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What is Financial Distress?

posted by Jim Hawkins

I’m new to teaching, so a lot of times I encounter new terms.  I started working on a paper last year about the relationship between fringe banking (payday loans, rent-to-own, etc.) and financial distress.  I realized half way into the project that I really didn’t know what financial distress meant.  The concept comes up a lotSeriously, I mean really a lot.  But, it is not defined very often.

I’ve looked at the 300 or so times financial distress comes up in law review articles on Lexis, and I still am left without a clear sense of what the word means.  I’ve settled on two definitions for my paper, but I’m curious about what people mean when they say “financial distress.”


Expenses are greater than income?

I would think that the inability to timely pay for basic needs (food, shelter, utilities, transportation) would be considered financial distress. The basket of needs probably depends on what class you're in or the style of life you are used to. Distress suggests in my mind not only the internal feeling you have, but the social pressure that is exerted on you by friends, neighbors, and family.

The Europeans call a cognate condition "overindebtedness," and they've been struggling to find a definition for years now. Both are elusive concepts to "define," and I never have been quite sure all of the effort is worth it. Can't we just leave it as "the twin brothers of obscenity--we know them when we see them"?

Seriously, the most common kind of approach to defining overindebtedness is something like "the manifest inability to pay one's debts as they come due," which we in the U.S. would probably call "cash flow insolvency." I don't think insolvency and financial distress perfectly overlap, though, so something short of this--perhaps WELL short--would constitute financial distress. If I forget my wallet when I go to pay for parking at the garage, am I not just then suffering from financial distress, however temporary? :-)

I define at the wolf coming through the door as opposed to knocking on it. By that I mean, the lawsuit gets filed, the car gets repoed, the house is going under the gavel or you need a doctor and are told to get in line at the county clinic. It's much the same for businesses, judgements, repos or not having items delivered because you are on a cash basis and don't have the cash.

To me, it's beyond the concept that you are juggling bills or robbing Peter to pay Paul, it's losing what you have because the people you owe are taking stuff from you.

Its a relative term. In consumer and small biz bks every bk is a snowflake. Its all in the perception of the person(s) going through it. In Texas people can't lose their homes(they live in) to unsecured debt...so there really isn't any "real" threat. The stress of collection calls though, especially to those recovering from serious illness can actually be deadly. People handle that type of stress differently and no two are ever...ever the same. To one person it is the end of the world (Financial Distress)to another its a "Chihuahua Barking" at them... in other words "all bark and no bite". Real or not to those who believe it is the "end of the world", it may very well be.

'Financial Distress' is when worrying about money makes it impossible for you to enjoy your life.

Jim, I haven't much to offer on the definition, but as you look at "fringe banking" you might take note of the real estate "contract for deed" which seems to be making a comeback.

I would agree with Wingo:

"I would think that the inability to timely pay for basic needs (food, shelter, utilities, transportation) would be considered financial distress..."

...with this addendum; that there is no easily accessible lower level of payments. That is, in order to adjust, the distressed person must undertake a structural change in their lifestyle.

So, not just trading in one cell phone for a cheaper plan, but losing the cell and going to a land line, or to nothing. Not just renegotiating the mortgage, but handing in the keys and moving to a rental, or to nothing.

It's not stressful to give up brie for cheddar. It is stressful to move all the way down to Kraft Dinner.

May I add, living at the lower levels is often more costly than living at the higher ones? Fringe banking is notoriously expensive, as a percentage of income.

In our experience, financial distress really begins when a consumer/borrower arrives at the point where they are embarrassed by their situation.

That's when strange things start to happen. They conceal things from their spouse or other family members and friends. That only adds to their distress.

It's a very personal condition for most people. Some respond by putting their heads in the sand and letting the problems get worse. Others react with panic and seek absurd quick-fixes. Some drag other people into their downward spiral.

They're almost universally easy to take advantage of and solutions aren't simple decisions. Because of that they wind up losing control of the situation and become just another bankruptcy statistic.

Lather, rinse, repeat.

Because we haven't bothered to educate young people about credit abuse, we're reaping what we have sowed.

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