'New debtors' buried in bills they can't pay
By PAUL WENSKE The Kansas City Star
When her husband died in 1998, Patricia J. had no money to repay a staggering $45,000 credit card debt the couple had accumulated over the years. She was still dealing with her grief when insistent creditors began a drumbeat of demands she pay up -- now.
Part of the debt resulted from her husband's job, for which he traveled. But the Kansas City, Kan., couple also used credit cards to pay the doctor bills that mounted over the three years he battled a rare lung disease.
"They called all the time," said Patricia, 65, who, like other debtors interviewed for this story, asked that her full name not be used. "I couldn't take it any more. So I filed for bankruptcy. I couldn't do anything else."
In doing so, Patricia joined 1.28 million other consumers who sought personal bankruptcy court protection from creditors last year -- more than twice as many as a decade ago.
She reflects what some analysts call the "new debtors," including single women and low-income couples -- frequently folks who only recently gained access to our expanding credit card culture.
They include Donna, a debt-ridden former Johnson County homemaker, who moved into subsidized housing with her two children after a bitter divorce. And Douglas and Lisa, who bought a house in Grandview and two cars and maxed out their credit cards in the process -- before they went bankrupt.
Such debtors are at the core of congressional debates over whether to make it harder for consumers to get relief in bankruptcy. They live in the shadow of the booming economy, consumers who not only aren't becoming millionaires, they're so saddled with debt that they scrape by or simply go broke.
Some analysts fear this growing army of debtors mirrors a larger truth: Our economy is so dependent on credit that the weight of too much debt could make any recession deeper and longer for everyone -- smashing our house of cards.
Credit cards are not the primary reason for bankruptcy, according to bankruptcy experts. But they are frequently the final straw.
While bankruptcies doubled in the past decade, total credit card debt has more than tripled, according to CardWeb.com Inc., from about $172 billion in 1989 to about $585 billion in 1999. The Federal Reserve, which uses a slightly different formula, puts the number even higher.
"Households are taking on extraordinary risk," said Bill Emmons, a Federal Reserve Bank economist in St. Louis. "People are borrowing against future income. But the debt service doesn't go away. What it tells you is that we are vulnerable to a very serious recession."
So what will the economy do, particularly as the wealth-boosting stock market boom, which has boosted the net worth of middle-class and affluent Americans, ages? No one knows for sure. What is sure is that we've already piled up record amounts of credit card debt, and we're pre-approved to charge far more -- in good times or in bad.
Explosion of credit
Even in a boom economy, consumers are spending money faster than they are earning it by borrowing.
Stuart Feldstein, a senior analyst at SMR Research of Hackettstown, N.J., said that to grasp the awesome meaning of our dependence on consumer debt one has to look at a very big number: $8.199 trillion -- more than $80,000 for every household. That includes mortgage debt, revolving debt, auto loans and student loans, among other categories. That doesn't include medical, utility and grocery bills.
But even more revealing is how much more debt we could pack on, thanks to expanding credit limits offered by credit card companies competing for more customers.
Between 1992 and 1999, bank card issuers increased credit lines more than fourfold, from $499 billion to more than $2.11 trillion -- nearly $21,000 per household.
"The extension of credit has been a huge gimmick in the credit card industry," Feldstein said. "The concern we have is it's just getting out of hand. There's all these (credit) lines sitting out there unused."
"What if we had a recession and large numbers of people were thrown out of work?" Feldstein asked. "It would be the first recession we've had where people could borrow up to (nearly) $3 trillion, whether or not they could pay it back. "This is entirely possible. You think there are a lot of bankruptcies now. The biggest problem we have is not how many people have credit cards, it's the amount of the lines of credit on them."
Affluent households still account for most of the rise in total credit card debt. But households in the more economically vulnerable bottom half of the income distribution, which are more likely to use credit cards to supplement income, charged up their cards at rates faster than the general population. Indeed, research by the Federal Reserve suggests deepening credit card debt among a larger proportion of lower-income Americans.
While the middle and upper classes enjoyed rising median net worth, families earning less than $25,000 watched their median net worth slip between 1995 and 1998, according to the Fed's Survey of Consumer Finances.
As their debts grew, families devoted more of their income to debt payments. That ratio, known as the debt burden, rose from 13.6 percent in 1995 to 14.5 percent in 1998.
The Fed also said the fraction of families facing financial distress -- whose debt payments amount to more than 40 percent of their income -- increased from 10.5 percent in 1995 to 12.7 percent in 1998.
Those families have a more difficult time paying off their debts when they become too entangled in credit cards.
The new debtors
Single women, people with medical problems and young people with modest incomes -- the new debtors -- are crowding America's bankruptcy courts.
Patricia's husband made good money on the road as a boilermaker. He used his credit card for motels and food. But three years ago he became ill.
They lived on unemployment benefits and credit cards until he died. But she had been a homemaker and had no money of her own.
"There's no way I could have paid back my creditors," she said. She owed $45,000 in credit card debts. "They called me. They wrote me, until my attorney gave me a paper to send to them saying I was under a terrible strain. I couldn't take anymore."
Women, especially those widowed or divorced, are now the fastest growing demographic group seeking to discharge all their debts in Chapter 7 bankruptcy, according to Elizabeth Warren, a Harvard law professor and bankruptcy expert. Charles Tabb, editor of the Bankruptcy Law Letter at the University of Illinois at Champaign-Urbana, said that women file bankruptcy "often after they were unable to collect support payments."
Last September, the Executive Office of U.S. Trustees surveyed 1,452 Chapter 7 bankruptcy cases from 60 federal judicial districts. It found that women filed more frequently than men. The report also found that the men had higher incomes and that the women debtors were far more likely to have dependents. "It's the most underreported issue in bankruptcy," said Maureen Skully, an attorney for United Auto Workers legal services.
Many women who earn $25,000 or less are using credit cards "to make ends meet," she said. "They use their money to pay the minimum and borrow more for living expenses."
Some women not only face mounting debts after a divorce, but also suddenly find they can't get new credit of their own.
Donna lived in a Johnson County ranch home until a divorce left her with two small children and more than $6,000 in credit card debt she said her husband racked up.
Because her name was also on the delinquent cards, card issuers denied her credit. So far, she has managed to avoid bankruptcy -- barely.
"I can hardly get my bills paid," said Donna, who is whittling away at the credit card debt. She and her children have moved into subsidized housing, and she is working two jobs "just to stay afloat."
Overall, bankruptcy records in Kansas and Missouri show that most filers have modest incomes but high debts. It's common to see families that make $25,000 or less but that have run up $35,000 or more in credit card debts.
"People are using credit cards when they get into financial trouble," said John Reed, a Chapter 7 bankruptcy trustee in Jefferson City. "They use their cards to pay necessities and use their cash to pay off other credit cards." Maurice Soltz, a Kansas City bankruptcy attorney, said, "They haven't got a drop of savings. They live paycheck to paycheck."
Lose that paycheck and they're in big trouble.
The scenario of inexperienced young adults spending their way into a hole also is increasingly common, said bankruptcy specialists. Rick Fink, the Chapter 13 trustee for Kansas City, said many debtors "don't look at the cost of the debt. They're just looking at their monthly minimum payment."
Doug and Lisa, married two years, wanted the American Dream and thought they could buy it on credit. The Grandview couple got dozens of "pre-approved" credit card offers in the mail. They used them for Christmas presents, a gas grill, to fix the car and for groceries.
Still in their 20s, with two young children, they were paying more than $300 just in minimum fees on their cards, plus the house payment and $800 a month on their two car loans. Then Doug was in a car accident and missed three weeks of work in his job as a construction laborer.
They fell behind on payments and faced late fees and higher interest. They had no savings to pay for food and health expenses. Doug's parents had gone through bankruptcy, and they advised him that it was the best way to erase his debts. Lisa was against it, at first.
But their more than $9,000 in delinquent credit card debt made it impossible to meet their basic monthly expenses and pay off their cards. So they filed Chapter 7 bankruptcy late last year.
"We just wanted too much too fast," Lisa said.
Why did bankruptcies balloon in a booming economy?
The answer depends on your point of view. The credit industry contends that too many consumers are irresponsible. But consumer advocates say card companies offer too much easy credit to people without the means to pay it back.
Writing in a Brigham Young University Law Review article last year, George Mason University law professor Todd Zywicki and Judge Edith Jones argued that a major reason for an increase in bankruptcies was "a decline in the level of personal shame and societal stigma that previously deterred individuals from filing bankruptcy.
"Bankruptcy is now too frequently a choice fostered by irresponsible spending habits and an unwillingness to live up to commitments."
The industry has taken this argument to Congress, where it has spent more than $60 million persuading legislators to tighten bankruptcy laws, citing lost revenues due to soaring bankruptcy rates. Under the proposal, consumers would have to pass a "means test" to prove they couldn't pay back their creditors.
That wasn't one of the recommendations of the National Bankruptcy Review Commission, appointed by the president, Congress and the chief justice of the United States. In 1997, the commission made recommendations that favored consumers.
Since then, a coalition of banks, credit unions, auto loan companies, credit card issuers and some retail lenders devised their own bill and took it directly to lawmakers, sidestepping the bankruptcy commission. Guess whose recommendations lawmakers heeded?
Both the Senate and the House have passed bills to tighten bankruptcy laws. Both bills are now being reconciled in joint conference.
Yet, little evidence exists to suggest that most Americans who file for bankruptcy have the means to pay much to their creditors.
In 1998, the National Consumer Bankruptcy Coalition, an alliance of banking and credit interests, launched an advertising campaign claiming that one-third of consumers who file bankruptcy do so to avoid debts they can pay. A subsequent study financed by Visa Inc. concluded that 11 percent of Americans could "repay a significant portion of their debts" to unsecured creditors, mainly credit card companies.
However, a Creighton University study, done for the independent American Bankruptcy Institute, found that only about 3 percent of the people who file Chapter 7 bankruptcy had any chance of repaying any part of their unsecured debts.
Consumer advocates grumble that limiting access to bankruptcy court to reduce bankruptcies is like closing cancer wards to stop cancer. They say the decision by some banks to take greater risks weakens their argument that irresponsible consumers get themselves into trouble and then try to dodge creditors by going bankrupt.
A Consumer Federation of America report asks: "Why have banks expanded solicitations and credit lines while forced to write off increasing bad debt losses?" The report cited a study by Veribanc Inc. of Wakefield, Mass., which tracks the industry, saying that bad debt losses rose from 3 percent in 1994 to about 4.5 percent during each of the last three years.
One answer to that question is that credit cards remain profitable. Card issuers gross $80 billion each year just in interest and fees, according to industry sources.
Given the marketing push to younger and lower-income customers, "The credit card industry shouldn't be surprised there are more bankruptcies in the last 10 years," said Peter Yoo, an Arthur Andersen economist in Chicago.
Indeed, a federal judge in Kansas City has ruled that credit card banks can't sit by as customers bury themselves under mounds of debt and then blame consumers alone for their folly.
U.S. Bankruptcy Judge Arthur B. Federman ruled in a 1996 case that a waitress who ran up $6,000 in charges on a credit card could discharge her debt in Chapter 7 bankruptcy. The bank argued she was already buried under $29,000 in card debt, and knew she could never pay any of it back.
But Federman sided with the debtor. He said the bank had the sophisticated capabilities to monitor the financial behavior of a customer and "should have realized that there might be some problem in extending credit" to a person carrying so much debt. The card issuer, Federman said, had the ability to limit credit to the debtor but didn't.
"So, they couldn't come in now and claim they were victims and had no culpability," said Carl Kimbrell, an attorney who represented the waitress. The case sent tremors through the credit industry. Bank attorneys said the case "devastated" the credit card issuers, who thereafter pushed harder to make bankruptcy laws less consumer friendly.
While the industry pushes for changes in bankruptcy law, consumer advocates seek curbs on what they call abusive credit card practices.
U.S. Rep. John LaFalce of New York said that consumers "should not be tricked or trapped into escalating interest rates and unnecessary fees."
Others say bankruptcies could be reduced if issuers offered less credit. But limiting the amount of credit is easier said than done.
Rationing credit would keep consumers from getting the credit they want, economists Kathryn Combs and Stacey Schreft argue in a recent Economic Review, published by the Federal Reserve Bank of Kansas City. And restricting how much credit the card issuers could extend to consumers would encourage card issuers to charge more fees.
That's what happened in 1980, when President Carter sought to limit how much credit banks could loan.
When the borrowing and spending stopped, however, the teetering economy collapsed into a recession. Credit controls were lifted. But by then the card companies had started charging annual fees to compensate for lost interest income.
"Reform is not going to have the kind of effect it's intended to have," Schreft said. "No one is forcing people to take a card and no one is telling them how to use them."
Even so, consumer advocates say credit card companies should be pushed harder to be more open in their come-ons and disclosure statements.
"The consumer is purposely kept ignorant," said Howard Strong, a former U.S. Senate staff member and author of the book, What Every Credit Card User Needs To Know. "The banks don't want you to know what's going on."
In the long run, credit card reforms will do little without savvy consumers. Learning ways to win the credit card game may be the ultimate solution.
Increasingly, debtors are finding help at nonprofit credit counseling centers, where counselors not only help them create a budget but work with their creditors to develop repayment plans. Credit counseling Web sites also are cropping up.
Still, experts see an urgent need to begin reaching consumers earlier, teaching personal finance at high schools and colleges. Last month, the Washington, D.C.-based Jump$tart Coalition for Personal Financial Literacy released a sobering report. It concludes that current high school seniors are using credit cards more but are less financially astute than students just three years ago.
Now, even the Federal Deposit Insurance Corp., a bank regulatory agency, is leaping into the breach to address credit card illiteracy. It has begun an experimental series of consumer credit education programs aimed at high schools, colleges and moderate- to low-income neighborhoods.
The program combines discussion and computer learning. It shows students and older consumers how to create a budget, explains the dangers of revolving credit card balances and emphasizes the importance of reading the fine print on the back of card offers.
"We're educating our students to be intelligent in math and English but I question whether we've taught them to understand financial matters," said Jack Misiewicz, FDIC regional director of compliance and consumer affairs in Kansas City.
He said the lesson that needs to be learned is as important to the nation's economy as it is to any high school student.
"You have to pay the money back sooner or later."