In the 15 mile drive to bankruptcy court yesterday, the radio had two doom and gloom stories about the housing market and the dive on Wall Street, interspersed with no less than three, back to back, buy-my-book-and-get-rich pitches. I think the juxtaposition is not random.

When people are out of work or underemployed, they are open to ideas to “eliminate their debt in months” or make a bundle trading stocks. These appear to be avenues of escape for those in financial distress. We saw it the last down turn: everyone around me in Silicon Valley became a day trader of stocks or a realtor. After all, who could lose money dealing in California real estate?
As always, the only people likely to prosper as a result of these products are the sellers, not the buyers.

May I suggest a New Year’s resolution to look at your financial situation, including your preparation for retirement, with detachment and consider whether a fresh financial start makes sense?
A university study done about 10 years ago found that one in 7 American families would be better off if they filed bankruptcy. The point was that Americans were not heedlessly filing bankruptcy to avoid repaying debt. At the time, about one in 17 families actually filed. My experiences in the past decade suggest that the finding remains true in 2008.

A life of minimum payments, minuscule bank accounts, and no retirement savings is a life fraught with financial danger. My clients all too often try to pretend that all is well if they can make the minimum payments on credit cards and juggle no-interest offers to move money from card to card. The debt remains and savings are postponed.

I did a little exercise that contrasted paying off a modest credit card debt by making minimum payments with devoting the same about of money to retirement savings. The results are mind boggling. However much money you have during your working life, you are likely to have less at retirement. Take a look at your statement from Social Security and calculate how you are going to live on that amount.

Clients walk into my office hoping that there is a magic wand, The Alternative to Bankruptcy, that I can wave and allow them to solve the debt problem without bankruptcy. For most, there is no such secret, unknown cure to debt.

It may be time to swallow your pride, file bankruptcy, and devote the energy now spent on managing debt to saving for the future and enjoying the present.

Usually, I try to be the voice of common sense, conservation of energy, and moving on after a debacle. The client I saw the other day had the warrior side of me overwhelming the lawyer’s logic.

The facts: the client, an immigrant carpenter with limited English literacy, “invested” in a rental house with partners who bailed on him. The loan was the typical sub prime, adjustable rate loan where the rents on the house could never have covered the debt service.

Then the “friendly” real estate professional helped him borrow some money on the rental to pay the closing costs on a no-money-down purchase of a home for himself. Realtor gets a real estate commission on the purchase and a fat commission on the two loans to buy the house. Again there were supposed to be partners who would contribute to the debt service and own some interest in the property. None of it was in writing, others bail, and again my client is left holding the mortgage “bag”.

Meanwhile, the home’s value goes down and the mortgage payments go up. While the client is willing to walk away from the rental, some self interested “expert” tells him that if he defaults on the rental mortgages, he will lose his home, on which he is current, even though the property is upside down. He works huge amounts of overtime, loses sleep, figures he will lose everything. He’s near tears when he sees me.
The good news in this scenario is, such as it is, that all the client has invested in these deals is about $15,000, and a year and a half of inflated mortgage payments on “investments” that are worthless now, and probably when purchased.

When I analyzed the first loan on the home, I calculated what the mortgage payment would be if, instead of an exploding ARM, it were a conventional, 30 year fixed rate note at 6.5%. The answer was that the monthly mortgage payment on a loan of that size, if it could be restructured, equaled his gross monthly income! What lender makes such a loan?
The rational part of me wants to tell the client, take your lumps, be glad you didn’t lose any more than you did, following the American dream. The warrior side of me says, who were this guy’s friends who engineered these “deals”, with commissions to themselves? Who gets away with misrepresenting the consequences of a foreclosure on the rental? Who were the lenders who participated in exploiting a simple man who couldn’t read the relevant documents?

Again, my advice will probably be to live in the property payment free til the lender forecloses . But my personal inclination is to sue the assorted bastards involved in this mess.

The high cost of higher education and the non dischargeable nature of student loans have the capacity to ruin lives just as much as to improve them. We encourage kids to go to college and we make loans freely available to pay for it. We don’t tell them that this choice, made before they get educated, will be with them for the rest of their lives as the Supreme Court recently decided that Social Security can be garnished to repay student loans.

There are few other choices we allow 18 – 21 year olds to make with such inescapable consequences. Tuition alone at the University of California is $9,000 a year. Add books, health care, room and board and the figure is probably close to $20,000. Private schools are double or triple that number. Student loan balances of $60,000 to $100,000 are not uncommon.

In 1998, Congress decided that there would be no statute of limitations on government guaranteed student loans and no discharge of these loans in bankruptcy except under the direst of circumstances.

In 2005, Congress added privately funded student loans to the list of debts that could not be discharged in bankruptcy.

As the commercial says, “diamonds are forever”. So are student loans.

I understand the policy arguments: student loans can be made without regard to present ability to repay if there is no option but to repay them. Education becomes more widely available to all.

I don’t believe we are adequately advising our children before they take on huge debt. Payments on student loans can equal or exceed a typical mortgage payment. Defer payment on the debt and the interest is added to the principle of the loan, on which more interest is charged. Employment choices and family choices are dictated by the need to repay the loan.

Our current legal standard for discharge of student loan debt, the Brunner factors, permits only the most minimal standard of living if the borrower wants to discharge the debt. There is something perverse about encouraging graduate education, then telling the borrower that if he and his family live at anything much above the poverty level, they can afford to repay the student loan.

One of my clients was a recent graduate of a very expensive private university; her degree was in art history and her debt in today’s dollars was $150,000. She was finding it difficult to get a job that would pay her $30,000. She probably hadn’t made a very good economic choice when she chose either the school or the major. Yet she was stuck with that loan for the rest of her life.

Another client was a psychologist, with a doctorate, working in his field at 52. His student loans were approximately $250,000. When he chose his field, psychologists were typically self employed, fee based professionals with earning capacity akin to MD’s When he got out of school, the field had dramatically changed; managed care had replaced private practice and annual incomes cut by 75%. Yet he was obligated to pay for an education in a field that for all economic intents and purposes was not the one he selected as a freshman.

We owe our kids more flexibility in their lives. Whether it is the kid whose interest changes over a lifetime or the economy that changes, student loans should not shackle them for the rest of their lives.

I wrote earlier that stress is a real and serious threat to physical health that needs to be factored in to the discussion about bankruptcy and the alternatives. Recent studies suggest that stress may also lead to obesity.

Individuals in debt tend to see their debts as a financial problem, when those debts are also a threat to physical, psychological, and social well being. An entire part of the debt puzzle is lost if you don’t factor in the consequences of unremitting stress on the body and the family.

For that reason alone, I don’t find that debt settlement programs are a real solution for most consumers. Even if the program is structured so that it actually works ( and most are not), the continuation of a substantial financial commitment to old debt is debilitating.

So, better health joins the need to save for retirement in my pantheon of reasons why bankruptcy so often is the better choice.

My blood boils when I read tripe like this pitch from a lender promoting a debt consolidation loan: it’s not a loan, says the headline, it’s a way out of debt. I’m sorry, but that’s baloney.

About sixth grade, I learned that 3+7 and 5+5 both equaled 10. No matter what order the numbers came in, they still totaled the same sum.

Likewise, a consumer is no better off if, instead of having five accounts of $2,000 each, they have one account of $10,000. They still owe $10,000. As my colleague Kurt O’Keefe wrote, you can’t borrow your way out of debt.

My clients, to a man (or woman), want to pay their debts. They are looking for any alternative to bankruptcy. But to call more borrowing a “way out of debt” is like consulting the Humpty Dumpty for financial advice. He, at least, was open that words ” mean just what I choose them to mean”.

Adam Savage, the speaker at my son’s graduation Saturday as a mechanical engineer, made a point equally applicable to his audience of newly fledged engineers as to my audience of those shouldering lots of debt: Look at the big picture.

For engineers, Savage hoped that they would look beyond the technical challenges of any task at hand to see where they, and the gadget they were making, fit in the larger world. For debtors, I want clients to look beyond making this month’s minimum payments to assess whether there is any meaningful chance of paying off the debt and achieving economic stability.

Short term thinking was exemplified recently for me by a client considering refinancing her home mortgage to a smaller payment “like her friend has.” I cautioned about loans with appealing initial payments that soon morph into monsters that the borrower can’t afford, putting the home at risk. Her response, to my dismay, was “I’ll deal with that when it adjusts.”

Looking at the long term was the theme of my recent post on the Bankruptcy Law Network, looking at the differing results if you paid off credit card debt with the contractual minimum payment or put the same money into an IRA over the same period.

Making good decisions about how to deal with a technical or a financial challenge requires that we lift our eyes from the desk in front of us to the future, and look at the bigger picture.

Thanks to my colleague Wendell Sherk for the pointer to the site of Americans for Fairness in Lending

I found their 10 Top Tricks of the Lending Trade right on point. The day before I had seen an earnest couple with a loan on their only car on which they owed twice what the car was worth. They were poster children for the techniques employed to sell bad deals to consumers. Given the age of this loan, a Chapter 13 will allow us to strip the secured obligation down to the present value of the car. I haven’t calculated how much they have overpaid before they got to my office.

This is all on point for me as I ponder what can I expect clients to learn from the circumstances that brought them to bankruptcy. In the case of my car buying couple, the fundamental problem of the couple was insufficient work in the husband’s trade and low wages in the wife’s restaurant industry. But the bad car loan may have been a precipitating factor that kept them from scraping by.

Is it reasonable to think that Joe Average can become sophisticated enough to avoid the rip offs? Is there a legislative strategy that won’t cripple honest business? Wish I knew, but it’s clear we need to think about it.

I met with a couple yesterday with over a $100K in credit card debt. When the bankruptcy schedules are filed, this will look like a case of consumer spending run amok. What, the casual observer will ask, did they buy for that amount of debt?

Medications, gas, and groceries, is the answer. Because this 50ish couple are both diabetic in addition to having been in a horrific car accident several years ago. When they moved to California from the midwest, their insurance premiums went from $800/ month to $1900/month. Their insurance does not cover doctor visits or medications. Credit cards help mitigate the desperateness of their situation for a while.

This supports my contention that credit cards simply mask, for a while anyway, the squeeze on the middle class. We can delude ourselves for a while that things are OK, when they are not.

In the space of 24 hours this week, I saw two clients with substantial credit card debt who had been servicing that debt faithfully and at a substantial sacrifice , hanging on to the slippery financial slope, when a single irregularity in payments to one creditor sent their interest rates from 4-9% to 30%. For each client, that was the triggering event: they made an appointment with a bankruptcy lawyer.

An objective look at the impact of using universal default as a “reason” to increase the interest rate on a card that is being paid according to terms suggests this is horrible policy. In the cases of my clients, the card issuers turned a performing account being paid by someone who could probably never have paid off the balance in full, and thus would be paying interest forever into a bankruptcy write off. Good going guys.

As the heat in Congress increases on credit card issuers, some claim to have abandoned the practice of universal default. Consumer Action’s latest study of credit cards says it isn’t so.

In a macabre way, I guess in my line of work, I should applaud universal default: it instantly brought home to my client base that credit cards are rigged against the consumer and that pretending that you can pay them off is self deception. Anyway, I have two new bankruptcy clients.

Cathy Moran

Bankruptcy in Brief