How Many People Out of Bankruptcy Are Insolvent?

One of the lurking empirical questions in any analysis of many debtor-creditor law issues is the question of how many people who are not currently in bankruptcy are insolvent.

Impressionistically, it seems as if almost everyone (90%+) against whom a lawsuit is filed is in a limited jurisdiction court by a financial institution creditor or landlord (who bring cases that make up perhaps 90%-95% of limited jurisdiction civil actions outside of the non-lawyer small claims court) acknowledges the existence of the debt and that they are in default (although there may be some disputes regarding the amount owed, particularly in landlord-tenant cases), and have defaulted not because of a dispute over the amount owed but because they are unable to pay their debts according to the agreed terms. The same seems to be true in the vast majority (95%+) of mortgage foreclosures. It also seems, reports about the credit reporting system, that a debtor who is in serious default on one debt, but not other debts, is very much the exception.

Probably the typical case is of someone who incurs debts and commits to a lifestyle at a certain point in time, suffers either a setback in income (e.g. the termination of a job held by someone in the household, non-payment of child support or alimony, a reduction in pay or hours, loss of rental income that is not replaced promptly, reduced revenues in the business of a self-employed person, an income reducing injury, illness or disablity, etc.), or experiences a sudden expense surge (expenses related to a DUI, a hike in a child's tuition, medical expenses, a divorce, a big increase in the monthly payment under an adjustable rate mortgage, an increase in monthly minimum payments on a credit card, a personally guaranteed loan for someone else goes bad, etc.) and can no longer pay expenses as they come due. Sooner or later, open lines of credit and savings prove inadequate to manage the imbalance, and the person becomes unable to pay their bills as they become due.

The stereotype credit card companies push of people simply living beyond their means for pleasure's sake seems to be the rare exception.

Leading up to that point where a judgment gets entered against someone in court, a barrage of late payment penalties, default interest rates that are triggered, accellerated debts, the burdens of dealing with collection efforts, and so on, lead to less rational financial decision making, intefere with the debtor's ability to generate income, and cause servicing of current debts to go from manageable to unmanageable. Typically, people go bankrupt when the situation seems hopeless, particularly when they have some future income or some exempt asset they wish to preserve. Sometimes this is called the "sweatbox" theory of bankruptcy. People sweat it out until they give up.

Each participant in the process tends to be so focused on their immediate needs that few people are asking if the status quo system, viewed at a forest rather than a trees level, makes much sense to deal with the heartland cases of debt non-payment.

Impressionistically, the 2005 reforms in the bankruptcy code have discouraged individuals from filing bankruptcy and tend to favor later bankruptcy filings than under prior law, and even before then, only a modest share of people for whom bankruptcy would be an available or even preferrable option don't file for bankruptcy.

Wouldn't it be better to have a system where bankruptcy filings happen not long after someone becomes unable to pay their debts as they come due, when assets that have not been depleted in inefficient collection actions, before unnecessary collection costs have been incurred by creditors, before disparities between similarly situated creditors arise, before debtors have been discouraged from earning income or having bank accounts or assets titled in their names, and before debtors and their families have experienced immense psychological trauma?