The Fear Economy
Many commentators worried that the 2005 bankruptcy law would discourage entrepreneurs from taking risks. Now it appears to be accelerating the housing downturn:
A new bankruptcy law, approved by Congress in 2005 after years of debate, makes it much harder for households to get out from under their consumer debt. The result: More people being forced to walk away from their homes, leaving lenders holding the bag. Perversely, a law intended to help the financial industry may be damaging the housing sector, creditors and borrowers alike.
Another recent BusinessWeek article shows just how weak bankruptcy protections may be becoming in the wake of a voracious debt-collection business and slow-footed credit bureaus.
In the 1990s, businesses adept at tracking and trading consumer debt expanded their reach to dabble in accounts enmeshed in bankruptcy. That dabbling has grown into a robust market. Some of the trade in so-called bankruptcy paper involves debts that remain collectible. What’s troubling is that the market now also includes billions in discharged debts, which ought to have no dollar value. Owners of canceled liabilities can revive their value in two main ways: by directly pressuring consumers to cough up cash or by gaming the credit system. . . .
After Chapter 7 cases, “debtors expect their credit is going to become pristine,” [one commentator] notes. “But now you have people who buy the debts, even bankruptcy debts, and all of a sudden, new people are supplying information to the credit bureaus.” She adds: “The way the system is working now, it doesn’t give [debtors] that fresh start.”
The new collectors are adept at resurrecting debt:
Pfister, 63, a retired AT&T technical supervisor in Denton, Tex., received a Chapter 7 discharge in 2001. Then, last January, while applying for a mortgage, he learned that two discharged credit-card debts, a Discover Card balance of $6,306 and a former Chase account for $2,683, were showing up on his credit reports. Lenders turned him away because of what appeared to be unpaid obligations, he says.
The Chase loan has been sold twice and is now owned by a debt buyer called Pinnacle Credit Services, according to Pfister’s reports from credit bureaus TransUnion and Experian. Pinnacle reported to those credit bureaus as recently as May—six years after the bankruptcy discharge—that the debt is still subject to collection. In addition, Pinnacle has given the former Chase debt a new account number. Pfister’s lawyer, James J. Manchee, says that creating a new account number is a strategy some debt buyers use to make it more difficult to tie accounts back to discharged debts, and therefore make the debts appear collectible. Pinnacle declined to comment. In June, Quicken Loans became the 12th mortgage lender to reject Pfister.
Since FICO score-setting mechanisms are a trade secret, I predict more and more consumers like Pfister are going to end up hounded for unenforceable debt and effectively unable to enjoy the protections bankruptcy is supposed to afford. I fear we are heading toward an economy of fear–where one bad break leads to a cycle of mutually reinforcing stigmas that law is incapable of addressing. As we reconsider our policies on debt and credit bureaus, we should keep in mind how new “reputation economies” can render old bankruptcy protections obsolete. As we make the key players in these economies more accountable, we should also consider the sound advice of sociologists Katherine Newman and Victor Tan Chen in their new book, The Missing Class:
Many banks shun poorer neighborhoods, depriving families of opportunities for savings, alternatives to check-cashing companies and their exorbitant fees, and loans at reasonable interest rates for buying a car or paying for a college education. The policies we’ve suggested are not handouts but investments in the potential of our country’s people. They will put in place the kinds of incentives that inspire individuals at the bottom to rise to the top. They will pay off for the whole country by making workers more productive and less at risk of sinking into poverty and illness — personal crises that nonetheless create burdens for the rest of society.
If the new “fear economy” advances unchecked, you might end up being a “music serf” for life for downloading a few dozen songs. Or you might end up with a credit report tarnished for years by a health emergency that happened while you were uninsured. And forget about ever fully understanding how the all-important FICO score (that translates these debts into a number indicating creditworthiness) is tabulated–trade secret protections make it a black box.