10 March 2009

Who Files For Bankruptcy?

Did the bankruptcy reforms of 2005 achieve their goals of changing the mix of people who file for bankruptcy?

Contrary to the advocates' claim that high-income filers would be driven from the system and, by implication, that those remaining would have more modest incomes, the data show no change in the income levels of bankruptcy filers after the amendments. These findings thus cast doubt on the suggestion that those purged from the bankruptcy courts - approximately 800,000 in 2007 alone based on trend extrapolation - were high-income deadbeats; they instead appear to have been ordinary American families in serious financial distress. The data also show that debtors filing for bankruptcy in 2007 have even greater debt loads than their counterparts from 2001, a development that seems to track a national trend of increasing consumer debt. The findings thus align with at least two predictions of some legal scholars. The first is that the bankruptcy reform bill was not aimed at high-income abusers but was instead a general assault on all debtors, regardless of their financial circumstances. The second is that debtors are waiting longer - and incurring more debt - before ultimately seeking bankruptcy relief, consistent with the so-called "sweat box" theory of credit card lending.

Median income (adjusted for inflation) was virtually unchanged:

Median income among Chapter 7 filers in 2001 was $23,761, while median income among Chapter 7 filers in 2007 was a virtually identical $23,136. Similarly, there is no statistically significant difference between the median incomes of Chapter 13 filers from 2001 and those from 2007, which were $33,742 and $35,688 respectively. . . . median household income for bankrupt debtors in 2007 was about $27,100— statistically indistinguishable from the $27,800 in 2001 and $27,100 back in 1991. Median household income across the United States in 2006 (the most recent year available) was $48,200. These figures put the income of the median bankrupt household in 2007 a full 45% below the income of the median household in the general U.S. population. In 2001, the story was the same. The median income for those filing for bankruptcy was 44% below the then-median income for all households.

The data also examined inflation adjusted income in $10,000 bands from $0 to $100,000 (and $100,000+) and found no major differences in the distributions of bankruptcy filers by income. About 72% of bankruptcy filers have under $40,000 (in 2007 dollars) of income. About 18% have $40,000 to $60,000 (in 2007 dollars) of income. Roughly half of the rest had $60,000-$70,000 of income. Notably, there were actually slight increases in the percentage of debtors in each of the categories from $70,000+ in 2007 compared to 2001, eliminating any possibility that the effect of the means test might have been felt by very high income debtors relative to mere moderately high income debtors.

Debt levels of bankrupt debtors, in contrast, have increased materially. "In the six years from 2001 to 2007, families that filed for bankruptcy were collectively carrying 20.8% more secured debt and 43.6% more unsecured debt – all on incomes that remained static." Debt to income ratios have also risen:

In 1981, the median bankrupt debtor owed about one year and five months of income (which is gross income, with no allowances for outlays such as income taxes or even food), for a total debt-to-income ratio of 1.4. By 2007, the median bankrupt debtor owed about three years and four months of income, for a debt-to income ratio of 3.3. . . . In 1981, the median household in bankruptcy owed just under six months of income in credit cards, medical debts, and other unsecured credit, for an unsecured debt-to-income ratio of 0.46. By 2007, the median household owed nearly 15 months of income to unsecured creditors, for an unsecured debt-to-income ratio of 1.22. This means that by 2007, the ratio of unsecured debt to income was two and a half times larger than the ratio in 1981.

What do the experts (whose ex ante theories were confirmed by the data) say?

The data are consistent, however, with at least one theory of consumer debt: Professor Mann’s sweat box theory of lending. Mann argues that the goal of the means test in BAPCPA was never to sort out can-pay debtors or to squeeze more payments from families in bankruptcy. Instead, he argues that what lenders really wanted from BAPCPA was more delay before filing bankruptcy.102 Mann observes that many credit card lenders have developed business models and fee structures that will allow a substantial boost of profit whenever families delay a bankruptcy filing. Mann thus reasons that the aspects of BAPCPA that should have the biggest impact on debtors are those that increase costs, insert more delays or otherwise raise the bar of desperation that a family must feel before making the decision to file for bankruptcy.

Provisions that increase the amount of paperwork and documentation debtors must produce, that require debtors to engage in prebankruptcy and during-bankruptcy counseling, and that drive up the costs for attorneys to provide their services would, according to this model, have a far greater impact on whether cash-strapped families in financial trouble turn to bankruptcy than a means test. The post-BAPCPA families’ higher debt loads, declining net worths, and higher debt-to-income ratios offerdata that are consistent with his analysis.

Professor James J. White takes a similar position, speculating that BAPCPA was a game of subterfuge. The true goal of the legislation may have been to make bankruptcy more undesirable to all, not just to the rich.

White argues that the amendments were designed to impose a death by a thousand cuts through low-visibility procedural burdens, and that high-visibility, substantive provisions, such as the means test, were simply distracting bonuses. With a mixture of apparent cynicism and admiration, White implies that the bankruptcy reform effort was an attempt to attack distressed consumers all along the income spectrum—an effort that was hidden behind the more politically acceptable rhetoric of the means test’s focus on high-income deadbeats:

By raising the cost in hundreds of little ways, you might make bankruptcy unpalatable to many who currently take bankruptcy. . . . Nor would you be obliged to admit that the true reason for advocating these bureaucratic changes was to degrade the machinery of bankruptcy; these rules could be justified as palliatives for acknowledged ills of the system.

107 One interesting new study conducted after BAPCPA finds not only that the change in law has been profitable for credit card lenders, but that none of that surplus has been shared with consumers. See Michael Simkovic, The Effect of 2005 Bankruptcy Reforms on Credit Card Industry Profits and Prices (Working Paper, July 8, 2008), available at http://ssrn.com/abstract=1157158 (finding consumers are paying higher interest rates, late fees and overlimit fees after the amendments’ implementation despite the lobbying promise that BAPCPA would eliminate alleged “bankruptcy tax” on non-bankrupt borrowers).

Mann’s theory of the creditors’ sweat box, White’s speculation on the real intent of BAPCPA, and our own findings about the increases in debt loads caused us to analyze two additional pieces of data. We report them here, in our discussion, because it was only after we reflected on our primary findings that we saw the importance of these results.

In both 2001 and 2007, the telephone surveys of the families in bankruptcy included questions about how long they had been seriously struggling with their debts before they filed for bankruptcy and about their experiences with debt collectors. The how-long-seriously-struggling options were blunt, pre-set categories. Indeed, the responses suggest that when we designed the question we had not fully anticipated how long people struggled with debts before filing. The modal answer was the longest interval category available: more than two years. More importantly for these purposes, the proportion of debtors choosing “more than two years” jumped significantly from 32.6% in 2001 to 43.8% in 2007. Thus it may not be that . . . non-filers have truly left the system; they may just be circling the drain longer. Again, more time will be needed to know what will ultimately happen to families squeezed from the bankruptcy system.

The increase in the length of time that people postpone filing for bankruptcy is consistent with creditor efforts to trap debtors longer in the sweat box, regardless of whether they eventually end up in bankruptcy. The increase in time struggling in the 2007 sample is particularly noteworthy because of the sharp increase in “transition bankruptcies” in 2005. Based on . . . predictions about strategic behavior, it would be reasonable to assume that people on the margin economically would have joined the rush to file for bankruptcy before the new law went into effect in 2005. To the contrary, our data suggest that many families that were already in trouble resisted “unstrategically,” only to end up in bankruptcy two years later. . . .

In the telephone survey of those who filed in 2007, 82% of households reported calls from debt collection agencies. Of these families, nearly a quarter— 23.6%—said the debt collectors had raised the subject of bankruptcy explicitly, threatening what would happen if they filed. More than half who received such warnings recount being told by the debt collector that it was “illegal” to file for bankruptcy, or that, if they filed, they might go to jail, the I.R.S. would audit them, or they could lose their jobs. The remainder received a mix of misinformation, including the oft-repeated “you won’t qualify.” These data suggest that after the 2005 amendments, the newly emboldened debt collectors may have had an important influence on people’s
willingness to file. In the wake of the publicity about the changes in the laws, debt collectors apparently worked hard to make debtors believe bankruptcy relief was now cut off.

112 Of the 845 debtors who had been contacted by a debt collector, these were the recorded responses:
1. It was illegal to file bankruptcy: 4.9% (n=41)
2. You might go to jail if you filed: 3.9% (n=33)
3. I.R.S. would audit you if you filed: 7.3% (n=62)
4. You might lose your job if you filed: 8.5% (n=72)
5. Something else might happen if you filed: 19.4% (n=164) (text fields recorded).

Overall, 12.9% (n=133) reported one or more responses in categories 1 through 4. The total with a response in any of 1 through 5 was 23.6% (n=244).

At least one expert shares this view. According to Bankruptcy Judge Michael Williamson:

I don’t think [the low filing rate] is a sign that people are not in financial difficulties. It’s just a sign that they have been scared off. From the anecdotal feedback we get, people apparently are being told by debt collectors that bankruptcy is no longer available.

It would be quite simple to eliminate provisions of the 2005 bankruptcy reform that simply create bureacratic obstacles for low income, low asset debtors without changing substantive bankruptcylaw remedies, eliminating, for example, the requirement to provide all schedules to the petition and to take a consumer credit counseling class prior to filing for bankruptcy, while preserving other more desirable reforms of the law.

(Citations and footnotes eliminated with a couple of exceptions with bold footnote numbers in the blockquotations. Full Disclosure: J.J. White was my bankruptcy law professor in law school.)

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