Bankruptcy and the Crisis: Why so Few?

Many thanks to Bob for the invitation to guest blog here.  Those who follow Bob's postings on bankruptcy filing numbers will have seen that U.S. consumer bankruptcy filings have been plodding upwards steadily, but only to roughly where they were before the BAPCPA bubble back in 2005.  One of the inscrutable mysteries of the financial crisis of 2007-??, which is after all a housing and consumer debt crisis, has been how few bankruptcies have been filed.  Somehow, historically unprecedented levels of consumer debt and loan defaults have not produced the surge in bankruptcy filings one would expect.

American households tripled their mortgage debt from $3.5 trillion at the end of 1996 to $10.5 trillion at the end of 2007.  Median income, meanwhile, rose by about 40%.  While credit card and other unsecured debt grew less dramatically, that is only because homeowners used mortgage refinancing to soak up quite a bit of credit card debt.  All this debt growth came to a screeching halt in early 2008, after subprime mortgage lenders were wiped out by early payment defaults, and the bond market, spooked by losses at Bear Sterns and elsewhere, suddenly lost its appetite for mortgage-backed securities.  

Unable to recycle their loans any longer, homeowners and consumers defaulted.  Debt defaults for consumers and homeowners are now running at two to five times their pre-crisis levels.  Each quarter for the past two years, the Mortgage Bankers Association has announced new all-time highs for mortgage default or foreclosure rates.  Through previous business cycles the combined rate of foreclosures and 90-day delinquencies has rarely exceeded 2% of all mortgages; it now stands at 9.7%, and will probably exceed 10% in the second quarter numbers due out this week.  Credit card charge-off rates for banks have been hovering around 10%, compared to their usual 3% to 5% range in the recent past.  So debt, and debt defaults, are much, much higher than they have been at any time since the 1978 Bankruptcy Code.  But filings are not.

The Treasury Department estimates that there are 1.6 million homeowners nationwide who are 60 days delinquent, and are otherwise candidates for workouts through the Administration’s HAMP program.  Chapter 13 filings, the logical choice for homeowners trying to work out mortgage debt, are running at 25% of filings,so we can expect perhaps 400,000 Chapter 13s for calendar 2010.

The gap between Chapter 13 filings and distressed mortgage borrowers looks even greater when you consider that not all Chapter 13s are filed to deal with foreclosures; some Chapter 13 debtors are not even homeowners.   Perhaps Chapter 7s are being filed by distressed mortgage debtors to help with a graceful exit, but bankruptcy is clearly not playing a central part in deleveraging the American homeowner.

While there may be good reasons for this disconnect between bankruptcy filings and the debt crisis, including the presence of a shadow consumer bankruptcy system (about which more later) this does raise the old question, “if bankruptcy is the solution, what is the problem?”    Or, “if not now, when?”

Comments

[Kelly]

If not now, when? After debtors are exhausted and have exhausted their exempt assets that they could have saved from creditors if they had only talked to a bankruptcy attorney BEFORE they took loans against their retirement accounts. The banks, credit card companies, and debt collectors haven't finished shearing and fleecing the flock.

[Susannah]

I second Kelly's comment. Also, since total student loan debt is now greater than credit card debt I wonder how many of the underwater hoam owners are also countersigned on non-dischargeable student loans. I haven't seen any statistics on this but it's surely the (an?) elephant in the room for some percentage of cases. I'd like to know the demographics of this segment (underwater/defaulted/distressed mortgage AND/OR cosigned loan status (paying for kids unable to pay, defaulted etc) AND/OR defaulted credit card debt, with employment status and household income over time.

[Knute Rife]

Soon. Much of that gap was diverted into "work-out" plans, including HAMP, that aren't working out and in fact have done nothing but extract a few more months of payments for creditors at the expense of everything else, including the long-term viability of the debtors. Debtors are waking up from that dreamworld and looking for alternatives. About the only one left is bankruptcy. Look for the surge to start in states like Utah where there is effectively no defense against garnishment of wages.

[Transor Z]

Here's an interesting potential precursor to increased filings: Fidelity reports that more are drawing down from 401(k)'s:

http://www.businesswire.com/portal/site/home/permalink/?ndmViewId=news_view&newsId=20100820005303&newsLang=en

[CM]

Chapter 13 is a joke. Thanks to our for hire representatives. The average chapter 13 costs $2500 - it's easier to turn the ringer off. People are fatigued and the confidence in this current financial system is cracking.

[rd]

Several of the comments above are probably some of the reasons. It is also likely that many of the creditors do not want to push for defined losses at this time due to extend and pretend. Pushing a debtor into foreclosure and bankruptcy locks in the loss that could otherwise not be fully reserved in the financial institutions' assets, giving better earnings reports.

At some point in time, accounting rules enforcement will require the completion of foreclosures and debt collection processes. It is likely that bankruptcies will increase then.

[S Brennan]

Now foreclosures are focused on those who have large equity built up...responsible people who have lost jobs and gotten sick. The underwater homes are under the extend and pretend umbrella.

[Craigie]

"Countersigning" is one of the largest urban legends sweeping the finance blogs and higher ed blogs. It is non-existent in the federal student loan programs.

Cosigners don't exist in the world of federal student lending. Federal student loans don't allow cosigners. Federal parent loans allow ENDORSERS, which are slightly different. Unlike federal student loans, where there is no credit check permitted, there is a minimal credit check for originating parent loans. Occasionally a child will endorse a parent loan, although this wasn't the original purpose of endorsing.

Cosigners are sometimes required for non-federal educational loans ("alternative loans"), particularly for undergraduates. In some cases parents will cosign those.

[Justin]

If you owe more than the house is worth, there's no reason not to just file a 7 and use the automatic stay to catch up with the house payments after that.

[Patches]

Talked with a guest speaker at our Southern District of Texas Bench-Bar Bankruptcy conference. In attendance were all of our Southern District of Texas BK Judges and a 5th Cir. Judge or two..? (Great conversation with Isgur on "Campbell" btw) I asked Texas Economist Dr. M. Ray Perryman, because no one else did, if easing the requirements for discharge in 7 could boost consumption and thereby employment. He affirmed that Bankruptcy reform could speed up our recovery. BAPCPA is stifling our recovery! We need to Reform Bankruptcy Reform.

What was frustrating to me was that no one wanted to ask him about bankruptcy and the economy! All they wanted to do was ask him "Conservative" loaded questions about entitlements...???? What the Heck? Leave it to me, apparently the only liberal in South Texas... I didn't care even though I wasn't a lawyer or a Judge.... At least I needed to know....

http://www.txs.uscourts.gov/news/SDTXBenchBar2010SavetheDate.pdf

[Matt]

It would also seem that the increase openness of lenders to do short sales might be reducing the number of bankruptcies filed. As well, there are more programs and offers of different types of credit counseling and debt relief services that are advertised on the radio frequently which might be reducing the bankruptcy numbers. I think most will avoid bankruptcy if there is another way (like a debt reduction program or short sale) and if they can get their wits about them to seek an alternative.

[Steve Sanchez]

It is true that the bankruptcy number might be skewed somewhat if everyone has another alternative. But the reality of it is that many people who have filed for bankruptcy is due is because they just cannot afford to keep paying for the high debt anymore.

[Michael]

The typical Chapter 13 Plan for a person in foreclosure who is trying to keep their home will require that the homeowner "cure and maintain" their mortgage payments. In other words, resume making mortgage payments plus pay something towards the missed payments. For most people in foreclosure today, the current mortgage payment is already too high. Therefore, a cure and maintain Chapter 13 plan is not helpful.
The better choice is to negotiate directly with the mortgage company for a loan modification reducing the mortgage payment and folding the arrears into the mortgage.

[Patches]

People under the gun or past the acceleration stage in foreclosure are being jerked around by the Servicers. You didn't sign this; you didn't initial that..... you don't qualify....etc. What we have been doing especially for those "under the gun" is filing the 13 and proceeding with a home modification with the Stay intact. There is always an underlying cause ie.. large credit card debt....maybe a vehicle we can cramdown..squeaking out some disposable income for the debtors.

For those Kooky Servicers who at the last second pull out of the Mod for no apparent reason we hold their feet to the fire in 13 and force them into that mod so long as the debtors have complied with the terms.....(yes it does happen)... We have pass thru mortgages in 13s down here or conduit payments as AMC used to call them. I would love to see a Mod on a HomEQ adjustable rate mortgage by Beneficial btw! To date I still consider that a "Kentucky fried RAT". I agree though that the 13 itself unless the debtors have improved their situation or likely to improve their situation that Chapter 13 offers very little on Mortgages for debtors. We do the best we can with what we have....and pursing mortgage mods while in 13 has been helpful and we have had some success.

[howard grant]

To this day this ladies words still astounds me. Its disgraceful. Not her but the politicians who take total advantage of the pitiful. This is why I left the Democrat Party.
Mortgages

[Ed Clements]

I help people threw my e book for free!