The Means Test: Increasing Punishment for Consumers as the Economy Declines?

The bankruptcy means test could be a new source of pain for consumers as the recession deepens.  The 2005 Congress tied everyone together in a community and, perversely, elected to punish consumers who live in the hardest-hit communities more.

In a nutshell, BAPCPA dictates that consumers with average income over the prior six-months which is greater than the median of a similar size household may be presumed to be abusing the bankruptcy process if they file Chapter 7.  A more detailed “test” may still allow the consumer to proceed, or they may prove special circumstances to the court’s satisfaction.  But the bottom-line is a higher threshold of scrutiny and a narrower window for relief.

Two factors in that simple analysis jump out at you, now that we are in the fifth quarter of a punishing recession, though.  And both are designed to punish consumers for factors beyond their control.

First, the consumer’s income for the test is based on the prior six-months.  In a declining economy, this virtually always means the consumer’s income will be overstated.  It will imply that they can afford to repay something –or repay more if they filed Chapter 13 — when they no longer can.  It is up to the Justice Department and the courts to minimize the impact of such unjust measurement methods.

A second — more insidious — punishment awaits as well.  If the state’s economy is in decline, the state’s median income may begin to decline.  We have not yet seen this occur on a broad-scale during this recession.  But if it continues for a long time, we may well see real declines in median household incomes.  Unfortunately, the cost of living shows no sign of coming down accordingly, though.

So, perversely, consumers may see their disposable income narrow or disappear but the bankruptcy system’s looking glass may say that it has.  If your income did not decline at the same pace as your neighbors, even if you have no more money left each month, you may have fewer options — or your options may be harder and more expensive to pursue.

Like a drink of polluted water, BAPCPA can be the gift that keeps on giving.