Hearing on Bankruptcy Reform and Financial Services Issues

Prepared Testimony of Mr. Mark McClellan
Deputy Assistant Secretary for Microeconomic Analysis
Office of Economic Policy
United States Treasury

9:30 a.m., Thursday, March 25, 1999

Thank you Mr. Chairman, Senator Sarbanes, and other Members of the Committee for the opportunity to provide Treasury's views on issues related to bankruptcy reform. As you know, last year the Administration supported the balanced bankruptcy bill that you and your colleagues in the Senate approved by an overwhelming bipartisan majority. We look forward to working with the Congress this year to craft bankruptcy legislation that the President can enthusiastically sign.

It is important to consider bankruptcy reform in the context of the dynamic financial services industry. The changes occurring in financial services--the result of competition, innovation, and new technologies in such areas as information management and electronic commerce--have had enormous benefits for consumers and the economy, and offer potentially even greater benefits in the future. However, these changes have also increased the complexity of consumer financial services and business financial transactions, and have implications for putting consumers and the economy at risk.

In the remainder of my testimony, I highlight some particular concerns we have about proposed bankruptcy reforms.

Consumer bankruptcy reform

One motivation for consumer bankruptcy reform is the growth in consumer bankruptcies in recent years, despite very healthy economic growth and low unemployment. Experts have offered a large number of competing explanations for this trend, which increases the cost of credit to all consumers, and it is likely that many factors are responsible.

Balanced reform of consumer bankruptcy law is essential to address the multiple causes. There is evidence of abuses by creditors as well as debtors that:

  1. may allow some debtors who are able to repay a substantial share of their debt to evade responsibility for repayment; and
  2. may prevent some debtors, especially those with limited means for obtaining sophisticated advice, from having equal opportunities for the "fresh start" of the bankruptcy system.

Bankruptcy reform should not take indiscriminate aim at either side alone, and should not treat only the symptom rather than the underlying causes of the rise in bankruptcies. Furthermore, it is essential that reforms to the bankruptcy system address these problems in ways that do not jeopardize the repayment of debts with very high policy priority, including family support .

The essential features of a balanced reform bill include the following:

Consumer Protection. Consumers need better and more relevant information on their credit opportunities in order to manage their finances effectively and to get the most benefit from the diverse credit-related services now available. In the last decade, there has been an explosion in the kinds and amounts of financial services available to consumers. These changes have had many beneficial effects--making it easier for consumers to obtain the credit needed to start a household, pay college tuition, and make other investments to achieve their financial goals. But they have also made personal financial planning much more complex. The evidence indicates that, with limited time and resources, many households are not able to make many of the calculations and informed judgments needed in this new financial era to develop and follow a financial plan effectively.

Fair and effective determinations of access to Chapter 7 debt relief. The balance between requiring debtors responsibly to honor their contracts with creditors, and providing debtors a fresh start sufficient to ensure their return to economic health, is critical to maximizing the benefits of bankruptcy law to our society and economy. It is also important to minimize the administrative, judicial, and personal costs of achieving this balance.

The President believes that a means test should deny access to Chapter 7 debt relief only for those who genuinely have the ability to repay a portion of their debts successfully under a Chapter 13 plan. The Administration is strongly opposed to a rigid and arbitrary approach to determining whether a debtor can use the relief offered in Chapter 7, which would not allow debtors an opportunity to have their specific circumstances considered adequately by bankruptcy courts with discretion to determine whether they genuinely have the capacity to repay a portion of their debts.

Consideration must also be given to cost in implementing a means test. There is little to be gained by requiring debtors who have little ability to repay to present detailed evidence and justification for an inflexible means test that must be reviewed at substantial additional cost by trustees and courts. More costs are added if debtors with little capacity to repay are inappropriately referred to Chapter 13 proceedings to set up repayment plans destined to fail. We believe that it is possible to draft legislation that will work significantly better than HR 833--to try to identify at relatively low cost the small fraction of potential Chapter 7 filers who have a reasonable chance of successfully repaying their debts under a Chapter 13 plan.

Curbs on predatory creditor practices. Bankruptcy reform should curb abuses by creditors as well as debtors. For example, debtors should be protected against predatory creditor tactics to coerce inappropriate and unwise reaffirmations of debt. Last year's Senate bill took laudable steps in this direction.

Protection of priority debts after bankruptcy. Bankruptcy reform should not create substantial new categories of nondischargeable debt that could compete, post-bankruptcy, with child support, alimony, taxes, or other debt with high public priority. If new categories of nondischargeable debt are to be created, they should be narrowly tailored for situations where the debtor is clearly abusing the system.

We and the rest of the Administration stand ready to work with you in the days ahead to craft a consumer bankruptcy bill that achieves needed and balanced improvements in the bankruptcy system, and that helps consumers manage their debts more effectively.

Netting and termination of certain financial contracts in insolvencies

I would now like to turn to our views on the netting and termination of certain financial contracts in business bankruptcies. The increasing significance of certain financial transactions has motivated the President's Working Group on Financial Markets to examine the U.S. legal regime governing netting and termination of certain financial contracts in insolvencies. On March 16, 1998, as Chairman of the Working Group, Secretary Rubin sent the Group's legislative proposals to Congress.

Since its adoption in 1978, the Bankruptcy Code has been amended several time in order to provide that certain financial transactions, including securities contracts, commodities and forward contracts, repurchase and swap agreements, are excepted from the automatic stay that bankruptcy imposes for general commercial contracts. In each of these cases, the exception from the stay is justified to minimize systemic risk to financial markets that could result if such contracts were not permitted to be enforced.

The amendments that the Working Group has proposed are designed to strengthen the provisions of the Code relating to termination and close-out netting and related provisions for certain financial agreements and transactions. These provisions include clarifying that cross-product close-out netting is permitted for positions in securities contracts, commodity contracts, forward contracts, repurchase agreements and swaps; and that the provisions are applicable in the case of a municipality filing. We have attempted to limit the provisions to areas in which public policy goals are clearly served; we are seeking to protect markets, not particular types of creditors.

In addition, the Working Group proposed amendments to the banking laws that, along with the proposed amendments to the Bankruptcy Code, harmonize the definitions of financial contracts receiving the special treatment and provide protection for the federal deposit insurance funds with exposure in the case of a depository institution insolvency. Under the proposed amendments, exercise of the right of counter parties to terminate or net qualified financial contracts is suspended for a short grace period, to allow receivers of failed depository institutions to transfer financial contracts to another institution.

Cross-border insolvencies and bankruptcy tax provisions

Reform of cross-border insolvency laws and bankruptcy tax issues are germane to bankruptcy reform but may not fall within the jurisdiction of the Banking Committee. Title VIII of S. 625 would add a new chapter 15 to the Bankruptcy Code to address insolvencies that cut across international borders. These provisions are based on a model law on cross-border insolvency that was adopted on May 30, 1998 by the United Nations Commission on International Trade Law. Title VII of S. 625 makes amendments to bankruptcy tax provisions.


Thank you again for this opportunity to discuss issues related to bankruptcy reform. The revolution in technology and increased competition in financial services are giving Americans more numerous and complex financial choices than ever before, and are making possible larger and more complex business financial transactions than ever before. We look forward to working with you and others in Congress to construct balanced bankruptcy legislation that keeps pace with these changes in financial services. I am happy to answer any questions you may have.

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