Bad credit: cashing in on the new bankruptcy law.

Remember "welfare queens"? That absurd image of black, inner-city, unwed mothers--purposely popping out illegitimate babies so that they could dine on filet mignon purchased with food stamps--strongly influenced the welfare "reform" debate and its pernicious outcome. The welfare-queen image was never an accurate description of the women who actually depended on welfare support, but it embodied precisely the type of simple-minded morality tale that too often drives social policy in this country. And it is happening again.

On April 20, President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. The Act's proponents--mostly banks and large credit-card companies--conjured up the image of families of "mall rats," middle-class moms, dads, and kids hitting the malls en masse and purposely maxing out their many credit cards, knowing that they could dodge the resulting debt simply by declaring personal bankruptcy and starting afresh with a new cycle of credit. This new type of financial planning, it was argued, not only hurts the lender, but hurts us all by pushing up credit-card interest rates and fees. The remedy: Find some way to stop them before they spend again!

More precisely, the Act's remedy is to make it more difficult for individuals to declare bankruptcy under Chapter 7 of the Bankruptcy Code--under which all eligible assets are sold to pay off debt, and whatever amount can't be repaid is discharged--especially if a debtor's income is higher than the state median. In addition, the law will require many debtors to pay higher legal fees and agree to a court-ordered repayment plan under Chapter 13 rather than have their debts discharged completely in a nonjudicial proceeding. On the face of it, this seems sensible. But is it really? That depends on whether the Act has accurately identified bankruptcy "abuse" as the problem, and addressed it both equitably and effectively.

To be sure, there is a bankruptcy problem in the United States, and it is tied to the consumer-debt explosion. Between 1980 and 2004, total consumer debt grew from $288 billion to more than $2 trillion. Revolving consumer debt (mostly on credit cards) expanded from $58 billion to $800 billion. Personal bankruptcies zoomed simultaneously: 1.6 million people filed in 2004, versus fewer than 300,000 in 1980 and about 800,000 in 1990. Nationally, 1 in every 72.8 households has declared personal bankruptcy. In some states, the average is much higher. The number of working and middle-class people barely avoiding bankruptcy by juggling credit cards and home-equity loans is also enormous, though hard to quantify.

How did this happen? Did Americans simply become more greedy and irresponsible as part of a general dissolution of the national character? Was the explosion of consumer debt another manifestation of our increasingly consumerist and materialist capitalist culture? While there is a real moral dimension to the phenomenon, the explosion can be traced to concrete historical events.

In the late 1970s, state laws made it difficult for companies to offer credit cards to higher-risk borrowers, because the usury limits prohibited charging the high interest rates lenders needed to charge such borrowers to compensate for the risk of lending to them. The combination of high inflation and judicial decisions questioning the enforceability of usury limits in the late 1970s led to the demise of the state usury laws and a revolution in consumer debt. Banks and credit-card companies were freed to charge higher interest rates. They developed new techniques for managing defaults, evaluating credit-worthiness, and pricing consumer credit, and thus were able to profit from consumers who previously had been shut out of the credit market. The most profitable companies were the biggest ones (such as MBNA) because they had the economies of scale needed for national marketing, processing, and risk-bearing. This produced massive market concentration, as well as the ability to offer credit cards to more and more people. By 2003, just ten credit card lenders controlled 80 percent of the market. These megalenders became ever more aggressive and efficient in making credit available to middle- and lower-income borrowers. All of this led to predatory lending and a huge increase in so-called "sub-prime" debt, that is, debt incurred by the people least able to repay it.

Compounding the increase in credit-card debt has been an equally massive increase in home-mortgage debt--buy not principally the debt incurred to buy a home. Americans have been borrowing on their equity at a record clip, currently more than $150 billion a year in the form of home-equity loans--many of which are used to pay off higher-interest credit-card debt. The steadily increasing value of real estate has created an irresistible temptation to liquidate part of homeowners' real-estate investment and turn it into spendable cash.

Over the last twenty-five years, changes in law, credit practices, and marketing allowed ordinary people--even college students--to accumulate debts that previously would have been unthinkable. As credit availability expanded, demand was stimulated, in part intentionally and in part inevitably, until the system began to feed itself and grow exponentially. Bankruptcy filings began to burgeon, not just because many borrowers couldn't handle the debt, but because the Bankruptcy Reform Act of 1978 made declaring bankruptcy easier for the consumer.

Did Americans saddle themselves with this debt simply because they could? Was it because bankruptcy laws let them get away with it? The mall-rat image presumes that the consumer debt/bankruptcy problem is finally a moral problem, the consequence of bad choices by people who should know better. That image, though, does not match the profile of the debtor population any better than the welfare-queen image described the welfare population. There is also nowhere near the fraud and abuse that the proponents of the Act claim. A letter sent to Congress and signed by ninety-two bankruptcy-law professors concluded that the Act "seeks to shoot a mosquito with a shotgun." They argued that "focusing on the opportunistic use of the bankruptcy system by relatively few 'deadbeats' rather than fashioning a tailored remedy ... would cripple an already overburdened system."

Data published by independent authorities show unequivocally that the debtor population is not made up of opportunists gaming the system, but is composed of the elderly, the sick, the recently unemployed, and the poor--all surviving on razor-thin credit margins. More than a third of personal bankruptcies are filed by individuals in families already below the federal poverty standard. More than 85 percent of filers cite job loss or medical expenses as the reason for entering bankruptcy, which is no surprise given the high level of unemployment, the rising cost of medical care, and the widespread lack of health insurance. The nonpartisan American Bankruptcy Institute estimates that only 3.6 percent of debtors would meet the median state-income requirement for being shifted to repayment under Chapter 13. This shows that most Chapter 7 debtors are not middle class or even lower-middle class. Even though only 3.6 percent of debtors will be shifted to Chapter 13, that creates a substantial burden for people who are usually unable to afford repayment or the higher costs of a Chapter 13 filing. Those debtors not subject to reassignment will also find the bankruptcy process slower, more cumbersome, and more expensive.

The real issue not addressed by the Act is how the credit-card industry shamelessly pushes credit on people who shouldn't have it. The industry seduces those people into late payments and defaults because, even if some borrowers default, profits still accrue through escalating late fees, penalties, and other charges. The industry can absorb the defaults because it can extract so much money from those still paying, and from those new borrowers their marketing machines continue to produce. That is the endless cycle of debt creation, and the real problem Congress must address.

Instead, Congress is creating new problems. Under the new law, debtors forced into the Chapter 13 repayment plan from Chapter 7 will have to pay higher legal fees (typically $1,500 in contrast to $500)--when they can least afford it. Bankruptcy courts that are already overburdened by the filing boom will be stuck with supervising a new raft of Chapter 13 repayment plans. All debtors will be required to take credit counseling before they file, yet the counseling industry is already too small, of questionable competence, and entangled in egregious conflicts of interest. In short, people who have not been abusing the system will find bankruptcy more expensive, more complicated, and slower. That burden will fall disproportionately on those who are least able to afford it.

Why is this happening? One could point cynically to the $29 million in election contributions to both parties paid by financial institutions in the 2004 election cycle. One could take the Act's description by Republicans (including the president) as a return to "personal responsibility" as yet another example of the administration's moralism without morality. The real explanation, though, is an age-old story: A small group of well-funded, highly organized, highly motivated, and politically influential business interests use government to solve their industry problems (that is, more bankruptcies than they like) through legislation co-opting the language of reform and the public interest. So who gets it in the neck? Not the mall rats, but those least able to bear the burden of "reform."

Mark Sargent is dean of the Villanova University School of Law.