Community banks gain littel from bankruptcy reform

Northwestern Financial Review, Jul 1-Jul 14, 2002 by Dullum, Justin

At this stage in the game, House and Senate bankruptcy reform bills are subject to little change. The legislation is in conference committee with nearly all issues resolved. That's too bad for community bankers.

Bankruptcy is a constitutionally-protected right iii the United States, but it has become over-used. Careless consumers, wooed by lenders willing to overextend credit, perpetuate the preponderance of bankruptcy filings. Pending legislation will fail to fix the problem because it restricts bankruptcy filers without addressing the lending practices of major credit card companies.

The imbalance has consumer groups ranting about credit card companies and banking associations, which both lobbied for the bill. The word "predatory" is getting thrown around a lot by these collectively powerful consumer groups, and they are not bothering to distinguish between various types of financial institutions.

In part, it's a matter of public relations for bankers who find themselves aligned with huge credit card companies in fighting for legislation that won't help banks and fails to address reality -people are borrowing more money than they can ever hope to pay back. New legislation won't stop this. It will only create more fodder for bankers' opponents without significantly decreasing the affect of bankruptcy on the balance sheet or society.

Why would community bankers side with credit card companies? Community bankers and credit card companies run different businesses. Community bankers avoid lending to people who can't pay back. Yet bankers have no control over their customers after they make a loan. If I were a banker, it would make me angry to eat a loan that goes bad because another lender overextends credit to my customer. Being publicly painted with the same brush as the irresponsible lender would make me even angrier.

Community bankers should champion a bill that would force credit card issuers to require a minimum monthly payment of 4 percent or more as opposed to 2 percent or 3 percent, which is now the norm. Such a compromise would make social sense and protect bank loan portfolios. With more of the minimum payment going to pay down principal, less-disciplined borrowers are less likely to stay in debt over their heads forever.

"The decline in the typical minimum payment to 2 or 3 percent is responsible for much of the rise in consumer bankruptcies through the past decade," said Stephen Brobeck, Consumer Federation of America, an organization that pushed for such a measure. "That low minimum payment, which barely covers interest obligations, convinces many borrowers that they are okay as long as they can meet all their minimum payment obligations."

Don't get me wrong, I'm all for legislation that forces more bankruptcy filers to repay their debts. Today, it's too easy to file a chapter 7, "clean slate" bankruptcy. Current legislation would establish a formula that would determine whether bankruptcy filers are able to pay off part of their debt. (The American Bankers Association estimates 10 percent of filers have the ability to repay.) Those earning at or above the median would have to make good on at least part of their obligations. Hooray! But it would do nothing to prevent fiscally irresponsible people from borrowing more money than they can ever hope to pay back.

With a higher minimum monthly payment, plenty of people would still file for bankruptcy. But debtors would reach their monthly payment threshold before accruing outrageous levels of debt, thereby making them better candidates to pay up under new bankruptcy rules. Who knows-that might even include the boat loan you made them two years before they racked up $40,000 in credit card debt.

By Justin Dullum, Associate Editor