somebody objects.

Now, will this system require some enforcement? Oh, yes. Any welfare system requires some enforcement, and this is part of our safety net. Of course it's going to require some enforcement. Two forms of enforcement are suggested. One is a straightforward, random audit which willoccur in a certain number of cases. And the other is a review by the trustee of those cases where the trustee finds a particular problem, and an ability of the trustee then to bring a petition--a motion--in court, so as to raise that issue with the judge.

In summary, we have a system today that is broken. A system that provides a welfare benefit without a means testing. A system which is inordinately susceptible to abuse. It is a system which statistics indicate is being abused. Surely that is a system which we should, this year, change and make it back into the system that it originally was designed and intended to be: a system to deal with people who have hardship, who have need, and in the tradition of American society, will be given a generous hand forward.

Thank you.

MR. WEDOFF: Thank you, Mr. Wallace. Mr. Klein, if you would give your opening statement then please.

OPENING STATEMENT OF GARY KLEIN

MR. KLEIN: Good afternoon.

There are three areas in which George and I are in sharp disagreement. First, we work in a system where 67 percent of Chapter 13 repayment-plan cases fail. If we force people into involuntary repayment plans, certainly even more cases will fail.

Second, more American families are using the bankruptcy system because more American families are facing overwhelming economic problems. There is no question of stigma involved at all; people file bankruptcy because they need to file bankruptcy.

And third, George failed to discuss the empirical evidence concerning how much debtors can afford to pay. I think it's clear when you look at the empirical evidence, that the system George envisions would cost more than a dollar to raise a dollar. What the credit industry is asking us to do as taxpayers is to fund a system where all of us pay to raise more money for creditors.

It's a mistake to demonize the many American families who have turned to bankruptcy for a fresh start. The vast majority of debtors are honest, hard-working people. They are struggling with foreclosure, repossession, utility shut-off, wage garnishment, uninsured medical expenses, andoverwhelming credit card debt.

In 1997, more than 2 million people went to consumer credit counseling services for help. The number of people who have sought consumer credit counseling assistance is actually increasing faster than the number of people filing bankruptcy. Not only does this suggest that people are not turning to bankruptcy as their first option, but also there really are a lot of people out there experiencing very significant financial problems.

I also hope that the policy-makers who are charged with evaluating these questions will see the increasing need for bankruptcy not as a problem for banks, but rather as a problem for their constituents. Banks, in fact, are doing quite well. Bank profits in third quarter of 1997 were $14.8 billion. That was the third consecutive quarter of record profits and the 19th consecutive quarter of profits in excess of $10 billion. Those profits have been driven, in large part, by credit cards. Banks are able to borrow money from the federal government at rates ranging from 3.5 to 6 percent, and they lend to consumers at rates between 15 and 20 percent. What those high rates do is allow the banks to search out people who are most likely to carry big balances. In short, they are searching out risky borrowers. The bigger the balance that a consumer carries, the more interest that they pay.

What's happening now is that credit card lending practices have put bankruptcy at the fulcrum of a chicken-and-egg problem: are the high rates justified by real risks, or is this high-rate lending creating the risk which is generating defaults and bankruptcy when people can't afford to manage their payment. Neutral academic studies show the latter. It's only the studies that have been bought and paid for by the credit industry that suggest that consumers are responsible for the increase in bankruptcy.

Yet another area of disagreement is that there is a perception on the part of the credit industry side that the rise in bankruptcy are disconnected from economic factors. In fact, the rise in bankruptcy is connected to economic problems at the family level. The economy is doing well, in large part because we have ratcheted up the pressure on American families.

A number of structural changes in our economy have increased the need for bankruptcy over the last 20 years. We've had enormous down-sizing, economic dislocation, and transition to lower-paying jobs. The real incomes of the bottom 60 percent of American families have fallen since 1980, and those are the people we are seeing in the bankruptcy system.

Another structural change is a trend towards higher debt-to-income ratios. People are carrying more debt thanever before. One family in nine spends more than 40 percent of its monthly income on debt service. And again, those are the people that we see in the bankruptcy system.

Another trend is that more American families require two wage earners to make ends meet, and that doubles the risk. If either breadwinner loses any part of their income, the family budget goes down the drain. And the cost of child rearing has become an unmanageable burden for many families; this is reflected in the fact that we see more women in the bankruptcy system now than men.

Another structural change in the economy is the increase in the cost of education. In just the last six years, the average debt burden of a college graduate has increased from $8,200 to $18,800. The folks we're seeing in the bankruptcy system are people at the high end of that scale.

And finally, the closest correlation is between bankruptcy and the rise in consumer credit. The number of bankruptcies has increased in lock step with the amount of consumer credit outstanding. A big part of the reason for this is that lenders want customers who carry big balances because those people pay more interest. They market to consumers in ways that are designed to get people sucked in. For example, lenders allow people to pay minimum payments. In many cases, the minimum payments don't even cover theamount of interest that's due on the loan on a monthly basis, so that the amount of debt increases and the interest charges ratchet up.

The credit industry sends more and more credit offers to every American. Last year, more than 2.5 billion credit card solicitations went out. And the message that many families get is that if the lender thinks they can carry more credit, then maybe it's a good idea to carry more credit. We see unilateral balance increases--people that are already in over their heads are told that they can borrow more because their credit limit goes up. We see teaser-rates of interest where people are encouraged to go out and borrow at 6.5 percent--without, in many cases, understanding that after a year the rate is going to go up to 16.5 percent. As banks lend to more people and particularly to more risky borrowers, we're going to see more bankruptcy because more of those borrowers are going to have financial problems.

One last structural change is that increasingly it is creditor actions that precipitate bankruptcy. I hear from creditors all the time that they are being careful and that they are acting in a responsible way in underwriting the loans that they make. But they don't understand that there may be other creditors out there who are not lending quite as responsibly. A family may have three credit cards, but when they get offered the fourth credit card, that's the one thatputs them over the edge. That family may need to file a bankruptcy case that doesn't just affect that fourth credit card issuer, but all of the other three as well.

In addition, we see creditors who refuse to work with borrowers. Twenty years ago, if you borrowed money, it was most likely from a bank that had a branch office in your neighborhood. And if you had a financial problem, you'd go into the branch office and work something out. That's not the case any more. Your loans are almost always serviced by someone in another part of the country--in Milwaukee, or California, or Texas, or Florida. And in many cases, those servicers don't understand the local conditions that lead to financial problems and put people over the edge. And it's when one creditor says: we're not going to work with you, we're going to garnish wages, that the family has to file a bankruptcy that affects all other creditors as well.

The other major piece of this question that George left out of his analysis is whether people really can afford to pay. Outside bankruptcy it's clear that no creditor would spend more than a dollar to collect a dollar. If the collection costs for a debt exceed the amount which would be paid back, the creditor would write off that debt. Nevertheless, in 1997, the Credit Research Center at Purdue University conducted a study of bankruptcy debtors which was paid for by the credit industry and which George mentioned. The results of that study have been criticized by the General Accounting Office for a variety of reasons, but primarily what the GAO has said is that the study unfairly makes every assumption in a way which is biased towards finding greater repayment capacity.

I think what's striking about their study is that in the final analysis its conclusions about ability to pay suggest that there isn't very much repayment capacity. On page 25 of the study it says: Chapter 7 debtors could have repaid, in total, 13.7 percent of their debts if they were forced into five-year repayment plans. That projects to only 2.75 cents on the dollar per year for creditors without interest.

And based on the GAO’s criticisms as calculated in the chart that I have passed out (Appendix 1), I'm going to show you that the actual number is actually even lower than 2.75 cents on the dollar.

The most important of the GAO's criticisms is that the Credit Research Center failed to account for the fact that many of the debts in Chapter 7 have to be paid back despite bankruptcy--those debts have to be paid back at 100 cents on the dollar. So, since the family's budget is a limited pie, if certain debts get paid back at 100 cents on the dollar, that reduces the amount that's available to pay other creditors. When that recalculation was made byProfessor Staten and Barron, in response to the GAO study, they reduced their calculation of total repayment capacity to what amounts to 8.6 cents on dollar--or 1.75 cents per year for five years.

And that's not the end of it. In addition, the study’s authors failed to make assumptions about failed cases--not every case where people are forced into a repayment plan, is going to succeed to the end. And in fact, we do know something about case failures--67 percent of repayment plan cases under Chapter 13 fail even though current law only requires a three-year repayment plan. But what I'm going to do is make an assumption that favors the credit industry and assume that only a third of the cases will fail under proposals for involuntary repayment plans and deduct another third off the 8.6 cent repayment capacity. That brings us down to 5.7 cents on the dollar, or 1.15 cents per year for five years.

Yet another deduction that the CRC authors failed to make is that if people are forced into payment plans, they're going to have to pay higher attorney's fees. Under current law, attorneys charge about $500 more to help someone through a five-year repayment plan period then they do for the six-month period of a Chapter 7 case. That is not attorneys gouging people, that’s just what it costs to do the extra work over five years. Five hundred dollars represents20 percent of the repayment capacity remaining, and reduces the total repayment capacity of Chapter 7 debtors to 4.5 cents on the dollar over five years. That is .09 cents annually without interest--less than one cent on the dollar per year.

Then we have to adjust for the trustee's fees that are charged in Chapter 13 repayment plans which run to 10 percent of the total plan payments. That's another 10 percent that has to be taken off, and that brings us down to four cents over five years.

So the correct amount of repayment capacity which could be recaptured if we were forcing debtors into repayment plans, as George seems to think we ought to do, is a total of .08 cents per year without interest. I think it's fair to say that at that level no reasonable creditor would expect to do this work on their own outside bankruptcy. Instead, what they're asking for is a bankruptcy system in which taxpayer money is used to generate that additional eight-tenths of one cent on the dollar.

The real problem in the bankruptcy system can't be solved by any type of legislation. Chapter 7 debtors are having financial problems and simply don't have income available to pay their debts. You can't get blood from a turnip. Some might ask: Even if it's only eight-tenths of one cent on the dollar per year, why shouldn't we spend somemoney and at least collect that amount? The answer is: It would cost money to raise that eight-tenths of one cent of the dollar per year. You'd be forcing people into Chapter 13 five-year repayment plans. We'd have to monitor cases for a longer period of time. We'd have more disputed eligibility issues--people would seek to be eligible for the Chapter 7 system. We'd have more disputed issues about whether people actually could repay their debt. And all of those cases would have to be resolved by judges. We'd need more judges in the system; we'd need more clerks in the system; and we'd need more trustees in the system.

In addition, I think we have to look at social costs associated with forced repayment plans. If at least 67 percent of repayment plan cases continue to fail and people don't get a second chance, we're going to be setting people up to have the continued stress and anxiety of unmanageable debts. That stress and anxiety, according to a number of studies, leads to family breakup and divorce; it leads to spouse abuse. There's a study that shows a very clear correlation between spouse abuse and money problems. It's going to lead to lost homes; it's going to lead to repossession; it's going to lead to utility shut-offs; and it's going to lead to the creation of a class of credit-disabled people in our economy who can't get a fresh start and the second chance that they need to get back on theirfeet.

These are just some of the reasons why the bankruptcy discharge has never been means tested. Means testing was rejected by Congress in 1978, in 1984, and in 1994. In addition, it was rejected by both of the last two government-appointed review commissions, most recently just last year. I hope that in this session of Congress, the idea of means testing is one which will be rejected again.

JUDGE WEDOFF: Thank you, Mr. Klein.

Mr. Wallace, five minutes for rebuttal.

REBUTTAL OF GEORGE J. WALLACE

MR. WALLACE: Thank you.

The central point I think we have to keep on coming back to is that we have a statute here which is not means testing. Gary has argued that it is inefficient to try to means test the statute. There's two responses to that. The first one is: it's time to fix the statute now. If there are no people who would be caught by the means-testing system, then there is no cost of means-testing the system. It's as simple as that.

However, looking at the way Gary dealt with the statistics, you should recognize that he's using average statistics rather than statistics based upon which group of people have the most income. If you look at all bankruptcy debtors, sure you start at 13 percent. But if you look at only the top 25 percent, the top 20 percent, the top 10, percent you get a very different result. For example, the top 10 percent, many of them can pay all of their debts. These are people who are using Chapter 7 today--they have the ability over five years to repay all of their unsecured debts. They're using Chapter 7. Their getting an unsecured debt discharge. Is that appropriate? Is it good to have a statute which encourages that behavior? Does that reinforce the sense of personal responsibility on which the consumercredit system is based? The answer is clearly: no.

This is a system which is broken. It is a system which needs to be fixed.

Now, trying to blame the credit industry for the increase in consumer bankruptcy is simply a discussion in irrelevances. You have a situation here where we have had a bipartisan policy for over 20 years that the volume of consumer credit--the availability of consumer credit--should be as generous as possible. That policy has been successful. There is a substantial amount of consumer credit out there. And there are calls every day that there should be more. Why is that? Because American consumers don't like to be turned down for credit. They do not like it. They are strongly opposed to the kind of treatment when that happens. They want the credit to be available to them. And if the credit is to be available to them, then we have to have a system which treats both debtors and creditors fairly.

Let me give you an example. If you have a system in which, let us say, ten percent of the people who are filing bankruptcy have some or complete ability to pay, then there are a number of people who have the ability to pay and yet they are not paying their fair share. What do creditors do? They're not collecting that money. Well, their solution is, of course, to try screen those people out. And as they try to screen those people out, what happens to theavailability of credit to those people who do us it? Remember that 96 to 99 percent of the people who do use consumer credit, repay it as contracted and on time, depending on the type of credit involved. That's the kind of people that your going to be affecting.

Now, finally, the studies that Gary claims are mere creditor studies have been validated. There's a new study out by Ernst and Young which indicates that Staten's results can be corroborated. But more important, if we want to go back to what Gary likes to call a neutral academic study--although that's certainly a word of art in this trade--you ought to look at Professor Warren's study--Warren, Westbrook, and Sullivan. In that study, she found that about 10 percent of bankruptcy in 1981 in her three-state sample had the ability to pay all of their debts. Now, in 1981 that wasn't a very big group of people. But in 1998, that's over 100,000 people. That's why the statute needs to be fixed.

Thank you.

JUDGE WEDOFF: Thank you, Mr. Wallace.

Five minutes for rebuttal, Mr. Klein.

REBUTTAL OF GARY KLEIN

MR. KLEIN: George, I don't have a problem with the idea that banks make a profit. And I don't have a problem with the idea that banks lend as aggressively as they do. And I appreciate the fact and the concession that 96 percent of American families who borrow money from banks repay that debt as scheduled. But when a bank makes a loan on a credit card at 18 percent interest, it made some calculations about risk. And that's why that rate is so high. And the fact that some people get caught up and can't make the payment, and some people get in over their heads, means that what we need is an effective and functioning bankruptcy system that gives those people that can't manage their credit a fresh start.

The other point that you've made is that it's just 10 percent of the people who are a problem. Well, first of all, that probably is not accurate either. That number is quoted out of the CRC study and the percentage would go down if the CRC were to correct for the various things that were left out of his analysis, as the GAO noted. So it might actually by five percent or four percent, and at that level I tend to agree with you, we should be doing something about making sure those debtors pay. Where we disagree, George, is that I think that that the tool that's necessary to addressthose cases is a scalpel and not a hammer. And certainly the kind of proposal that you've got in H.R. 3150 is much more than a scalpel. It affects every bankruptcy debtor. It would affect all of the honest people in the system as well as all the people you're calling abusers.

A couple of major problems--if we have time over the course of the rest of the debate, I will try to get back in and talk about some other problems with H.R. 3150--but first a couple of major problems. One is that H.R. 3150 tries to fit everyone into a cookie cutter. It makes assumptions about what people can afford based on standards that aren't going to work for any American family. Every family would be entitled to some exception to the budget rules that are set out in H.R. 3150. Some families are going to have child care expenses; other families are going to have medical expenses; still others are going to have educational expenses. We want to protect the debtor's right to tithe. We want to protect people's ability to get personal therapy and family therapy when they need it. We want to protect people who have gone into business and who have business expenses. And none of those things are allowed for in H.R. 3150. All of those issues would have to be litigated by the families involved who need help in the bankruptcy system. The reality, of course, is that it's only the wealthy families that could really afford to litigate thosequestions. And it's the families that are facing emergencies; the families that are facing foreclosure; and the families who really can't afford to pay an attorney to address those issues who are really going to be hurt.

In addition, the cost of plans is going to go up. You have a system where 67 percent of cases fail when those plans are based on the debtor's actual budget. 3150 creates fictional budgets for people that are completely unmoored from what's going on in their lives and, with that kind of fictional budget, more people are going to be unable to make their payments.

In addition, the system envisioned in 3150 isn't even going to end the kind of manipulation that the credit industry complains about. I expect that if 3150 passed tomorrow, the credit industry would be back a year later complaining that people were continuing to manipulate the system.

For example, it rewards debtors who would quit their jobs, who would lower their income deliberately, so that they wouldn't be caught by the income test in 3150. Similarly, it rewards people who run up more debt. The standard in the bill is that if you can afford to pay 20 percent of your debt, you have to make payments. So, anyone who runs up more debt so that they can’t reach the 20 percent threshold is going to remain in the Chapter 7 system. Thecredit industry will be back complaining that those people have manipulated the system.

I think there's an area of agreement here which is that we agree that people at the very high end ought not to be able to discharge their debts without payments. But, what I think we need to do is set up a system which catches only those people at the high end and doesn't trap the small fish in a net that's too broad.

JUDGE WEDOFF: Thank you very much, Mr. Klein. At this point, as I announced at the outset, we're fortunate to be joined by Representative Jerrold Nadler of New York who will make his comments and questions to both of our debaters.

STATEMENT AND QUESTIONS OF THE HONORABLE JERROLD NADLER

MR. NADLER: Well, thank you very much. Let me start by thanking the American Bankruptcy Institute for making this discussion possible.

We, that is, Congress has before us some really critical choices to make regarding the rights that American families have long had available to them under the Bankruptcy Code. These questions surrounding personal bankruptcy have proved very difficult. They have divided academics, practitioners, judges, and, most recently, the National Bankruptcy Review Commission. It is into this difficult area that Congress now steps with two very different approaches, one introduced by my colleague from Pennsylvania, Mr. Gekas, and one I have put forward with Mr. Conyers for consideration.

I think it's important to remember that the bankruptcy system exists to benefit both debtors and creditors. It has been designed to give those American families facing overwhelming financial crises an opportunity to pay what they can to their creditors, and then to obtain a fresh start, to rejoin the mainstream economy as productive citizens and consumers. The bankruptcy system also provides substantial benefits to creditors. It is an orderly process, one which is held down the course of collection bydiscouraging excessive litigation. I don't think anyone could seriously argue with these goals, though I think some of the proposals we have been hearing would seriously undermine these most outstanding aspects of the system by encouraging litigation, by raising costs, by imposing needless roadblocks in the path of honest and distressed American families seeking a fresh start, and by failing to do anything about some of the real problems which have given rise to the $1.3 million annual individual bankruptcies, or to deal with abusive creditor practices which push families trying to work their way out of financial difficulty into bankruptcy.

Some of the proposed changes are, indeed, radical, and so, my first question is to Mr. Wallace concerning the need for such sweeping and radical change. Much of evidence cited by proponents of these radical changes to the Code have been supported by the studies which purport to show that approximately 25 percent of Americans filing for bankruptcy--for Chapter 7 could repay 30 percent of their non-priority, non-housing debts in Chapter 13, though this same study also concluded that a clear majority of Chapter 7 debtors have no income to repay non-housing debts. Yet, in reviewing the work of Dr. Staten and the Credit Research Center, whose so-called "findings" have been reported to every member of Congress in lobbying visits by the credit card industry, theGeneral Accounting Office as we know is highly critical and we've heard some of the discussion of the GAO report today.

There has, however, been a long-established link between increased indebtedness and rising bankruptcies, especially now in some segments of the industry, appear to be aggressively seeking to lend money to people in over their heads at what can only be described as usurious rates. And, my favorite example is a thing we specifically address in the bill that Mr. Conyers and I have introduced, where we say, you're not going to be able to--where we're going to penalize the credit card company for piling up debts by putting ATMs in casinos for compulsive gamblers.

Many of us in Congress have also been deeply concerned about other factors which contribute to bankruptcy, including a decline in real wages for 60 percent of the workforce, the loss of health and retirement benefits by growing segments of the population. How can Congress justify this sort of radical changes that are being proposed when the proponents of change have yet to bring forward the proof that the system has really broken down as seriously as they say it has, particularly in light of the statistics we have seen that say that the instance of bankruptcy per debt, per amount of debt outstanding, has not changed at all in 20 years.

MR. WALLACE: Yes, well, I think that your question really is, is there statistical evidence to support theoccurrence of people who are using Chapter 7 bankruptcy and are--have some ability to repay the debt? And, since that is the question, the answer is yes, indeed, there is statistical evidence to that effect. And that statistical evidence is really based upon three different studies. One is by Professor Warren and her coauthors. She found approximately 10 percent of the Chapter 7 debtors could pay all of their debts. Professor Staten and Professor Barron found that approximately 30 percent of 1997 debtors in the 13 cities they studied could have paid approximately 30 percent of their unsecured debts. And, the confirmation of that study using a sample of over 5,000 participants in the period 1992 through 1993 where the findings were that they--under 3150, approximately 12 percent of the individuals who were using Chapter 7 would be able to file--would be able to pay some or all of their debts. This is a substantial amount of their debts that we're talking about here; we're not talking about peanuts.

So, yes, the answer is there is statistical evidence, it's persuasive evidence, it's both academic studies and a major, Big 6 accounting firm. They were well done, they show that there is a problem out there, and yes, it is necessary to deal with that.

I don't think that--I don't agree with your characterization that the reforms are radical. I think thatthe reforms are very well structured and are structured so as to carefully separate those people who would have the ability to pay from those who do not have the ability to pay at an extremely low cost. Remember that 75 percent of the individuals who will use Chapter 7, and who are using it today, will never be touched by the means testing that we're talking about here. Seventy-five percent of them will still have their choice between Chapter 7 and Chapter 13. The system will be left alone--

MR. NADLER: How do you figure that?

MR. WALLACE: --it is only at the higher levels that you have any kind of a needs-testing system under the proposals that are now before Congress.

MR. NADLER: The proposals that are now--the Gekas bill would submit for a family of four that you'd have the means testing for income above $26,619. Twenty-six thousand, six hundred, nineteen dollars--

MR. WALLACE: A family of four is 37--

MR. NADLER: which--family--

MR. WALLACE: A family of four--

MR. NADLER: Excuse me. A family of--

MR. WALLACE: --is 37--

MR. NADLER: Sir, I was in the middle of--according to the median income, 1996, the median income in the United States for a family of four is $35,492, 75 percent of that is$26,619. It seems to me that what you're saying is to a very large number of people in this country--I characterize it as radical because for the first time we're saying to a very large number of people in this country, you do not have the right as of right now to have a discharge of your debts.

And I would observe, I think--I would observe that you ignored the question that I was asking about the GAO debunking of the statement report. You simply stated again that it was a good report. I would also observe that if the--one of the reports you cited says 10 percent of Chapter 7 filers can pay their debts, all their debts, that means 90 percent cannot. And, even the 30 percent who can pay 30 percent of their debts, that means 70 percent cannot. No one denies that some people abuse the system. The real question is what is the evidence that the number of abusers of the system or the percentage of the abusers of the system, not that it exists, but that it has greatly increased so it justifies such radical change in the nature of the system.

JUDGE WEDOFF: We just have two minutes left, so if it could be a brief answer, perhaps we can get a question from Mr. Klein.

MR. WALLACE: Well, I'm sorry if I didn't respond to the question that you thought you were asking. There were just a lot of questions in there and I tried to deal with the one that I could remember.

With regard to the GAO study, the GAO study, I think, raised four or five different objections. They also observed that it was a good beginning study. I will tell you that bankruptcy is an area that is extraordinarily difficult to study and even the best studies, and the Staten study is one of them, has not produced statistically significant results. You just can't seem to do that in the amount of money that's available. The Warren study, which is usually cited by the opponents of needs-based bankruptcy reform, was not a statistically significant sample either and it was subject to all of the objections that the GAO people have. So, the difficulty we have here is that a standard of criticism was created by GAO which nobody so far who's worked in the bankruptcy area has been able to meet. That's a fairly high standard and I think it's an unfair one.

With regard to the 20--I'm sorry, what was your other question?

MR. NADLER: I'd like to turn to Mr. Klein--

MR. WALLACE: Okay.

MR. NADLER: --at this point very quickly, because we have maybe one minute left.

There are clearly some people--some debtors who take advantage of the fact that they have the option of choosing between Chapter 7 or making payments on the debts of future earnings in Chapter 13. How does the current Codeprotect creditors against debtors who gain the system and don't you think there are any loopholes that need to be plugged to prevent debtors from walking away from debts which they do have the ability to pay?

MR. KLEIN: There are substantial winnowing tools in Chapter 7 which already catch some of the abuses. The CRC data, and, again, the Ernst & Young data, did not go back and look at how many of the people who they say have substantial repayment capacity were, in fact, forced by current law out of Chapter 7 and into Chapter 13, and that happens every day. In a certain percentage of cases, the United States Trustee raises a motion called "A Motion to Dismiss for Substantial Abuse" and many of those motions are granted because people can afford to pay, and, in fact, that money is captured for the system under the Code as we know it. Perhaps what would make sense is to tighten up that test just a little bit, rather than to enact the broad and radical reforms that are present in 3150.

JUDGE WEDOFF: Okay. Thank you, Mr. Klein. At this point, we're going to initiate our questioning from the panel here and I have the privilege of reading that questioning off.

QUESTIONS FROM THE PANEL

JUDGE WEDOFF: My first question will be addressed to Mr. Wallace. The bankruptcy bills that you mentioned, Mr. Wallace, would require debtors in bankruptcy to put all of their disposable income into debt repayment for a three to five year minimum. Would this proposal cause a shift in the incentives that currently impact the issuers of credit? Specifically, if the bankruptcy system collects defaulted loans, whenever the debtor can repay them, at no direct cost to the lender, would credit issuers be encouraged to spend less of their resources in screening credit applicants? And second, if bankruptcy becomes less attractive to debtors, or even unavailable, would credit issuers be encouraged to refuse to negotiate voluntary repayment plans outside of bankruptcy, such as through consumer credit counseling services?

MR. WALLACE: I think you have two questions there?

JUDGE WEDOFF: Yes.

MR. WALLACE: Let me see if I can remember the first.

JUDGE WEDOFF: Incentives to screen being changed and incentives to negotiate voluntary--

MR. WALLACE: Yeah.

JUDGE WEDOFF: --payment plans being affected.

MR. WALLACE: The incentives to the creditors, it seems to me, are simply chimera; they don't exist. The debtors--if debtors have to repay their debt and they have to repay part of their debt--let's suppose they have to repay 20 percent of their debt--30 percent of their debt. The creditor is still losing 70 cents on the dollar.

Creditors are spending enormous sums right now trying to separate those who are likely to file bankruptcy, those who are likely to default, from those who cannot, and who will not. They will continue to do that because the economic incentives are enormous to the creditors to try and figure who that person is. If they can do it, they will, and those people will not get credit. They probably shouldn't. On the other hand, there are people that we can't predict whether or not they will go into bankruptcy or whether or not they will have debt difficulty. Those people are just blurred in there and you have to cut back credit availability overall in order to try to reach those people.

Does the underlying bankruptcy system, as proposed in 3150, increase the incentives to creditors to try to do something there, to try to increase the volume of consumer credit? On the margin, perhaps, of very slight bit, but on the margin there's a much greater economic incentive to separate out those people who have the predicted ability or the predicted inability to repay and to keep them out of thesystem. So, I don't think it's going to affect creditor incentives significantly one way or the other.

Your second question was?

JUDGE WEDOFF: Negotiating voluntary agreements outside of bankruptcy.

MR. WALLACE: Well, of course we want to have as many negotiated voluntary agreements outside of bankruptcy, and, generally, that is the cheaper; your incentives are very strong already to do that. Generally, a creditor will work that out. It's cheaper to do it, and if it is cheaper, they will do that. On the other hand, there are cases which wind up in bankruptcy and those cases, it seems to me, there should be a needs-based bankruptcy system to handle those kinds of problems.

JUDGE WEDOFF: Okay. Mr. Klein, a brief response?

MR. KLEIN: Well, it does strike me that there's absolutely going to be a change in the way creditors grant credit, if their risks are reduced. And, if their risks are reduced, they're going to be able to grant credit even more aggressively than they already do, and, in fact, that will only lead to more defaults and perhaps make a bad problem worse. Quite clearly if credit is offered more aggressively, even more people will be reached who have financial problems and are unable to pay.

JUDGE WEDOFF: Okay. My next question that wouldbe for you, Mr. Klein, and, to some extent, it's going to echo what Representative Nadler asked you. But I want to focus on the message that current bankruptcy law is giving to the citizens of the United States.

It has been said that this message, particularly as promulgated by late-night lawyer advertising, is fairly simple. The message is: no one should ever be troubled by excessive debt. Anyone at any time for any reason should be able to toss their debts away. If you believe that this is not the message of current law, could you identify what provisions of that law are now operating effectively to discourage unnecessary bankruptcies, and, if not, what should be done to discourage unnecessary bankruptcies? That scalpel you were talking about earlier.

MR. KLEIN: The current system is not perfect and I would be the last one to say that there aren't some things that could be adjusted to make it work better. But, what we don't need is to set the process up as a collection agency for creditors. Creditors have enough opportunities to collect outside the bankruptcy process without also forcing everyone in the bankruptcy process into a repayment agreement.

A couple of problems I have with your premise. One is the idea that the late-night lawyer advertising is encouraging bankruptcies. The lawyers involved are respondingto a need. They're not creating a need. Saying lawyer advertising causes bankruptcies is like saying aspirin commercials create headaches.

The other part of your premise is that somehow the Chapter 7 process lets people off scott-free without any evaluation of their financial circumstances. First of all, I think it's important to note that we do make people pay a variety of different types of debts, even when they file bankruptcy under Chapter 7. People have to pay all of their secured debts, the liens of secured debts passed through bankruptcy unaffected by the bankruptcy discharge, so that those debts are paid despite the Chapter 7 filing.

Second, we have a whole category of non-dischargeable debts; debts which society believes should be paid back, even if the debtor gets a discharge. These include child support and student loans, and they also include debts where the consumer has committed some fraud. A creditor can come in and say, you defrauded us out of our money, so that that debt has to be paid back.

In addition, we see creditors coming in if people hide their assets; a creditor can come in and have the case thrown out of court entirely or have the discharge denied entirely. We have attorneys’ ethical obligations. In a case which an attorney is involved in, we're not seeing the kinds of abuses that George was talking about because an attorneydoesn't want to put their license on the line. We have criminal sanctions; if people hide their assets, they can be tried criminally and we're seeing an increased focus from the Justice Department on bankruptcy crimes. And then last, we have the tool that I mentioned, which is dismissals for substantial abuse, and that is the tool which I think might be strengthened in order to get at some of the very well-off people who are able to use Chapter 7. Make that tool stronger, but make it a scalpel that only applies in cases where people have substantial ability to pay.

JUDGE WEDOFF: Thank you, Mr. Klein. A response, Mr. Wallace?

MR. WALLACE: Well, the short answer is that there's no effective control in present law upon this group of people and that's why the statistics show that a substantial group of people are using Chapter 7 who have some ability to pay. The provisions that Gary talked about are simply not enforced on any regular basis. There are one or two courts where they are enforced, but make no mistake about it. There are over 300 bankruptcy judges out there and, in most of their courts, 707(b), which is the provision that he's primarily referring to, is simply a dead letter. Also, 707(b) cannot be raised by anybody who is interested in doing so; it can be raised only by the United States Trustee who has, so far, refused in most jurisdictions taking theeffective action whatsoever. So, there's no effective control in present law whatsoever. That's why we have the problem. That's why we need to deal with it.

With respect to attorney advertising, my Lord, there is an extraordinarily high pressure on attorney advertising. You see it not on late-night T.V.--I see it over in Alexandria when I watch The Weather Channel. There's an advertisement on for my friendly local consumer bankruptcy attorney. There is an enormous awareness amongst American consumers that bankruptcy is an advantage, that it is there, and they can get information very quickly. Of course that's having an effect upon the increased filing of consumer bankruptcies. There's no--more information about it, there's less stigma about it. Of course that is why bankruptcies are increasing at the rate they are increasing.

JUDGE WEDOFF: Okay. Our next questioner is Deborah Williamson.

MS. WILLIAMSON: Mr. Wallace, policy as to what debt should be discharged and what debt shouldn't be discharged obviously has received a lot of attention. Only last week, Congress held hearings on whether we should have a policy to allow debtors to include religious and charitable contributions as legitimate expenses. Under H.R. 2500, such policy decisions will be made by the IRS and not at the Congressional level. Aren't judges really in a betterposition to determine a debtor's ability to repay and wouldn't merely strengthening 707(b) accomplish that goal?

MR. WALLACE: The short answer is no. As I mentioned before, there are over 300 bankruptcy judges. We do not have a uniform bankruptcy law, particularly in this area. Judges values, which become important when they are determining how much expenses are appropriate for a debtor, vary widely across the spectrum of judges. What you need is a clear guideline to the judges on how much are appropriate expenses.

Now, H.R. 3150 as drafted provides that bright-line test, but there are exceptions permitted; there are exceptions if there are extraordinary circumstances. And, that will be determined in the final result if someone objects by the individual judges. So, you have a bright-line test, followed by flexibility for extraordinary expenses, which does draw upon the expertise of judges. Will that introduce some non-uniformity in the system? Yes. But, frankly, I'm not sure that there's--at least I've not been able to think of any other way that I could suggest to reduce that and still have a flexible, fair, and really good policy system.

JUDGE WEDOFF: Mr. Klein?

MR. KLEIN: I feel compelled to defend the United States Trustees and the judges. It seems clear to me that ifthe United States Trustees aren't bringing motions, it's not that they're ignoring their statutory duties; it's more likely that they're just not finding the level of abuses that the credit industry seems to think are out there. Similarly, if judges are not striking down people's budgets, perhaps it's the case that the judges don't see the kinds of unreasonable budgets that the credit industry thinks are out there.

The two empirical studies that George talked about are both studies that were bought and paid for by the industry. They had not been adjusted to take account of all expenses, as I discussed in my main presentation. If it is the case, as I think it is, that all the studies show is an ability to pay less than one cent on the dollar per year for five years, there's just not that much repayment capacity out there that could be recaptured by the system. The question is whether we should be making the effort beyond what I've already conceded, which is that there ought to be some tightening for the very highest-end debtors by tightening up the substantial abuse test already in the Code.

MS. WILLIAMSON: Mr. Klein, you said there should be some tightening for the highest level of abusers. Do you disagree that there should be some objective standards that are to be used, so that when one is being counselled by an attorney, you know what the chances are of breaching thatstandard?

MR. KLEIN: Let me go back to the chart I handed out (Appendix 1). The question about tithing, I think, is a very interesting one because it's something that many people who work in the bankruptcy system and many people in Congress think that debtors ought to be allowed to do in the bankruptcy process. In fact, the main proponent of 3150 is also a proponent of a bill to allow tithing. But, the data that the credit industry has come up with doesn't account for those families that want to tithe.

If you look down at the bottom of the list--I don't even have tithing on my list--but there's about eight or nine other things that have to come out of a family budget which reduce people's capacity to pay. And remember, I think we already had this down to a realistic number of about eight-tenths of one cent per year repayment capacity. This is a list of additional things that will reduce repayment capacity. There are non-reaffirmed secured debts; in a majority of jurisdictions, people with car loans don't need to reaffirm but nevertheless must pay those car loans. Neither the CRC nor Ernst & Young took account of those debts. There are non-dischargeable debts; those have to be paid at 100 cents on the dollar. And again, those reduce a family's repayment capacity on their other unsecured debts.

JUDGE WEDOFF: Mr. Klein, Ms. Williamson has askedme to ask you if you could comment on the desirability of objective standards for determining disposable income.

MR. KLEIN: I did comment on that earlier. I think the answer is that if the idea of an objective standard is to create a cookie-cutter approach and say that every American family has to run their budget in a particular way, it's just not going to work. We see enormous regional variations and we see enormous differences in what people have to budget for; people with children have special expenses, people with elderly family members living at home have special expenses, people with medical needs have special expenses. So, there is no one-size-fits-all objective standard that really makes sense.

What we've got now is a system which accounts for people's actual budgets and, when the budget is out of whack, we have a trustee who is responsible for bringing that to the attention of the court. Most of the time, that issue gets negotiated out of court, and, in fact, most people do commit all of their repayment capacity in Chapter 13.

MR. WALLACE: The objective standards, of course, are necessary. They're necessary in order to produce some uniformity in the system. We've got a national bankruptcy system. It is a system which affects sense of personal responsibility, and yet, it's a system which has no national standard because it's administered now and, by the way, it'salready in the statute.

There's already the substantial abuse provisions in the statue, there's already a disposable income concept in the statute, which is used in Chapter 13 cases. This kind of a determination is already made but the results have been highly variable from one judge to another. Of course we need objective standards, and of course we need something that is both a bright-line test and something that provides sufficient flexibility for the hard case, and I think that that's already in 3150 and it was certainly intended to be there and it's appropriately there.

JUDGE WEDOFF: Would you like to comment on the question of tithing and its appropriateness in determining disposable income?

MR. WALLACE: If you feel it's within the scope of the question.

Tithing is, indeed, an interesting question. If you look at the IRS standards, it permits charitable contributions when they are appropriate; therefore, in some circumstances, tithing may very well be permitted under those standards. In a certain circumstance, whether or not an individual judge decides that tithing is an appropriate expense, then--of course, then that will become an extraordinary expense and will be well known within that judge's courtroom and it will be administered appropriately.

I'm not going to address whether or not I tithe, or whether you tithe, or whether anybody else should tithe; if it is a deeply felt need of the debtor, and the debtor is willing to give up some other expense so as to not wind up saying I'm going to give money to my charitable source and, yet, not pay my creditors as much, well, then I think there's nothing wrong with tithing. That's a personal choice which the debtor makes.

JUDGE WEDOFF: Okay. Our next questioner is Professor Corr.

MR. CORR: Alright, thank you. Mr. Wallace, I guess my question for you has two parts. If I understand you, you believe that much of the current need for consumer bankruptcy reform arises from the fact that Americans currently are losing their sense of moral obligation to repay debt. At the same time, I've understood you to say that between 75 and 90 percent of American Chapter 7 debtors, individual debtors, would, if subject to your proposal, be excluded from it. Wouldn't that indicate to you that perhaps those debtors do have a sense of moral obligation and simply can't pay? And, wouldn't that suggest that the numbers showing dramatic changes between 1978 and 1998 could be misleading?

The second part of the question goes to your issue of consumer availability. It's not really necessarily true,is it, that the credit lending industry has to cut off availability of credit? All it has to do is sharpen its focus. It could, for example, instead of cutting off availability of credit, charge a sliding scale of rates, depending on what it's estimate of the risk was so that higher risk or marginal risk people would pay a higher rate of interest to compensate for the fact that they're greater risK.

MR. WALLACE: Well, if the credit industry could risk base price with complete accuracy, we wouldn't be here because there would be no default. You simply wouldn't extend money to people whom you knew were going to take a bankruptcy way out or not pay their debt. Otherwise, it seems to me, we still have a problem in bankruptcy, as we certainly do with $1.35 million filings a year, and we have to address that.

With respect to the 10 percent or what--the issue that you raised with regard to whether or not there are 50 percent or whether there's a large group of people who are abusing the system, I don't think anybody is arguing today, and certainly I'm not arguing, that there are 50 percents of the bankrupts who are now using a system who are abusing it.

But, I am saying something that is very, very important. Approximately over $400 billion is discharged in consumer bankruptcies each year. Ten percent of that is $4billion. I've already told you that 10 percent of the present filers is 130,000 people. That's a lot of people who are going through the system, even if it is only 10 percent.

And let me also say that the study which Gary keeps on forgetting to mention, which found that there were at least 10 percent of the people who were using bankruptcy in 1981 who could pay all of their debts, that study was done by Elizabeth Warren who is certainly an academic. Therefore, we have independent information of a problem that is supported by Professors Staten and Barron, both of whom are academics--yes, their study was funded by the credit industry, where else are you going get somebody to fund an academic proposal in this day and age. You certainly won't get it from the Federal Government.

And, finally, it has been corroborated by a Big 6 accounting firm. That is very strong evidence and it's evidence of a problem and that problem, even though you can try to say, oh, it's only 10 percent or it's only 30 percent, is still a lot for the American consumer to have to pay for.

MR. KLEIN: You know, the idea that a Big 6 accounting firm that takes money from VISA or MasterCard would necessarily be unbiased strikes me as a little peculiar, George. It seems to me that if you make the same mistakes that Professor Staten and Barron made, you're going to get the same mistaken results.

I talked before about the fact that it looks like the CRC study overstated repayment capacity by about 13 times. The fact that the Ernst & Young similarly overstates repayment capacity by ignoring the same factors that affect people's ability to pay doesn't make the overstatement any more accurate.

The problem that we have in the bankruptcy system is that people's income is a fixed pie. Everybody wants their slice of the pie and we've got a system which is designed to force people to pay back their secured debts and pay back non-dischargeable debts, and pay back debts that they reaffirm. And that comes out of their repayment capacity. And, neither the CRC nor the Ernst & Young study accounted for that.

The other study that came down--and it seems like the credit industry's releasing a study every week these days--the one that supposedly shows that $40 billion worth of debt is discharged in the bankruptcy system involves a number that's pulled out of thin air. There's no discussion of the methodology. But, again it’s overstated because it assumes that every dollar that's discharged in the bankruptcy system is a dollar that would be paid back but for the bankruptcy. And the fact is that most of it would simply be written off because the people involved just don't have the money to pay. And, unless we're going to change our economic system, thereare going to be some debtors who just don't have the money to pay.

What makes sense is to have a bankruptcy system that forgives them, that gives them a fresh financial start. We had that system going back to the Bible and it is not time now to throw that out, like so much dirty laundry. You wouldn't throw out dirty laundry. What do we throw out?

(Laughter.)

MS. WILLIAMSON: You don’t throw out dirty laundry.

(Laughter.)

MR. KLEIN: The baby and the bath water.

(Laughter.)

MR. WALLACE: The rest of us wash it.

(Laughter.)

JUDGE WEDOFF: A question.

MR. CORR: Mr. Klein, I didn't know that Chapter 7 went back to the Bible, but, in any event--

(Laughter.)

MR. KLEIN: The right to a discharge and the fresh start goes back to Deuteronomy. There's a provision for a discharge of debt every seven years written into Deuteronomy (15:1).

MR. CORR: You've given us a handout, Mr. Klein, which was distributed to the audience which we all appreciate, suggesting, if its numbers are accurate, that ina Chapter 13 proceeding, Chapter 7 debtors forced into it would repay a very small amount of their outstanding unsecured debt. If that's the case, there's very little harm to those people in forcing them into Chapter 13 and there is at least some small benefit to the creditors in collecting whatever they're able to collect. In fact, there might even be, wouldn't there, some benefit to these debtors who are, after all, in some measure, a group of people who may be very unlucky, but who are probably also not terrific at managing their money? If you place them under a budget and under discipline, won't they be better off for the experience, even if the creditors don't collect much of what they're owed?

MR. KLEIN: No matter what you think about the importance of personal discipline, it seems to me that we don't want to set up a federal system where a taxpayer spends a dollar to raise 80 cents for the credit industry. And that's what I think we'd have going on here.

In addition, there is some point in people's lives where they have so many financial problems, where they're struggling to keep food on the table, where they're struggling to keep up with the mortgage payments, where they're struggling to prevent the lender from repossessing, that you want them to focus on those very important debts, and sometimes that means letting the creditors who don't have security go.

Our system recognizes that some creditors protect themselves by obtaining collateral as security, and one of the reasons that the credit card industry is so profitable is that they've made a decision not to take security, not to have collateral for those debts, but to charge higher interest rates to compensate themselves for the risk. Now they're back in Congress saying, we want to be able to do this type of lending without risk at all. And that's just not possible.

MR. WALLACE: First of all, Gary did not have the ability to share his numbers with me in advance so I have not seen them, but I am generally familiar with them and they are totally specious. It's an approach which is extraordinarily inaccurate and it vastly understates what we're really actually talking about here. We're talking about a lot of money. We're talking about perhaps as much as $4 billion a year that is sifting through the system right now, $4 billion which could go back into the system to lower the cost to American consumers of using consumer credit. And, it's money that should be put back into the system for two reasons; one, because it's right, and second of all, because we do, as your question suggested, need to undergird that sense of personal responsibility in this society. We do need to have a system that undergirds the responsibility that people do and should have to repay when they borrow if they have the ability to doso.

So, there's no question that this statute as proposed would be a improvement over the present statute, and I think that two-year point is well taken, that the consumer would be better off with the experience of trying to learn how to handle a budget. Right now, one of the great failings of the bankruptcy is, as I mentioned at the very beginning, it's just a simple in and out. You go in, you get discharged, and you come out. You aren't taught how to manage your debts if you go into Chapter 7. And Chapter 13 does provide some discipline and some help in that regard.

Finally, with regard to Gary's constant use of credit card debt, please remember something: credit card debt is only 6 percent of the outstanding consumer credit in this country. Whatever is going on with regard to credit card debt, as far as I am concerned, it's perfectly alright, but whatever is going on with regard to credit card debt is not what we're talking about here. We're talking about the whole pie. The whole pie is affected in bankruptcy, and focussing on credit card debt alone is missing the whole point.

JUDGE WEDOFF: In the time that we have left, I'd like to propose one additional question to Mr. Wallace and then turn the podium over to Representative Nadler.

And my question has to do with the statement thatyou've made, Mr. Wallace, that for debtors who are in the lower 75 percent of average income the new bill would have no effect as far as cost is concerned. Would there be costs involved in each of the following areas: first, the need for the debtors to present additional financial information, including three years of past due tax returns, pay stubs, and an analysis of their extraordinary expenses; second, the need for trustees to expend much more time and effort to investigate and to file reports on the debtor's financial condition; third, the requirement for a two percent auditing of cases conducted by Certified Public Accountants under standards applicable to auditors generally, and finally, additional judicial resources required to adjudicate disputes regarding the debtor's income and expenses?

MR. WALLACE: The short answer to your question is that don't we want to have a honest system? I think we do want to have an honest system, and if it costs a little bit more in order to have an honest system, well, then, surely it's worth it. Elsewhere in our American fabric in which we try to help those people who are disadvantaged, we do have controls and those controls are paid for and appropriately paid for in one way or the other. That's true here.

However, there is something that I want you to keep in mind. You mentioned additional costs to debtors of filling out a schedule. Well, they are already filling outSchedules I and J. This is going to be a revised Schedule I and J. It's probably going to take about the same amount of time.

Yes, the debtor's going to have to provide a tax return over the last three years. Yes, sometimes that may be a little bit hard, sometimes that may delay things. Ont the other hand, if it's necessary in order to keep the system honest, isn't it worth it?

And, yes, the trustee is going to have to do their job. They're already required to do their job. They're supposed to review the statement of affairs. In my own experience, that's an interesting process which occurs sometime during the six-minute first meeting of creditors, in which the trustee for the first time sees the statement of affairs and reviews it at that time. Nonetheless, this is a system in which they are paid, and they're paid to do a job and they should do that job. I'm not sure that there is an additional expense here; at least not with regard to the people that you mentioned who are the people below the 75 percent of median income because the trustee really has no enforcement responsibility with respect to them.

And finally, yes, the cost of audit is always there and it's real and we shouldn't ignore it. But, as I said to you before, isn't it better to have an honest system than to have a system which today is simply a joke? We believe thatSchedules I and J are simply a joke today. The debtor, under oath, tells us what their income and what their expenses are, and it's believed not to be true. But there is no effective enforcement of that.

Surely we need to have an honest bankruptcy system. I mean, this is 1998. This is a civilized society. Surely we want to have a system that requires people to tell the truth, that makes sure that they do for those people who have some difficulty doing that, and assures the rest of the American public that when a needs-based bankruptcy system is delivered, it's delivered honestly and fairly.

JUDGE WEDOFF: A very brief response, Mr. Klein?

MR. KLEIN: We have tools in the system to catch the dishonest debtors. Those tools are working well. I think it's a mistake to assume that most of the folks that are in bankruptcy are being dishonest. People don't go into bankruptcy lightly. It's not the case that people want to give up the control of their assets to a trustee for a period of time. It's not the case that people want the embarrassment of having their friends and neighbors find out they're having financial problems. I think that any approach to reform of the bankruptcy laws has to continue to assume that the vast majority of debtors are honest and need help.

JUDGE WEDOFF: Representative Nadler?

MR. NADLER: Thank you. I'd like to make just acouple of observations, then I have two questions.

First, it wasn't mentioned so I'd like to observe that the bill that Mr. Conyers and I have introduced does tighten up 707(b) to provide some additional protections for what I regard as the small minority of people who are abusing the system.

Secondly, I simply want to say that the--if you want to really reduce bankruptcies, we should get the credit card companies to stop aggressively marketing credit to people already in over their heads and they should follow public policies generally designed through a reverse of situation, which we've had for the last 20 years, of 60 percent of the population having falling incomes and not remove one of the few safety nets we have.

My question is, to Mr. Wallace, you stated in your first statement that consumers pay for these abuses, as you put it, of the bankruptcy system in the form of higher interest rates. I would simply--and the corollary to that, I suppose, is that if we stop these abuses, the interest rates might decline.

I would simply observe that when I was in the StateLegislature in New York in 1980, we were persuaded, or the legislature was persuaded, to remove the ceilings on interest rates on the grounds that when you had a 17 percent inflation, you couldn't hold interest rates low. We were told that when we eliminated those interest rates, they would go up to represent high inflation; when inflation came down, they would go down. They never, of course, came down. Those consumer card interest rates are still up at 17 and 19 and 22 percent, even though inflation is now 2 percent.

So, my question is what makes you suspect that the credit card companies and the large banks would reduce interest rates by anything at all, as opposed to simply increasing profit ratios, if we turned the bankruptcy system into a taxpayer-funded collection agency?

MR. WALLACE: I always like your questions, Representative Nadler.

(Laughter.)

MR. NADLER: They're loaded.

(Laughter.)

MR. WALLACE: Yes, I think they are loaded.

Well, there are several answers to that. First of all, the credit card system is extremely competitive and I disagree with your premise. If you shop for credit today, you can get a 12 percent credit card, you can get a 14 percent credit card. Yes, there are 18 percent credit cardsout there and they added a whole bunch of additional services that people seem to want to have. I don't know why but they do. So, that's the market system, we've always had a market system, and it's no different than if somebody who is selling a machine decides to put fins on it or decides not to put fins on it. Some people don't like fins, some people do like fins, some people have to pay more for fins.

But, the market is itself competitive and you'll find that credit prices always do go down. In the end, that's the way it'll work because if shareholders are going to make more money with credit card companies, then--if credit card companies are going to make a lot more money, then somebody else will come in there and drive the price down.

But, I am told that my time is up.

JUDGE WEDOFF: Yes, and the time actually of our entire afternoon is up, unfortunately. We're going to have to conclude.

Again, on behalf of ABI I want to thank everyone who has attended and I also want to let everyone know that a transcript of today's proceedings will be available on the ABI website and otherwise through ABI, so you'll be able to read what you've heard. I hope this afternoon’s presentation has been an enlightening one. Thank you.

(Whereupon, the proceedings concluded at 3:00 p.m.)