- March 2020 saw fewer than 60,000 total bankruptcy filings in the US, the lowest number for the month of March in the past ten years. However, a sharp increase is to be expected in April and subsequent months.
- The vast majority of bankruptcy filings in the US are non-business or consumer (individual) bankruptcies, with business bankruptcies typically accounting for less than 5 percent of all filings.
- During the Great Recession, consumer bankruptcies increased to 1.5 million a year by 2010, before declining steadily during the recovery. In 2019, there were 752,160 consumer bankruptcy filings.
- Job loss is one of the key drivers of consumer bankruptcy filings. For the period since 2006, the correlation between quarterly individual filings and the US unemployment rate is 0.93.
- The household debt-to-income ratio is another major factor in the bankruptcy decision. In Q4 2007, right before the Great Recession hit, the aggregate household debt-to-income ratio for the US was at an all-time high of 1.24. In early 2020, it was far lower at 0.95, indicating a healthier economic situation for the average US household.
- As of the end of 2019, the US average household debt service ratio (debt service payments to income) was 9.7%, the lowest it’s been in over 40 years – again, a positive sign going into the current crisis.
- The CARES Act, passed last month, increases unemployment benefits and softens bankruptcy law, both lessening the economic hardship for US households and making bankruptcy more attractive. Consequently, it will be hard to determine its impact on bankruptcy filings. Either way, it is unlikely to change the prospect of a sharp increase in the number of US consumer bankruptcy filings starting April 2020.
- A spike in bankruptcies is likely to result in large losses to creditors, and potentially in a tightening of credit in the US economy. Credit card issuers have begun to respond by easing some of the debt burden on their customers in an effort to reduce the risk of large-scale defaults.
BackgroundOver the past four weeks there has been a sharp spike in unemployment claims in the United States. With nearly 95% of Americans now under stay-at-home orders, the decline in consumer spending has been staggering as well. As businesses contract and permanently close, employment will be hit even harder. Households across the country faced with decreases in income that far exceed declines in expenses will be faced with the decision to file for bankruptcy. In March 2020, total bankruptcy filings in the US were just in excess of 60,000, a ten-year low for the month of March. However, the economic impact of the current crisis can be expected to ripple through to bankruptcy filings in the coming months.
Bankruptcy Filings in the USIn the United States, individuals have the option to file for bankruptcy as a means to reduce the burden of servicing their household debt. Household debt can be divided into two broad categories: (1) secured debt, which includes home mortgages, home equity lines of credit, and automobile loans, and (2) unsecured debt, which includes credit card and other consumer loans. Lenders of secured debt have the right to foreclose on a house or repossess a car in case of default, regardless of whether the debtor files for bankruptcy. However, bankruptcy can protect the debtor from having to repay all of their unsecured debt. In the US legal system, there are two separate bankruptcy procedures, named, after parts of the bankruptcy law, Chapter 7 and Chapter 13. When debtors file under Chapter 7, they agree to give up certain non-exempt assets which are liquidated to repay debt in exchange for discharging any remaining unsecured debt. Under Chapter 13 bankruptcy, debtors don’t have to give up any assets, but they must agree to repay a portion of their debt from future income over several years. While businesses also file for bankruptcy, the vast majority of US bankruptcies tend to be non-business, or consumer, filings. Figure 1 below shows the number of business and non-business bankruptcy filings for the period since 1980.
As seen in Figure 1, non-business bankruptcy filings in the US increased nearly five-fold from 1980 to 2004, from an annual average of slightly fewer than 300,000 in the early 1980s to 1.5 million filings a year by 2004. The sharp decline from 2005 to 2006 was the consequence of the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), after a decade-long lobbying effort by lenders. The new law made it more difficult for debtors to qualify for a Chapter 7 filing, requiring that the debtor’s income be below the state median and below a level that would allow repayment of at least 25% of their “nonpriority unsecured debt” such as credit card bills (based on a prescribed formulaic calculation).
Prior to the enactment of BAPCPA, Chapter 7 filings accounted for about 70% of all non-business bankruptcy filings because they allowed debtors to wash away significant portions of their unsecured debt. Proponents of BAPCPA predicted that toughening the qualification requirements for a Chapter 7 filing would increase debt repayment and protect creditors. After a sharp increase in filings (especially Chapter 7) leading up to the date of BAPCPA’s passage in October 2005, there was a dramatic decline in 2006. But filings began to rise again and by 2009–2010 the number of annual filings were back at 1.5 million a year due to the subprime crisis.
Factors Leading to Individual Bankruptcy
Economic studies have shown that consumers tend to file for bankruptcy when faced with adverse economic events – such as job loss, unforeseen medical expenses or divorce – that reduce their income or increase their living costs. The ratio of household debt to income is also an important factor in the individual bankruptcy decision.
Depending on the study, somewhere between a third and two-thirds of bankruptcy filers cite job loss as the reason for their decision to file. As seen in Figure 3 below, during the period under the current bankruptcy regime (since the passing of the BAPCPA in late 2005), quarterly bankruptcy filings tend to move together very closely with the unemployment rate. The correlation between quarterly individual filings and the US unemployment rate for the period from 2006 to the present is 0.93.
Another factor that increases the likelihood of bankruptcy filing is a higher household debt-to-income ratio. Household debt is comprised of several categories of debt that include mortgages, auto loans, home equity revolving debt, credit cards, student loans, and other. As seen in Figure 4 below, the U.S. household debt-to-income ratio increased steadily from 0.63 in 1980 to 0.81 in 1998, before a dramatic increase during the subprime mortgage bubble, which saw the aggregate debt-to-income ratio peak at 1.24 in the fourth quarter of 2007. During the Great Recession, households saw a sharp reduction in their debt-to-income ratios, both as a result of defaulting on their loans, as well as a tightening of belts by reducing consumption. When the coronavirus pandemic struck the US economy, the aggregate debt-to-income ratio was 0.95, a far healthier figure than at the start of the Great Recession.
As per Figure 5 above, US household debt service payments as a percent of personal income decreased starting in late 2007 because of the subprime mortgage crisis. People lost their mortgages, reduced their credit card balances, and lenders were far less willing to lend than during the credit boom in the run-up to 2007–08. During the recovery, as incomes continue to rise, the ratio above continued to decline. As of early 2020, the average debt service burden on US households was the lowest it’s been since before 1980.
The Response of Creditors
A sharp uptick in the number of personal bankruptcies will result in the writing off of a large amount of unsecured consumer debt. Creditors, faced with large losses, are likely to reduce the supply of consumer credit, both by raising interest rates on more risky debt and by making it more difficult for lower-income individuals to qualify for credit cards and other consumer loans. The tightening of credit is likely to hit lower-income, low-asset households harder, resulting in a possible redistribution of credit towards high-asset, high-income borrowers.
Faced with the current crisis, credit card issuers, such as American Express, Capital One, and Apple Card, have already taken measures to ease the pressure on consumers, including allowing customers to skip a monthly payment or two without accruing interest, waiving certain fees, and increasing credit lines. It remains to be seen how consumer credit issuers continue to respond as the current situation unfolds.
The Potential Impact of Government Actions on US Bankruptcy Filings
On March 27, 2020, the President signed into law the $2.2 trillion stimulus bill known as the Coronavirus, Aid, Relief, and Economic Security (CARES) Act, passed that same day by the House of Representatives. Among other things, the CARES Act includes a $600 per week increase in benefit for up to four months for unemployed workers, as well as federal funding of unemployment insurance benefits for those usually not eligible, such as self-employed, independent contractors, and those with limited work history. With respect to individual debtors with confirmed Chapter 13 plans as of the date of enactment, the CARES Act also expressly excludes any Covid-19 related payments from the federal government from being treated as part of the debtor’s income. Moreover, Chapter 13 debtors will be able to request a hearing to seek modifications to their payment plans if they are experiencing a “material financial hardship” due “directly or indirectly” to the pandemic. For instance, debtors will be able to extend their repayment terms from three or five years to seven years. As of now, it is not entirely clear what other modifications debtors will propose and what courts will accept.
By increasing unemployment insurance benefits, the Act reduces the impact of job loss, the leading factor in bankruptcy filing. On the other hand, the direct adjustments to bankruptcy law will ease the burden on existing and future bankruptcy filers, possibly making Chapter 13 bankruptcy more attractive.
One of the immediate consequences of the coronavirus pandemic has been the unprecedented increase in unemployment, with nearly 22 million initial unemployment claims filed during the past four weeks (March 16 through April 11, 2020). While the job losses in the present downturn are a direct result of the necessary social distancing measures, and not of a market failure as in previous recessions, the negative impact on household incomes, and on the number of bankruptcy filings, is, nonetheless, expected to be dramatic. On the positive side, the state of the US economy in terms of debt-to-income ratios and the debt-service burden was much healthier in March 2020 than it was at the start of the Great Recession. Finally, the CARES Act has taken measures – likely not to be the last the federal government will take – to ease the hardship being felt by US households.
The impact of the increasing debt burden on consumers will depend on the response by creditors in the coming weeks and months. Credit supply is likely to tighten, and redistribute towards high asset households, but actions taken by creditors to mitigate the situation could help contain the bankruptcy situation. Depending on the scale of the bankruptcy event to come, the consumer credit industry might change for years to come.
Reint Gropp, John Karl Scholz & Michelle J. White, 1997. “Personal Bankruptcy and Credit Supply and Demand”, The Quarterly Journal of Economics, Vol. 112, No. 1 (Feb. 1997), Page 217–251.
Michelle J. White, 2007. “Bankruptcy Reform and Credit Cards”, Journal of Economic Perspectives, Vol. 21, No. 4 (Fall 2007), Page 175–199.
Sumit Agarwal & Chunlin Liu, 2003. “Determinants of Credit Card Delinquency and Bankruptcy: Macroeconomic Factors”, Journal of Economics and Finance, Vol. 27, No. 1 (Spring 2003), Page 75–84.
Joanna Stavins, 2000. “Credit Card Borrowing, Delinquency, and Personal Bankruptcy”, New England Economic Review (Feb. 2000), 15–30.
Teresa A. Sullivan, Elizabeth Warren, & Jay Lawrence Westbrook, 2020. “The Fragile Middle Class – Americans in Debt”, Yale University Press, Feb 18, 2020.
Business and Non-Business Bankruptcy Filing Counts, 1980–2019, American Bankruptcy Institute.
Non-Business Bankruptcy Filing Counts by Chapter, 1994–2019, American Bankruptcy Institute.
Unemployment Rate, 2006–2019, Bureau of Labor Statistics.
U.S. Aggregate Household Debt to Income Ratio, 1980–2017, Federal Reserve Board.
Household Debt Service Payment Ratio, 1980–2019, Federal Reserve Economic Data.
 Reint Gropp, John Karl Scholz & Michelle J. White, 1997. “Personal Bankruptcy and Credit Supply and Demand”, The Quarterly Journal of Economics, Vol. 112, No. 1 (Feb. 1997), Page 217–251 at 222.
 Chapter 11 filings, which account for about a quarter of all business filings, are extremely rare in the case of individuals.
 Michelle J. White, 2007. “Bankruptcy Reform and Credit Cards”, Journal of Economic Perspectives, Vol. 21, No. 4 (Fall 2007), Page 175–199 at 175.
 Chapter 7 bankruptcies increased to 80% of all non-business bankruptcies in 2005 as individuals filed in large numbers in anticipation to the change in law.
 Sumit Agarwal & Chunlin Liu, 2003. “Determinants of Credit Card Delinquency and Bankruptcy: Macroeconomic Factors”, Journal of Economics and Finance, Vol. 27, No. 1 (Spring 2003), Page 75–84 at 75.
 Joanna Stavins, 2000. “Credit Card Borrowing, Delinquency, and Personal Bankruptcy”, New England Economic Review (Feb. 2000), 15–30 at 15.
 Teresa A. Sullivan, Elizabeth Warren, & Jay Lawrence Westbrook, 2020. “The Fragile Middle Class – Americans in Debt”, Yale University Press, Feb 18, 2020.
 Gropp, et. al. (1997), at 221.