An Explanation for the Low Bankruptcy Rates: Debt

Yesterday, I noted the U.S. bankruptcy filing rate of 2.38 per 1,000 persons is at historic lows. The next question is always why. In this post, I am going to try to walk through an explanation in four graphs. The upshot is that consumer debt is low but rising. As I like to say, it takes years of study to come to the conclusion that people file bankruptcy because they are in debt. This is not to say that other factors are not contributors -- unemployment, general economic conditions -- but the primary macroeconomic driver of bankruptcy filings is the amount of debt on household balance sheets.

The first graph shows total U.S. consumer credit. The consumer credit data come from the Federal Reserve's G.19 data series on consumer credit. The Fed's definition of consumer credit includes nonrevolving debt like car loans and revolving debt like credit cards. These figures do not home mortgage debt, which the Fed tracks elsewhere but also that I have found not to be predictive of bankruptcy filing rates. Even over the time periods in the graph, it is important to account for population increases and inflation. I use population data from the U.S. Census and the Consumer Price Index from the Bureau of Labor Statistics. (And, for those who did not know that, there is your fun fact for the day: the BLS is the government entity that calculates the inflation rate.)

Thus, this first graph shows per capita consumer debt adjusted for inflation, not including mortgages. That figure currently stands at $11,471 per person -- every man, woman, and child -- in the United States. (It would be better to use the adult population as the base, but that additional complication makes data-gathering more difficult without increasing the accuracy of our conclusions.) As the graph clearly shows, after a small dip in the Great Recession total consumer credit has been climbing. That would suggest the opposite of what we have been seeing -- increasing bankruptcy filing rates.

But, the consumer credit figure includes student loans. Bankruptcy generally is much less effective in dealing with student-loan debt. Absent a difficult showing of "undue hardship," student loan debt is nondischargeable in bankruptcy. Student loan debt is now the largest component of consumer debt, more than credit cards, and has been for some time. Therefore, to get an accurate picture of how consumer debt levels are interacting with the bankruptcy system, we have to back out student loan debt from the amount of consumer credit. The second graph shows consumer credit without student loans, again on a per-capita, inflation-adjusted basis. Now, the dip in consumer borrowing becomes more pronounced. But, still since 2013, consumer credit minus student loans has been rising. Bankruptcy rates have been falling.

The third graph adds the bankruptcy filing rate to the second graph. The left-hand axis is the same as before with consumer credit minus student loans. On the right-hand side is the daily bankruptcy filing rate adjusted for population, as shown by the red line. This third graph demonstrates what we already suspected. The consumer credit graphs and the bankruptcy filing rate graphs do not appear to be following the same trends when laid on top of each other.

But, we also know that people do not file bankruptcy the moment they incur new household debt. If a borrower is on the brink of imminent bankruptcy, many avenues of consumer borrowing are foreclosed. In any event, only in the fevered dreams of neoclassical economists do massive numbers of people borrow money with the intention of strategically defaulting immediately.

How long does it take for the effects of household borrowing to show up in the bankruptcy courts. My previous research suggests two or three years. The last graph takes the midpoint -- ten calendar quarters or two-and-a-half years--and lags bankruptcy bankruptcy filings. It matches up the household borrowing of, for example, early 2006 with the bankruptcy filing rate in mid 2008. Now, the trendlines match up more closely. The scales are not the same on the both sides as the graphs are not intended to show the exact point estimates for the relationships but the general trends in the data.

I have said it many times on this blog: bankruptcy filing rates are about the amount of consumer debt. These graphs are yet another way to understand that relationship. And, because consumer debt has been rising, we should expect bankruptcy rates to follow in the coming years.

 

Comments

[George]

I liked your analysis. It not only makes sense, but the graphs illustrate the point very well too.

I wish someone could do a similar analysis on federal tax debt soon. As there are many announcements of IRS-related scams, it could be very useful to know where we are standing in that department.

Cheers.

[Steven Rebein]

Does consumer debt include medical bills? I heard just today Senator Tim Kaine assert that Obamacare has slashed bankruptcy filings by 1/2

[Bob Lawless]

Mr. Rebein, I don't believe most medical debt would be in the Federal Reserve's data. But, if medical debt is on a credit card, it would be. Also, to the extent people need to borrow to pay for living expenses because they are servicing medical debt, that would show up. The causal chain here is tricky.

But, I think it is patently false that Obamacare alone has slashed bankruptcy filings by half. There is some research to suggest that Obamacare has driven down bankruptcy rates, but there is no evidence to suggest the entire drop in bankruptcy filings is due to Obamacare. Correlation is not causation.

Paul Ryan's campaign complained about Obama because bankruptcies had gone up in his first term: http://www.creditslips.org/creditslips/2012/09/paul-ryans-bullshit-about-bankruptcy-data.html.

[John Rogers]

Great article and stats, Bob ... thanks for sharing !

[Brook Gotberg]

Thanks Bob! I was trying to explain this phenomena to a reporter the other day, and your graphs and explanation are incredibly helpful! Passing it along . . .

[Matthew T. Berry]

Bob, what is the historic "break-point" where filings begin to rise appreciably?

[Matthew T. Berry]

Duh...nevermind

[Leon Bayer]

The low bankruptcy filings can't be entirely explained by graphs and Fed data. Somehow, the effect of the 2005 Bankruptcy Act has to figure into this.

Many people consult me with the pressing need to file Chapter 7 bankruptcy, (a decision they don't reach lightly, and which still carries a painful stigma).

But lawyers often have to tell "high" income earners they can't file Chapter 7 bankruptcy because it isn't allowed. (I am not referring to super earners, I am speaking of single people earning $70,000, with student loans and who don't own a home nor have a car payment to deduct on their means test).

Filing bankruptcy for people with above median income is restricted by the 2005 Act. It isn't necessarily impossible. It is often doable. But it is much harder,
as I pointed out in my own recent blog at http://www.mybankruptcy.lawyer/bankruptcy-for-high-income-earners/.

Filing Chapter 11 bankruptcy or Chapter 13 bankruptcy for for high income earners who really need need a Chapter 7 is a poor option for the client, (but a lucrative option for us lawyers who make far more in fees than would ever be earned to handle a Chapter 7 case for that client).

The attorney fees to handle a small Chapter 11 from filing through confirmation, and beyond are hideously expensive. Those high fees are driven by administrative requirements of the U.S. Trustee and local court rules. All that red tape is designed to deal with big Chapter 11 cases, yet it is made applicable to the mom and pop cases, too. Mom and pop can't afford it, especially when they really need and want a Chapter 7 case.

Chapter 13 bankruptcy is a marvelous remedy in the right circumstances. But it is a very poor substitute for a client that really needs a Chapter 7 case. There is a very high failure rate in Chapter 13, with most cases never coming close to being completed.

One reason for that is because Chapter 13 is often treated like a 5 year prison sentence. There is a culture among most trustees, and quite a few bankruptcy judges, that Chapter has "to hurt." And they do practice what they preach.

Because of that culture, Chapter 13 debtors are being pressed to the limit to commit to payment plans they really can't afford. The typical plan leaves most debtors to live on inadequate, poverty levels of subsistence in the name of repaying enough unsecured debt to "make it hurt."

Many debtors who are driven into Chapter 13 bankruptcy would probably prefer a lashing with the "cat 'o nine tails." At least that would be fast and over in a few minutes, in preferable comparison to the grinding years of poverty imposed by a 5 year Chapter 13 plan.

What ever happened to the spirit of "Fresh Start" espoused by the sponsors of the 1979 Bankruptcy Reform Act? I'll tell you what happened. A cabal of big banks killed it, and replaced it with the draconian laws enacted in 2005.

I will say again, graphs are useful but don't tell the whole story.

[Knute Rife]

If credit is available, people don't file bankruptcy, they extend and pretend. When credit dries up, that's when they when they head for a bankruptcy court, and with significantly increased debt. Unless the doors have been sealed shut for them as Mr. Bayer lays out. Then they look for any way possible to become invisible and get off the radar, including working the gray market economy, not filing tax returns anymore, and even going Walter White. Bankruptcy "reform" has worked wonders.