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135

Consumer Over-Indebtedness:A U.S. Perspective

A. MECHELE DICKERSON

SUMMARY

I. INTRODUCTION....................................................................................................... 136

II. U.S.CONSUMERS AND OVER-INDEBTEDNESS ........................................................ 136A. Going into Debt: In General ........................................................................ 136

B. Credit Card Debt........................................................................................... 138C. Housing Debt................................................................................................ 1391. Benefits and Perils of the Democratization of Homeownership .......... .... 1392. Current Crisis .......................................................................................... 141

III. U.S.RESPONSE TO OVER-INDEBTEDNESS .............................................................. 143A. The Consumers Right to a Fresh Start......................................................... 143B. The Consumers Duty to Behave Responsibly: BAPCPA............................. 144C. BAPCPAs Success?...................................................................................... 146

IV. COMPARATIVE PATTERNS OF INDEBTEDNESS......................................................... 149A. Going into Debt............................................................................................. 149

B. Getting out of Debt........................................................................................ 150V. POTENTIAL SOLUTIONS FOR CONSUMER OVER-INDEBTEDNESS ............................. 150

A. Need for Response ......................................................................................... 150B. Crafting a Response: Recognizing Creditor Motivation .............................. 153C. U.S. Response to Consumer Over-Indebtedness ........................................... 154

1. Disclosure and Consumer Education....................................................... 1542. Regulation ............................................................................................... 1553. Changing Issuer and Lender Practices .................................................... 158

VI. CONCLUSION .......................................................................................................... 158

Fulbright and Jaworski Professor of Law, University of Texas School of Law. I delivered earlier drafts ofthis Article in lectures I presented on October 2, 2007, at the Federal University of Rio Grande do Sul in PortoAlegre, Brasil and on October 3, 2007, at the annual meeting of Consumer Protection Division of the FederalOffice of the Attorney General. I am grateful to the Hon. Antonio Benjamin and to Professor Claudia LimaMarques for inviting me to present these lectures and to Brasilcon for providing support for the lectures. I also amgrateful to the editors of the Texas International Law Journal for their assistance with this Article.


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136 TEXAS INTERNATIONAL LAW JOURNAL [VOL.43:135

I. INTRODUCTION

Contrary to conventional wisdom, consumer over-indebtedness is not, by itself, a bad

thing. Indeed, credit can be a good thing since it lets people pay forcurrentexpenses usingfuture income. High current debt levels are acceptable for people who have good reason tobelieve their income will increase in the future. Over-indebtedness may also enhance thepresent quality of life of consumers who can afford to repay their debts with future incomebecause it lets them splurge and occasionally buy luxury items. In addition to the benefits tothe consumer, consumer spending (and high debt levels) also help develop a nations wealthand, in the case of the United States, has kept the nations economy from stalling.1 Ofcourse, the reason for the current global consumer over-indebtedness problem is not becauseconsumers are in debt. Or that their debts exceed their income. Rather, consumers arewaaaaaaaaay in debt. They are drowning in debt and are not likely to receive relief underthe present consumer insolvency statutes.

This Article will discuss overall consumer over-indebtedness in the United States andtwo specific types of credit that have increased consumer debt in the United States: creditcards and mortgages. It describes how the U.S. Bankruptcy Code allows consumers to ridthemselves of some of their debts and then contrasts consumer over-indebtedness and theU.S. response to this problem to that in other countries. It concludes by suggesting waysthat the U.S. Government could respond to consumer over-indebtedness and issues Brazilshould consider in deciding how or whether to adopt a comprehensive consumer insolvencyregime.

II. U.S.CONSUMERS AND OVER-INDEBTEDNESS

A. Going into Debt: In General

A recent article in the Harvard University alumni magazine observed that[c]onsumerism is as American as cherry pie. Plasma TVs, iPods, granite countertops: youname it, well buy it.2 Americans are voracious consumers, but meager producers andsavers. By way of contrast, the difference between what Americans produced and what weconsumed in 2006 is about equal to the entire annual output of Brazil, which is striking sinceBrazil ranks tenth in the world in total GDP.3 Because the United States consumes muchmore than it produces, the U.S. economy relies heavily on imported goods.4 In fact, the U.S.economy is now based on providing financial services, not the production of goods. Thisshift from a manufacturing to a financial-services economy, often referred to as thefinancialization of the American economy,5 means that, instead of making money by

1. Consumer spending has kept the U.S. economy afloat and if Americans were to stop consuming, oureconomy would collapse. Spending, Incomes Disappoint; Public Projects Help Offset Housing Slump, CHI.TRIB., June 30, 2007, at C3; Nell Henderson & Howard Schneider, Commerce Report Raises Eyebrows: SlowerGrowth and Higher Inflation Suggest a Hint of Stagflation-Lite, WASH.POST, Apr. 28, 2007, at D1; GretchenMorgenson,Economy Is Surging but Wall St. Is Down in the Dumps, N.Y. TIMES, Apr. 27, 2002, at A1.

2. Jonathan Shaw,Debtor Nation: The Risking of the American Dream, on a Borrowed Dime, HARV.MAG.,JulyAug. 2007, at 40.

3. WORLD DEVELOPMENT INDICATORS DATABASE, WORLD BANK 1 (2007), http://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP.pdf.

4. The increase in U.S. imports has been good for our trade partners but detrimental to the U.S. labor market.See Martin Feldstein, The Return of Saving, 85 FOREIGN AFF. 87, May/June 2006.

5. See Greta R. Krippner, The Financialization of the American Economy, 3 SOCIO-ECON.REV.173, 174
http://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP.pdfhttp://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP.pdfhttp://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP.pdfhttp://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP.pdf


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2008] CONSUMER OVER-INDEBTEDNESS: AU.S.PERSPECTIVE 137

making things, Americans increasingly make money by moving money around. Much ofthis financialized economy involves moving money from the financial services industry toconsumers in the form of consumer debt.

In 2006, total U.S. household debt was $12.8 trillion, an increase of more than atrillion from total household debt in 2005.6 Debt has risen much faster than income formiddle-income families in the United States and the ratio of debt to disposable income isnow approximately 125 percent.7 Some of this debt level is no doubt attributable to theseemingly insatiable desire of U.S. consumers to have the latest gadgets, trinkets, and toys.But many Americans, especially lower- and middle-income Americans, borrow money anduse credit to compensate for stagnant or declining wages and to pay for health care, spiralingcollege tuition8 and, increasingly, for housing.9 Rather than buying now knowing that theylikely will be able to pay for those items later, consumers are using credit to finance presentconsumption even though they have no idea how they will repay those debts in the future.

The U.S. savings rate or, more accurately, the lack of consumer savings, is closelyrelated to the problem of American consumerism and carries similarly broad implications

for overall U.S. financial health. Since 2006, the United States has had a negative savingsratethat is, Americans save less than they spend on goods or services.10 One reason theU.S. savings rate is so low is because of the large number ofbaby boomers who arespending down their retirement income, i.e., dissaving.11 The negative U.S. savings rate hasnow made the U.S. increasingly dependent on non-U.S. funds. In fact, just as thefinancialization of the U.S. economy forces the United States to rely on imported goods, theUnited States must also import savings from other countries just to finance domesticbusiness investments.12

(2005).

6. GLOBAL POLICY FORUM, U.S. HOUSEHOLD DEBT: 19662006 (2006), http://www.globalpolicy.org/socecon/crisis/tradedeficit/tables/household.htm [hereinafter U.S.HOUSEHOLD DEBT].

7. Improving Credit Card Consumer Protection: Recent Industry and Regulatory Initiatives: HearingBefore the Subcomm. on Financial Institutions and Consumer Credit of the H. Comm. on Financial Services ,110th Cong.2 (2007) (statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation), availableathttp://www.house.gov/apps/list/hearing/financialsvcs_dem/htbair041707.pdf [hereinafter Bair Statement].

8. CHRISTIAN E. WELLER, DROWNING IN DEBT: AMERICAS MIDDLE CLASS FALLS DEEPER IN DEBT ASINCOME GROWTH SLOWS AND COSTS CLIMB 67 (Ctr. For Am. Progress, May 2006), available athttp://www.americanprogress.org/kf/boomburden-web.pdf. Student loan debt doubled from 1997 to 2007.COLLEGE BOARD, TRENDS IN STUDENT AID 2 (2007), http://www.collegeboard.com/prod_downloads/about/news_info/trends/trends_aid_07.pdf.

9. Kirstin Downey,Basics, Not Luxuries, Blamed for High Debt, WASH.POST, May 12, 2006, at D1; KarenE. Dynan & Donald L. Kohn, The Rise in U.S. Household Indebtedness: Causes and Consequences 45 (Fin. andEcon. Discussion Series Working Paper No. 2007-37, 2007), available athttp://ssrn.com/abstract=1019052.

10. Press Release, Bureau of Econ. Analysis, U.S. Dept of Commerce, National Economic Accounts:

Personal Income and Outlays (Nov. 1, 2007), available at http://www.bea.gov/newsreleases/national/pi/2007/pi0907.htm; Press Release, Bureau of Econ. Analysis, U.S. Dept of Commerce, National EconomicAccounts: Personal Income and Outlays (Dec. 22, 2006), available at http://www.bea.gov/newsreleases/national/pi/2006/pi1106.htm.

11. Feldstein, supra note 4, at 8889; Martha M. Hamilton, Could the Market Fall Down and Go Boom?WASH. POST, Feb. 4, 2007, at F3. Like in Brazil, the non-Hispanic white population in the U.S. is an agingpopulation. See generally Johannes Doll & Marli Sampaio, Elderly Consumer Weakness in WithholdingCredit,Paper presented at the annual meeting of the Law and Society Association (Draft July 25, 2007); JenniferCheeseman Day, POPULATION PROFILE OF THE UNITED STATES: POPULATION PROJECTIONS,http://www.census.gov/population/www/pop-profile/natproj.html (last visited Mar. 15, 2008).

12. Feldstein, supra note 4, at 89.
http://ssrn.com/abstract=1019052http://www.census.gov/population/www/pop-profile/natproj.htmlhttp://www.census.gov/population/www/pop-profile/natproj.htmlhttp://ssrn.com/abstract=1019052


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B. Credit Card Debt

In the United States, just about anyone or anything can get a credit card. Indeed,

former Federal Reserve Chair Alan Greenspan once commented that children, dogs, cats,and moose can get credit cards.13 In 2006, U.S. consumer credit debt (which includes creditcard and other non-mortgage debt) totaled $2.4 trillion and U.S. residents had $745 billionin debt on general purpose credit cards.14 While it is clear that credit card debt is highlycorrelated with consumer bankruptcy filings,15 it is unclear why so many U.S. consumers areunable or unwilling to properly manage their credit card debt. Several factors are typicallycited as the leading causes of increased credit card debt.

As a general matter, many people do not view credit cards as a form of borrowing,since these loans theoretically can be repaid in full without paying interest. Many of thosewho understand that a credit card transaction is a loan do not understand credit card billingterms because (a) pertinent information is not effectively disclosed (i.e., a lack oftransparency); (b) the complexity of the terms makes it virtually impossible for the average

consumer to understand the true cost of the credit; or (c) because the terms changefrequently.16 Other consumers use their credit cards to balance their budget each month andmake ends meet and appear to give little regard to the ultimate cost of that credit.17Moreover, because of how issuers market credit cards and because certain people have atendency to overestimate their ability to exercise self-control and borrow more than they canrepay in the future, some consumers may find it hard to resist the temptation to charge,charge, charge.18

Credit card issuers, not surprisingly, target the customers they feel will be the mostprofitable. For example, issuers covet and aggressively pursue higher risk consumers suchas college students, even though they have no income and have high rates of default.19Despite their present risk of default, college students are ideal long-term credit cardcustomers because they are comfortable with indebtedness (due to their student loans) and

13. Credit Cards at 50: The Problems of Ubiquity, N.Y.TIMES, Mar. 12, 2000, at C11.14. See FED. RESERVE BD., STATISTICAL RELEASE, G-19 CONSUMER CREDIT (2007),

http://www.federalreserve.gov/releases/g19/Current; U.S. HOUSEHOLD DEBT, supra note 6; Lewis W. Diuguid,Despite Credit Woes, We Just Keep on Digging, KANSAS CITY STAR, Oct. 17, 2007, at B9.

15. TERESA A. SULLIVAN, ELIZABETH WARREN & JAY L. WESTBROOK, THE FRAGILE MIDDLE CLASS:AMERICANS IN DEBT 12122(2001).

16. GEN. ACCOUNTING OFFICE, CREDIT CARDS: INCREASED COMPLEXITY IN RATES AND FEES HEIGHTENSNEED FOR MORE EFFECTIVE DISCLOSURES TO CONSUMERS 3356 (2006), available athttp://www.gao.gov/new.items/d06929.pdf; Bair Statement, supra note 7;Examining the Billing, Marketing, and

Disclosure Practices of the Credit Card Industry, and Their Impact on Consumers: Hearing before the S. Comm.

on Banking, Housing and Urban Affairs, 110th Cong. 4(2007) (statement of Elizabeth Warren, Professor of Law,Harvard Law School) [hereinafter Warren Statement] (citing statement by international business consulting groupvice-president that banking products are too complex for the average consumer).

17. JOS A. GARCA, BORROWING TO MAKE ENDS MEET; THE RAPID GROWTH OF CREDIT CARD DEBT INAMERICA 1 (2007), available at http://demos.org/pubs/stillborrowing102407.pdf; WELLER, supra note 8, at 5.The need to obtain additional funds, even if on unfavorable terms, to make ends meet also appears to explain thewillingness of elderly Brazilians to take out loans against their meager pensions. Doll & Sampaio, supra note 11.Declining pensions and increasing prices for drugs and health care might also explain why credit card debt hasbecome a serious problem for older Americans. Credit Cards and Older Americans: Hearing before theSubcomm. on Financial Institutions and Consumer Credit of the H. Comm. on Financial Services , 110th Cong. 1(2007) (written statement of Bob OConnell, Executive Council Member, AARP) [hereinafter OConnellStatement].

18. Oren Bar-Gill, Seduction by Plastic, 98 NW.U.L.REV. 1373, 13951400 (2004).19. Jessica Silver-Greenberg, Countering Credit-Card Pushers, BUSINESSWEEK ONLINE,Oct. 11, 2007; Bair

Statement, supra note 7, at 4 (discussing higher rate of late payments for young adults).


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also because they theoretically will have higher incomes once they graduate and get jobs.20Because most of the revenue credit card issuers receive comes from customers who do notpay their balances in full each month, issuers rationally prefer these customers because they

make higher profits if the customer treats the transaction as a loan that will be repaid overtime.21 Thus, even if college students or other high risk customers have shockingly highdefault rates, they are quite profitable to issuers as long as they continue to at least paysomething most months. Similarly, credit card companies have now increased their directmail credit card offers to subprime customers who have lost or likely will lose their homes ina foreclosure because these customers can no longer tap into the homes equity for cash. 22Customers who have recently lost their homes are, ironically, good long-term credit risksbecause they can no longer access the equity in their homes, which gives them a strongincentive to take out cash advances on their credit cards.

C. Housing Debt

1. Benefits and Perils of the Democratization of Homeownership

Homeownership constitutes the largest component of household net worth for allpopulations in the United States, except perhaps the highest income groups.23 Housingprices more than doubled in some U.S. housing markets this decade and have tripled insome markets over the last thirty years.24 Americans have become over-indebted in the lastfew years almost exclusively because of the astronomical increase in housing prices andconsumers increase in housing debt for the last twenty years.25 The acceleration in house-price appreciation, in turn, caused homeowners to increase their consumption based on theirbelief that they were wealthier and could spend more.26

Total U.S. home mortgage debt is staggering: in 2006, it was $9.7 trillion, an almost

trillion dollar increase from 2005.27

Consumers over the last ten years eagerly took outlarge loans to buy homes because even with large jumbo mortgages28 homeowners

20. See Michelle Singletary, The Extra Credit Students Dont Need, WASH. POST, Oct. 18, 2007, at D2;ROBERT D.MANNING,LIVING WITH DEBT: ALIFE STAGE ANALYSIS OF CHANGING ATTITUDES AND BEHAVIORS25,42(2005),available athttp://www.lendingtree.com/livingwithdebt/collateral/full_ report.pdf.

21. See Warren Statement, supra note 16, at 3.22. Robert Gavin, Credit Card Companies Woo Struggling Mortgage-Holders, BOSTON GLOBE, Sept. 4,

2007, at A1.

23. U.S. CENSUS BUREAU, U.S. DEPARTMENT OF COMMERCE, NET WORTH AND ASSET OWNERSHIP OFHOUSEHOLDS:1998 AND 20004 (2003), available athttp://www.census.gov/prod/ 2003pubs/p70-88.pdf. ContraZhu Xiao Di, Role of Housing as a Component of Household Wealth 6 (Joint Center for Housing Studies ofHarvard University, Working Paper No. W01-6, 2000), available athttp://www.jchs.harvard.edu/publications/markets/di_w01-6.pdf (stating that, by 1998, stock values had surpassed

home equity as a major component of household wealth).24. Dynan & Kohn, supra note 9, at 15. See generally Wenli Li & Rui Yao, Your House Just Doubled in

Value? Dont Uncork the Champagne Just Yet!, BUS. REV., Q1 2006, at 25, available at http://www.philadelphiafed.org/files/br/Q1_06_Housevalue.pdf.

25. Dynan & Kohn, supra note 9, at 1314 (noting that a significant percentage of the increase in householddebt relative to income is attributable to home mortgage debt). See also Bair Statement, supra note 7, at 2.

26. Li & Yao, supra note 24, at 25; Dynan & Kohn, supra note 9, at 6.27. U.S.HOUSEHOLD DEBT, supra note 6.28. In general, a jumbo mortgage is a loan that exceeds the amount ($417,000) that can be sold to

government sponsored enterprises (i.e., Fannie Mac and Freddie Mac). Floyd Norris & Eric Dash, In a CreditCrisis, Large Mortgages Grow Costly, N.Y. TIMES, Aug. 12, 2007, at A1.


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monthly mortgage payments remained reasonable due to escalating housing prices anddecreasing interest rates. Homeowners also used home equity loans to remove the equitythey had accumulated in their homes, essentially treating their homes like an automated

teller machine. When interest rates were low and housing prices were escalating, consumersremoved equity to buy durables, to renovate their homes, to pay off higher interest creditcard debt or other consumer loans, or to borrow money to pay for college tuition andexpenses.29 Escalating housing prices also caused homeowners to stop saving, to stopcontributing to retirement accounts, and to even withdraw funds held in their retirementaccounts.30

Due to the encouragement of the U.S. Government, lenders developed innovative loanproducts to make mortgage credit more readily available to lower income, but often higherrisk, consumers.31 This push for a greater democratization of credit32 generally resulted inlenders giving higher risk borrowers, a group generally characterized as subprimeborrowers, greater access to credit in the form of non-traditional mortgage products.Financial institutions were eager to loan to homeowners, even subprime borrowers, becausethey viewed the loans themselves as low-risk. That is, as long as housing prices continued

to rise and the loan originators could continue to quickly sell the subprime mortgage loans inthe secondary market, the entities that originated the loans bore little risk that they would notbe repaid if the borrower defaulted on the loan payments. In fact, the ability to originate butthen quickly sell mortgages had the effect of decreasing the originating lenders incentive tomake careful lending decisions since the risk of default would pass from the loan originatorto the investors that purchased the loan in the secondary market.33

The affordability products that lenders created to make homeownership moreaccessible to subprime customers changed traditional notions of home ownership. Theseproducts had several non-traditional features which, when layered together, made it easierfor consumers to buy homes, but also made it more likely that the consumer would defaultand, ultimately, lose the home in a foreclosure sale. These include scenarios whereborrowers were offered stated-income loans that were approved even though the borrowers

provided no written proof of their income.34

These loans generally are referred to as low-documentation, no-documentation or liar loans because they gave borrowers an incentiveto inflate their income in order to qualify for a larger loan.35 Borrowers could also get a

29. See Bair Statement, supra note 7, at 3 (discussing use of cash-out refinancing proceeds to pay off creditcard debt); WELLER, supra note 8, at 1, 3.

30. Dynan & Kohn, supra note 9, at 6 (discussing why consumers may not behave rationally whenincreasing their mortgage debt); WELLER, supra note 8, at 21.

31. Dynan & Kohn, supra note 9, at 1718 (suggesting that financial innovation did not help increase thenumber of households that could borrow but instead increased the amount of debt held by households who alreadyhad access to mortgage loans); see also Vikas Bajaj & Ron Nixon, Subprime Loans Going from Boon to Housing

Bans; Minority Buyers Especially Hurt as Interest Rates Adjust Higher, N.Y. TIMES,Dec. 6, 2006, at C1.32. Dynan & Kohn, supra note 9, at 6.33. Kathleen C. Engel & Patricia A. McCoy, Turning a Blind Eye: Wall Street Finance of Predatory

Lending, 75 FORDHAM L.REV. 2039, 204850 (2007) (discussing the lemons problem and how securitizationlets lenders shift the risk of default onto the investor); seealso Vikas Bajaj & Christine Haughney, Tremors at the

Door, N.Y. TIMES, Jan. 26, 2007, at C1; Lawmakers Debate Necessity of Lending Reforms: Congress Wadinginto Housing Markets Complexity, May 8, 2007, available athttp://www.msnbc.msn.com/id/18560483.

34. Gretchen Morgenson, Crisis Looms in Market for Mortgages , N.Y. TIMES, Mar. 11, 2007, available athttp://select.nytimes.com/2007/03/11/business/11mortgage.html?_r=1&scp=1&sq=crisis+looms+in+market+for+mortgages&st=nyt&oref=slogin; Peter Henderson, Tim McLaughlin, Andy Sullivan & Al Yoon,Frenzy of Risky Mortgages Leaves Path of Destruction, May 8, 2007, available athttp://www.reuters.com/article/reutersEdge/idUSN0329892220070508.

35. Morgenson, supra note 34;Preserving the American Dream: Predatory Lending Practices and HomeForeclosure: Hearing before the S. Comm. on Banking, Housing and Urban Affairs, 110th Cong. 45 (2007)(written statement of Jean Constantine-Davis, Senior Attorney, AARP Foundation) (describing perils to consumer


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mortgage to purchase a home without making any down payment.36 Because of the hightransaction costs associated with purchasing a home (realtor and attorney fees), a borrowerwho makes no down-payment will have no equity in her home when the loan term begins,

may not have built up any equity in the home even after making her monthly payments forthe first few years, and may find that her loan balance is increasing (i.e., negativelyamortizing), especially if the loan permits the borrower to defer interest payments.37 Finally,though mortgages traditionally have been for fifteen- or thirty-year terms, lenders offeredforty- and fifty-year mortgage terms to provide a product with lower monthly payments,even though the length of the mortgage term effectively treated the owner as a long-termrenter.38

Potential homeowners, especially subprime borrowers, were often offered adjustable-rate mortgages (ARMs) that had very low introductory interest rates and initial payments.Low payments (especially if combined with no down payment) made it possible for cash-strapped renters to buy a home. Once the introductory period passed and interest ratesincreased, however, borrowers monthly payments would increase often quite dramatically.Borrowers then found that they needed to refinance the ARMsometimes more than

onceto get a more affordable product.39 Because of the risks associated with subprimeARMs, bankers and consumer advocates alike have referred to them as neutron loans:they kill all the people, but leave all the houses.40

2. Current Crisis

Making homeownership more accessible to more potential buyers is not a bad thing, ifdone responsibly. Unfortunately, the current turmoil in the U.S. housing markets hasrevealed that many consumers were approved for loans they could not afford based on theiractual income.41 Lenders appeared willing to approve these loans largely because housingprices were escalating and the escalating values protected their interest in the home. Even ifthe borrower failed to repay the loan, the lender could foreclose on the home and sell it orcould convince the borrower to refinance the mortgage to get lower monthly payments.Likewise, borrowers seemed willing to buy houses they could not afford because of their

ofstated income loans). A different variation of stated income loans are no income, no asset (NINA) loans.With these loans, the borrower is not required to disclose income orassets. See, e.g.,Best No Doc Loans, No Doc

Loans, http://www.bestnodocloans.com/content/no_doc_loans.htm (last visited Mar. 16, 2008). These loanswould be approved based on the borrowers employment, credit history, the property value, and the down payment(if any). Another variation, a NINANE (no income, no asset, no employment) loan, does not require the borrowerto disclose income, assets, or employment. See, e.g., No Doc Loan and No Doc Mortgages,http://www.loanshoppers.net/no-doc.htm (last visited Mar. 16, 2008).

36. ALLEN J. FISHBEIN & PATRICK WOODALL, CONSUMER FEDN OF AM., EXOTIC OR TOXIC? ANEXAMINATION OF THE NON-TRADITIONAL MORTGAGE MARKET FOR CONSUMERS AND LENDERS 12 (2006),

available athttp://www.consumerfed.org/pdfs/Exotic_Toxic_Mortgage_Report0506.pdf.37. See Calculated Risk: Assessing Non-Traditional Mortgage Products: Hearing Before the Subcomm. on

Housing and Transp. and Subcomm. on Econ. Policy of the S. Comm. on Banking, Housing and Urban Affairs,109th Cong. 11 (2006) (statement of Michael D. Calhoun, President, Center for Responsible Lending), availableathttp://www.responsiblelending.org/pdfs/Testimony-Calhoun092006.pdf.

38. Gretchen Morgenson,Home Loans: A Nightmare Grows Darker, N.Y. TIMES, Apr. 8, 2007, at C1.39. See FISHBEIN &WOODALL,supra note 36, at 10, 19.40. Mara Der Hovanesian, Nightmare Mortgages, BUSINESSWEEK, Sept. 11, 2006, at 70, available at

http://www.businessweek.com/magazine/content/06_37/b4000001.htm.41. See Justin Lahart, After Subprime: Lax Lending Lurks Elsewhere, WALL ST.J., Feb. 20, 2007, at C1;

FISHBEIN &WOODALL, supra note 36, at 14.


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overly optimistic assumption that housing prices would continue to escalate.42 In addition tomisjudging the unaffordability of their loans, consumers also did not appear to fullyunderstand the terms of the loan.43 Because many of the subprime ARM borrowers were

first-time buyers, many of them did not appear to be aware of the additional responsibilitiesof home ownership, such as the need to put aside money in escrow for taxes and insurance ifthe lender did not automatically escrow.44

Because lenders approved non-traditional mortgages for borrowers with weak credithistories, many of those high-risk borrowers are now defaulting on their loans. In fact, muchof the increase in foreclosure rates is attributable to non-traditional and subprime mortgagesthat originated in late 2005 and early 2006,45 and many loans were in default after borrowersmade only one or two (or no) payments.46 For example, in the first half of 2007, 320,000foreclosures were initiated in the United States.47 Since the average number of annualforeclosures for the last six years has been 225,000, the United States is on track to havealmost twice as many foreclosures in 2007 as it has had on average for the last six years.48Moreover, most economists and realtors are projecting that the decrease in home values anddeclining home sales will not recover until at least 2009.49

Recent changes to U.S. consumer bankruptcy laws, as discussed in more detail in PartIII, make it harder for consumers to rid themselves of consumer debt. The inability torestructure debts in general and the virtual impossibility of restructuring mortgage debts inbankruptcy make the soaring foreclosure rate particularly problematic for consumers. To besure, some state exemption laws do allow homeowners to prevent general unsecuredcreditors from seizing their homeseven large, expensive onesafter they file forbankruptcy.50 Moreover, U.S. consumers, unlike consumers in other countries,51 generally

42. See Allan Sloan,Junk Mortgages Under the Microscope; A Close-up of One Deal Shows How Subprime Mortgages Went Bad, Says Fortunes Allan Sloan (Oct. 16, 2007), CNNMONEY.COM,http://money.cnn.com/2007/10/15/markets/junk_mortgages.fortune (last visited Apr. 5, 2008).

43. Calculated Risk: Assessing Non-Traditional Mortgage Products: Hearing Before the Subcomm. on

Housing and Transp. and Subcomm. on Econ. Policy of the S. Comm. on Banking, Housing and Urban Affairs,109th Cong. 23 (2006) (statement of Allen J. Fishbein, Director of Housing and Credit Policy, ConsumerFederation of America); Brian Bucks and Karen Pence, Do Homeowners Know Their House Values and

Mortgage Terms? 2022 (Fed. Reserve Bd. of Governors, FEDS Working Paper No. 2006-03, 2006), available athttp://ssrn.com/abstract=899152 (noting that households with low income and less education are less likely toknow the terms of their mortgage).

44. See The Role of the Secondary Market in Subprime Lending: Hearing before the Subcomm. on Fin.Institutions and Consumer Credit of the H. Comm. on Fin. Servs. 110th Cong. 5 (2007) (statement of Larry B.Litton, Jr., President and CEO, Litton Loan Servicing LP) (recommending that subprime borrowers establish anescrow account to pay taxes and insurance); Susan Schmidt Bies, Member of the Board of Governors of the U.S.Fed. Reserve System, Remarks at the National Credit Union Administration 2007 Risk Mitigation Summit:Enterprise Risk Management and Mortgage Lending 4 (Jan. 11, 2007), available athttp://www.bis.org/review/r070112e.pdf (suggesting the prudence of escrowing tax and insurance payments orinforming borrowers how much they should set aside for those payments).

45. Subprime Mortgage Lending and Mitigating Foreclosures: Hearing before the House Comm. on Fin.

Servs., 110th Cong. 2 (2007) (statement of Ben Bernanke, Federal Reserve Chairman) [hereinafter BernankeStatement I]. Estimates are that two million ARMS will reset to a higher rate in 2007 and 2008. SeeMajor Lenders Move to Offer Subprime Help: Freddie Mac, Washington Mutual Will Help Refinance Billions in

Mortgages, MSNBC, Apr. 18, 2007, http://www.msnbc.msn.com/id/18184371 (last visited Apr. 5, 2008) .46. Norris & Dash, supra note 28.47. Bernanke Statement I, supra note 45.48. Id.49. Chris Isidore, Realtors: Home Prices Slump Through08, CNNMONEY.COM, Sept. 11, 2007,

http://money.cnn.com/2007/09/11/news/economy/realestate_outlook (last visited Apr. 5, 2008). 50. See A. Mechele Dickerson, Race Matters in Bankruptcy Reform, 71 MO.L.REV. 919, 92324 (2006)

(discussing bankruptcy policy allowing debtors to protect real property).51. Donna McKenzie Skene & Adrian Walters, Consumer Bankruptcy Law Reform in Great Britain , 80 AM.


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are not forced to use the equity in their homes to repay their debts.52 However, U.S.consumer insolvency laws have staunchly protected mortgage loans and make it virtuallyimpossible to remove a lenders interest in the collateral (i.e., the home) that secures the

mortgage loan.

53

Thus, consumers who are over-indebted because of mortgage loans maybe able to discharge their personal obligation to repay the loan but, at least for now, it isalmost impossible to use bankruptcy laws to modify or discharge the lenders securityinterest in the borrowers home.54

III. U.S.RESPONSE TO OVER-INDEBTEDNESS

A. The Consumers Right to a Fresh Start

Over-indebted U.S. consumers can seek formal financial relief by attempting todischarge some or all of their debts using the U.S. consumer bankruptcy laws.55 Unlike a

number of countries (including Brazil), the United States has had a formal consumerinsolvency regime since 1898 largely because of the recognition that it is virtuallyimpossible for an individual consumer to reach a global debt renegotiation with all hercreditors unless a federal law forces the creditors to accept a particular payment plan.Historically, U.S. consumer bankruptcy law have given over-indebted consumers a freshstart that allowed them to discharge their debts and become productive members of themarket economy.56 Many have suggested that the best way to evaluate and respond toconsumer over-indebtedness is to examine why consumers find themselves unable to repaytheir bills.57 Others argue that the causes of consumer over-indebtedness should beaddressed outside of bankruptcy, that consumer bankruptcy laws generally should not beviewed as being part of the protections provided by the welfare state, and that bankruptcylaws should largely be unconcerned about why people found themselves unable to repaytheir debts.58 As we shall see in the following sections, a consumer insolvency scheme thatignores the causes of insolvency is unlikely to provide appropriate relief.

BANKR.L.J.477, 485 (2006). Similarly, over-indebted Brazilians appear to be able to keep their homes only ifthose homes are small and reasonably modest in value.

52. See Dickerson, supra note 50, at 92324.53. See 11 U.S.C. 725 (2008) (requiring trustee to protect interest of entity that has a lien on property of

the estate); 11 U.S.C. 1322(b)(2) (allowing modification of lender s security interest in debtors principal

residence).54. Emergency Home Ownership and Mortgage Equity Protection Act of 2007, H.R. 3609, 110th Cong. 3

(2007).55. 11 U.S.C. 727; 11 U.S.C. 1328.56. The fresh start policy gives the honest but unfortunate debtor who surrenders for distribution the

property which he owns at the time of bankruptcy, a new opportunity in life and a clear field for future effort,unhampered by the pressure and discouragement of pre-existing debt. Local Loan Co. v. Hunt, 292 U.S. 234,244 (1934).

57. See Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 MICH.L.REV. 336 (1993)(arguing that bankruptcy laws are created to deal with the problems of market imperfections).

58. See Eric Posner, Should Debtors be Forced Into Chapter 13?, 32 LOY.L.A.L.REV. 965, 969 (1999).


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B. The Consumers Duty to Behave Responsibly: BAPCPA

The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), enacted

by the U.S. Congress in 2005,59

significantly changed the U.S. Bankruptcy Code and movedU.S. consumer law policies closer philosophically to the European concept of an earnedrather than fresh start.60 European consumer debt adjustment systems appear to bedesigned to give consumers an incentive to modify their spending habits and to make wiserspending choices, but also to force them to live with the economic consequences of unwisechoices.61 Many in Congress seemed to believe that earlier versions of the U.S. consumerinsolvency laws were too lax and allowed too many people to discharge debts they couldafford to repay.62 BAPCPA was designed to make it harder for people to file for bankruptcyand to give consumers an incentive to avoid over-indebtedness. Rather than use bankruptcylaws to provide comprehensive relief to over-indebted consumers, the U.S. Congress wantedconsumers to understand that they have a moral duty to make responsible spending decisionsand to at least attemptto repay their debts.63

Before BAPCPA was enacted, consumers had almost complete control to decidewhether they wanted to attempt to repay some of the debts over a three to five year period ina Chapter 13 debt repayment plan, or whether they wanted a quick discharge of their debtsin a Chapter 7 proceeding and not even attempt to repay those debt.64 To reduce the overallnumber of bankruptcy filings and to force more consumers into Chapter 13 debt repaymentplans, Congress made a number of changes to restrict virtually all consumers access tobankruptcy. Perhaps the biggest change in the new law is a means test, a complicatedquantitative test consumers must pass before they are deemed to have earned the right toa quick discharge of their debts in a Chapter 7 liquidation proceeding.65 Until 2005, theU.S. approach had been to allow debtors a quick discharge if they had few assets theywanted to keep, or only had assets that they were allowed to keep statutorily (i.e., exempt)based on either applicable state or federal bankruptcy laws.66 Consumers who fail this newmeans test either must attempt to repay some of their debts through a Chapter 13 debt

repayment plan or must attempt to renegotiate their debts outside of bankruptcy.67

Forcingconsumers to prove that they are entitled to a particular type of debt relief moves the U.S.

59. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat. 23(codified as amended in scattered sections of 11 U.S.C.) [hereinafter BAPCPA].

60. UDO REIFNER ET AL., CONSUMER OVER-INDEBTEDNESS AND CONSUMER LAW IN THE EUROPEAN UNION166 (2003).

61. Id. at 16769.62. SeeBankruptcy Reform Act of 1998: Hearing on H.R. 3150 Before the Subcomm. on Commercial and

Admin. Law of the H. Comm. on the Judiciary, 105th Cong. 11 (1998) (statement of Rep. James P. Moran)[hereinafter Hearing on H.R. 3150] (characterizing pre-BAPCPA bankruptcy as a convenient financialmanagement tool and highlighting its convenience and ease); id. at 1214 (prepared statement of Rep. JamesP. Moran); 151 CONG.REC. S1834, S1843 (daily ed. Mar. 1, 2005) (statement of Sen. Orrin Hatch) (stating thatdebtors abusive misconduct is all too often encouraged by a bankruptcy bar that ushers people into Chapter 7

without ever fully considering the clients ability to repay.); see H.R.REP.NO. 109-31, at 5 (2005) [hereinafterHouse Report] ([T]he present bankruptcy system has loopholes and incentives that allow and sometimes evenencourageopportunistic personal filings and abuse.).

63. See 151 CONG.REC. S1856 (daily ed. Mar. 1, 2005) (statement of Sen. Charles Grassley) ( I think thesystem needs to be reformed because it is fundamentally unfair. This bill will promote personal responsibilityamong borrowers and create a deterrence for those hoping to cheat the system.). See alsoHearing on H.R. 3150,supra note 62, at 11 (statement of Rep. James P. Moran) (suggesting that moral principal has been evisceratedbecause bankruptcy is now the option of first resort for some debtors who are capable of repaying their debts).

64. Dickerson, supra note 50, at 921.65. 11 U.S.C. 707(b)(2)(A).66. Id. 522(b)(1).67. Id. 707(b)(1).


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system a bit closer philosophically to the structure and substantive policies of debtadjustment systems in other countries.

The Code also requires all consumers to participate in mandatory credit counseling

before they file their bankruptcy petition68

and mandates that Chapter 13 debtors receivefinancial management training from an approved financial education provider before theycan receive a discharge.69 The number of documents consumers and their attorneys mustprovide to creditors before and during the bankruptcy case also increased under the newlaw.70 Finally, because of the additional time lawyers must now spend on each case andbecause of higher filing fees, it costs more for consumers to get relief from their over-indebtedness.71

Making it harder for over-indebted consumers to avoid repaying their debts is easily justifiable if purchases of iPods, plasma TVs, Hummers, or sable fur coats cause mostconsumer over-indebtedness. But empirical data collected by prominent U.S. academicsshow this is not the case; medical debts, a divorce, or a job interruption cause mostconsumer bankruptcies in the United States.72 Although these life circumstances, rather than

profligate spending, appear to trigger most bankruptcy filings, the U.S. Congressnonetheless found that only two groups of over-indebted consumers should be viewedcharitably and favorably and should be spared from BAPCPAs harsh consequences.

68. Debtors are ineligible for bankruptcy relief unless they receive a briefing from a credit counselingagency approved by the Office of the United States Trustee within 180 days before they file for bankruptcy. Thiscounseling can occur either over the phone or the Internet. 11 U.S.C. 109(h)(1) (2007). See U.S. TrusteeProgram: List of Credit Counseling Agencies Approved Pursuant to 11 U.S.C. 111,http://www.usdoj.gov/ust/eo/bapcpa/ccde/cc_approved.htm (last visited Mar. 16, 2008) (providing a list ofapproved counseling agencies by jurisdiction). Debtors pass online briefings typically by answering a series ofquestions that are posed after each section. See, e.g., American Bureau of Credit Services, Inc.,http://americanbureauofcredit.com/pricing.html (last visited Mar. 16, 2008) (providing an example of an online

debtor education course).69. 11 U.S.C. 1328(g)(1) (2005).70. Before the new changes, debtors or their lawyers were required only to file the bankruptcy petition,

schedules that list creditors, assets, income, etc., and a statement of financial affairs. Now, they must provide thatinformation plus a host of other documents, including copies of all payment advices (i.e., pay stubs), a statementof monthly net income explaining how the amount was calculated, a means test calculation, an annual incomestatement, and tax returns. 11 U.S.C. 521(a) (2005); 11 U.S.C. 1308(a) (2005).

71. Section 325 of BAPCPA originally increased Chapter 7 filing fees to $200, but decreased Chapter 13filing fees from $155 to $150 (ostensibly to encourage more debtors to file under Chapter 13). Congress amendedBAPCPA to increase the Chapter 7 fee by an additional $20 as part of the 2005 Emergency SupplementalAppropriations Act for Defense, the Global War on Terror, and Tsunami Relief, Pub. L. No. 109-13, 119 Stat.231, 297 (codified as amended at 28 U.S.C. 1930(1)(A)). That the increase was included as a technicalamendment in this bill is somewhat ironic, since it forced all debtors even those below-median debtors whopresumptively deserve Chapter 7 reliefto pay higher filing fees to help finance foreign aid and the Iraq war. Inaddition to the $220 filing fee, other fees due on filing are $54, making the total fees due $274.

In February 2006, Congress increased Chapter 7 filing fees again (from $220 to $245) and increased Chapter13 filing fees from $150 to $235) as part of the Deficit Reduction Act of 2005, Pub. L. No. 109-171, 120 Stat. 4,184 (codified as amended at 28 U.S.C. 1930(a)). Total Chapter 7 fees due on filing are $299. Stated differently,between the time BAPCPA was signed into law (April 2005) and the first anniversary of the signing, Congressincreased the cost of filing under both Chapter 7 and 13 by 63%. Moreover, by using bankruptcy filing fees tohelp offset the federal deficit, Congress substantially diminished the economic incentive for debtors to file forrelief under Chapter 13 ($235) rather than Chapter 7 ($245). In addition, because of the increased administrativeburdens, attorney fees have skyrocketed since the changes went into effect as well. See Jeanne Sahadi,

Bankruptcy Fees could Skyrocket, CNNMONEY.COM, Apr. 14, 2005,http://money.cnn.com/2005/04/12/pf/bankruptcy_fees/ index.htm (last visited Apr. 5, 2008).

72. SULLIVAN,WARREN &WESTBROOK,supra note 15, at 75, 14142, 18283.


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First, consumers who can document that they are in debt because of medical billsrelating to serious medical conditions are largely unaffected by BAPCPAs additionalrequirements.73 However, consumers who chose to use their credit cards to make ends meet

while they were injured and unable to work were not viewed as favorably. That is, if aconsumer used credit cards to compensate for income a debtor lost while injured, such aperson cannot easily avoid BAPCPAs additional requirements (i.e., means-testing,mandatory credit counseling, additional reporting) since the credit card debt would nottechnically be medical debt. To a lesser extent, BAPCPA also favors certain members ofthe armed forces (current and retired) who can avoid having to comply with some ofBAPCPAs additional requirements.74 The decision to favor members of the armed forceswas, of course, an unabashedly political decision: no member of the U.S. Congress wantedto be viewed as penalizing consumers who are in debt solely because they had beendeployed to fight in one of the many U.S.-led wars.75

C. BAPCPAs Success?

While BAPCPA has changed how and when people file for bankruptcy, it has also hadunintended consequences and imposed additional administrative burdens and costs onconsumers. The number of consumers who filed for bankruptcy relief plummeted afterBAPCPA became fully effective: there were over 1.5 million filings in 2004,76 over twomillion in 2005,77 but fewer than 600,000 in 2006.78 Given this dramatic drop, BAPCPAarguably succeeded in both making it harder for people to file for bankruptcy and alsomaking people understand that they have a moral duty to repay their debts. However, manyrecognize that filing levels after October 18, 2005 remained low through mid-2006 becauseso many people rushed to file their bankruptcy petition before the effective date.79 Indeed,of the over two million people that filed for bankruptcy in 2005, approximately 600,000 (or,stated differently, an amount equal to the total number of filings in 2006) filed in the weeksbefore BAPCPAs October 17 effective date.80 While consumer filings remained low for

much of 2006, the numbers already have started to increase as there was a forty percent

73. See 151 CONG. REC. E704 (daily ed. Apr. 19, 2005) (statement of Rep. Dennis Moore) (noting thatS.256 properly allows bankruptcy filers to challenge the means test by demonstrating special circumstances,such as a serious medical condition, that justify additional expenses or adjustments to their income). See also 11U.S.C. 707(b)(2)(B)(i) (2007) (codifying protections for deserving debtors).

74. 11 U.S.C. 727(a)(11) (2005); 11 U.S.C. 707(b)(2)(B)(i); 11 U.S.C. 109(h)(4).75. H.R. REP.NO. 106-123, pt. 1, at 10607 (1999); see also 151 CONG.REC. S2424, S2427 (daily ed. Mar.

10, 2005) (statement of Sen. Richard Durbin) (Mr. President, this amendment will exempt from the bankruptcybills means test those disabled veterans whose indebtedness occurred primarily during a period of militaryservice. They have given us their arms, their legs, very important parts of their lives. . . . We need to honor theseveterans who have given so much to America.).

76. Statistics from the Admin. Office of U.S. Courts, Table F-2: Business and Nonbusiness Bankruptcy

Cases Commenced, by Chapter of the Bankruptcy Code During the Twelve Month Period Ended Dec. 31, 2004,available athttp://www.uscourts.gov/bnkrpctystats/bankrupt_f2table_dec2004.pdf.

77. Statistics from the Admin. Office of U.S. Courts, Table F-2: Business and Nonbusiness BankruptcyCases Commenced, by Chapter of the Bankruptcy Code During the Twelve Month Period Ended Dec. 31, 2005,available athttp://www.uscourts.gov/bnkrpctystats/bankrupt_f2table_dec2005.xls.

78. Statistics from the Admin. Office of U.S. Courts, Table F-2: Business and Nonbusiness BankruptcyCases Commenced, by Chapter of the Bankruptcy Code During the Twelve Month Period Ended Dec. 31, 2006,available athttp://www.uscourts.gov/bnkrpctystats/bankrupt_f2table_dec2006.xls.

79. Press Release, American Bankruptcy Institute, Bankruptcy Filings Set Record on Eve of New Law (Dec.15, 2005), available at http://www.abiworld.org/AM/Template.cfm?Section=Home&TEMPLATE=/CM/ContentDisplay.cfm&CONTENTID=39570.

80. Id.; Statistics from the Admin. Office of U.S. Courts 2005, supra note 77.


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increase in consumer filings in 2007.81 While no one expects filings to return to the pre-BAPCPA apogee, filings appear to be headed toward the one million mark and totalconsumer filings likely will continue to increase for the next few years in large part because

of the massive amount of consumer debt.

82

Perhaps more importantly, while the number ofconsumers who filed Chapter 13 petitions increased after the new changes went into effect,fewer consumers are now filing Chapter 13 petitions relative to Chapter 7 petitions.83 So,despite Congressional attempts to decrease bankruptcy filings, over-indebted consumers arestill filing for bankruptcy and more of them are now seeking to discharge their debts ratherthan attempt to repay them.

One other post-BAPCPA development suggests that the revised consumer insolvencylaws and the additional requirements BAPCPA imposes on consumers have not had theirintended results. The evidence has shown that the credit counseling requirement to be anadministrative obstacle to debtors, rather than a financially beneficial exercise.84 Therequirement that all consumers receive credit counseling before seeking formal debt relief isnot, by itself, particularly objectionable or unusual. Indeed, debt counseling is commonoutside the United States and professional debt counselors in Europe historically have been

very active in helping consumers restructure their debts and navigate formal debt adjustmentprocedures.85 In imposing the new credit counseling requirement, however, members of theU.S. Congress assumed consumers would consult with an impartial counselor before theyfiled a bankruptcy petition and would then realize that they actually had the ability to repaytheir debts outside of bankruptcy in a private debt management plan.86 Thus, the basicnormative goal of the new credit counseling requirement is to make consumers understandthat they have the responsibility to control and manage their financial affairs in a responsiblemanner. The specific goal of the counseling was to help potential debtors make aninformed choice about bankruptcy, its alternatives, and [the] consequences of filing forbankruptcy.87

Despite these admirable goals, commentators uniformly have concluded that pre-filingcredit counseling is of little value to most consumers because, by the time most people are

contemplating a bankruptcy filing, their financial situation is so dire that they have norealistic alternative but to file for bankruptcy.88 For example, empirical studies conducted

81. Press Release, American Bankruptcy Institute, Consumer Bankruptcy Filings Up Nearly 40 Percent in2007 (Jan. 3, 2008), available at http://www.abiworld.org/AM/Template.cfm?Section=Home&TEMPLATE=/CM/ContentDisplay.cfm&CONTENTID=50271.

82. Id.; Charles J. Tabb, Consumer Filings: Trends and Indicators, Part II, AM. BANKR. INST. J., Dec.2006Jan. 2007, at 4243.

83. Press Release, American Bankruptcy Institute, Bankruptcy Filings in First Half of 2007 Up 48 PercentFrom a Year Ago (Aug. 16, 2007), available at http://www.abiworld.org/AM/Template.cfm?Section=Home&TEMPLATE=/CM/ContentDisplay.cfm&CONTENTID=48413.

84. Bankruptcy Reform: Value of Credit Counseling Requirement Is Not Clear: Hearing Before theSubcomm. on Commercial and Admin. Law of the H. Comm. on the Judiciary, 110th Cong. 1011 (2007)(statement of Yvonne D. Jones, Director, Financial Markets and Community Investment) [hereinafter Jones

Statement].85. Iain Ramsay, Comparative Consumer Bankruptcy, 2007 U. ILL. L. REV. 241, 252 (2007); Jason J.

Kilborn, Out with the New, In with the Old: As Sweden Aggressively Streamlines Its Consumer BankruptcySystem, Have U.S. Reformers Fallen Off the Learning Curve?, 80 AM.BANKR.L.J. 435, 441 (2006).

86. 147 CONG.REC. 3737, 3737 (Mar. 15, 2001) (statement of Sen. Jeff Sessions) ([T]his is fundamentallywhat the lawyer tells them. He says: Now, when you get your paycheck, you save that money, and you bring itstraight to meall that moneyand maybe your second check. As soon as I have $1,500 or $1,000, I will fileyour bankruptcy. Dont pay any of your other debts . . . . Use your credit card. Run up everything you want to onyour credit card . . . . They are told this is the right thing to do.).

87. H.R.REP.NO. 109-31, pt. 1, at 2 (2005).88. See H.R. REP. NO. 108-40, pt. 1, at 56162 (2005) (dissenting views) (discussing findings that the


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during the last two years have found that the overwhelming majority (approximately ninety-seven percent) of debtors who participated in pre-bankruptcy counseling simply did not haveenough money to pay their bills, or do anything else except attempt to get relief for their

over-indebtedness by filing for bankruptcy.

89

The futility of credit counseling is especiallypronounced for Chapter 13 debtors since many of them are facing imminent foreclosures ontheir homes and can stall the foreclosure only by filing a bankruptcy petition.90

Thus, the mandatory pre-filing counseling requirement has failed everyone involved:it has not helped consumers and it is not financially beneficial for credit counseling agencieseither. Credit counseling agencies are not benefiting because Congress mandated that thecounseling services be provided at a reasonable cost and that fees be waived for the poorestconsumers (typically based on an amount that is well below the U.S. poverty line).91Because of this, most agencies provide counseling on the Internet (the cheapest way) andmany have eliminated face-to-face counseling (the most expensive way) even thoughcounseling experts argue that the most effective way to counsel consumers is face-to-face.92Because most credit counseling agencies charge consumers only fifty dollars, most arefinding that even using the cheapest way to provide these services is not profitable.93

The credit counseling requirement would have been profitable for these agencies ifmore consumers could afford to repay their debts in a debt management plan (DMP).Consumers who participate in DMPs are required to repay some of their unsecured debtsover an extended period of time outside of a bankruptcy proceeding. DMPs are profitablebecause credit card companies typically give credit counseling agencies a percentage of theamount consumers pay to their creditors. However, there is virtually uncontrovertedevidence that in just two years the pre-filing counseling requirement has diverted fewpotential debtors into private DMPs.94 Thus, in addition to placing additional administrativeburdens and unnecessary costs on consumers, the credit counseling requirement has failed tobe a financially profitable venture for the credit counseling agencies who provide theseservices for the simple reason that most consumers are too over-indebted to benefit fromanything other than discharging their debts in a bankruptcy proceeding.95

increase in the filing rate is a symptom, rather than a cause, of financial difficulties); see also Jones Statement,supra note 84, at 1011 (clients perceived the counseling session as an administrative obstacle rather than auseful exercise.).

89. NATL FOUND. FOR CREDIT COUNSELING, MEETING THE MANDATE: CONSUMER COUNSELING ANDEDUCATION UNDER THE BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT 12 (2006)[hereinafter MEETING THE MANDATE], available at http://www.nfcc.org/Newsroom/NFCC%206%20month%20report%20FINAL.pdf; see also INST. FOR FIN. LITERACY, FIRST DEMOGRAPHIC ANALYSIS OFPOST-BAPCPA DEBTORS 4 (2006), available at http://www.financiallit.org/resources/pdf/24.1.11_WP_First_Demographics.pdf.

90. See In re Sosa, 336 B.R. 113, 11415 (Bankr. W.D. Tex. 2005); In re Cleaver, 333 B.R. 430, 435(Bankr. S.D. Ohio 2005);In re Talib, 335 B.R. 417, 419 (Bankr. W.D. Mo. 2005).

91. 11 U.S.C. 111(c)(2)(B) (2006).92. See Leslie E. Linfield, Credit Counseling: BAPCPAs Grendel, AM.BANKR.INST.J.,Oct. 2005, at 28,

72; Kathleen Day, Credit Counseling Agencies Dealt Setback; Banks Reduce Funding as Bankruptcies Rise;Consumer Groups Hit Move, WASH. POST, July 16, 1999, at El. Consumers also tend to prefer telephone orInternet counseling, largely because it is the most efficient way to satisfy the counseling requirement. JonesStatement, supra note 84, at 15.

93. Jones Statement, supra note 84, at 13; MEETING THE MANDATE, supra note 89, at 1215.94. NOREEN CLANCY & STEPHEN J. CARROLL, PREBANKRUPTCY CREDIT COUNSELING 1013 (2007),

available athttp://www.rand.org/pubs/technical_reports/2007/RAND_TR509.pdf.95. Jones Statement, supra note 84, at 13; MEETING THE MANDATE, supra note 89, at 9, 1315.


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IV. COMPARATIVE PATTERNS OF INDEBTEDNESS

A. Going into Debt

Due in large part to the kindness and generosity of the U.S. financial services industry,consumers throughout the world now can experience the joys provided by thedemocratization of credit. Starting in the early 1980s, credit cards and other forms ofconsumer credit were deregulated in most global economies and consumer credit is nowmore readily available to middle- and lower-class consumers.96 As is true in the UnitedStates, a greater access to credit is not necessarily a bad thing. For example, when the inter-bank interest rates dropped in Brazil a few years ago and lending laws were relaxed to makeit easier for lenders to seize property pledged as collateral for loans that are in default, moreof Brazils working poor gained access to credit and were able to buy their own homes.97Consumers in Brazil, Europe, and elsewhere (like their U.S. counterparts) now have

staggering amounts of debt. For example, outstanding debt in British households is roughly150 percent of personal income, which is actually higher than the U.S. figure of 125 percentof personal income.98

Like U.S. consumers, world-wide consumers routinely spend more than they earn eachyear. Also, like U.S. consumers, over-indebted consumers in Brazil and other countriesappear to be hopelessly in debt because they are attempting to make ends meet. Empiricalstudies conducted in Brazil appear to indicate that the same factors that cause consumerbankruptcy filings in the United States (medical debt, divorce, loss of job) also are the mostcommon causes of indebtedness and that stagnant or declining wages cause many middleand lower income Brazilians and Americans to borrow money not to over-consume, but justto keep up with the cost of living.99 Similarly, because of stagnant or declining wages, manyconsumers find themselves unable to pay their bills each month and they decide to use creditcards to help close the gap between what they earn and what they need to pay their bills.100

Not surprisingly, these high levels of consumer indebtedness caused many Europeancountries to face the same economic patterns at the end of the 1980s and the beginning ofthe 1990s that we are now facing in the United States: increased household debt followedby decreased personal savings and rising housing prices, followed by plummeting housingprices.101 This cycle then triggered a banking crisis in these countries, just as the subprime

96. See, e.g., Diane Ellis, The Effect of Consumer Interest Rate Deregulation on Credit Card Volumes,Charge-offs, and the Personal Bankruptcy Rate, Bank Trends 98-05 (FDIC, Div. of Ins., Mar. 1998).

97. See Interview with Dean Newman, INVESTMENT ADVISER, Mar. 19, 2007, available athttp://www.ftadviser.com/InvestmentAdviser/Archive/Features/article/20070319/3ea109e0-ea4f-11dc-abcd-0015171400aa/Dean-Newman.jsp.

98. David Smith, Still Climbing the Debt Mountain, TIMES (London), Mar. 12, 2006, at 4; Darren Williams,

UK Household Debt: Cause for Concern?, ALLIANCEBERNSTEIN: EUROPEAN ECONOMIC PERSPECTIVES, Mar.16, 2007, at 2, available at http://www.alliancebernstein.com/investments/us/StoryPage.aspx?nid=5342&cid=43892; see also David Smith, Debts a Burden, but Not for Most, TIMES(London), Jan. 7, 2007, at 4 (indicating that the ratio of annual disposable income to debts in the UK was almost160%, which was higher than the proportion for the US (135%) or Canada (126%), but well below the percentagesin other Commonwealth countries (Australia173%, New Zealand181%) and even a few European countries(Denmark260%, Netherlands246%)).

99. TAMARA DRAUT &JAVIER SILVA,BORROWING TO MAKE ENDS MEET: THE GROWTH OF CREDIT CARDDEBT IN THE 90S 9 (2003).

100. Id.101. Kilborn, supra note 85, at 437; see also Iain Ramsey, Functionalism and Political Economy in the


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housing meltdown has created a financial crisis in the United States.102 In effect, onceEuropean consumers were told to buy now, pay later, they bought, but then found theywere unable to repay when unemployment rates rose and there was a general slowdown in

the European economies in the 1990s. Thus, as is true in Brazil and the United States now,the credit binging created a credit hangover.

B. Getting out of Debt

Despite the similarities of world-wide consumer behavior, the U.S. insolvency schemeis fairly unique. Most debt adjustment systems outside the United States are not ascomprehensive as the U.S. consumer insolvency system either because they do notrestructure all of the consumers debts or because they lack the ability to dispose of all theconsumers assets. In addition, these systems generally are not designed to help theconsumer discharge her debts. Instead, consumer debt adjustment systems outside theUnited States appeared designed to help creditors collect debts, to prevent over-

indebtedness, and to enforce the societal norm that people have an obligation to honor theircontracts and pay their debts.103 Traditionally, non-U.S. consumer insolvency laws have notbeen designed to treat the problem or the causes of over-indebtedness.104 This was the viewthat many in Congress held in enacting BAPCPA and making it harder for U.S. consumersto discharge their debts in bankruptcy.

V. POTENTIAL SOLUTIONS FOR CONSUMER OVER-INDEBTEDNESS

While it is unclear whether the U.S. Government should bail out consumers,investment banks, hedge funds, or any other entity that helped facilitate the massive amountof consumer over-indebtedness in the United States, one thing is clear: the current U.S.approach to handling consumer over-indebtedness is just not working. Consumer debt is at

a record level, bankruptcy filings are increasing, foreclosure rates are astronomical and thesubprime mortgage meltdown has caused chaos in the financial markets.

A. Need for Response

When foreclosure rates began to increase in early 2006, some questioned the wisdomof bailing out borrowers who were at risk of losing homes they should have known theycould not afford and some politicians continue to argue against homeowner bailouts.105Preventing borrowers from fully internalizing the costs associated by their reckless behaviorwould, it is said, create a moral hazard problem. Because of the negative externalitiesassociated with home foreclosures, however, the subprime mortgage crisis should not be

Comparative Study of Consumer Insolvency: An Unfinished Story from England and Wales, 7 THEORETICALINQUIRIES L. 625, 65253 (2006) (discussing over-indebtedness legislation in the UK).

102. See Ramsey, supra note 85, at 244.103. See Jacob Ziegel, Facts on the Ground and Reconciliation of Divergent Consumer Insolvency

Philosophies, 7 THEORETICAL INQUIRIES L. 299, 30507 (2006).104. Ramsey, supra note 85, at 254; see Pablo Lerner, The Chief Enforcement Officer and Insolvency in

Israeli Law, 7 THEORETICAL INQURIES L. 565, 569 (2006).105. Larry Rohter and Edmund L. Andrews, McCain Rejects Broad U.S. Aid of Mortgages, N.Y. TIMES,

Mar. 26, 2008, at A18; Kathleen Pender, Why We Shouldnt be Bailing Out Subprime Lenders or Borrowers , S.F.CHRON., Apr. 22, 2007, at D1; Meddling in the Markets, THE ECONOMIST, Dec. 7, 2007, available athttp://www.economist.com/agenda/displaystory.cfm?story_id=10273477.


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viewed as an isolated problem that affects just the reckless, over-indebted homeowner.Even if individual homeowners should be forced to suffer the most harm (i.e., the loss oftheir homes and any equity they may have accumulated in those homes) from their own

improvident credit decisions, the U.S. and global capital markets have an incentive to careabout these borrowers because of the harmful spillover effects of consumer over-indebtedness.

Consumer over-indebtedness leads to greater credit card defaults and mortgageforeclosures; and increased foreclosure rates harm municipalities and neighboring propertyowners. Municipalities suffer whenever there is a real estate slump because they lose therevenue that is generated by the building or selling of homes (e.g., the issuance of buildingpermits). In addition, property tax revenues fall because of the foreclosed homes andmunicipalities suffer a decline in revenue because of potentially lower real propertyassessments.106 Lower tax revenues also affect cities ability to borrow cheaply107 or toadequately fund schools and other public services, or provide other vital governmentalservices.108 Additionally, though faced with declining tax revenues, cities are often requiredto increase police protection in areas with vacant homes to prevent vandalism and to prevent

criminal activities from taking place in the homes.109Cities often respond to decreased revenue by passing the costs on to its citizens in the

form of tax increases. For example, the City of Chicago recently requested a fifteen percentincrease in property taxes as well as increases in sales, gasoline, and parking taxes tocompensate for the lost revenue caused by flattening property assessments and risingmortgage foreclosures.110 Of course, just as cities likely will seek to increase property taxesto compensate for lost revenue, homeowners have an economic incentive to seek lowerassessments and lower taxes to reflect the decrease in their property values caused by themortgage foreclosures.

Studies consistently show that foreclosures impose costs on neighboring properties bylowering their market value.111 Even if the owner of a neighboring home has not borrowedrecklessly, the close proximity of foreclosed properties to property the owner wants to sell

increases the risk that the responsible owner will be financially harmed because theneighboring foreclosed properties will negatively affect the sale price for her property.112 Inaddition, depressed home prices make it harder for owners to refinance their existing loansor to obtain new financing, which then creates a negative cycle of disinvestment.113 Thepresence of foreclosed properties in a neighborhood also gives people an incentive to

106. Monica Davey, Housing Downturn Takes Big Toll on Cities Revenue, N.Y. TIMES, Oct. 18, 2007, atA20.

107. See id. (explaining that cities may be prevented from borrowing cheaply because the value of thecollateral for municipal loansi.e., the assessed value of their property basewill be lower).

108. Id.109. See Dan Immergluck & Geoff Smith, The Impact of Single-Family Mortgage Foreclosures on

Neighborhood Crime, 21 HOUSING STUD.851,86364 (2006); see also Engel & McCoy, supra note 33, at 2076(describing generally the abuses associated with predatory lending).

110. Peter Slevin & Kari Lydersen,Daley Urges Sweeping Tax Hike, WASH.POST, Oct. 15, 2007, at A3.111. Editorial,Losing Homes and Neighborhoods, N.Y. TIMES, Apr. 10, 2007, at A20.112. See Calculated Risk: Assessing Non-Traditional Mortgage Products: Hearing before the Subcomm.

on Housing and Transp. and the Subcomm. on Econ. Policy of the S. Comm. on Banking, Housing, and Urban

Affairs, 109th Cong. 10 (2006) (statement of William A. Simpson, Vice President, Mortgage InsuranceCompanies of America).

113. Press Release, Comptroller of the Currency, Comptroller Dugan Expresses Concern over SubprimeMortgage Foreclosures; Receives Making-the-Difference Award from Credit Counseling Foundation (Apr. 24,2007), available athttp://www.occ.treas.gov/ftp/release/2007-44.htm (last visited Apr. 5, 2008).


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vandalize the vacant home, steal copper, or conduct criminal activities in the home.114 Anincreased risk of criminal activities in a neighborhood populated with homes that are inforeclosure stigmatizes the neighborhood. Once a neighborhoods overall reputation for

quality of life declines, the quality of schools and other neighborhood amenities andactivities will likely decline.

In addition to the harm to individual homeowners or neighboring communities andmunicipalities, the subprime meltdown has detrimentally affected the U.S. and global capitalmarkets. The subprime meltdown triggered a liquidity crisis that has harmed primeborrowers who sought to obtain mortgage credit and were not in default. Since 2006,lenders have been reluctant to initiate mortgage loans generally, and jumbo mortgagesspecifically, even to consumers and businesses with good credit ratings.115 This liquiditycrisis also has harmed entities that invested, or sought to invest, in subprime mortgagesbecause lenders restricted the credit available to hedge funds or private equity firms becauseof the risks associated with securitized subprime loans.116 This credit restriction has madeinvestors less willing to buy mortgage-backed securities, which has decreased the issuanceof these securities.117

To spark economic activity and prevent further damage to the economy caused by thetightening of credit and general chaos in the housing and credit markets, since October2007, the Federal Reserve has repeatedly cut interest rates.118 The Chairman of the FederalReserve also conceded that the gravity of the problems with the U.S. housing market hashurt the overall economy.119 A number of major retailers in the United States, includingHome Depot and Wal-Mart, have reported lower corporate earnings because of slower thanexpected consumer spending; U.S. auto manufacturers lowered their 2007 sales forecasts aswell.120

Finally, the problems with the U.S. mortgage market have affected global financialmarkets. Despite interest rate cuts, the U.S. and global stock markets have been on analmost non-stop roller-coaster ride due in large part to the liquidity crisis caused by thesubprime lending meltdown.121 Indeed, the liquidity crisis has caused the collapse of a

major U.S. investment bank and several major U.S. hedge funds that had invested insecuritized subprime loans, caused a run on at least one bank in Great Britain, lead to the

114. Les Christie, The Ugly Face of Foreclosure, CNNMONEY.COM, May 7, 2007,http://money.cnn.com/2007/05/02/real_estate/face_of_foreclosure/index.htm. Immergluck & Smith, supra note109, at 856.

115. The Economic Outlook: Hearing Before the Joint Economic Comm., 110th Cong. (2007) (statement ofBen S. Bernanke, Chairman, Board of Governors of the Federal Reserve System) [hereinafter Bernanke StatementII], available athttp://www.federalreserve.gov/newsevents/testimony/ bernanke20071108a.htm.

116. Id.117. Id.

118. Id.; see also Bob Davis, et al., U.S. Mulls Next Steps in Crisis, WALL ST.J., Mar. 18, 2008, at A1; PaulR. LaMonica, Fed Cuts Rates to 4.5%, CNNMONEY.COM, Oct. 31, 2007,http://money.cnn.com/2007/10/31/news/economy/fed_rates (last visited Apr. 5, 2008). There is some concern thatother large institutional investors, like pensions and university endowments, will be harmed by the subprimemortgage crisis. See Julie Creswell & Vikas Bajaj, $3.2 Billion Move by Bear Stearns to Rescue Fund, N.Y.TIMES, June 23, 2007, at A1.

119. Bernanke Statement II, supra note 115.120. Terry Kosdrosky & John Flowers, Credit Turmoil is Likely to Crimp U.S. Auto Sales, WALL ST.J., Mar.

19, 2008, at A11; Mike Spector, Jeffrey C. McCracken & Neal E. Boudette, How Housing Slump Is Risk To BigThree Rebound, WALL ST.J., Nov. 27, 2006, at A3.

121. See Bob Davis, et al, U.S. Mulls Next Steps in Crisis, WALL ST.J., Mar. 18, 2008, at A1; Adam Shell,Subprime Troubles Send Stocks into Swoon, USATODAY, Mar. 14, 2007, at 1B.


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termination of the CEOs of Citigroup and Merrill Lynch, and is wreaking general havocwith the global financial markets.122

B. Crafting a Response: Recognizing Creditor Motivation

Neither creditors, who loaned recklessly nor debtors who borrowed recklessly shouldbear the sole blame for the current problems. However, as Brazil considers possiblesolutions to its increasing problem of consumer over-indebtedness generally, or the specificproblems involving credit card or other forms of consumer debt, policymakers shouldcarefully consider why creditors engage in certain behavior and why that behavior is notonly understandable, but is actually quite rational. As market actors, businesses that providecredit to consumers have an incentive to act solely in the interest of maximizing their profits.Thus, it is not surprising that credit card issuers target U.S. college students since they are inthe habit of being in debt and their potential future income makes them a lucrative customerbase.123 Likewise, while unsettling, it should not be surprising that credit card issuers have

targeted undocumented workers124

as well as homeowners who are facing a foreclosure and,thus, losing access to the equity in their homes,125 since it is perfectly rational for companiesto aggressively market to customers who have limited access to other types of credit.

Before the United States imposes additional regulations on the subprime lendingmarket, or before Brazil or other countries decide what type of consumer insolvency systemto adopt, policymakers must realize that, quite simply, it is extraordinarily profitable to dobusiness with consumers with weak credit histories or who are perceived to be financiallynave or desperate. These customers can be charged higher interest and fees and, if they aregiven a credit card, are more likely to carry large credit card balances and to make only themonthly minimum payments.126 In fashioning relief to over-indebted consumers,policymakers must understand that creditors generally will engage in acts that are not profit-maximizing only if there is a concerted effort to discourage consumers from participating inmarket activities that increase their over-indebtedness, or if judicial or administrativesupervision, such as laws or agency regulation, force them to do so, or if some extra-legalcultural norm shames them into being benevolent. As discussed in the following sections,these factors of profit-maximization, social optimality, and regulatory pressure all appear tobe at work as the United States considers how to respond to the current consumer over-indebtedness crisis.

122. Bob Davis , et al, U.S. Mulls Next Steps in Crisis, WALL ST. J., Mar. 18, 2008, at A1; Eric Dash &Landon Thomas Jr., Citigroup Chief Is Set to Exit Amid Losses , N.Y. TIMES,Nov. 3, 2007, at A1; Landon ThomasJr. & Jenny Anderson,A Risk-Takers Reign at Merrill Ends With a Swift, Messy Fall , N.Y. TIMES,Oct. 29, 2007,

at A1; Julia Werdigier, Official Assurances Fail to Stem Rush of Withdrawals at British Bank, N.Y. TIMES, Sept.18, 2007, at C3. The U.S. housing crisis is somewhat similar to the housing problems that affected someEuropean nations (including France, Great Britain, Finland, and especially Norway) during the 1990s. There wasan escalation in real estate values followed by somewhat steep declines, which then triggered a private consumerdebt crisis. Johanna Niemi-Kiesilinen, Consumer Bankruptcy in Comparison: Do We Cure a Market Failure ora Social Problem?, 37 OSGOODE HALL L.J. 473, 48081 (1999).

123. See Singletary, supra note 20.124. Ieva M. Augstums,BofA Steps Into Immigration Minefield, OAKLAND TRIB., Mar. 4, 2007.125. Another example is that Brazilian lenders are targeting the elderly to offer them high interest loans

secured by their meager pension. Cf. Doll & Sampaio, supra note 11.126. RONALD MANN,CHARGING AHEAD 146,20102(2006).


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C. U.S. Response to Consumer Over-Indebtedness

1. Disclosure and Consumer Education

When the U.S. credit crisis started earlier in 2006, few members of Congress and noone in the current Bush Administration were willing to propose substantive, immediatesolutions to the housing crisis. No one wanted to be perceived as arguing for a bailout ofeither homeowners or hedge funds. Instead, the most common response was to proposeeither additional homeowner counseling services or to suggest that consumers be given evenmore disclosures about the terms of their mortgages or credit cards.127 In crafting a responseto the problem of consumer over-indebtedness, policymakers in both the United States andin Brazil should avoid adopting a solution that merely increases the amount of informationor disclosures that consumers receive before each credit transaction.128 While disclosureinformation appears to be useful for higher income borrowers, consumer counseling

organizations in the United States have generally found that consumers who have receivedcounseling still are prone to succumb to the aggressive marketing and advertising of lendingorganizations.129 Thus, additional counseling or enhanced disclosures by themselves are notlikely to help resolve the problem of consumer over-indebtedness.130

Counseling and additional disclosures are especially unlikely by themselves to helpdecrease consumer over-indebtedness because of certain cognitive biases people have. Thatis, people are prone to be overly optimistic about their financial futures and to systematicallyunderestimate the risk that bad things will happen to them, such as an inability to repay theirdebts. People also tend to discount the harm that may occur to them in the future, such asdefault, because they tend to place a high value on positive current events: the ability toown their own home or to buy something with a credit card.131 Given this, it is unrealistic toassume that most consumers will consistently control the impulse to over-consume. Sincesome consumers (like college students) may have reason to believe that their incomes willincrease significantly in a few years, providing additional disclosures will likely bemeaningless in convincing them to temper their spending.132 Finally, shifting the burden tothe consumer to understand the terms of complex credit transactions creates perverse

127. See, e.g., Calculated Risk: Assessing Non-Traditional Mortgage Products: Hearing before theSubcomm. on Housing and Transp. and the Subcomm. On Econ. Policy of the S. Comm. on Banking, Housing

and Urban Affairs, 109th Cong. 8 (2006) (statement of George Hanzimanolis, President-Elect, NationalAssociation of Mortgage Brokers), available athttp://banking.senate.gov/_files/hanzimanolis.pdf (Once the . . .borrower possess[es] the financial literacy tools necessary to understand the information imparted throughout theloan origination process, the disclosure becomes an invaluable communication tool. ). The mortgage industrycontinues to argue that the best way to help consumers is to provide additional counseling to consumers and toencourage homeowners to contact their lenders to participate in the lender s loss mitigation programs.Straightening Out the Mortgage Mess: How Can We Protect Home Ownership and Provide Relief to Consumers

in Financial Distress?: Hearing before the Subcomm. on Admin. and Commercial Law of the H. Comm. on theJudiciary, 110th Cong. (2007) (statement of Steve Bartlett, President & CEO, The Financial ServicesRoundtable), available at http://judiciary.house.gov/ oversighttestimony.aspx?ID=1107 [hereinafter BartlettStatement].

128. Cf. Bair Statement, supra note 7, at 1617 (expressing skepticism about improving credit carddisclosures without imposing additional regulations).

129. Bucks & Pence, supra note 43, at 2021; WILLIAM C.APGAR, CREDIT, CAPITAL AND COMMUNITIES:THE IMPLICATIONS OF THE CHANGING MORTGAGE BANKING INDUSTRY FOR COMMUNITY BASED ORGANIZATIONS75 (2004), available athttp://www.jchs.harvard.edu/publications/ communitydevelopment/ccc04-1.pdf.

130. APGAR, supra note 129, at 75.131. Bar-Gill, supra note 18, at 1400.132. See Singletary, supra note 20.
http://www.jchs.harvard.edu/publications/communitydevelopment/ccc04-1.pdfhttp://www.jchs.harvard.edu/publications/communitydevelopment/ccc04-1.pdfhttp://www.jchs.harvard.edu/publications/communitydevelopment/ccc04-1.pdf


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incentives for creditors. That is, if the burden is placed solely on the consumer tocomprehend the often complicated credit transaction, creditors have an incentive to providelong, confusing disclosures133 and have an even greater incentive to target vulnerable

populations like the elderly or college students who they conclude will not handle creditwisely.

2. Regulation

In response to the meltdown in the U.S. mortgage market, the U.S. Congress has heldnumerous hearings and has considered legislation designed to respond to the problem ofover-indebtedness generally, and the housing crisis specifically. Unlike Brazil, the U.S. hasa legal structure, namely the U.S. Bankruptcy Code, which can be used to enact laws thatrespond to new or existing problems involving consumer over-indebtedness.134 Indeed,many of the bills that recently have been proposed are designed to weaken the protectionsmortgage lenders have in bankruptcy. For example, one bill would allow consumers aged

fifty-five and older to exempt up to $75,000 in any equity they have in their homes.135

Otherbills would allow over-indebted consumers to waive the mandatory credit counselingrequirement and seek immediate bankruptcy relief if they are filing bankruptcy in order tosave their home from foreclosure.136 One proposed bill also would let consumers dischargethe entire amount of the mortgage loan if the lender engaged in certain fraudulent acts orviolated certain state and federal laws.137

Perhaps the most controversial aspect of the recent proposals is that they would protectconsumers who find themselves upside-down on their home loans. That is, because ofmultiple refinancing, no down payments, and other exotic loan features, many homeownersfind that they owe more than the home is worth.138 Borrowers whose loans permit them todefer interest or pay significantly lower interest rates than the stated rate in the loan havefound that their loan has negatively amortized since their principal loan balances wouldincrease because of their failure to pay all accumulated interest. Proposed legislation wouldlet a borrower who sought relief in Chapter 13 reduce the amount of the lenders interest inhis home to the value of the home, and also would let the consumer modify the terms of the

133. OConnell Statement, supra note 17, at 6.134. Though it has turned out not to be particularly effective, the 2005 amendments to the Code attempted to

increase consumer awareness of the perils of over-indebtedness by making credit counseling mandatory and alsoattempted to make credit card terms more transparent. Many view these attempts as failures, largely because ofthe length of the disclosures already required by the Truth in Lending Act and also because of the complexity ofthe terms used in typical consumer disclosures. See Richard Wiener, Susan Block-Lieb, Karen Gross & CorinneBaron-Donovan, Unwrapping Assumptions: Applying Social Analytic Jurisprudence to Consumer Bankruptcy

Education Requirements and Policy, 79 AM.BANKR.L.J. 453, 475.

135. S. 2136, 110th Cong. 204 (2007).136. S. 2136, 110th Cong. 102 (2007); S. 2133, 110th Cong. 4 (2007); H.R. 3778, 110th Cong. 4

(2007); H.R. 3609, 110th Cong. 5 (2007).137. S. 2136, 110th Cong. 205 (2007).138. For example, some of the non-traditional loan products let borrowers skip a specified number of

payments each year (miss-a-payment option) or let borrowers choose the amount of their monthly payments(payment option ARMs). These payment options dramatically increase the likelihood that the loan will negativelyamortize since they contain features (like deferring accrued interest payments) that could cause the principalbalance to increase even though the borrower makes mortgage payments. See Der Hovanesian, supra note 40, at70; THE FED.RESERVE BD.,INTEREST-ONLY MORTGAGE PAYMENTS AND PAYMENT-OPTION ARMSARE THEYFOR YOU? 3 (2007), available athttp://www.federal reserve.gov/pubs/mortgage_interestonly.


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loan to make low initial payments, then a large balloon payment in three to five years inanticipati

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