The Two-Income Trap - Elizabeth Warren [40]
The Easy Way Out
The Myth of the Immoral Debtor has its variations. Some critics claim that families have gotten sneakier. Federal Judge Edith Jones, rumored to be a potential Bush appointee to the Supreme Court, asserts that “[b]ankruptcy is increasingly seen as a big ‘game,’ with the losers being those who live within their means, while the bankrupts pursue more interesting and carefree lives.”14 In the good old days, families would work their fingers to the bone to pay off their debts. But today, according to Judge Jones, “bankruptcy more and more is looked at as an option of ‘first,’ rather than ‘last’ resort.” Families could pay their bills, but would rather take the easy way out.
Before we evaluate this claim, we should fill in a few basic facts about what it means to file for bankruptcy. Bankruptcy offers a one-time get-out-of-jail-free card. Although the specifics vary, the basic ideas are the same for both corporate and personal bankruptcies. When someone has gotten into serious financial trouble, he may seek protection from his creditors by filing for bankruptcy. The bankruptcy judge will supervise the case to ensure that creditors are repaid to the extent possible, while the debtor gets a chance to recover from disaster and make a fresh start.15 For a business that is failing, the court takes legal jurisdiction over the company’s assets and makes every effort to treat the various creditors equitably, which usually means only partial repayment of the outstanding debts.16 In some cases, such as the high-profile dot-com failures of the early 2000s, the business is shuttered and the assets are sold off piecemeal, with all proceeds parceled out to the various creditors. In other cases, such as K-Mart and United Airlines, a portion of the debt is written off, and a leaner, “restructured” company is allowed to continue its operations.
For an individual who files bankruptcy, the process is similar. The courts take legal control over all his assets—the bank accounts, the house, the car—everything right down to Fluffy the cat and the old bike with a flat tire.17 The judge orders those assets to be liquidated and used to repay creditors to the extent possible. So, for example, bank accounts must be emptied and stock portfolios must be sold; the judge might also order that jewelry or newer appliances be auctioned off to repay past debts. There are a few exceptions. Families are typically permitted to keep some clothes, furniture, and a few household goods. Home equity—the value of the home that exceeds the mortgage—creates a thorny problem. A few states, such as Florida and Texas, permit families to keep all their equity safe from other creditors, no matter how valuable the home; other states, such as Delaware and Maryland, force families to give up any equity in their homes, no matter how small.18 But in all states, the creditors who have security interests—the home mortgage company and the car lender, for example—must be paid if the family wants to hold on to the asset. And some debts are never forgiven, no matter what. Taxes, student loans, alimony, and child support must be paid in full, regardless of how long it takes; bankruptcy offers no relief whatsoever.19 But the rest of the debts—the credit cards, the hospital bills, the electric and gas bills—are paid proportionately from whatever property was sold off. At the end of the bankruptcy process, the family, like the corporation, gets to start with a clean slate. Most of their assets have been wiped out, but so have