Going broke follows much the same rules as winning the lottery — which is to say, the rules of chance.

Bankruptcy “reform,” on the other hand, much like welfare “reform,” assumes that people who benefit from the existing system just need a little tough love to force them to take financial responsibility for their own lives. Accordingly, the bankruptcy bill now making its way through Congress makes it harder for middle-class people to make a fresh start after declaring bankruptcy, because they will have to pay back more of their creditors.

Who declares bankruptcy?

About half of all debtors file bankruptcy because of medical bills, even though three-quarters have health insurance during all or part of their illness. Many lose coverage as a result of losing their jobs. Three out of five can’t afford to visit a doctor or dentist when they needed to, at least once during the two years before filing for bankruptcy. Almost 40 percent of patients with terminal illnesses report having to cope with financial problems as they prepare to die.

There are big gaps in the patchwork of income supports available when you can’t work because of illness or disability. Worker’s compensation doesn’t cover all employees, and only applies to conditions caused by work itself. State disability payments don’t cover all employees either, and they only last for six months. You can’t get federal disability payments until you’ve lost a year’s income, and even then, you must be facing death or another year away from work in order to qualify for benefits. The Family and Medical Leave Act allows many workers to retain health coverage while they care for sick family members, but it doesn’t provide any income.

The American Bankruptcy Institute estimates that fewer than four percent of filings are by people who could actually pay their debts. Many debtors put off declaring bankruptcy until they have lost their telephone service (40 percent), gone without necessary medicine (43 percent), or been too poor to buy food (19 percent) at least once.

Children are a big risk factor for insolvency: married couples with children and single mothers are two and three times more likely to go bankrupt, respectively, than their childless counterparts. Divorced mothers face an additional risk, because they often lose health coverage linked to their ex-husbands’ jobs.

The Effect On New York City

New York residents will be hit especially hard if the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 becomes law:
The number of personal bankruptcies is going up faster in New York City (8.4 percent in 2003) than nationwide (5.6 percent). During 2004, there were about 76,000 filings for personal bankruptcy in New York State.
New Yorkers face greater financial challenges than the average American. Prices are rising faster in the city than nationwide, due to large increases in the cost of housing, food, and transportation. In 2003, local salaries dropped by 1.6 percent, when adjusted for inflation.
The new law would eliminate important protections for debtors whose landlords are evicting them for back rent.

Personal Bankruptcy Before “Reform”

Bankruptcy itself is not a financial disaster. It protects filers from collection agents, “repo men”, and other consequences of an overwhelming level of debt.

In 2004, four out of five personal bankruptcies were filed under “Chapter 7,” which allows all debts to be cancelled except for student loans, overdue tax payments, child support, and alimony. Debtors must sell any available assets to pay their bills before debts are written off, but 96 percent of them have nothing to sell.

Under “Chapter 13,” the bankrupt person or family must follow a court-approved repayment plan under which all available income is paid to creditors for three to five years. In practice, two-thirds of them never finish the repayment plan. Some are allowed to change over to Chapter 7 status, if it becomes clear that repayment is impossible for them. Others lose the protection of bankruptcy and have to deal directly with creditors again, with additional interest on their debts for the time they were in bankruptcy.

Under both Chapters 7 and 13, debtors must keep up-to-date on payments for loans backed by houses, cars, or other assets, or those items will be repossessed by the creditor.

Changes Under The Proposed Bankruptcy Bill

The biggest change would be that people who earn more than their state’s average income might not be allowed to file for Chapter 7, regardless of their actual expenses. The Internal Revenue Service sets annual guidelines for how much money a household needs for such essentials as food and housing; any income beyond those levels would be considered available for paying creditors. Judges would no longer be able to take individual circumstances into account, as they do now.

The poorest debtors would not be affected by this change. Many don’t file for bankruptcy, as they have no assets to lose. Those who do file would still be eligible for Chapter 7 status. Wealthy debtors retain major loopholes under the new bill, such as the right to keep valuable homes and retain assets in special trusts.

The changes would fall squarely on the shoulders of middle-class people facing life crises like illness, disability, unemployment, divorce, and death in the family. Democratic members of Congress unsuccessfully introduced dozens of amendments that would have helped consumers and debtors, including specific protections for the elderly, veterans, and caregivers to sick or disabled family members.

Some single parents who manage to avoid bankruptcy themselves would have a harder time collecting child support and alimony. When noncustodial parents are forced to declare bankruptcy under Chapter 13, rather than Chapter 7, the repayment plan diverts some of their limited income from child support and alimony to credit card debts.

Legal fees would probably rise sharply under the proposed bill, which would hold attorneys responsible if their clients filed bankruptcy petitions with missing or incorrect information. This would lead to more paperwork and higher malpractice premiums. In addition, more bankruptcy court judges would be needed, so the bill raises court fees to pay their salaries.

Never A Free Ride, Soon To Be Worse

While bankruptcy can free debtors from their worst predicaments, it has never been a comfortable safety net. A stigma of failure and irresponsibility surrounds it. Credit reports list bankruptcy for up to ten years, a problem even for those who have no interest in new borrowing. After bankruptcy, insurance premiums are often raised, as well as interest rates on new or remaining debt. An increasing number of landlords and employers are checking credit reports as part of the application process.

One year after they file for bankruptcy, half of all filers report that they are no better off financially. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 would prolong their troubles, and ensure that more filers get less protection from the law.

Linda Ostreicher, a former budget analyst for the New York City Council, is a freelance writer and consultant to nonprofits.