Today's Consumers Prefer Chapter 7 Bankruptcy 3 to 1

While the media focuses on the total number of filings, a drill down into those data can also tell us something about the pain that families are suffering. In the last two years, since the foreclosure crisis, the fraction of all consumer filings that are chapter 13 cases has plummeted. In the language of taste tests of soda pop, today's consumers prefer chapter 7 three-to-one over the competition (aka chapter 13). Check out these data from the UST Program. In 06-07, chapter 13s averaged about 38% of all filings. In 08, there was a steep drop to 31%; and in 09, a further drop to 26.5%. These are really big changes in such a large system.

 

The obvious explanation for this fall in chapter 13 is a decline in people trying to save their homes, which we think is a major reason that people chose chapter 13 instead of chapter 7. 

Homeowners in 2008 and 2009 seem to have realized three things: 1) home prices are not going up anytime soon; the "crisis" is  a long-term change in the housing and mortgage markets; 2) they are not going to get a loan modification; the Administration's projected numbers of those who would be helped by HAMP and HARP were fanciful (dare I say "misleading"?); and 3) they simply cannot make their mortgage payments in a world where overtime is being eliminated, unemployment is a fear or reality, increased tax burdens loom as states and localities can't make ends meet, and many other costs remain high (gas, health care, etc.) Many people had these realizations in 2008, and many more had them in 2009. Each year, the share of chapter 13 filings plummeted. And all this, despite BAPCPA's purported intent of driving up chapter 13 filings and making people pay more of their debts.

Homeowners' pessism may not be a bad thing. In a research paper that I authored with John Eggum and Tara Twomey, we found that chapter 13 filers in April 2006 (before the foreclosure crisis) had very high homeownership costs, with more than 70% of homeowners trying to save homes that subsumed more than 30% of their incomes (the long-standing standard for affordable housing). The lower fraction of chapter 13 filings may ultimately translate to a higher rate of plan completion for chapter 13; if consumers are reticient to try to save homes with high costs, maybe more than 1 in 3 chapter 13 plans will make it to completion and a higher fraction of chapter 13 debtors will earn a discharge. Time--a long time, given the five year repayment plans that dominate chapter 13--will tell if the lower proportion of chapter 13 cases as a share of total bankruptcies will correlate with a higher discharge rate for chapter 13.

Comments

[AMC]

Despite the large disparity in the number of cases, Chapter 13 still pays out far more each year to unsecured creditors. One reason Chapter 7s pay far less is because only about 1/10th of Chapter 7s are asset cases.

In 2001, when 70% of bankruptcy filings were Chapter 7s, Chapter 7 Trustees paid unsecured creditors about $350 Million (page 7), while Chapter 13 Trustees paid unsecureds more than double that - about $800 Million. (page 9)

http://www.phil.frb.org/payment-cards-center/publications/discussion-papers/2003/ConsumerBankruptcy_112003.pdf

I'd be curious what those ratios to unsecured creditors are today for each chapter.

One thing that may increase the number of Chapter 13s being filed - all those thousands of debtors who filed ahead of BAPCPA in 2005 are now eligible for a Chapter 13 discharge. And they have more than three years to go before they will be eligible for a Chapter 7 discharge.

[Katie Porter]

I think there have always been lots of chapter 13 cases that paid nothing at all to unsecured creditors, and there are more today than there were in 2001, in part because I believe that zero percent plans are more common now after BAPCPA. The data that I've seen suggest that about 30-33% of all chapter 13 cases disburse nothing at all to unsecured creditors. Scott Norberg's paper found that 59% of all chapter 13 cases paid nothing to unsecured creditors. The total dollars recovered are bigger in chapter 13, but that is a function of some cases paying a lot. We shouldn't lose sight of the fact that many chapter 13 cases yield nothing for unsecured creditors.

The point about BAPCPA and refiling is intriguing. Assuming no legal changes, I predict chapter 13 filings will stay around 25% for the next two years, reflecting the troubled housing market.

[Ken Doran]

I would say your realizations are essentially correct, but I would add a similar one that is related but perhaps simpler and more direct: more people than ever before are seriously under water on their first mortgages. That is true even here in flyover country (Wisconsin) where the boom-and-bust was less extreme than some coastal areas. With no cramdown-to-value option available, Chapter 13 has very little to offer those homeowners, even those with decent incomes.

[Patches]

Wow 59% paying nothing to unsecured??? I guess if you consider dismissed cases? I guess..?? We are in the wrong division! 0% plans are supper rare down here unless you count hardship discharges and/or conversions. Maybe its our particular UST but 7s down here are tough! We are even getting hassled on our Biz 7s! We file way more 13s than 7s.

[Jamie McFarlane]

In the 9th Circuit, another great benefit, for the time being, of using a Ch. 13 for my clients is the avoidance of a entirely unsecured junior lien on the client's primary residence. In re Zimmer, 313 F.3 1220. With a zero percent plan, it is possible to strip-off the entirely unsecured second lien and get out early under In re Kagenveama and In re Sunahara.

[Mark Ankcorn]

note, too, that the chart is for filings -- not plan completions. If you factor in the voluntary conversions to Chapter 7, I suspect the preference for Chapter 7 is even more pronounced among consumer debtors.

[Charles E. Andersen]

The decline in Chapter 13 filings is mostly due to the 2005 bankruptcy reform act and the way it is enforced. Chapter 13 trustees are now under directives from the US Trustee to take an adversarial position to Chapter 13 debtors making confirmation of a plan a moralizing struggle while chapter 7 debtos obtain an easy wipeout with little consideration given to the budget in most cases.

Generally speaking if the Chapter 7 debtor is under the median income he gets an immediate discharge without an in depth inquiry as to how he spends his money.

Strict enforcement of the means test makes Chapter 13 a very undesirable alternatice for over the median income debtors with no dependents, and the anti cram down provisions no longer allows Chapter 13 debtors to get more out of Chapter 13 than out of Chapter 7.

After a while the bad experience people are having under chapter 13 gets around

[Charles E. Andersen]

More Chapter 13 bankruptcy is filed in upstate New York and other rural areas rather than the large coastal cities because the low cost of real estate results in a higher percentage of homeowners. Homeowners commonly neglect their mortgages and use chapter 13 to get caught

Also because lower cost of living results in higher disposable income allowing most people to have room for a repayment plan.

New York has a very limited range of personal property exemptions, combined with strict enforcement makes the loss of personal property in Chapter 7 a realstic possibility. Thus Chapter 13 may be a serious alternative for some people in spite of the 2005 bankruptcy reform act