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December 4, 2008
TESTIMONY OF JOHN RAO
BEFORE THE SENATE JUDICIARY COMMITTEE
"Credit Cards and Bankruptcy: Opportunities for Reform"
December 4, 2008
This is particularly true for older consumers with diminished incomes after retirement or those who unexpectedly lose income due to disability or death in their households. There is little margin for error for these consumers.
Numerous researchers have highlighted the connection between the increase in credit card debt and increases in bankruptcy filings. Thus, Senator Whitehouse, I applaud your efforts to explore legislative changes to our bankruptcy laws to assist borrowers who have been pushed into bankruptcy due to credit card debt.
Specific Practices That Harm Consumers
Credit cards provide a great convenience for many consumers. The danger comes from the borrowing features of credit cards, the exorbitant costs of borrowing, and the downward spiral that hits consumers once they get into trouble. Specific practices that harm consumers include:
Credit card companies push consumers into borrowing because they derive profits mainly from consumers that use their cards to borrow ("revolvers"), not from convenience users who pay off their cards. As discussed above, income loss and increased expenses lead to shortfalls that many consumers attempt to make up by using credit cards. To make matters worse, credit card companies aggressively sell the borrowing features of the cards and push convenience users into borrowing. Companies do this by increasing consumers' credit limits, and encouraging them to take cash advances at high rates or to increase spending to get rewards. All of this is done with little attention to whether the consumer can actually afford to borrow at these rates.
Punitive Fees and Interest Rates
A significant contributor to snowballing credit card debt is the enormous increase in both the number and amount of non-periodic interest fees charged by card issuers. These punitive fees include cash advance, balance transfer, wire transfer fees, late and over-limit fees. Credit card issuers have made these fees higher in amount, they impose them more quickly, and assess them more often. Card companies now impose these fees not as a way to deter undesirable consumer behavior - which used to be the primary justification for imposing high penalties - but as a significant source of revenue. The average late payment fee has soared from $14 in 1996 to now over $32. Average over-limit fees have similarly jumped from $14 in 1996 to over $30.
A penalty rate is an increase in the card's initial annual interest rate (APR) triggered by the occurrence of a specific event, such as the consumer's making a late payment or exceeding the credit limit. Penalty interest rates can be as high as 30% to 40%. The new terms apply to the old balance - leaving consumers stuck to pay often high balances at interest rates far higher than was originally agreed, with devastating consequences. This practice is especially outrageous when applied retroactively.
"Universal default" policies are even more abusive. Under universal default, credit card issuers impose penalty rates on consumers not for late payments or any behavior with respect to the consumer's account with that particular issuer, but for late payments to any of the consumer's other creditors. In some cases, issuers will impose penalties simply if the card holder's credit score drops below a certain number, whether or not the drop was due to a late payment or another factor.
Creditor Practices Push Consumers Into Default
There are numerous examples of consumers who play by the rules and try to pay their debts, but who are driven hopelessly into default by their credit card company. Rather than work with consumers to reduce their debt by curbing excess fees and interest, card companies prefer to get as much out of consumers for as long as possible until they eventually stop paying or file bankruptcy. This was best described in a March 2005 speech by Julie Williams, chief counsel of the Comptroller of the Currency: "Today the focus for lenders is not so much on consumer loans being repaid, but on the loan as a perpetual earning asset." The following consumer stories help illustrate this point:
Fees and Interest
Over-limit Fees $ 1,518.00
Total $ 9,056.28
Ms. Owens would have been far better off if she simply stopped paying Discover Bank years earlier and had them sue her in state court. If Discover Bank had obtained a court judgment for $2,000, all of the card fees and high-rate interest would have stopped and Discover would have then been entitled to 10% or less interest per year under Ohio law. Rather than have her debt increase, Ms. Owens' payments would have paid off the debt in full in approximately 4 years.
3. With 8 kids, 13 grandkids and 10 great-grandkids, Elaine had a lot of gifts to buy and she enjoyed buying them. She didn't mind working to pay for those gifts, either. There was enough money to keep current on her credit accounts, each with small balances that she mostly used for gift buying. She was going strong at age 71, working as a cleaning lady in the Manchester, New Hampshire, City Hall and sewing wedding gowns at home on the side. Until, that is, she had a stroke.
I would like to inform you that I have no money to make payments. I am on Social Security Disability. After paying my monthly utilities, there is no money left except little food money and sometimes it isn't enough. If my situation was different I would pay. I just don't have it. I'm sorry.
The Ohio judge assigned to the collection case found that Ms. Owens was not a deadbeat. He stated that her "instincts were always that she wanted to plug away at meeting her financial obligations. While clearly placing her on the moral high road, that same highway unfortunately was her road to financial ruin. How is it that the person who wants to do right ends up so worse off? It is plain to the court that the creditor also bears some responsibility."
event, payments of $400 a month that weren't denting her balances clearly would not be sustainable on her $735 monthly Social Security check, her only income after the stroke.
Credit Card Accounts in Bankruptcy
A bankruptcy case from Virginia tells the story of another consumer's efforts to avoid bankruptcy. During the two year period before she filed bankruptcy, the consumer made only $218.16 in new charges on her Providian Visa. After making $3,058 in payments, all of which went to pay finance charges (at the rate of 29.99%), late charges, overlimit fees, bad check fees, and phone payment fees, the balance on her account increased from $4,888 to $5,357. On her Providian Mastercard for the same period, she made only $203.06 in purchases while making $2,008 in payments. Again, all of her payments went to pay finance and other charges, and her account balance increased from $2,020.90 to $2,607.66.
Proposals for Change
By requiring that claims filed on "high cost consumer credit transactions", as defined in S.3259, are subordinated to all other claims in a bankruptcy case, the bill will give the credit card industry an incentive to keep interest and costs below the definitional trigger. We support this change, though we recommend that an even stronger deterrent would be achieved if the legislation provided for the disallowance of the claim.
S.3259 also provides that the means test under section 707(b) of the Bankruptcy Code would not apply if a consumer's bankruptcy filing "resulted from a high cost consumer credit transaction." We also support this provision as it would help some consumers avoid potential litigation costs in proving that a bankruptcy filing was not abusive. We believe the provision could be improved by including some type of categorical exemption from the means test for consumers having high cost consumer debt without the need to prove that such debt caused the bankruptcy filing. Especially for debtors below the median income, the expense of proving causation might eliminate any benefit gained by an exclusion from the means test.
2. The National Association of Consumer Bankruptcy Attorneys (NACBA) is the only national organization dedicated to serving the needs of consumer bankruptcy attorneys and protecting the rights of consumer debtors in bankruptcy. NACBA has more than 3,100 members located in all 50 states and Puerto Rico. NACBA has been actively involved in promoting reasonable and fair bankruptcy legislation since it was founded in 1992.
3. CENTER FOR RESPONSIBLE LENDING, DEMOS, THE PLASTIC SAFETY NET: THE REALITY BEHIND DEBT IN AMERICA 10 (October 2005), available at http://www.responsiblelending.org/pdfs/DEMOS-101205.pdf.
4. Board of Governors of the Federal Reserve System, "Report to the Congress on Practices of the Consumer Credit Industry in Soliciting and Extending Credit and Their Effects on Consumer Debt and Insolvency" at 16 (June 2006) available at http://www.federalreserve.gov/boarddocs/rptcongress/bankruptcy/bankruptcybillstudy200606.pdf.
5. For an excellent summary of these studies and an analysis tracking the link between credit card debt and bankruptcy, see Ronald J. Mann, "Credit Cards, Consumer Credit & Bankruptcy", The University of Texas School of Law, Law and Economics Research Paper No. 44 (Revised March 2006), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=690701.
6. See Kathleen Day & Caroline Mayer, Credit Card Fees Bury Debtors, Washington Post, Mar. 7, 2005, at A1.
7. Ms. Owens' experience with her credit card company is discussed in detail in Discover Bank v. Owens, 822 N.E.2d 869 (Ohio Mun. 2004).
8. Like many card customers, Ms. Owens was being charged for one of the numerous insurance-like products sold by card companies. Often, these products are sold through high-pressure telemarketing sales. In this case, Ms. Owens was charged approximately $10 per month for a Discover card product called CreditSafe Plus, which apparently provided for a suspension of payments and finance charges if Ms. Owens became unemployed, hospitalized, or disabled. Since Ms. Owens was already on Social Security Disability and unemployed, the CreditSafe product presumably would apply only if she became hospitalized. Ms. Owens was no doubt paying for a product that would likely never benefit her.
9. Discover Bank v. Owens, 822 N.E.2d 869 (Ohio Mun. 2004).
10. This consumer's story is recounted in a report issued by the National Consumer Law Center, The Life and Debt Cycle Part One: The Implications of Rising Credit Card Debt Among Older Consumers, Deanne Loonin, July, 2006.
11. In re Blair, No. 02-1140 (Bankr. W.D.N.C. filed Feb. 10, 2004).
12. In re McCarthy, No. 04-10493-SSM (Bankr. E.D. Va. filed July 14, 2004).