What's wrong with this picture? Six years into the current economic expansion, both stock prices and personal bankruptcies are at record levels. A case of the rich getting richer and the poor getting poorer? Maybe, maybe not. This much is clear: Companies that depend on consumer credit for much of their earnings had better watch their step. Not only are consumers pretty well tapped out, but they're also more likely than ever to default on their debt by declaring bankruptcy.
That explains why a growing number of credit card issuers, including at last count Sears, Roebuck and Co.; Federated Department Stores Inc.; GE Capital Services; and AT&T Corp., have all recently run into legal trouble by dunning deadbeats. To make matters worse for lenders, Congress may make it even harder to go after such customers.
The issue is gaining attention as the National Bank-ruptcy Review Commission puts the final touches on several recommendations for overhauling federal bankruptcy law. The idea is to bring more uniformity to the kinds of protection from creditors that bankruptcy provides. Currently, in many states, state exemption laws hold sway over federal when it comes to what assets can be kept and what debts can be discharged, and the statutes vary widely. In such states as Florida, for example, homes are off limits for creditors no matter how valuable they are. But other states are much more restrictive.
At press time, the commission was due to submit its recommendations to Congress. And if Congress extends the protection afforded by Chapter 7, the section of the federal law that applies to individuals, consumers could "see bankruptcy court as a way to manage their finances rather than as a last resort," says David Sandor, a spokesman for Visa U.S.A. Inc., in San Francisco.
Consumer advocates challenge that view. "The notion that consumers are standing gleefully at the door of bankruptcy court is erroneous," says Karen Gross, a professor at the New York Law School and author of a book on bankruptcy. Also, the commission's recommendations are not without congressional opponents. A bipartisan bill introduced in September would make it less attractive for some people to declare bankruptcy, and should improve the chances that those with the ability to pay be required to pay off a portion of their debts.
While it is too early to predict the outcome of the debate, Gross points out that "the best thing that could have happened to debtors is the Sears debacle. For the first time, the media have focused on creditor behavior instead of debtor behavior."
Whatever the motivation, personal bankruptcies are rising even as the economy continues to expand. The number of new bankruptcies throughout the nation rose to an all-time high of 1 million last year, and it is should exceed 1.4 million this year, says the Administrative Office of the U.S. Court.
Adding to the confusion, consumers with no history of late payments are seeking the law's protection, giving no warning to lenders.
THE SEARS BLUEPRINT
But the phenomenon is surely linked to a larger problem: a continuing decline in personal savings. Household debt as a percentage of disposable income keeps soaring. At last count, it was up to around 92 percent, a far cry from 66 percent in 1980 (see chart, right). So what will happen if the good economic times end? The problem threatens to grow worse even if Congress doesn't side with consumers.
Of course, not all companies that lend heavily are equally vulnerable to mounting credit card losses and to attempts to make it more difficult to collect. Take what happened to Sears. Mounting credit card losses have not prevented it from executing a dramatic turnaround. Despite a $26 billion credit card portfolio that makes it one of the biggest issuers in the nation, Sears is one of the least vulnerable, thanks to its astute management practices. But you never would have guessed it from the scandal that broke last April. Remember the headlines? Sears suddenly found itself embroiled in class-action lawsuits and potential legal action by attorneys general in all 50 states over charges that the company had illegally tried to collect from consumers who had declared bankruptcy while owing Sears money.
What sparked the suits? A decision by Judge Carol Kenner in the U.S. Bankruptcy Court in Boston to cite Sears for contempt for "willful and intentional flouting of the Bankruptcy Code." The matter first came to Judge Kenner's attention in the case of Francis Latanowich, who had filed for bankruptcy in 1995 and was having trouble making so-called reaffirmation payments he had agreed to make on several items bought at Sears.
Latanowich's pleas to get Sears off his back prompted Judge Kenner to take a closer look at the company's collection practices. Granted, tens of thousands or more customers had voluntarily accepted the reaffirmation of all or part of their debt in return for being able to keep their merchandise and continue charging items to their Sears card. But Kenner found that the company had failed in many, if not most, cases to get the court approval that the law requires before dunning the customers for late payment. Moreover, this had been Sears's standard practice with reaffirmations for more than a decade, according to analysts.
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