The Bankruptcy Reform law enacted in 2005 made it more difficult and more expensive to seek bankruptcy protection, but it has not offset the effects of job losses, declining incomes, rising living costs, and an erosion in home equity that has eliminated a financial cushion on which many consumers had come to rely.
As a result, personal bankruptcy filings increased by 37 percent in 2007 over the previous year; for the 12 months ending in June of this year, filings were up by nearly 30 percent, suggesting that the year-over-year increase for 2008 is likely to top the 2007 statistic.
The Administrative Office of the U.S. Courts recorded nearly 1 million bankruptcy filings in 2007, 96.5 percent of them for individuals. More than half the personal bankruptcies were Chapter 7 filings in which most debts are eliminated, notwithstanding the new bankruptcy rules, which are designed to force borrowers into Chapter 13 debt restructuring filings instead.
“The rise in bankruptcies is not about something that happened last week or last month; it’s about the fundamentals,” Elizabeth Warren, a Harvard Law School professor and an expert in bankruptcy law, told the Washington Post. “It’s about declining wages rising costs, inadequate health insurance, and job instability. More hardworking middle-class families simply can’t make it in this economy, and it’s only getting worse,” she said.
Declining home values – part of the continuing collateral damage from the subprime mortgage crisis – are contributing to the bankruptcy trend, according to analysts, who note that many consumers, juggling mortgages they can’t afford, are using Chapter 13 filings as a strategy to forestall foreclosure and renegotiate the terms of their loans.
Personal bankruptcies peaked at nearly 2 million in 2005, as consumers raced to file before the more stringent rules took effect. But d=filings had been trending steadily downward until last year, when the housing market hit the rocks and the economy began to slow.
In a significant change from historical patterns, older consumers account for an increasing number of the individuals seeking bankruptcy protection – 22 percent in 2007 compared with only 8 percent in 1991, according to the AARP, which is funding a study of the issue. Those percentages rise with age. For seniors between the ages of 55 and 64, bankruptcies increased by 40 percent during the 18-year study period. The increase was 125 percent for those between 65 and 74 and 433 percent for the oldest category, between 75 and 84.
What has changed, the study notes, is the financial profile of seniors, an increasing number of whom are entering retirement with large mortgages and consumer debt loads unknown to prior generations of retirees and facing rising costs for health care and other living expenses that their Social Security benefits can’t offset.
“Older Americans are hit by a one-two punch of jobs and medical problems, and the two are often intertwined,” explained Warren, who was one of the authors of the study. “They discover that they must work to keep some form of economic balance,” she told the Associated Press, “and when they can’t they’re lost.”
HOME VALUES FALLING
Falling home values have left an estimated 70,000 homeowners with mortgages that exceed the value of their homes and could push another 1.7 million people into a negative equity position if values continue to decline. That warning comes from analysts at Standard & Poor’s, who say one in six homeowners would be underwater if values fall another 17 percent, as some economists are predicting, before the market stabilizes.
That prospect was very much on the minds of economists attending the Federal Reserve’s annual gathering, held recently in Woods Hole, Wyoming, who focused at length on the extent to which the ailing housing market exacerbating the economic slowdown – and vice versa. “It is simply not clear —at least, not clear to me — what will stop this re-enforcing process,” economist Martin Feldstein, former president of the National Bureau of Economic Research (which pronounces the official beginning and end of recessions) told reporters covering the conference. Feldstein described the cycle this way: Rising foreclosures put downward pressure on home prices, triggering more defaults and foreclosures and further depressing home values. Declining values and foreclosures, in turn, impair the value of mortgage securities in the portfolio of financial institutions, impeding their ability to provide the credit needed to bolster the sagging economy.
Feldstein agrees that a housing market correction is needed, but he’s concerned that a market that created a deadly bubble going up will produce an equally devastating over-correction coming down. His solution for avoiding that risk and breaking the “self-perpetuating” cycle: “Mortgage replacement loans.” The idea, described in an op-ed article published in the Wall Street Journal, is that the federal government would offer all homeowners “vulnerable to a further price declines” the opportunity to replace 20 percent of their existing mortgage with a low-interest government loan, up to $80,000. Lenders would have to take a partial pay-off of their loan, reducing the borrowers’ monthly payments accordingly. The resulting decline in loan-to-value ratios would prevent large numbers of homeowners from slipping into negative equity positions and “would help all homeowners and the economy as a whole,” Feldstein suggests.
“Limiting the destruction of homeowners’ wealth would help maintain consumer spending, boosting production and employment….Stabilizing the values of mortgage-backed securities would strengthen financial institutions, increasing credit flows that would further stimulate the economy. There may be better ideas for stopping the downward spiral of house prices,” Feldstein concludes, “but I haven’t heard them.”
OCC DIFFERS ON CREDIT CARD RULES
Playing an increasingly familiar role as odd-agency out among financial industry regulators, the Office of the Comptroller of the Currency (OCC) is opposing a Federal Reserve (Fed) proposal defining a number of common credit card practices as “unfair and deceptive.” The Office of Thrift Supervision (OTS) and the National Credit Union Administration (NCUA) have both endorsed the proposal, released in May, which would limit rate increases on existing credit card balances, ban double-cycle billing, and establish rules for allocating payments among existing and new charges, among other major changes aimed at practices consumer advocates and regulators have deemed abusive.
In a letter to the Fed, Comptroller of the Currency John Dugan, whose agency oversees approximately 80 percent of the nation’s credit card issuers, warned that the proposed rules will weaken banks, increase their liability risks, restrict the availability of credit to many consumers and increase credit costs for all.
“We believe that particular aspects of the proposed rule would have unintended and undesirable consequences that raise safety and soundness concerns, are not necessary to assure fair treatment of consumers, and in some respects, run counter to consumers’ interests,” Dugan wrote.
Dugan echoed the concerns of financial institutions, which have criticized most key components of the proposal but objected most strenuously to the provision that would allow issuers to increase rates on existing balances only if a promotion rate has expired or if a card holder’s payment is more than 30 days delinquent. That restriction would prohibit lenders from increasing rates in response to changes in a borrower’s credit score, and would bar “universal default” rules – a common industry practice under which issuers increase rates if borrowers are delinquent on other accounts, even if they are current on their card payments….
Those restrictions on risk-based pricing are unwarranted and potentially damaging, according to Christine Favilla, president of Discover Bank, who likened the proposal to “making it an unfair practice [for insurance companies] to raise premiums on drivers who accumulate speeding tickets or DWI convictions, and allowing adjustments only if the driver files an accident claim or stops paying premiums.”
Banking industry trade groups and industry executives have flooded the Fed with comment letters blasting the credit card proposal. Consumer groups have matched that outpouring with comment letters supporting the proposal and urging the Fed to adopt more stringent consumer protections. All told the Fed has tallied 56,000 responses, a record for any regulatory proposal, agency officials said.
Meanwhile, the House and Senate are considering measures that would go further than the proposed UDAP rules in restricting credit card practices. The Senate Banking Committee hasn’t yet vetted a measure co-sponsored by Chairman Christopher Dodd (D-CT) and Sen. Carl Levin (D-MI), but the House Financial Services Committee recently approved a “Credit Card Bill of Rights.” That measure incorporates key components of the Fed’s proposal (barring double-cycle billing and universal default pricing), adding to them provisions that would:
- Require issuers to give consumers 45 days advance notice of a rate increase;
- Require issuers to mail bills at least 25 days before the due date and classify as “on time” payments received before 5 p.m. EST on the due date
- Prohibit issuers from charging a late fee if the customer can prove the payment was mailed within seven days of the due date.
- Require issuers to give borrowers the option of a fixed credit limit that cannot be exceeded and prohibit them from charging over-limit fees on those accounts.
- For subprime credit cards, require that fixed fees totaling more than 25 percent of the credit limit be paid up front, before the card is issued and not charged against the credit limit.
While Congress isn’t expected to act on the legislation this term, Congressional focus on the issue will have a strategic impact on the Fed’s rule-making process, consumer advocates and industry analysts agree.
“It’s going to hem in the Fed,” Travis Plunkett, legislative director of the Consumer Federation of America, told reporters. “It sends a message that says, ‘You did the right thing. Don’t weaken it; move it along.’”
A CRITICAL MARKET
Credit unions can count on loyalty and inertia to keep older members from straying, but that assumption won’t apply to younger customers -- members of Generations X and Y – who are more likely to find fault with their financial institutions and to jump ship when they do.
A survey of 1,000 younger customers, found that:
- 37 percent of the Gen X group (aged 30 -42) and 36 percent of Gen Y (aged 18-29) thought they would get better service at a financial institution other than the one they were currently using.
- 22 percent of Gen Y and 21 percent of Gen X said they had been angered in the past year about high fees, compared with only 14 percent of “Baby Boomer” customers and 6 percent of older “Silent Generation” respondents.
- 18 percent of Gen Y and 17 percent of Gen X respondents reported being upset about a lack of ATM locations, compared with 11 percent of boomers and 3 percent of “silents”.
Most telling, and potentially ominous for credit unions eyeing these younger cohorts, 53 percent of Gen X respondents and 61 percent of Gen Y said they had either changed their primary financial institution in the past two years or considered doing so.
“Younger people are usually more open to experimentation and are willing to take risks, “Thad Peterson, division vice president in charge of sector strategy and solutions at Maritz, said in a press release summarizing the survey results.
Relationships with younger customers are inherently unstable, Peterson said, because “younger people haven’t settled into a stable pattern yet.” To cement those relationships – a good idea, given that boomers, despite their expectations, aren’t going to live forever — Peterson says credit unions have to connect solidly in the areas most important to younger customers. H e suggests specifically:
- Become the source of their primary debit card;
- Offer efficient, competent service. Younger customers expect instant solutions to problems, “a key to securing lifelong patrons,” Peterson notes.
- Provide state-of-the-art on-line banking, bill-paying, and mobile banking services younger customers view as hallmarks of their banking experience.
But don’t go overboard, Peterson cautions. He thinks using Facebook and other social networking sites to reach out to younger customers, as many businesses are doing, is a mistake, “like standing in a corner passing out business cards at a cocktail party. If you don’t have a genuine relationship with them,” Peterson warns, “all you are going to accomplish is to diminish the value of your brand to that individual.”
THEY DON’T LOVE NEW YORK!
Fannie Mae and Freddie Mac have announced that they will no longer purchase some subprime loans secured by properties in New York State because of liability concerns created by a newly enacted state law. The legislation, which became effective September 1, is designed to curb predatory lending practices by imposing stricter standards on a new category of “high-risk” loans. The standards of most concern to Fannie and Freddie and lenders in the state establish a “duty of care” requiring mortgage brokers to verify the suitability of loans for borrowers and make loan purchasers, including Fannie and Freddie, potentially liable for loans that do not meet the statutory requirements.
Freddie Mac cited the “potential for heightened legal and business risk exposures for the purchasers or assignees of these loans,” in announcing its decision to shun New York loans that meet the new “high-risk” definition. Fannie Mae was less specific, saying only the company “will not purchase or securitize any mortgage loan that meets the definition of a subprime home loan under New York law, regardless of whether any provision of the law is preempted by federal law with respect to a particular mortgage or for a particular originator.”
Mortgage lenders and industry attorneys said they understood the decision. “The statutory right of consumers to assert defenses to foreclosure against the holder is a form of assignee liability that the market chooses not to accept,” Nanci Weissgold, a partner with the Washington, D.C. law firm K&L Gates, told NewsEdge. “There are only so many ways that a loan purchaser can say it won’t put its money at risk for an originator’s failure to satisfy some subjective standard,” she added.
But consumer advocates criticized the GSEs’ decision, saying they were “over-reacting” to the New York law and abnegating a responsibility they have to help address the foreclosure crisis in New York and elsewhere. In an interview with Newsday, Bertha Lewis, executive director of New York Acorn complained, “New York and the nation got into this crisis in the first place because Fannie Mae and Freddie Mac turned a blind eye to the abuses of loan originators.”