Reform bankruptcy laws before Covid debt comes due

Even with the latest coronavirus relief bill, the economic stresses from the pandemic will continue to mount. An assortment of federal, state, and local foreclosure, eviction, and debt collection moratoria have kept creditors at bay, and unemployment insurance has helped many families to stay afloat.

But neither the collection moratoria nor unemployment insurance will last forever, and they are likely to lapse as Covid-19 wanes. That’s when the bill will come due.

Collection moratoria merely stop collection actions; they do not cancel debts. Unemployment insurance typically replaces only a fraction of consumers’ income, so bills mount up when a consumer is out of a job. When the moratoria lapse, consumers will still owe months of back rent or mortgage payments, not to mention interest and late fees that have been accruing. 

Those debts will not go away as the economy picks up. Many families were just getting by before Covid. They have no financial safety net, and little if any ability to catch up on overdue bills from their future earnings. And for some families, there will not only be the usual bills, but also crushing medical bills related to Covid. 

The scope of the problem is hard to quantify, but there is no question that it is enormous. When collection moratoria end, there will be a tsunami of foreclosures, evictions, and collection actions. 

Bankruptcy has long been the economy’s safety valve for financial distress. When consumers get overloaded with debt, bankruptcy gives them the possibility of a fresh start and serves as a type of social insurance by spreading losses among creditors. Unfortunately, however, the bankruptcy system poses too many obstacles to consumers getting the immediate relief they need. 

Under current bankruptcy law a consumer can choose between filing for chapter 7 bankruptcy or chapter 13 bankruptcy. In chapter 7, the consumer surrenders her assets (other than certain minimal necessities), but retains all future income, and gets an immediate “discharge” of her debts. 

In chapter 13, the consumer retains her assets, but commits to a repayment plan under which creditors get all of her disposable income for the next three to five years. In chapter 13, the consumer only gets a discharge upon completion of the repayment plan, something most debtors fail to achieve. These consumers who fail to complete their plans have lived under onerous conditions during the duration of the plan, with little to show for it. 

Higher income consumers are required to file for chapter 13, but many lower income consumers do so to out of necessity: there is no provision for payment of the…