The Two-Income Trap (13 page)

For an individual who files bankruptcy, the process is similar. The courts take legal control over all his assets—the bank accounts, the
house, the car—everything right down to Fluffy the cat and the old bike with a flat tire.
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The judge orders those assets to be liquidated and used to repay creditors to the extent possible. So, for example, bank accounts must be emptied and stock portfolios must be sold; the judge might also order that jewelry or newer appliances be auctioned off to repay past debts. There are a few exceptions. Families are typically permitted to keep some clothes, furniture, and a few household goods. Home equity—the value of the home that exceeds the mortgage—creates a thorny problem. A few states, such as Florida and Texas, permit families to keep all their equity safe from other creditors, no matter how valuable the home; other states, such as Delaware and Maryland, force families to give up any equity in their homes, no matter how small.
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But in all states, the creditors who have security interests—the home mortgage company and the car lender, for example—must be paid if the family wants to hold on to the asset. And some debts are never forgiven, no matter what. Taxes, student loans, alimony, and child support must be paid in full, regardless of how long it takes; bankruptcy offers no relief whatsoever.
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But the rest of the debts—the credit cards, the hospital bills, the electric and gas bills—are paid proportionately from whatever property was sold off. At the end of the bankruptcy process, the family, like the corporation, gets to start with a clean slate. Most of their assets have been wiped out, but so have their debts—or at least some of them.

There are some important wrinkles in the consumer bankruptcy code. Unlike corporations, individuals must wait until the seventh year after filing for bankruptcy before they will be permitted to file again (a period drawn from biblical references).
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Another wrinkle is that families have a choice about which form of bankruptcy to use. The first option, Chapter 7, permits a debtor to wipe out his debts in just a few months. In Chapter 13, the debtor files for bankruptcy in order to buy some time to pay what he owes, rather than to get rid of his debts altogether. The family works out a repayment plan, under which it commits to living on a sharply restricted budget for the next three to five years, handing over the remainder of each paycheck to a trustee who
distributes it among the creditors.
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Only after the payments are complete can the family discharge any debts that remain unpaid.
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In order to escape their debts, families must publicly disclose all their financial dealings, show their personal budgets to their creditors, and submit to supervision by a court-appointed trustee. For ten years, their credit reports will document their bankruptcy, making everything from car insurance to house payments more expensive. In some parts of the country, their names will be published in the newspaper. With online searches, the fact of their bankruptcy may pop up whenever someone tries to find them via the Internet. Future employers will discover the bankruptcy if they run a credit check (now a routine screening process for many jobs), which can lead to embarrassing explanations or, worse, a lost chance for a much-needed job. Most important, the family will still owe a large chunk of its debts—the home mortgage, the car loan, the taxes, the student loans, and so forth—even after filing for bankruptcy. But if a family is willing to go through all that, it can have at least some of its debts erased, no questions asked.

So is it possible that Judge Jones is right and today’s families are using the bankruptcy courts more liberally than they used to? Once again, the data just don’t support that argument. If a growing number of people were looking for the easy way out, then we would expect to find that families in bankruptcy today are in relatively better shape than those who filed a generation ago. For example, we might find that they have smaller debt loads relative to their incomes, with the clear implication that at least some of those folks could pay off the debts if they tried a little harder. Instead, just the opposite has happened. Today’s bankrupt families are deeper in debt than their counterparts just twenty years earlier, and their overall financial picture—assets and debts—is worse.
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In 1981, the median family filing for bankruptcy owed 80 percent of total annual income in credit card and other nonmortgage debts; by 2001, that figure had nearly doubled to
150 percent
of annual income. Even the credit industry, which has the most to gain from prying a few more dollars out of bankrupt families, estimates that only about 10 percent of families
who file for bankruptcy could actually afford to repay even a portion of their discharged debts (although independent academics put that number closer to 1-2 percent). The remaining 90 percent are tapped out, too broke for even their creditors to bother with.
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There are other signs that families are not rushing headlong into bankruptcy at the first sign of trouble. The average person who filed for bankruptcy reports spending more than a year struggling with his debts before filing. Before they finally gave up and filed for bankruptcy, 50 percent of the families had their utilities or telephone shut off for non-payment and nearly 60 percent did without needed medical care in order to save money. Indeed, one in five of these college-educated, home-owning families in bankruptcy said they had done without food at some point before filing because they simply couldn’t afford it. By the time they sought refuge in the bankruptcy courts, the average family owed more than
an entire year’s income
in nonmortgage debt.

Besides, the bankruptcy statistics are not the only signs of financial distress. The number of home foreclosures has more than tripled in the past 25 years, and car repossessions have doubled in just five years.
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Judge Jones may think that bankruptcy filings are just a “big game,” but for a family who no longer has a roof over their heads, we doubt that financial failure is much fun.

The Myth of the Immoral Debtor has one other variation: Today’s families are more willing to lie, cheat, and file for bankruptcy under false pretenses. Everyone from Senator Orrin Hatch to the American Bankers Association contends that massive numbers of families filing for bankruptcy are engaged in “fraud and abuse.”
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Could they be right?

No one knows for certain how much fraud there is, although the courts go to great lengths to try to prevent it. If a person wanted to commit fraud in a bankruptcy petition, he would usually try to hide his assets from his creditors, perhaps in an offshore account, a bogus
trust, or through transfer to a separate corporation or another person. In order to prevent this, every single personal bankruptcy filing is accompanied by detailed financial disclosures, filed under penalty of perjury, reviewed by a court-appointed trustee, and made public for any creditor or other interested party to scrutinize. Every debtor seeking bankruptcy relief must come to court in person, swear to “tell the truth, the whole truth, and nothing but the truth,” and submit to cross-examination both by the trustee and any creditors who appear. If anything suspicious emerges, the debtor will be ordered back into court by a judge and examined further—under oath. Anyone who files a fraudulent bankruptcy petition or misrepresents his circumstances violates federal law and risks prosecution by the Department of Justice. A guilty verdict can result in jail time.
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Any creditor who can show that a debtor lied on a credit application or otherwise committed fraud can have that debt exempted from discharge in bankruptcy; the creditor is also entitled to file criminal charges.

Even if they had evil in their hearts, it would be extremely difficult for the average family in bankruptcy to commit serious fraud. The overwhelming majority of people who file for personal bankruptcy aren’t the financial sophisticates one usually associates with Swiss bank accounts and dummy corporations. They are ordinary, middle-class families whose total assets consist of a home, a car, and maybe a checking account. In our study of more than 2,000 bankrupt families, only one owned a second home—a small rental house that produced income, not a vacation place—and no one had an offshore account or a self-settled trust. Nor did these families have a personal attorney on retainer or a longtime accountant who might be persuaded to do a little finagling on the side. Just the opposite. Most people who filed for bankruptcy never even met a lawyer until the mortgage company sent a foreclosure notice, at which point they hired someone whose ad appeared in the yellow pages or on late-night television.
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Typically the attorney spent less than half an hour giving them advice before passing them on to a paralegal who completed the paperwork necessary for the bankruptcy filing.
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The number of families committing fraud may have inched up over the years, although there is no evidence to support that claim. But if fraud alone accounted for the increase in the number of bankruptcies over the past generation, then eight out of every ten families filing for bankruptcy today would have to be committing fraud.
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It seems pretty absurd to suggest that over the past decade roughly
10 million
families independently decided that they would commit a felony that could land them in jail—and that no one else heard about it.

The Myth of the Immoral Debtor might make for good headlines, but, like the Over-Consumption Myth, it won’t hold up to hard analysis. Are there some families who are cheating? Of course. Just like there are some families who are over-consuming. Being in financial trouble confers no special state of grace that eliminates all the sharp operators and crafty manipulators who travel among us. But the stark numbers—bankruptcy filings that have quintupled, mortgage foreclosures that have tripled, car repossessions that have doubled—cannot be explained away so easily.

If the bankruptcy system isn’t packed with frauds and cheats, then why are so many families in trouble? With a million and a half families declaring bankruptcy each year, one might expect innumerable explanations for all that financial mayhem. During our interviews we heard a wide variety of reasons. Some were victims of crime, some had made bad investments, some had problems with alcohol or gambling, and some had lost their homes in a flood or an earthquake. A few interviewees had actually done just what the “over-consumption” camp had accused them of—they had bought too many goodies on their credit cards. Perhaps the stand-out story was the man who filed for bankruptcy after he was shot while trying to foil a robbery at a nearby hardware store, and the resulting hospital bills and time off from work destroyed him financially.

Source:
2001 Consumer Bankruptcy Project

FIGURE 4.1 Reasons for filing for bankruptcy: families with children

While many of the stories are memorable for their odd details, the statistics reveal a much simpler picture. The overwhelming majority of financial failures are surprising not for their uniqueness, but for their sameness. Nearly nine out of ten families with children cite just three reasons for their bankruptcies: job loss, family breakup, and medical problems.
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All the other reasons combined—acts of God, called up for military service, personal profligacy, and so on—account for just 13 percent of families in bankruptcy.

There’s nothing new or exotic about the problems faced by American families today. Jobs have come and gone, couples have broken up, and illnesses and injuries have been facts of life since the first cave-man kissed the first cavewoman good-bye and headed off to the hunt. But the Two-Income Trap compounded the ordinary risks of daily life. With Mom in the workplace and the family’s safety net forfeited, a short-term job loss or a medium-sized illness now poses a far
greater menace to a family that has no reserves. It takes less to sink these families; as a result, more of them go under.

But the two-income family didn’t just lose its safety net. By sending both adults into the labor force, these families actually
increased
the chances that they would need that safety net. In fact, they doubled the risk. With two adults in the workforce, the dual-income family has
double
the odds that someone could get laid off, downsized, or otherwise left without a paycheck. Mom
or
Dad could suddenly lose a job.

The basic math may seem obvious, but the consequences are surprising. Consider Tom and Susan, the typical 1970s single-income family introduced in chapter 2. Statistically speaking, Tom faced a 2.5 percent chance of losing his job in any given year.
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Had Justin and Kimberly, our present-day two-earner couple,
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been around back then, they would have had a 4.9 percent chance of a major drop in income—almost double the chances of a single-income family.
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The odds aren’t doubled to exactly 5.0 (2.5 + 2.5) because in some of the families both the husband
and
the wife will be laid off, so the total number of families who experience a layoff is slightly less than 5.0 percent. (Of course, that also means some families get hit with two layoffs, a double catastrophe.) No matter how the odds are calculated, the principle is straightforward: two workers, two chances to lose a job.