16 February 2010

Why Do People Go Bankrupt?

Many people who could file for bankruptcy don't. What drives those that do?

In a nutshell:

Most consumers who file chapter 7 are driven to it by credit card collectors. Chapter 13s of course are driven by foreclosure sales. . . .

Generally, apart from foreclosure-related filings, the emergency bankruptcy filing is largely a myth. Creditor collection activity does not force people into an immediate bankruptcy. On the contrary, it wears them down slowly but ineluctably, like water dripping on a stone. Second, the primary factor that affects the date on which people actually file is their ability to save up the money to pay their attorneys and filing fees. Thus, among other things, we see an annual peak shortly after families receive their tax refunds, and a semi-monthly peak related to the receipt of paychecks.

The authors of the referenced study suggest reforms:

First, we argue that the existing collection process is flawed by a prisoner’s dilemma that leads to excessive and wasteful “dunning” by creditors. Because each creditor has an incentive to be first in line to collect, and because the creditors can dun their debtors at little or no cost to themselves, creditors as a group naturally engage in dunning activities that debtors find intolerable – a level of activities from which a rational single creditor would refrain.

We recommend a variety of solutions to strengthen the FDCPA. Some are at the level of detail (extending it to in-house collection, increasing the statutory damages, and the like). But the most important is a “do-not-call” rule modeled on the do-not-call list for telemarketers. Specifically, we recommend a low-transaction-cost mechanism (activated by telephone call or Internet site) that would automatically and immediately stop all creditor collection activity.

Second, corollary to our argument that excessive collection causes inappropriate filings, we also believe that the excessive filing costs deter socially valuable filings. . . . we argue that low-income low-asset filers should have access to a simplified administrative process that provides prompt relief without the costs and delay of judicial process.

The observation that it would be socially valuable for many people who don't go bankrupt to do so is an important observation.

More proposed bankruptcy reforms (some of which I agree with, and some of which I don't) are found here.

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