This is the introduction to my book Bankruptcy 101: An Insider’s Guide to Filing Bankruptcy by Yourself, Without an Attorney, available on Amazon and elsewhere. It is a little dated, but still feels good to share…
When I first realized that the credit card companies and banks don’t care about me, it came as quite a shock. Of course, I realized intellectually that these are for profit, public corporations, who must put their shareholders’ interests first. But I believed that they were honorable corporate citizens, fair dealers in an economy where the myth of capitalism thrives, where loyalty and a handshake still mean something, where the long-term good is a consideration. I was wrong.
I guess you could say that I was a little slow on the uptake since it took me two incidents before I really came to understand how unscrupulous the large banks are. But like most people, I was so steeped in the culture of laissez-faire that I couldn’t believe banks would operate in this way.
The first incident came when I had just decided to start my law practice. At the time, I had been working in a cushy government job for a decade. The paycheck was steady, the benefits good, but the truth is that I was never going to get rich as a bureaucrat. So I decided to chase the American dream. Having read the statistics, I knew that the primary reason most new businesses fail was due to lack of start-up capital. To address this problem, I had a plan.
Over the years, I had developed an outstanding credit rating. The credit limits on one card in particular just kept going up as I faithfully made my payments on time. But so did the balance. By the time I wanted to start my business, my limit and my balance on this one card exceeded $30,000. So it seemed logical to think that if I paid off this card, I would have another $30,000 in credit to use over the next year as start-up capital. With that in mind, I emptied the deferred compensation account I had been accumulating over the past ten years and handed the funds over to the bank thinking myself very clever.
You can imagine my surprise when upon cashing my check the bank immediately closed the account and wouldn’t even let me charge a hamburger with that card. I called the customer service line immediately and told them about my loyalty, told them about my many years of faithfully paying my bill, told them about how I had just liquidated my savings, but none of it mattered. They didn’t care.
Fortunately, due to my good credit rating, I did have other credit cards and was able to cobble together enough credit to start my practice. I thought the behavior of this other creditor was simply an aberration. Boy was I wrong.
As my practice grew, I started to rely more and more on one credit card in particular. Much of what I charged were court filing fees. Many courts have been moving to electronic filing over the internet. To use this service, attorneys need to have a credit card on which they can charge the filing fees. Clients would typically pay these fees up-front, so the funds were there to pay the debt. So every month, as I filed more and more cases, the debt on this one card would go up. But since I had already received the filing fees from my clients, I was able to pay it off every month. Month after month, I would charge more and more on this credit card, and then pay it off, on time, every month. It seemed like a great arrangement because this one credit card gave me great benefits. When I took my family on a vacation to Hawaii one year, much of that vacation was paid for by points from this one bank. As a result, I started paying more and more bills with that credit card. I paid my phone bill, advertising expenses, internet service. I knew the account number and expiration date by heart from entering them into the websites so often. Every month, I was accumulating tens of thousands of dollars of debt on that card, and every month, I was paying it off.
Then one month, out of the blue, that creditor suddenly cut me off. I called them, uttering that plea that would I would hear again and again in my practice: “I have been a loyal customer, I have always done what you asked of me, and now you’re abandoning me.” I was hurt at first, then angry, then I learned my lesson.
Ironically, when both these incidents occurred, I was an attorney. I had worked in responsible government and private sector management positions for nearly twenty years. Indeed, I had always been interested in Bankruptcy law, and when I started my practice, that is the field in which I specialized. But I still fell pray to the beliefs I hear expressed in my office by prospective clients every day: “we do what the banks ask of us, we behave honorably toward them, shouldn’t they behave the same way toward us?” Unfortunately, the answer is actually no.
Every day in my office I hear similar stories. People tell me about losing a job, having a business fail, going through a divorce, falling prey to an addiction, enduring a serious illness, or some other very real tragedy. They had always made all their payments on time. They had paid off their creditors, again and again. They had high credit ratings. They wanted to pay back their debts. So they did what they thought was the responsible thing: they called their credit cards and explained their situation. They made reasonable requests, asking for a little more time, a little less interest, a little lower payment, just to get them through this difficult time. But the banks almost always said no. They wanted their money now. They said to make a payment, then they’ll consider a change. But the people make the payment, and the bank still says no. My clients beg and plead, they explain that if the bank doesn’t work with them, they will have no choice but to file for Bankruptcy, and then the bank will get nothing. They point to their history and their long loyalty to the bank as a demonstration of their good faith. But the banks still say no. Usually, to their shock and dismay, the people end up in a Bankruptcy attorney’s office because they feel they have no other choice.
Most of the time, it’s true, they have no other choice. Sadly, many of these people have drained 401Ks and IRAs to stay current on credit card debt. These were supposed to be their retirement savings, but instead they went to pay interest. And they still ended up in the same situation they were in when they started. Many people made their credit card payments rather than their house or car payments, ending up just as in debt but now facing foreclosure on their home or the repossession of their vehicle. All my clients played by the rules, as I did, only to find out that these rules don’t apply to the banks.
All of us grew up steeped in a culture that celebrates private enterprise. We watch commercials by the banks telling us of how much they care about us. We watched It’s a Wonderful Life where Jimmy Stewart worked with his bank’s customers, allowing them to make payment arrangements on their debts when they ran into hard times. We believe that we should be responsible and honorable, and if so, that others will behave similarly. But that’s not the case with the banks.
Take the recent recession. This recession was basically created by the banks because of their greed and irresponsible risk-taking. The banks leant mortgages to people who were unable to pay them over the long term. The way they got people to sign on the dotted line was to write an adjustable rate mortgage. The initial rate would be so low that the borrower could afford, often barely afford, to make the payments. Within three years, however, the rate would jump to a more reasonable rate. The borrowers were told not to worry, however, that they could just refinance the mortgage before the rate increased. Believing the expert mortgage broker, the borrower signed and took the money with that intention. After all, the borrowers reasoned, why would they give us money if they didn’t think we’d be able to repay it? Jimmy Stewart wouldn’t have done that.
What we didn’t realize, however, is that the banks were actually not lending their own money. They had no skin in the game. At every step was a salesman just trying to make his commission. The mortgage broker was actually just a salesman, making a hefty commission for lending as much money as possible to as many people as possible. Once the borrower signed on the dotted line, the mortgage broker was out of the picture. What about the bank who we make our payments to, you ask, they lose out if we don’t make our payments, don’t they? No. In fact most people are making their mortgage payments to a servicer, someone who just accepts your payments, takes a commission and sends on the rest of the payment to the actual owner of the mortgage. So who is the owner of the mortgage? It’s not the broker, it’s probably not even his or her employer. The broker would immediately sell the mortgage to one bank, then another, then another. At each step, the mortgage would get packaged up along with more and more similar mortgages and split up as investments: bonds. That is what the banks call “securitizing” the mortgages. At each step, of course, commissions get paid. Eventually, various investors will buy these bonds that represent a certain share of a large pot of mortgages. These are the people who actually eventually end up with your mortgage payments.
Who are these investors? They are often banks, life insurance companies, pension funds. When you buy life insurance, for example, the insurance company has to invest your premiums to make sure that it has the funds to pay out when you die. Similarly, pension funds need to invest each year to make sure funds are available to make the payments when you retire. These are just two examples. There are many more, but the point is that the investors are far removed from your original mortgage broker and even more from the bank you send your payments to every month. These relationships are governed by complex legal contracts developed with an eye for protecting the property of the investors but not with an eye of working with the original borrowers whose mortgages are tiny pieces of this huge pie split up between major institutional investors.
Residential mortgage backed securities, the bonds or investments that represent a share of this huge pie, used to be very secure investments for these institutions. Typically, a very small percentage of people defaulted on their home mortgage. After all, home ownership is a big part of the American dream, and people would do just about anything to keep their home. What’s more is that we have always been told to view our homes as an investment, a safe place to put our money rather than wasting it on rent. So as certain mortgage brokers, like the now defunct Countrywide, for example, started writing more and more loans for more and more individuals, there were always investors there waiting to snap up the bonds without asking the question of whether the individuals could make the payments over the long term. Fannie Mae and Freddie Mac, the government-backed private companies that invest in mortgages did ask those questions, but then they started finding it harder and harder to find mortgages to buy because so many other investors were willing to look the other way. So to stay in the game, they lowered their standards… substantially. There was so much money to be made in mortgage securities that everyone had to jump on the train. Insurance companies like AIG started selling insurance to the investors in case their investments went bad, never expecting to have to pay on it. Investment banks like Lehman Brothers invested their profits from packaging up these mortgages and selling shares of them in the profitable bonds. They didn’t want to miss out on the party too. Since the mortgage brokers were making money from commissions, the servicers were making money from commissions, the investment banks who bundled up the mortgages and sold shares of the big pie to investors were making money from commissions, everyone was happy, right?
What started the collapse was probably imperceptible at first. Somebody defaulted on a mortgage. The house went into foreclosure. At first, it was no big deal, because, as always happened, the home was sold at the Sheriff’s sale and the mortgage was paid off. But when a home is sold by the mortgage company, it usually fetches a lower value than it would have gotten if sold by its homeowner. After all, the homeowner is usually the home’s best sales-person. The homeowner keeps the house in tip-top shape to show it off to potential buyers. The homeowner talks up the house in the neighborhood, and is willing to wait until a good offer comes along. None of that is the case when the mortgage company is selling the home.
To the mortgage company, the house is just an expense, it is not a home. The mortgage company must pay to keep the home heated and cooled, to keep the electricity and water on, and to maintain the property. The sooner that the mortgage company can sell the house, the sooner the mortgage company cuts its losses. What’s more is that the now dispossessed homeowner typically feels no requirement to keep the house up for the mortgage company to maximize its value. In many cases, angry homeowners go beyond that and strip the home of anything they can use in their new house. As a result, by the time someone buys the home, it often needs a lot of work.
Neighborhoods are a big part of what determine housing values. As a result, if you own a home worth $200,000 and a similar home next to you sells for $100,000, now your home is worth something closer to $100,000. So when the foreclosure happened, and the house sold at a fraction of its earlier value, suddenly all the houses in the neighborhood were worth slightly less than they were before. So when people in that neighborhood suddenly wanted to refinance their home to avoid the big jump in payment with the adjustable rate mortgage, there was no longer enough equity in their home to refinance. Continuing with the earlier analogy, say the home had been worth $200,000 and the homeowner refinanced three years ago for $180,000 — that would have been a conservative mortgage back then, but it illustrates our scenario. Now, due to the sale of the home next door for $100,000, then home is only valued at $150,000. Therefore, the value of the home is worth less than what it would take to refinance it. The bank can’t write a mortgage because if you default, there isn’t enough equity there to repay the investors. Through no fault of your own, then, you are stuck with an adjustable rate mortgage that you can’t refinance, and the payment is about to jump to a level you can’t afford. Soon, you are foreclosed upon too.
Each foreclosure, therefore, multiplies the problem. Every time a house gets foreclosed upon and gets sold for below-market value, that sale decreases the value of the other homes in the neighborhood. Suddenly, other people can no longer refinance their adjustable rate mortgages because there is no longer the equity there to protect the investors in case of default. More and more people can’t refinance their adjustable rate mortgages as they intended to, leading to more and more foreclosures. You can see how it becomes an endless loop that feeds on itself.
In the days of It’s a Wonderful Life, at some point, cooler heads would have prevailed. After all, it makes more sense for the bank to give the homeowner a break and get its payments rather than foreclosing and getting a fraction of what it is owed, doesn’t it? The problem is, who was going to step in? Not the mortgage broker who originally sold you the mortgage and promised you that you would be able to refinance in three years. Not the servicer who you send your payment to every month — they just accept your payment and pass it on. Not the investment bank that packaged up your mortgage with all those other mortgages and sold shares of that big pie to investors. Not even the final investors who really get hurt can do anything because they don’t know what portion of which pie which mortgage is a part of.
You can see where this quickly becomes an out-of-control train hurtling off the bridge. Our economy is so inter-connected that the financial crisis soon extended to every corner of our country. When people defaulted on their mortgages, suddenly they became unable to finance cars or other major purchases. Then the manufacturers are in trouble. The mortgage brokers can no longer write mortgages since nobody qualifies, and so they lose their jobs. The realtors can no longer sell homes since the property values have declined so much due to the increasing number of foreclosures so the homes won’t sell for enough to pay off the mortgage. Investors who had counted on mortgage-backed securities as safe investments stop investing in mortgages so people can no longer purchase homes. Builders go out of business since people are no longer purchasing homes. Everyone gets affected because the people who used to work in these industries no longer have money to spend on vacations, new cars, appliances, or other non-essential products and services. Even government gets into trouble because with less income, people pay less taxes. So even government workers get laid off. Before you know it, a couple of foreclosures turn into the great recession of the late 2000s, and we have no idea how or when it will come to an end.
The federal government and the Federal Reserve Board have stepped in to try to stop this crisis. In some ways, they have succeeded, but in other ways, not so much. On the one hand, most economists agree that things would have been worse without the rescue efforts of the federal government. On the other hand, the steps taken by the government — and the steps not taken by it — have clearly illustrated for all to see the reality about the banks in this country. The truth is that the banks don’t have to play by the rules because if they don’t like the rules, they just go to Congress to change them.
When the crisis first spiraled out of control, the banks ran to the government asking to be saved. At first, the Federal Reserve jumped to the rescue, as with AIG, the insurance company that had insured all these real estate investments without the assets to back up the guarantees. But then, because of the outrage of Americans over this blatant effort to protect bad behavior, the Fed refused to save Lehman Brothers, who had made unbelievable profits packaging up, selling and investing in mortgages. But then, realizing that the government wouldn’t save everyone, the stock market cratered. The response of the government, then, was to forget about the Lehman Brothers approach, and to save everyone big enough to impact the stock market. The problem is, though, that the government now saves all the big banks, while allowing millions of people to lose their homes.
So we bailed out the banks. Most of them are now making profits as a result of the bailout, and they are hoping to pay back the small portion of the aid that they received in the form of loans so they can go back to giving their executives excessive bonuses and trips to the Bahamas. One would think that the extraordinary assistance we gave to the banks would be repayed with some sense of gratitude, some sense on the part of the banks that they, who had originally caused this crisis, and who were rescued by the American taxpayers, should play some part in fixing it. If you thought that, you’d be wrong.
The President recently gave a speech in which he expressed the frustration of the American people with the banks. He told the banks that since they had been such beneficiaries of the generosity of Congress, that they should start lending again to small businesses, homeowners and others on Main Street to help get the economy going. The banks, for their part, have pretty much ignored that plea, and have put many small businesses in receivership by cutting off their lines of credit. But that isn’t even the worst part.
There is a solution to this crisis, and many Bankruptcy attorneys such as myself have been talking about it for years. The fundamental problem in the economy right now, as I have described above, is that there is no way to realistically adjust the mortgages to a decent interest rate and a reasonable value. Somebody had to play the role of Jimmy Stewart and come up with a reasonable resolution, one in which the bank gets most of its money back and the homeowner gets to keep his or her home. But there is a place where such deals are done, and have been for years: the Bankruptcy Court. There is a provision in the Bankruptcy Code that allows judges to “cram down” debts like mortgages and car loans. The banks, of course, hate this provision. In the 1990’s and early 2000’s, they lobbied Congress to limit the cases where car loans could be crammed down. And even before that, there was a provision in the Code that allows cram downs on real estate mortgages except where the real estate is your primary home. As a result, if you are a business and you file Bankruptcy, we can reduce your interest rate, reduce your payment, and reduce the balance on the mortgage based upon the current value of the property. But for homeowners, we can’t do that.
The proposal was to simply get rid of that limitation. Bankruptcy judges and attorneys are used to dealing with property valuations and cram downs since those elements have been part of the process for years. Finally, a third party could step in and come up with a reasonable resolution. The process was in place, all they needed to do was to change one sentence in the Bankruptcy Code.
Shortly after the election of 2008, when the Democrats took control of Congress and the White House, it seemed like this proposal was destined to pass. First it passed the House of Representatives with a huge majority. Vice-President Joe Biden had expressed his support for this plan during one of the debates, and the White House pledged to support it. But then the banks, after we spent hundreds of billions of dollars saving them, spent over a hundred million dollars lobbying Congress against this policy change. And the Senate, despite the Democratic super-majority, defeated the plan by one vote.
Emboldened by their success, the banks have fought off every effort to limit their greed. They apparently want their cake and want to eat it too. They lobby against everything that would protect us from another crisis. They lobby against everything that would limit their ability to charge outrageous interest rates. They even lobby against every bill that would limit the pay of their executives to something reasonable.
At first, I was amazed that Congress would listen to the banks after all the problems they had caused and after all the help they had been given. But then I realized that the banks really are the ones running this country. They, along with their partners in crime the insurance companies, have bought themselves the best Congress money can buy. The Republicans, their preferred party, are blatant in their belief that the banks and insurance companies should be allowed to steal as much as they want and get away with it. The Democrats, however, are part of the problem too. After all, the Democrats were the ones in charge when many of the so-called reforms that allowed this crisis to happen. The Democrats could have passed the cram down legislation. And the Democrats could have easily voted to stop the excesses of the banking industry and its executives. But they didn’t.
The reason for this failure goes back to Watergate. After the Watergate crisis came to light, in the 1974 and 1976 elections, Democrats won huge margins in the House of Representatives in Congress. The leadership was aware of the fact that many of these new members of Congress represented Republican districts. So to protect them, the Congressional leadership embarked on a policy of selling “access” to the Democratic members of Congress to the big financial power players, the banks and insurance companies. Yes, they told these traditionally Republican groups, you may not like us as much as the Republicans, but the Democrats are in charge. If you want to be able to talk with us and impact legislation, you had better contribute heavily to our campaigns. That’s what the Democratic Congressional leadership told the banks and insurance companies. And realizing the harm that Congress could do to them, the banks and insurance companies played along, giving so much money to the Democratic members of Congress that the Democrats were able to hold onto this majority in the House of Representatives for twenty years.
Over time, a cozy relationship developed between the groups, one that still exists to this day. So that when Ronald Reagan came along and articulated a political rationale for the “steal everything you can” goal of the Republicans, the Democrats were happy to go along, just with a few tweaks here and there. It should come as no surprise that the first Democratic President after Reagan appointed Robert Rubin as his Secretary of the Treasury. Rubin was a former investment banker who opposed regulating the kind of investments that caused the current financial melt-down. He was also one of the biggest Democratic fundraisers in the country. Did Robert Rubin do a good job? Perhaps. But he represented the connection between the banking industry and the Democratic party. In this environment, who could be counted on to represent the interests of the American people when they diverge from the interests of the banking and insurance industries? The answer is: nobody.
There is only one place left where people can stand up to the banks with some protection, and that is the Bankruptcy Court. You should know that the banks and other creditors do have certain rights in the Bankruptcy Court, and those rights have to be protected and respected. But unlike everywhere else in today’s America, average people have rights there too.
Not surprisingly, the banks hate the Bankruptcy Court. Also not surprisingly, the banks have lobbied year after year to limit the powers of those courts, as I described above. In October 2005, a major reform of the Bankruptcy Code was passed that gave the banks many things they had been lobbying for. Ironically, that reform bill was called the Bankruptcy Abuse Prevention and Consumer Protection Act — a lie if ever there was one. Be that as it may, despite all the misinformation published by the media about this legislation, most people can still file Chapter 7 Bankruptcy, most people can keep all their property through a Chapter 7 Bankruptcy, and there are still some significant protections for average people in the Bankruptcy Code.
Every day when I meet with prospective clients, I hear again and again about how terrible people feel about filing bankruptcy against their banks. I don’t think anyone should feel bad for the banks. Believe me, they will take care of themselves. We need to establish a new kind of relationship with the banks, one that recognizes the important place they play in our economy as providers of credit, but one that does not expect them to play fair. You must protect yourself in dealing with the banks, and you have few tools available to do so.
Proof of the loathing on the part of the banks toward Bankruptcy is evident in the shocking lengths that banks go to in an effort to keep you from filing Bankruptcy. In my opinion, the biggest outrage of late has been the public relations effort aimed at convincing people that even without this legislation, banks will work with people to help them keep their homes. I believe this effort is just public relations to stop Congress from stepping in and passing substantive legislation once and for all. I have represented too many people who have been led on by a bank, told that the bank would modify their mortgage to reduce their payments and help them keep their homes, only to have the bank drag its feet and eventually foreclose. Even where the bank does agree to a modification, the vast majority of the time, the modification is so minimal that it really does nothing to help the homeowners keep their home over the long-term. In my opinion, the number of times the banks actually modify the mortgages in a helpful way is tiny, but their p.r. flacks trumpet those modifications to such an extent that people believe the banks might actually be working to really help people. From what I have seen, the mortgage modification programs are nothing more than window dressing.
The debt consolidation or debt settlement programs you see advertised on television are another example of this effort. They claim you can avoid the harm of Bankruptcy by working with them. What they don’t tell you is that these companies don’t work. Here’s why. When you sign up with one of these companies, that company sets up a bank account for you. Every month, you make a payment to that bank account rather than paying your credit cards. Of course, the first funds into the bank account go to pay your fees to that company, which are typically very high. While you are making these payments rather than paying your credit cards, of course the banks don’t sit idly by. They call you incessantly, they harass you, they send you threatening letters, and eventually they sue you. These companies don’t tell you that debt consolidation offers you no protection from these collection efforts. The theory is that eventually, the bank will give up on its collection efforts and will be willing to settle the debt for less than you owe. If you have accumulated sufficient funds in your account to do so, the consolidation company will cut a check to the bank, closing that account. In theory, by making these payments monthly, if you can put up with the harassment, you can settle all your debts.
The problem comes with the reality of this approach. I have seen many clients come into my office who are making payments to one of these companies and getting their wages garnished by creditors. These companies don’t tell you that can happen. If they are successful in getting one or more creditors to settle your debt, then the difference between what you owe and what the bank is willing to settle for is considered taxable income and you will likely have to pay taxes on that amount. Furthermore, this process is entirely voluntary, so some banks simply won’t settle. Finally, this process likely hurts your credit score even worse that Bankruptcy. Let me explain.
It’s true that Bankruptcy will hurt your credit. According to some recent reports, the typical Chapter 7 will cut your credit score by 150 to 200 points. According to what I have seen, however, that reduction varies based upon what your credit score was at filing. In my experience, a Bankruptcy won’t typically reduce your credit score much below the mid-500s. Missing a payment to a creditor, however, only impacts your credit score by 20–30 points. But that is only half the story. Each time you miss a payment to a creditor, you get that 20–30 point hit. As a result, if you have four credit cards, you stop paying on them all, each month, you experience an 80 to 120 point cut. Within two months, you have exceeded the damage that would be done to your credit score with a Bankruptcy.
What’s most surprising to my clients is how quickly the credit score bounces back. Most of my clients, within a year, if they follow some simple steps, are in the mid- to high- 600s or even higher. A good credit score is typically considered anything over 680 to 700. So within a year and a half post-Bankruptcy, most people have pretty good credit. Usually within two years, it will be like the Bankruptcy never happened.
These are the facts as I see them, day in and day out in my Bankruptcy practice. Over the past few years, I have represented over a thousand people in Bankruptcy, so I feel like I have a pretty good sense of the environment. In this book, I am going to tell you the realities as I see them, and often you will find that these realities contrast strongly with what the banks tell you. The banks, for example, will never tell you how quickly your credit score will bounce back.
As a Bankruptcy attorney, I am a big believer that this is a complex and difficult process. Nevertheless, there are some people who want to file Bankruptcy without an attorney’s assistance. That is your right. I just believe you should have as much information and as many tools available to you as possible if you choose to go on your own. If you are one of those people, then this book is for you.
Even if you want an attorney to assist you in filing Chapter 7 Bankruptcy, it might be helpful to have some information to inform you about the process. If you want a comprehensive but understandable primer on Bankruptcy, then this book is for you too.
If nothing else, however, I hope that this book helps individuals stand up to the banks. Don’t feel bad about looking out for your own interests, the banks certainly don’t care about that. The reason we pay interest on our loans, in part, is due to the risk the banks take in lending you money in the first place. If banks are cognizant of the risk in lending you money, perhaps we should be aware of that risk too. We should no longer feel that the banks hold all the power, and we should no longer allow them to walk all over us. Even the threat of Bankruptcy should be enough to get the attention of a creditor, because that is the one place where you have rights too. My suggestion is that you know your rights and use them. That is what this book is all about.