The Daily Reckoning
London, England
Tuesday, March 22, 2005
The Daily Reckoning PRESENTS: The new bankruptcy bill may deter some debtors from further "credit card kamikaze," but if property prices decline, the bill could leave millions of homeowners underwater on their mortgages. Rick Ackerman explores...BORROWERS SHOULD GO FOR BROKEby Rick Ackerman
As indebtedness in its many insidious forms mounts globally toward an epochal climax, prudence begs the question of why lenders are still frantic to put even more unearned dollars in our sweaty little hands. Zero percent auto loans are everywhere; mortgage money remains easy to come by, even after a 150-basis-point tightening of administered rates; and anyone who is not deceased or in prison can borrow for 3% or less by writing a check on a revolving charge account.
Why are lenders making it so painless for us to get in even deeper over our heads? Don't they know that it can only end badly for borrowers and creditors alike? The simple answer is that their greed has long since exceeded their good sense. Since it costs big banks and retailers almost nothing to raise funds for consumer loans, and because the alchemy of securitized debt has created a practically unlimited supply of lendable dollars, why not just go for it? And so they have, with the laudable goal of gaining market share, but with a relentless zeal that in recent years has savaged the moral and ethical boundaries of lending.
And yet, in a legalistic sense, lenders appear to be acting rationally, if not prudently, owing to certain provisions in a bankruptcy bill that recently was enacted into law after an eight-year struggle in Congress. I followed the bill avidly each step of the way, since it represents the one instance in my adult life where I've been on the same side of the political fence as the likes of Bill Clinton, Ted Kennedy and Charles Schumer, all of whom opposed the measure vehemently. Not surprisingly, the bankruptcy overhaul has the enthusiastic support of credit-card companies, banks and retailers. Also not surprisingly, the legislation remained moribund under Clinton, freighted with riders and amendments that kept it bottled up in committee.
Oddly enough, it was pro-abortion sentiment that prevented the bankruptcy bill from passing earlier. As earlier amended, it would have allowed pro-lifers to use the bankruptcy courts to evade fines imposed for illegal protests, including violent antiabortion demonstrations. The issue was sufficiently nettlesome to prevent the legislation's enactment under Clinton, but its prospects revived under a politically ascendant Bush. Now it is the law of the land, impelled by a phalanx of well-financed and highly capable lobbyists, and by a Republican majority strong enough to sweep aside all obstacles that had been imposed by the political left's Old Guard.
In practice, the bill will make it far more difficult for an individual to walk away from debt by declaring personal bankruptcy through a Chapter 7 filing. Under the legislation, those able to pay off some of their debts would have to file under Chapter 13, which allows the court to set up a partial repayment plan. Before, debtors who got in over their heads could wipe the slate clean and start a new life, financially speaking. But under the new laws, some debts could weigh on borrowers for years, perhaps until they die; and then, presumably, the burden would shift to their survivors.
Make no mistake; the new law will cause some opportunistic borrowers to think twice before attempting to commit credit-card kamikaze. But it will also wreck the lives of many otherwise financially responsible individuals who get deeply in hock for reasons beyond their control. Take, for example, the widow who gets stuck with her deceased husband's huge medical bills. Absent the felicity and forgiveness of Chapter 7, the woman could find herself unable to access credit for the rest of her days. Some will argue that that's better than languishing in a debtor's prison, but for the widow and her family, the financial purgatory of creditlessness could be almost as debilitating and demeaning.
Ominously, there is far more at stake than the fate of unfortunate widows with probate problems. For conceivably, the new bankruptcy law could destroy the lives of tens of million of Americans, whose net worth - and borrowing power - is tied to the value of their homes. What if property values were to decline in the U.S., triggering a severe recession and leaving a substantial fraction of the nation's homeowners underwater on their mortgages? Could it actually happen? Renowned money manager John Templeton thinks so: "When home prices do start down, they will fall remarkably far," Templeton said in a magazine interview. "In Japan, home prices are down to less than half what they were at the stock market peak. A property price decline of as little as 20% would put a lot of people in bankruptcy."
Templeton noted at that time, late in 2003, that Americans owed a total of $31 trillion - three times the nation's GNP - and that this has put debtors in great jeopardy. "Think of the dangers involved. Almost everyone has a home mortgage, and some are 89% of the value of the home (and yes, some are more). If home prices start down, there will be bankruptcies, and in bankruptcy, houses are sold at lower prices, pushing property prices down further."
Now that the bankruptcy bill has become law, those who are merely decimated by the coming credit collapse may find themselves in far worse shape than profligate borrowers who literally went for broke. Pennilessness might be a ticket to financial freedom, but those barely scraping by will be on the hook for as long as they continue to work.
If Templeton is right and millions of mortgagees are reduced to subsistence living, lynch mobs will be demanding the repeal of these new laws five years from now. Until then, the lenders, having legally hedged their bets, will probably think they're sitting pretty if the economy should implode. Any comfort they might take in this belief is delusional, however; for there can be no winners or losers in a deflationary collapse, only survivors.
Regards,
Rick Ackerman
for The Daily Reckoning