We are shooting the albatross.

This was also posted on my law blog, but I thought it merited being read here, as well.

Further and further down the rabbit hole we go with student loans, which you'll recall are loans made by private banks, or the federal government, with little to no risk on the part of the private bank, because most student loans are federally guaranteed, entitled to faster administrative procedures for collection, and have no statute of limitations.

Student loans are thus the apex predator of debt, and are the reason why we are not climbing out of the Great Recession and in fact will likely be in for worse.  Despite that, the government and creditors continue to insanely insist that every student loan debtor be saddled with debt for the rest of their natural lives, regardless of the circumstances.

The latest outrage/judicial ruling comes from In re Jones, an Eastern District of Michigan Bankruptcy Court decision.  Vicky Jones, a registered nurse, filed bankruptcy. She had monthly expenses -- expenses the bankruptcy court found reasonable -- that were only $2 less than her monthly income, meaning that she was able to save or have discretionary spending of TWO WHOLE DOLLARS per month.

Included in those monthly expenses were a $500 per month payment on her student loans. The student loans were not what forced Vicky into bankruptcy but they were (SPOILER ALERT!) what forced her out of bankruptcy.

No, what forced Vicky into bankruptcy was that another creditor (apparently? it's unclear) had recently gotten a judgment against her and garnished her wages to the tune of $650 or so per month.  If you are keeping track, this now means that Vicky's budget is short $648 per month. Give or take.

Vicky's unsecured debts totaled about $150,000, and of those, $131,000 were student loans. Vicky filed for Chapter 7 bankruptcy, which liquidates any non-exempt assets and then discharges (meaning she doesn't have to pay) any debts -- other than student loans.

So Vicky's bankruptcy plan was essentially to get rid of $19,000 in debt to allow her to keep paying her $131,000 in student loans.

In comes the United States government, in the form of the bankruptcy trustee, who objected to Vicky's filing and said it should be converted to a chapter 13. In that chapter 13, the trustee noted, Vicky would make payments for five years to all unsecured creditors, and the creditors who were owed the $19,000 would realize about 20% of their outstanding debts. To this, Vicky replied that such a plan would actually increase her student loans by about $37,000, as well as making her ineligible for at least some post-bankruptcy repayment options on those loans.

The bankruptcy court first had to consider whether the student loans were 'consumer' debt. This is because if you are a consumer, you can be found to abuse bankruptcy under various circumstances, and thus be denied the right to file bankruptcy. The court determined that the debts were consumer debts because Vicky's first petition had said so.

When you file bankruptcy, you have to note the kind of debt you have, and on that first petition, Vicky (presumably through her lawyer) said they were consumer debts. When the trustee filed its motion, she amended her petition to state they were not consumer debts.

Amending claims and petitions to address perceived deficiencies is relatively common, so common in fact that Wisconsin and federal rules allow a party to amend its pleading at least one time without even seeking permission.  I'm not sure what the rules in bankruptcy are, but I do know that despite the fact that amended pleadings entirely supplant the prior pleading, there is a trend among lawyers to argue that earlier pleadings can be used against you.

This is a strange and sad rule, because often a person pleads something based on what they know at the time, and subsequent investigation might cause them to alter or omit that claim. About 50 years ago, the rules of civil procedure in federal courts were liberalized to get past the formalities of law; the idea was that rather than throw cases out on what seemed mere technicalities, the courts and litigants were to focus on the merits and substance of the case. Over the past five years or so, there has been a retrenchment of that liberalization, with formalities becoming ever more important.

Here, the bankruptcy court determined that Vicky was estopped from claiming her debt was not consumer debt, because of that first petition. The court felt that the amendment, coming right after the trustee filed the motion, demonstrated "gamesmanship" and that thus Vicky could not change her position: the debts were deemed consumer debts, regardless of their actual status.

That, in turn, meant that a provision of the bankruptcy code meant to avoid abuse of bankruptcy by consumer debtors applied to this case, and the Court analyzed whether it should dismiss the case. The Court found that Vicky had a stable source of income, and that because her debts could be repaid at least in part to the other unsecured creditors, it was 'premature' for Vicky to file for bankruptcy:

The Court concludes it is premature for the Debtor to seek either Chapter 7 or Chapter 13 relief at this time. First, she could obtain a temporary stay of proceedings while she attempts to negotiate an installment payment of the judgment that she owes. Second, there is insufficient evidence before the Court that she cannot accomplish a debt restructuring of her student loans at this time.

Essentially, this is a ruling that Vicky must first try to work with the judgment creditor, and her student loan lenders, without the protection of the bankruptcy court rule, or alternatively that she can convert her case to a chapter 13.

Bankruptcy is meant to treat all creditors fairly; it's not a debtor's law at all. (Many, many laws seemingly enacted in favor of debtors are in fact laws that were favored by and provide benefits to, creditors. Any marital property law fits that definition, for example, because it expanded creditors' ability to lend to people who otherwise might not be able to borrow, and collect from people who had not in fact borrowed.)

What this judge here did is send Vicky back out of bankruptcy court, where she would have to try to prefer two specific creditors -- the judgment creditor and the student loan lender -- over the others. But also, while Vicky is negotiating, those other creditors are free to sue her and obtain judgments if they can, and try to collect against her as well.  It is exactly the kind of free-for-all that bankruptcy was intended to avoid.  Alternatively, if Vicky converts to a chapter 13, that extends the delinquency and bad marks on her credit as much as five more years. (Most delinquent credit records stay on your credit report for 7 years. Bankruptcy stays for 10 years after discharge, so a chapter 13 bankruptcy might result in bad credit for 15 years, as opposed to 7.)

Chapter bankruptcies are also more expensive, because lawyers charge more for them, and because debtors have to pay the bankruptcy trustee a portion of the payments of the case (the last I heard, the payment was equal to 10% of their total payments throughout the plan.)

Many bankruptcy trustees are paid only if there are "assets" in the case. That means that chapter 7 bankruptcy trustees make money by finding assets they can sell, and take a cut of, on behalf of creditors. Chapter 13 trustees also make money by the payments from debtors. While bankruptcy trustees are technically employed by the US government, in Wisconsin they are mostly private lawyers who have their own practices, some of which is acting on behalf of the 'official' bankruptcy trustee.

So what appears to have happened here is that a lawyer -- the trustee-- objected to a bankruptcy and wanted it converted to a more expensive form of bankruptcy that would pay fees to the trustee.  The effect of that conversion would be to increase Vicky's student loans (nondischargeable, easily collectible, with no student loans) by some $37,000, while paying other creditors 20% of the amount they were owed. To do this, Vicky will also have to pay her lawyer, and the bankruptcy court more.  Remember: Vicky started this process having only $2 leeway in her monthly budget.

This is America.