The Benefits of Bankruptcy

Last weekend I watched the movie Larry Crowne, starring Tom Hanks and Julia Roberts.  In the movie, Tom Hanks plays a character that had recently been terminated for his job due to his lack of formal education, so he decided to go back to community college to remedy the situation.  He took an economics class there with an eccentric professor.  One day, the two of them were outside the school having a discussion on whether there were any economic benefits to filing for bankruptcy, I believe with Tom Hanks arguing that there were not and the professor arguing that there were.  Granted, this was not the focus of the film (and I haven’t known bankruptcy to be a topic discussed in economics classes – I didn’t discuss it in mine), but the professor was right.

Bankruptcy is not something that a person should strive for.  We all know that.  However, for the honest debtor who finds himself or herself in a truly difficult financial situation which is unanticipated, bankruptcy does operate as a “fresh start,” which is its stated goal.  What I generally mean by an “honest debtor” is a debtor who is not committing fraud by doing something like running up credit card debts in anticipation of bankruptcy, but that’s for another blog entry.  In this entry, I will be referring to consumer bankruptcy.

The most pervasive aspect of the fresh start is through the discharge under section 523.  A bankruptcy discharge simply relieves the debtor from any further personal liability for the debts covered by the discharge.  A bankruptcy discharge does not, however, eliminate the debts: the ability of creditors to look to other parties such as guarantors and insurers is unaffected.  And, a bankruptcy discharge does not eliminate liens: the ability of secured creditors to look to their collateral is unaffected.

There is also the automatic stay under section 362.  This means that from the moment you file for bankruptcy, your creditors cannot attempt to collect the debts that you owe them.  They cannot send you letters or call your phone (by the way, even if you don’t file for bankruptcy, creditors are required by law to obey you if you tell them to stop calling your cell phone at any time, though you can’t make them stop calling your home phone without the automatic stay).  They also cannot do things like terminate your utilities with the automatic stay protection.  A creditor can be held in contempt for violating the automatic stay.   

In certain situations, bankruptcy can also help a debtor’s credit score.  This is because individuals who file for bankruptcy in the first place typically have low credit scores in the first place, often with things like late payments and charged-off accounts.  When consumers receive the bankruptcy discharge, the items will be marked as included in a bankruptcy, rather than showing a high account balance, or otherwise being a bad debt.  To be certain, this is not always the case; in a generic sense, the bankruptcy filing, in and of itself, will lower a consumer’s credit score.  It is only the effect on the consumer’s other accounts that can sometimes improve a credit score.  I should also mention that bankruptcy discharge can only stay on a credit report for ten years. 

There is also plenty of free assistance for those who need it.  I spent my summer in 2011 working only on pro bono bankruptcy cases.  They were referred to us by Legal Services of Northern Virginia.  The individuals who received the pro bono assistance did not get the bankruptcy representation for absolutely nothing – they still had to pay small fees to, among other things, pull their credit reports.  They did not, however, have to pay several thousand dollars in fees, which is typical of a bankruptcy filing. 

Bankruptcy is not always a bad thing.  For the honest debtor who finds herself in a difficult economic situation, it can provide a fresh start, free of phone calls from creditors and personal liability for debts.  Though it is often expensive to hire a bankruptcy attorney, there are often programs (such as those in Northern Virginia) to provide assistance to those who cannot afford the attorney’s fees.  Based on the complexities of the bankruptcy code, though, it is probably not a good idea for most debtors to file bankruptcy pro se (without legal representation).

Thanks for reading.  I’ll be back with a new post within the next few weeks.

J.P. Morgan

Credit Reform

As a person who regularly checks his credit report, I was surprised a few years ago when one of the credit bureaus reported that I had filed for bankruptcy.  This was not true; I was only eighteen or nineteen at the time, and had no reason to file.  It was actually a family member of mine who had filed for bankruptcy.  Adding to the absurdity of the situation was that the bankruptcy had been filed in 1995, when I was only 7 years old.  Despite the inherent nonsense, I still had trouble convincing the representative of the credit bureau over the phone that the bankruptcy did not actually belong to me.  I eventually got the situation resolved, but it took a lot of needless time.

Of course, that was not the only account listed on my credit report that did not actually belong to me.  There were multiple other accounts past due which were incorrectly attributed to me on my credit report.  I believe I have had incorrect listings on my credit report every time that I have checked it, including earlier this year.  Based on the way that credit reports are currently structured, it seems to me that the system runs contrary to its stated goals.

First, I should mention that the only website that will give you an actual free credit report every year is AnnualCreditReport.com.  It will give you your reports for Equifax, Experian, and Transunion.  I find it troubling how few people are aware of this; television, of course, is littered with commercials for websites with misleading names about the prices of their credit reports, which lead to monthly account charges. AnnualCreditReport.com is mandated to exist as a consequence of 2003’s Fair Credit Reporting Act, and will provide anyone with a truly free credit report once every year.

The goal of credit reports, as I understand it to be, is to provide information on the worthiness of a customer to receive credit.  Some aspects of the credit report adequately serve this function: if I were considering lending money to a consumer, I would certainly like to know whether that consumer has recently defaulted on loans, has filed for bankruptcy, or has substantially more debt than income.

My main problem, though, is that a consumer’s credit score lowers when the consumer has his or her credit checked, whether that is by the consumer or by a potential lender.  This, to me, should be changed.  Whereas things like bankruptcy and past due accounts generally show a degree of financial mismanagement, frequent checking of one’s credit is indicative of diligent awareness of one’s creditworthiness.  Even beyond this, people in my situation, with incorrect information constantly showing up on my credit report, have somewhat of a “damned if you do, damned if you don’t” scenario.  If I fail to check my credit report frequently, then incorrect information shows up and I don’t have the chance to correct it until I have already been denied credit due to the faulty information.  If I do check my credit report frequently, my credit score will consequently decrease, and I will similarly have a difficult time obtaining credit.  I am aware that there are services available which alert consumers about changes to their credit reports, but I have trouble believing that every consumer should have to pay a monthly fee to utilize such a service, considering the mandatory nature of having reports with the three major credit bureaus for any consumer who wishes to obtain credit.

If that aspect of the credit system does not change (or even if it does), then new procedures need to be put in place to ensure that information on credit reports is actually correct.  For example, for any information that appears on my credit report, if either the creditors or the bureaus had bothered to verify that my social security number matched that of the delinquent debtor, they would have discovered quickly that the accounts did not actually belong to me.  Instead, however, many of these creditors see a similar name and/ or the same address, they incorrectly report the debt to the credit bureau without any further verification.  A mandatory social security number verification, by either the credit bureau or the creditor, would easily resolve this situation.

When incorrect information does appear on a consumer’s credit report, the consumer’s remedy is to submit a dispute to the credit bureau.  The credit bureau will then contact the creditor and ask them to verify that the information is correct.  If the creditor fails to report back to the bureau with affirmation that the information is indeed correct, then the credit bureau is legally required to remove the information.  This system is not perfect either, however.  With at least one account that has incorrectly been reported as mine on my credit report, I disputed the account, and the company STILL reported incorrectly that I was past due on an account with them.  When the credit bureau contacted the company, the company was lazy enough to report back to the credit bureau that I actually did owe them money, clearly without adequate verification.  I eventually got in contact with this company and asked why they still reported that I owe them money, even after the dispute gave them reason to believe that the information was faulty.  Their response was that they get hundreds of those every day, and sometimes these things just slip through.  I dislike a mandatory credit system that allows for corporate laziness to harm consumers in such a way.

My solution is for Congress to act on this and either put more stringent requirements to verify credit information or to remove the disincentive to check one’s credit report frequently.  The system, as is currently is, produces bizarre results and incentives that often do not reflect creditworthiness, but instead harm consumers for forces beyond their control.  Unfortunately, this is not a talking point that receives much attention in the media, so I am not confident that such changes are imminent.

Please let me know what you think.  Unlike my previous blog entries, this one is largely based on opinion, and I am curious to see whether other have similar gripes.  Also, you may have noticed that I said I said in my last entry that I would write about the discharge of medical malpractice debts.  I felt more motivated to write about this at the moment.  I’ll probably write about that at some point.  I plan on writing every other week from this point, and I am not sure at the moment what my next entry will be. Please come back here in a couple weeks and find out. Thanks for reading.

J.P. Morgan