Tuesday, July 7, 2009

Bankruptcies low in states that don't seize wages

States that allow debt collectors to seize consumers' wages have sharply higher bankruptcy rates than neighboring states that prohibit or strictly limit the practice, an Associated Press analysis has found.

This link highlights a dilemma for credit-card companies and other debt chasers: By going after wages — an increasingly popular maneuver since the recession began, lawyers say — they risk pushing consumers into bankruptcy court, where judges can reduce or wipe away all sorts of financial obligations.

The apparent relationship between so-called garnishment laws and states' bankruptcy rates also bolsters the arguments of consumer advocates, who have long said that intercepting someone's wages to pay their debts only increases their financial vulnerability.

After gathering millions of bankruptcy records from 2006 until now, the AP plotted the number of filings for each U.S. county in its Economic Stress Map — a geographic, chronological and visual depiction of economic misery based on unemployment, foreclosure and bankruptcy data.

While bankruptcy rates vary for many reasons, the five states that prohibit or strongly limit wage seizures — North Carolina, Pennsylvania, South Carolina, Florida and Texas — all have drastically lower rates than their neighbors, with particularly striking differences along borders, where economic conditions are similar but bankruptcy rates are not.

South Carolina's bankruptcy rate is almost one-quarter that of Georgia's; Pennsylvania has half the rate of Ohio; North Carolina has about one-third the rate of Tennessee; Texas has a smaller rate than all its neighbors; and Florida has just about half the rates of Georgia and Alabama.

The Carolinas, Pennsylvania and Texas prohibit wage garnishment, except in special circumstances such as unpaid taxes or child support. Florida prohibits garnishing wages from the head of a household.

The nationwide bankruptcy rate is 42 percent higher than the rate in those five states.

Bankruptcy filings have been steadily rising since the end of 2005, when a change in federal law sent filing rates plummeting. The number of filings in May were 35 percent higher than a year earlier, and more than 1.2 million cases have been filed in the past 12 months.

Debts are usually delinquent for several months before companies target consumers for recovery. Creditors must get court approval to seize a person's wages or other assets. Federal law and state laws restrict how much can be taken — typically 25 percent of "disposable" income, or income after taxes and other legally required deductions.

If a person files for protection under Chapter 7 or Chapter 13 of the federal bankruptcy code, it automatically overrides a court order to seize somebody's wages.

While counties do not maintain statistics on wage seizures, attorneys say the recession and credit crisis have made lenders more aggressive about seeking court orders to grab borrowers' wages. The reason is simple: with the competition for collecting unpaid debts on the rise, a creditor that gets the authority to garnish wages gets the first grab at a person's finances, leaving others to fight over what's left.

The mere threat of a wage seizure is enough to cause some people to seek bankruptcy-court protection, attorneys say.

Still, credit collection companies view wage seizures as a tool of last resort, according to David Cherner, the director of state government affairs at ACA International, a trade group that has hundreds of debt collection members around the country.

"The debt collection industry isn't necessarily enjoying a lot of success at this point," in part because personal bankruptcies are on the rise, Cherner said. "While volume (of credit collection activity) is up, consumers are hurting."

In South Carolina, limits on wage seizures have given people leverage in their negotiations with creditors and have helped keep them out of bankruptcy court, said Carri Grube Lybarker, a staff attorney with the state's department of consumer affairs. Lybarker said those who are behind on their debts because of an emergency medical expenditure, divorce or job loss are sometimes able to regain their financial footing and make good on what they owe.

Professor Rich Hynes, who teaches and researches bankruptcy and finance issues at the University of Virginia School of Law, said he sees signs that garnishment is playing a role in bankruptcy rates, but he added that plenty of other factors are at play.

Bankruptcy rates may be influenced by a variety of state laws that protect consumers, including rules on how foreclosures can proceed, regulations on attorney advertising or debt-to-income ratios. Hynes also said issues such as the culture of local courts can play a role in those differences.

In Tennessee, which has the highest concentration of bankruptcies, Nashville-based attorney Edgar Rothschild said wage seizures frequently tip his clients over the edge, and into a Chapter 7 or Chapter 13 filing. He also said the rates may be influenced by the differences of local judges, trustees and lawyers.

Cheryl Greer of Vinemont, Ala., sought protection from creditors under Chapter 7 of the federal bankruptcy code in May.

Before filing for bankruptcy, Greer, who mainly lives off Social Security checks but also works part-time as a clerk at Wal-Mart, managed to pay off thousands in credit-card debt and keep up with other bills, including the monthly mortgage on an $80,000 home.

But she couldn't escape the unpaid debts of a former roommate she had tried to help out.

Greer agreed a few years ago to help her roommate consolidate debt. That left Greer on the hook for several thousand dollars her roommate owed to a debt collection company, which in February 2008 was granted the authority to begin seizing up to a quarter of Greer's monthly income.

When she eventually filed for bankruptcy, Greer reported $7,112 in non-mortgage debt, most of it stemming from her former housemate.

In Greer's county of Cullman, bankruptcy rates are moderate by Alabama's standards. But over the past year there have been 16 bankruptcy filings for every 10,000 individual tax returns — a higher rate than any county in the five states with stiffest anti-wage garnishment laws.

For people in dire situations, filing for bankruptcy may be the only way to prevent themselves from digging an ever-deeper financial hole.

For her part, Greer said she might have one day been able to pay off her debt — if it wasn't for the court order allowing her wages to be taken away. Although disappointed by her financial failures and somewhat stung by the stigma that comes with a bankruptcy filing, she's also feeling a sense of relief now that she's filed for bankruptcy.

"I don't have (creditors) hounding me," she said.

US lurching towards 'debt explosion' with long-term interest rates on course to double

In a 2003 paper, Thomas Laubach, the US Federal Reserve’s senior economist, calculated the impact on long-term interest rates of rising fiscal deficits and soaring national debt. Applying his assumptions to the recent spike in the US fiscal deficit and national debt, long-term interests rates will double from their current 3.5pc.

The impact would be devastating by making it punitively expensive to finance national borrowings and leading to what Tim Congdon, founder of Lombard Street Research, called a “debt explosion”. Mr Laubach’s study has implications for the UK, too, as public debt is soaring. A US crisis would have implications for the rest of the world, in any case.

Using historical examples for his paper, New Evidence on the Interest Rate Effects of Budget Deficits and Debt, Mr Laubach came to the conclusion that “a percentage point increase in the projected deficit-to-GDP ratio raises the 10-year bond rate expected to prevail five years into the future by 20 to 40 basis points, a typical estimate is about 25 basis points”.

The US deficit has blown out from 3pc to 13.5pc in the past year but long-term rates are largely unchanged. Assuming Mr Laubach’s “typical estimate”, long-term rates have to climb 2.5 percentage points.

He added: “Similarly, a percentage point increase in the projected debt-to-GDP ratio raises future interest rates by about 4 to 5 basis points.” Economists are predicting a wide range of ratios but Mr Congdon said it was “not unreasonable” to assume debt doubling to 140pc. At that level, Mr Laubach’s calculations would see long-term rates rise by 3.5 percentage points.

The study is damning because Mr Laubach was the Fed’s economist at the time, going on to become its senior economist between 2005 and 2008, when he stepped down. As a result, the doubling in rates is the US central bank’s own prediction.

Mr Congdon said the study illustrated the “horrifying” consequences for leading western economies of bailing out their banks and attempting to stimulate markets by cutting taxes and boosting public spending. He said the markets had failed to digest fully the scale of fiscal largesse and said “current gilt yields [public debt] are extraordinary low given the size of deficits”.

Should the cost of raising or refinancing public debt in the markets double, “the debt could just explode”, he said, adding that it would come to a head in “five to 10 years”.