Consumers take the credit, then they take the blame

by Jacob Ziegel

This commentary was first published in the Globe and Mail on February 14, 2008.

Just before Christmas, with little scrutiny, the Senate adopted two very lengthy lists of amendments to Canada's bankruptcy legislation. The body's banking, trade and commerce committee has now resumed hearings on these amendments. The committee would perform a sterling public service in taking a close look at Canada's current handling of personal insolvencies, because important aspects of the current statutory provisions are seriously out of step with marketplace realities.

The Senate's investigation would be no academic exercise. Since 2000, the number of annual personal (mainly consumer) insolvencies has amounted to about 100,000 a year. Canada has the dubious distinction of having the highest rate of personal insolvencies in the Western Hemisphere.

The main difficulty about the current provisions is that they proceed from a false premise. They assume that the insolvent consumer is primarily to blame for his predicament because of his fiscal irresponsibility, or that he is using bankruptcy as an easy solution to debt problems. This was the perception that animated Canada's first insolvency act in 1869. It still haunts the Bankruptcy and Insolvency Act, adopted in 1949 and amended extensively since.

The assumptions were false in 1869; they are markedly so in 2008, in most cases. There were relatively few personal insolvencies before the 1970s. As late as 1972, the number (3,647) was smaller than the number of business bankruptcies. The number of personal insolvencies grew rapidly thereafter, to 21,025 in 1980 and an all-time high of 102,539 in 2001.

There is no secret about the reason for this astounding escalation: the enormous growth of consumer credit of all types, particularly credit cards. Most adult Canadians, and many younger ones, own at least one. The number of cards in circulation grew from 8.2 million in 1977 to 61.1 million in 2006. There is relentless pressure for Canadian consumers to spend, even beyond their capacity to repay. The ready availability of credit cards, teaser interest rates, low monthly payments and undemanding down-payment requirements make it almost sinful not to succumb.

However, this is not the picture drawn in the current insolvency legislation. The focus is on debtor conduct and misuse of consumer credit. Bankrupt debtors are required to attend two mandatory counselling sessions to learn how to budget properly. Available evidence is that they have minimal effect. Bankrupt debtors are also required, for a basic period of nine months (now about to be extended to 21 months) to turn over 50 per cent of their monthly income over the Low Income Cut Off figure prescribed by the regulations for distribution among their creditors. In practice, creditors derive very little benefit from these payments. About 80 per cent of consumer bankrupts have no surplus income, even by the less than generous LICO standards.

Demeaningly, debtors are also required to surrender their credit cards - not to the issuers but to debtors' trustees in bankruptcy, as if the credit-card companies were somehow incapable of protecting their own interests.

What is striking about these requirements is their one-sided character. There is not a word in the legislation about the creditors' contribution to the current malaise. They are not subject to any sanctions for careless or irresponsible lending practices. They emerge smelling like roses. But it is an illusion. It takes two to tango.

This is the prism through which the Senate committee should examine the current insolvency provisions. They urgently need to be changed, to reflect current market realities and to vanquish the 19th-century view of the bankrupt as social outcasts and financial threats.

Canada should learn from the cataclysmic meltdown of the U.S. subprime mortgage market. Prevention is better than any cure. The first line of defence should be responsible lender conduct. It is these reasonable restraints, not heavy-handed sanctions against insolvent consumers, that will ensure a sane and healthy consumer credit market.

To be sure, there are other personal bankruptcy problems that also need to be addressed. Student loans that cannot be repaid because of unemployment or matrimonial problems are among the best known. Even in these cases, however, responsible lender conduct can mitigate the financial problems by ensuring that consumers are not overburdened with debts while they are trying to address these other challenges.