B&W Image of Letter B © 2006, Belinda Mooney;                                     Big Bird © Sesame Workshop; Color By Author. “… So, boys and girls, I hope everyone enjoyed the story of AIG and The Hole That Could Not Be Filled. You all should learn an important lesson from that story. Can anyone tell me what the lesson was? … How about you Melissa?” “Big Bird, that’s why - God invented bankruptcy!” “Exactly right! Now, I’d like to tell you two more stories about Bankruptcy. So, gather ‘round, and listen real close. OK? Everyone ready? Here goes! …” STORY #1: BANKRUPTCY REFORM AND CREDIT CARDS “Years ago - before you were born - Congress decided to help God fix the bankruptcy laws. Between 1980 and 2004, the number of personal bankruptcies increased by five times… this many!” said Big Bird, holding up fingers on both of his four-fingered hands. “By 2004, more Americans were filing for bankruptcy than were graduating from college.” “So Congress decided to crack down on those who tried to run away from their debts. Four years ago, Congress made it much more difficult and expensive for debtors to file for bankruptcy, and passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.” “This caused the number of filings to drop sharply, from

• 2 million in 2005; to
• 600,000 in 2006.

“Can everyone see Figure 1? … Good!” Figure 1: Personal Bankruptcies & Consumer Debt Source: Michelle J. White, NBER – Bankruptcy Reform and Credit Cards, NBER WP #13265, July 2007. But something unexpected happened - financial distress went up!” “Why? The new law made it harder for consumers to run away from their debts, so banks started to lend more! Even to consumers with bad credit!” “Credit card debt increased more quickly between 2005 and 2007 than at any time during the five years before the new law. Consumers should have responded to the new harsher bankruptcy law by borrowing less, which would have lowered their risk of getting into financial distress. But not all consumers behaved in this thoughtful way. “Many ‘shortsighted’ consumers – who did not think things through - took advantage of the greater availability of credit to borrow more than they could easily handle, and their debts skyrocketed.” “But the new law prevented them from using bankruptcy to limit their financial distress, and they ended up with more problems than they would have before Congress ‘fixed’ the bankruptcy law.” “So, then – what might be the moral of this story? … How about you, Evan!” “Big Bird, how about Congress is NOT as smart as God!” “Hmm, that’s not exactly what I was thinking, but it’s close enough. Does anyone have to go to the restroom? No? OK – Here’s the last story.” STORY #2: BANKRUPTCY AND THE MORTGAGE CRISIS “Girls and boys, the Bankruptcy Reform Act of 2005 did the following:

• It raised the cost of filing for bankruptcy by imposing new filing and registration requirements on both debtors and their bankruptcy lawyers;

• It introduced an ‘ability to pay – or means - test.’ People filing for bankruptcy with higher incomes must use some of their future earnings to repay their existing debts.”

Note: A more complete listing may be found in Table 1 of D. Morgan, B. Iverson, & M. Botsch, Federal Reserve Bank of New York - Seismic Effects of the Bankruptcy Reform, SR#358, Feb 2009. “Now, does anyone know what the Federal Reserve is … Steve?” “Oooh! My Daddy says that they are responsible for the money supply, and that the smartest economists in the world work there, even if some of them forget to pay their taxes until the IRS finds out.” “Umm, right you are – on everything! Your Daddy is very smart!” “Well, the smart economists at the Fed took a look at what the 2005 Bankruptcy law did. And do you know what they found?” “They found that the 2005 law led to a ‘destabilizing surge’ in subprime mortgage foreclosures, and foreclosures overall - because it shifted risk from the credit card and auto lenders to mortgage lenders.” Figure 2: Subprime Foreclosures & Bankruptcy Reform Source: D. Morgan, B. Iverson, & M. Botsch, Federal Reserve Bank of New York – Seismic Effects of the Bankruptcy Reform, SR#358, Chart 1, Feb 2009. “This was caused by the ‘ability to pay’ or ‘means’ test.” “The means test gave credit card and other unsecured creditors a stronger claim on borrowers’ cash flow, and this weakened the claims of the secured mortgage lenders.” “By making it harder for borrowers to AVOID paying their credit card debts, the law made it harder [for borrowers] to pay the mortgage, hence higher foreclosure rates.” “Who can tell me what the lesson – or moral – of this story is … Gail?” “Big Bird … umm … I think it’s that if you’re not smart enough to be an economist, you can always be a Congressman.” - - - - - - - - - - -     I used to work with numbers for a living. I’ll have to see if a cookie really will be good enough for me as I look for a new job, or at least my next idea? Till next time. REFERENCES   D. Morgan, B. Iverson, & M. Botsch, Federal Reserve Bank of New York – Seismic Effects of the Bankruptcy Reform, SR#358, Feb 2009. Michelle J. White, NBER – Bankruptcy Reform and Credit Cards, NBER WP #13265, July 2007.