Bankruptcy Filings Will Be the Lowest Since 1995 -- Here Is a Reason Why

In June, I said we are on track for just over 900,000 bankruptcy filings for 2014. The latest data are in from Epiq Systems, and that 900,000 figure remains the best estimate for the calendar year. We have had 556,875 total bankruptcy filings this year, and in 2012 and 2013, the last five months added 39.5% more filings. That gives an estimate of abut 907,000 filings for 2014.

Year-over-year declines remain large. There were 77,489 total bankruptcy filings in July or 3,521 filings per business day, a 11.7% decline from the previous year.

As the chart shows, the number of bankruptcy filings will be the lowest in the last seventeen years -- indeed the lowest since 1995. Those of you paying attention at home might point out that 2006 and 2007 appear to be lower, but these were the years around the passage of the 2005 bankruptcy amendments. If we average 2005 - 2007 for a more accurate picture, there were 1.1 million filings per year.

Whenever I post these updates, someone will ask the reasons for the decline. Well, I have studied individuals who file bankruptcy, and I have arrived at the sort of conclusion that only can come from academic study -- people who file bankruptcy are heavily indebted.

Bankruptcy is all about the household balance sheet, specifically the right-hand side of the balance sheet. No debt, no bankruptcy. And, it has to be debt that a bankruptcy filing will help.

Overall debt levels are deceiving. Total consumer debt (not including mortgages) is about $3.1 trillion. which seems like an increase from 2006 when it was $2.4 trillion. Since 2006, however, the Fed has been separately reporting student loans, and that figure has been growing as a percentage of total consumer debt. Of course, a bankruptcy filing can do very little for student debt because of the strong presumptions against dischargeability.

The punch line is that if you subtract student loan debt and adjust for inflation and population growth, the consumer debt for which bankruptcy is most effective has fallen about 20% since 2006. "Bankruptcy" is not a synonym for "financially distressed." Rather, it is a legal act with legal consequences, and those consequences have become less beneficial for U.S. households.  There is less debt that can be discharged in bankruptcy, lowering demand for bankruptcy filings.

Sometimes, I get push back about the relevance of unemployment rates. Sure, rising incomes and with full employment can dramatically lower the need for a household to file bankruptcy, but a crushing debt service -- perhaps from an medical crisis -- can overwhelm an income that was perhaps satisfactory for the debt that previously existed but not for the new obligations. Unemployment and income play a role, but the main factor driving the bankruptcy rate down is the lack of household debt, especially debt that can be discharged in bankruptcy.

Comments

[Bryan]

Interesting test of your hypothesis (with which I agree) will be if Congress ever does allow discharge of non-governmental student loans. That should lead to a spike in BK filings, probably less dramatic than the 2005 pre-BAPCPA spike, but still statistically significant.

[chris m]

and the reason for less debt is...?

perhaps more limited household income, resulting in fewer eligible for debt of the discharge-able variety.

debt to income ratios are up, so lending decreases resulting in fewer bankruptcies.

that's my theory, anyway.

it is counter intuitive but my theory is that better times for the middle class mean more bankruptcies, not less, because more folks qualify for more debt.

my theory assumes that folks are equally inept at managing their debt at all times.

comments to my theory are invited.

[John Rogers]

Also, keep in mind that when employment levels and rates increase, those that were previously unemployed and had judgments against them, and thus exempt from paycheck garnishment, now become employed and subject to paycheck garnishment. These folks will often file bankruptcy to stop a garnishment, when they did not file while unemployed.

[Brett Weiss]

I have found that most people file for bankruptcy when either (1) they have something they don't want to lose; or (2) the other alternatives are worse.

With the hit that the middle class have taken over the last decade, a large group of folks don't think that they really have much to lose, and "what can they do to me?". As the economy improves, so will the risk of losing something (wages, bank accounts, home, car) and the filing numbers will increase.

Brett Weiss

[Wallace]

Interest rates have been declining, and with it the cost of debt. http://files.dailywealth.com/images/DW815-bw.gif

[SYSM]

I advise people not to file bankruptcy until you're at imminent risk of losing some money. This requires, at the very least, that you be sued. (Actually it requires a judgment, and then judgment collection proceedings to commence; but let's just take institution of a lawsuit as a good enough point.) Most en-masse creditors are not suing until ~2.5 years after default at the EARLIEST. So you would expect bankruptcy filings to trail defaults by 2.5 years at least.

[debt serf]

I'm an attorney in the midwest and anecdotally I've seen less credit card collections lawsuits in general being filed. I direct mail advertise and I've even seen the number of letters I send out decrease because the suits just aren't being filed. I'm even seeing cases that were previously dismissed being refiled with is a rarity often within months of the SOL. However, this all makes sense because credit card DQ's are the lowest they've been since the Fed's been keeping records since 1991. I heard the other day that new foreclosure filings (IDK nationally or just my state) are now at pre-recession levels.

I believe that there are various reasons for this. First and foremost, credit was tightened back in 2007/2008 and hasn't loosened up much yet. Consumers need debt to go BK and without access to credit, they cannot take on the debt. the consumers who are taking on debt are well qualified - I heard that the average credit score for a new mortgage is in the 760's! Long gone are the days of the 570 score no money down loan. Also, anecdotally, the banks are trying to give away credit to well qualified buyers. I bought a preowned certified vehicle the other day and they were going to let me walk off the lot with no money down and a 2.49% interest rate. Of course my FICO was in the 800's but that seemed desperate to me to give away cars no money down even to well qualified buyers.

Secondly, the economy is doing better. For example, companies are making money - or at least they have the ability to issue to low interest junk bonds or even VC capital. These keep people employed at companies that don't make money. A lot of the long term unemployed have found jobs or other employment (or SSDI) and there are no Hoovervilles right now.

At far as the short to medium term I believe the DQ rates will get even lower and bankruptcies will continue to fall until 2015/16 or so. After that my opinion is a lot of the low interest junk bonds, subprime car notes, and modified foreclosures will explode and ripple through the economy. The stock market will correct, layoffs will ensue, causing bankruptcies and DQ's to increase.

The fact of the matter is that total outstanding consumer credit at $3,211.2 billion is still quite a bit higher than $2,552.8 billion in 2009 at the end of the recession. Yes, the great recession only wiped out only a small portion of consumer credit which was then borrowed again in 2010-2014. The consumer debt in our economy is still there, and it's still being serviced, and any disruption in the economy causes DQ's to rise. The Great Recession was a once in a generation event but smaller recessions will be the norm as they have always been.

[Steve]

I have seen an uptick in new clients, and it seems they are of the variety that file on old debt because they want to improve their credit. When there is no hope for credit or earnings to pay credit in the near future, people don't file. So, maybe they are more optimistic about loans and their future incomes.

I have noticed in recent years more filers with multiple suits and garnishments, whereas in the old days they wanted to file as soon as the phone started ringing (or before). Thus, my "smart phone theory" of delayed bankruptcy filings: smart phones allow a socially acceptable, and non-embarrasing way of avoiding unwanted phone calls from collectors.

[Knute Rife]

Most people I talk to who aren't filing are obtaining new financing so they can kick their debt servicing issues down the road. If money tightens back up, watch out. The folks who are filing typically fall into one of these categories: 1) They have new jobs and so a blipping on the collectors' radars, either for judgment or garnishment; 2) they don't have new jobs but are sick of being hauled in for supplemental proceedings; 3) they were construction subcontractors who have done commercial work over the last few years, were driven into the ground by a certain set of contractors and developers, and are now being pursued on their personal guarantees; or 4) their houses are being foreclosed 5-7 years after default because the REMIC regs have been straightened out, and the banks feel tax risks are manageable.