Hundreds of thousands of Americans are hounded mercilessly by debt collectors, but unable to afford to file for bankruptcy.

Ten years after the passage of the “new” bankruptcy law we find a new class of Americans “the permanently insolvent”.    You won’t find reference to this group in any financial magazine.  But, hundreds of thousands of Americans are in a position of being hounded mercilessly by debt collectors, but unable to afford to file for bankruptcy.

“The reform has generated a substitution, from formal bankruptcy to insolvency,” said Stefania Albanesi, lead author of “Insolvency After the 2005 Bankruptcy Reform,” a new study by economists at the Federal Reserve Bank of New York and Columbia University.

“Since insolvents are unable to repay debt, they are subject to collection actions and financial judgments and have difficulties obtaining unsecured credit,” she said. “This is particularly bad for low income individuals, as they have little savings and sometimes rely on debt to face unforeseen expenses and the like.”

Their poor credit does not allow them to obtain credit to buy a home, vehicle or even get a credit card. They tend to be part of the group that uses payday loans or title loans. By falling into the trap of using these high interest loans (sometimes as much as 750%) they are forever trapped.

The study, which was published in January and summarized this week in a Federal Reserve blog post, reached a variety of conclusions about the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005. Few of the economists’ findings were encouraging for consumers.

  • The bottom lines of credit card companies, banks and other financial institutions have been nourished by the act, which was proposed by Wall Street interests, passed by Congress, and signed by President George W. Bush on April 20, 2005. It went into effect Oct. 17, 2005. “We cite research … suggesting that profitability has risen for credit card companies as a result of BAPCPA,” Albanesi said.
  • But consumers have suffered. Low income Americans, those most in the need of help, have been the most deeply damaged by changes that made it more difficult and far more expensive to file for protection under bankruptcy laws. “Our analysis suggests that the 2005 bankruptcy reform caused a decline in bankruptcy filings, which were replaced by a sizable rise in insolvency and foreclosure,” the study’s authors reported. “We show that insolvency is a state associated with a high degree of financial distress in comparison to bankruptcy. This consequence of BAPCPA is potentially welfare reducing for households.”
  • Though it may not seem to matter if you are bankrupt or insolvent — after all, you’re broke either way — the differences are profound for consumers, especially those struggling to find a fresh start.