Racial Dimensions of Credit and Bankruptcy

Washington and Lee Law Review, Fall 2004 by Skeel, David A Jr

At least as significant as the technology were two critically important legal developments that occurred in 1978: the Supreme Court's decision in Marquette National Bank v. First of Omaha Service Corp.10 and President Carter's signing of the 1978 Bankruptcy Code.71 In Marquette, the Supreme Court held that the relevant rules for interest rates on consumer debt would be determined by the law of the bank's state of incorporation, rather than by the state where the credit card customer lived or used the card.72 As innocuous as the Court's conclusion may sound, it had profound implications for the credit card industry.73 Credit card banks could simply pick the state with the weakest interest rate regulations and set up shop there, with the assurance that any interest rate permitted by the bank's home state would apply to transactions throughout the country. Banks immediately flocked to South Dakota, which permitted banks to charge up to 24% interest, and within a few years to Delaware, which also entered the competition to attract credit card lenders.74 In effect, Marquette deregulated interest rates. Freed from the shackles of restrictive state usury regulation, credit card companies could charge extremely high interest rates and give credit cards to almost everyone.75 Even if many of these new borrowers defaulted, the banks' high profits would more than offset the losses.76

The enactment of the 1978 Bankruptcy Code had a similarly profound effect. The 1978 Code is best known for making the bankruptcy process much more hospitable for debtors, an effect that was reflected both in specific provisions and in the terminology of the new Code.77 But creditors were not simply abandoned by the drafters of the Code. Not only does the Code provide a variety of basic creditor safeguards, but a few politically influential creditors garnered special treatment for themselves.78 None were more successful than home mortgage lenders.79 The mortgage lending industry persuaded Congress to include provisions that give mortgagees almost complete protection, provisions that have figured prominently in the rise of subprime lending.80

Bankruptcy is designed to permit consumer debtors either to restructure their obligations in Chapter 13 or to erase them altogether in Chapter 7. With home mortgages, however, a small cluster of provisions in the 1978 Code prohibits consumer debtors from interfering with the mortgage in any way.81 Unlike debts secured by other interests in property, which can be reduced to the value of the property if the property is worth less than the amount owed, the debtor's home mortgage must be paid in full if the debtor wishes to keep her house after she files for bankruptcy.82 Mortgage lenders insisted that the new provisions were more than simply a valentine from Congress, of course; the lenders had a very plausible argument for why the protection was necessary.83 If debtors could scale their mortgage obligations down to the current value of the house, lenders argued, the mortgage lending industry would have to pass on these losses to the next round of homebuyers.84 This would mean higher interest rates and, for some would-be homebuyers, no financing at all. Protection of home mortgages was therefore in everyone's best interest because it would ensure a steady stream of affordable financing to ordinary Americans who wished to buy their own homes.85