The Bankruptcy Code is an important part of American law. It serves an important role in preventing the development of debtor’s prisons in the United States. Its fundamental importance was recognized by the founders who embedded it in Article I, Section 8 of the U.S. Constitution, along with Congresses power to regulate naturalization laws.
Perhaps this is because the founders recognized the need for those who have suffered bad luck to be able to obtain a fresh start and a second chance. They recognized the hopelessness engendered by the prospect of debts you cannot pay. The bankruptcy laws were supposed to help people escape this type of endgame with no exit, but the last major revision to the Code helped credit card companies more than individuals.
Two significant problems in our economy are not adequately dealt with by the Code. One is the student loans. There could be a student loan crisis brewing, which is second only to home mortgages in the rank of debt it represents, and it could provoke a similar economic downturn. New graduates face difficult prospects, with incomes flat and full-time jobs still difficult to come by.
However, discharging a student loan is a very difficult task, and the extreme hardship test requires that you are virtually destitute and have no prospect of ever obtaining a job that would allow you to repay your loan. There is no real justification for this extreme standard.
The other issue was made visible during the Great Recession, as home prices crashed through the floor millions were left underwater. Had the bankruptcy code permitted cramdowns of mortgage loans, it is likely thousands of homeowners in Wisconsin and across the nation would have been able to keep their homes instead of giving up and abandoning their property during a foreclosure.
Such a change would also place the risk where it belonged: with the banks. They contributed to the real estate bubble and were able to lock-in inflated values that the market could not support. They should not have benefited from this wrongdoing.
Source: politico.com, “Donald Trump Proves What’s Wrong With Bankruptcy Laws in America,” Robert B. Reich, September 28, 2015