One Million Personal Bankruptcies a Year: Economic Implications and Policy Options

One Million Personal Bankruptcies a Year: Economic Implications and Policy Options

97-637 E
CRS Report for Congress
Received through the CRS Web
One Million Personal Bankruptcies a Year:
Economic Implications and Policy Options
Updated May 14, 1998
Mark Jickling
Economic Analyst
Economics Division
Congressional Research Service ˜ The Library of Congress

ABSTRACT
This report examines various explanations for the rapid rise in personal bankruptcy filings in
the United States since 1980, the economic significance of the phenomenon, and policy
options. This discussion and analysis provide a background for consideration of legislation
before the 105th Congress ( H.R. 3150 and S. 1301), which proposes to reform the consumer
bankruptcy process. For a more detailed analysis of these proposals, see CRS Report 98-276
A. This report, which does not assume extensive familiarity with bankruptcy law, will be
updated as legislative developments warrant or as new economic data become available.

One Million Personal Bankruptcies A Year: Economic
Implications and Policy Options
Summary
In 1996, the number of personal bankruptcies in the United States exceeded one
million for the first time in history. In 1997, the figure climbed to 1.35 million, more
than triple the number recorded in the early 1980s. That the number of households
in severe financial difficulty should have risen so dramatically is perplexing, given that
unemployment and interest rates have been falling since 1980 and that the economy
has enjoyed two long periods of expansion.
The rise in bankruptcy filings is often attributed to a rise in household debt
burdens. Since 1980, household debt (mortgage plus consumer credit) has risen from
about 61% to 85% of total disposable personal income. Credit card debt (a
component of consumer credit) has risen at a much faster rate, but accounts for less
than 10% of the total household debt. Nevertheless, credit cards are at the center of
the bankruptcy debate: creditors complain of debtor abuse and imprudence, while
others criticize the aggressive marketing efforts of credit card issuers.
Why has household debt risen? Different explanations focus on (1) weakness in
the economy (such as stagnant or falling real wages, corporate downsizing, lack of
universal medical insurance, etc.) or (2) the strength of the economy (spending and
borrowing grow with wealth and income gains and with confidence in future
economic prospects).
Other explanations for the rise in bankruptcy rates involve social factors such as
a declining sense of shame or stigma associated with debt and bankruptcy, divorce
and singe parenthood, legalized gambling, and so on. Others focus on local factors:
automobile insurance requirements, state bankruptcy laws, etc. These various
explanations are not contradictory; no single cause for the bankruptcy phenomenon
can (or need be) identified.
Although loan losses from bankruptcy run into the billions of dollars, there is no
immediate threat to banking institutions, even those that specialize in consumer
lending. Likewise, there is no evidence that consumers will soon react to rising debt
levels by cutting spending, and thus pushing the economy toward recession.
Policy options to reduce the incidence of bankruptcy or to make the bankruptcy
system more fair and efficient focus on amendments to the bankruptcy code, which
is often criticized as too lenient toward debtors. Possible changes might include
incentives (or requirements) for Chapter 13 bankruptcies (where debtors with regular
incomes agree to pay off some of their debts over time) rather than Chapter 7 cases
(where the debtor’s property is sold and remaining debts discharged, or canceled),
provisions to deter fraud and abuse, and greater uniformity in the administration of
the law. Bankruptcy reform legislation is pending before the 105 Congress, which
th
also has received the report of the National Bankruptcy Review Commission, created
in 1994 to study the law and recommend changes.

Contents
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Chapter 7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Chapter 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Choice of Chapters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Who Files for Bankruptcy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Explanations for the Rise in Bankruptcy Filings . . . . . . . . . . . . . . . . . . . . . . . . . 6
Credit Market Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Why Has Household Debt Risen? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Sociological Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Local Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Bankruptcy’s Effects on the Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
What Can Be Done? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
List of Figures
Figure 1. Bankruptcy Filings, 1980-1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
List of Tables
Table 1. Personal Bankruptcy Filings by Chapter, Selected Years . . . . . . . . . . . . 4
Table 2. Personal Bankruptcies, 1980-1997:
Number and Rate per 1,000 Population . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Table 3. Selected Components of Household Debt as a Percentage
of Disposable Personal Income, 1980-1996 . . . . . . . . . . . . . . . . . . . . . . . . 8
Table 4. Bankruptcy Rates (Filings per 100 Households)
for Selected States: 1980, 1990, and 1996 . . . . . . . . . . . . . . . . . . . . . . . . 12
Acknowledgment
The author is grateful for the comments of Gail Makinen, of the Economics
Division.

One Million Personal Bankruptcies a Year:
Economic Implications and Policy Options
In 1996, the number of personal, or nonbusiness, bankruptcy petitions filed
exceeded 1,000,000 for the first time. The 1,125,006 personal bankruptcies
represented about 1.2% of all American households. During 1997, the Administrative
Office of the U.S. Courts recorded 1,350,118 personal bankruptcy petitions, an
increase of 20% over 1996.
The rise in personal bankruptcy has not been easy to explain. Current
bankruptcy filings are about triple the levels of the early 1980s, when rates of interest
and unemployment were significantly higher than today. Moreover, there has been
no corresponding rise in business failures: 1996 business bankruptcies (53,549 filings)
stood at 65% of their 1987 peak. Many observers are troubled by the apparent rise
in financial distress in the household sector over a period when business and
macroeconomic conditions have showed steady improvement. Some seek the causes
not in economics, but rather in sociological and legal factors, such as long-term shifts
in consumer attitudes towards bankruptcy. In 1994, Congress created a National
Bankruptcy Review Commission to study and recommend changes in the bankruptcy
law. The Commission’s report, completed October 1997, contains 178 proposals for
changes in bankruptcy law. Legislation that would make significant changes in the
bankruptcy code has been reported out of committee (H.R. 3150 and S. 1301) in the
105th Congress.
This report analyzes the explanations put forward for the rise in personal
bankruptcy and considers their economic implications. Do the various factors that
may have played a causal role reveal economic weaknesses hidden behind generally
positive macroeconomic news? Or, is financial fragility a by-product of increasing
wealth and income? Another section of the report deals with what bankruptcy filings
at current or increased levels portend for the economic future. Will consumers at
some point cut back on spending and try to reduce their debt loads, sending the
economy toward recession? Is the soundness of banks and other creditors at risk?
Finally, what actions can or should be taken to reduce the number of filings?
Background
To the individual, bankruptcy is a means of escaping a burden of debt that has
become unmanageable. Upon the filing of a bankruptcy petition, all debt collection
efforts must cease, and a process of court-supervised negotiation or accommodation
between debtor and creditors begins. The bankruptcy code offers two principal
alternatives for individuals: Chapter 7 (liquidation) and Chapter 13 (wage-earner)
bankruptcy. A debtor will usually choose between the two procedures after

CRS-2
consulting with a lawyer, who will consider how the individual’s particular financial
situation meshes with the complexities of the bankruptcy law. The discussion that
follows summarizes the major advantages and disadvantages of each chapter, from the
debtor’s point of view.
Chapter 7
Chapter 7, or “straight” bankruptcy, is the most common bankruptcy procedure.
Under the supervision of a trustee appointed by the federal bankruptcy court, a
debtor’s assets are sold and the proceeds divided among the creditors. Debt that
remains is discharged, or wiped out, and the debtor is free to make a fresh start.
There are a few complications to this simple arrangement. First, not all the
debtor’s property becomes part of the bankruptcy estate, to be sold for the benefit of
creditors. Federal law provides a number of exemptions — property which the debtor
is allowed to keep. Exempt property includes household items with less than a certain
value, specified amounts of equity in a home or an automobile, life insurance policies,
pension rights, and so on. There is also a provision in federal law permitting
individual states to make their own lists of exemptions: 35 states have done so, with
the result that bankrupt debtors in some states are allowed to keep substantially more
of their property than in others.1
Second, not all forms of debt can be discharged. Secured debt, where the lender
is protected by a lien on the borrower’s property or some collateral arrangement,
cannot be discharged. Thus, home mortgages survive bankruptcy, as do most loans
for automobiles and other “big-ticket” consumer items. Some forms of unsecured
debt cannot be discharged, either. Most back taxes, alimony and child support,
student loans made or guaranteed by the government, and tort judgements arising
from intentional harm to others or from drunk driving cannot be wiped away by a
Chapter 7 proceeding. The court may also refuse to discharge any debt that was
incurred through fraud — if the debtor lied on a loan application, for example, or
exhausted a line of credit just prior to filing for bankruptcy.
Debts that are otherwise dischargeable may remain in force if the debtor
voluntarily agrees to repay a particular creditor. Debtors may sign such reaffirmation
agreements out of guilt, friendship, or pressure from the creditor. If the reaffirmation
agreement is approved by the bankruptcy judge, that debt will not be included in the
general discharge of debt that is the conclusion of the Chapter 7 proceeding.2 Some
view such agreements as conflicting with a central principal of Chapter 7: equal
treatment for all unsecured creditors.
In
1
some states, for example, debtors are allowed to keep their homes, with no limit on
value. In others, this homestead exemption is zero.
Sears,
2
Roebuck & Co. Recently agreed to refund $100 million collected from 200,000
bankrupt customers pursuant to reaffirmations that were not approved by the bankruptcy
court. See: Segal, David. Sears Agrees to make $100 Million in Refunds. Washington Post,
June 5, 1997. p. D1.

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Chapter 13
Chapter 13 bankruptcy is available to debtors who have a regular income and
who wish to repay at least part of what they owe. Under the supervision of the court,
the debtor puts forward a repayment plan, which lasts from 3 to 5 years, at the end
of which debts are formally discharged and the debtor emerges from bankruptcy.
Under the Chapter 13 plan, the repayment of secured debt may be stretched out, and
unsecured debt may be reduced. (Home mortgages are the exception: the terms
cannot be altered by Chapter 13.) The law provides for minimum payments by the
debtor, and specifies that priority claims, such as taxes and alimony, must be paid in
full.
There are two major advantages for the debtor in Chapter 13: personal assets
are not seized, and the range of debts that can be discharged is greater than in Chapter
7. The drawback is that if the debtor fails to make payments according to the
repayment plan, the case can be dismissed, whereupon the debtor loses all protection
of the bankruptcy court. Creditors can resume their collection efforts under state law.
Often, the failed Chapter 13 debtor has no recourse but to file a Chapter 7
bankruptcy, incurring another set of legal fees. Approval, or confirmation, of a
Chapter 13 plan is contingent upon a judge’s finding that the debtor has a reasonable
chance of meeting its terms.
The Choice of Chapters
Generally, debtors with steady income and assets they wish to protect have an
incentive to choose Chapter 13, while those with few assets (or whose dischargeable
debts far outweigh the value of their assets) will prefer the quicker Chapter 7 process,
which leaves their future income unencumbered. However, the complexity of
bankruptcy law — only hinted at here — makes the choice highly dependent on the
type of assets owned, the forms of debt owed, and other factors of the individual
debtor’s financial situation.3
Individual debtors may also use Chapter 11, the bankruptcy procedure that is
most often used by large businesses.4 Chapter 11 provides for the reorganization of
the debtor’s finances and requires an extensive judicial process involving committees
of creditors, proposed plans, negotiation, and voting. Legal fees tend to be much
higher, with the result that relatively few personal bankruptcies take place in Chapter
11, as the table below shows.
For
3
a more thorough summary of the bankruptcy code see CRS Report 95-302 A, A
Bankruptcy Primer: Liquidation and Reorganization Under the U.S. Bankruptcy Code, by
Robin Jeweler.
See
4
CRS Report 96-426 E. Chapter 11 Bankruptcy: The Economic Issues, by Mark
Jickling.

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Table 1. Personal Bankruptcy Filings by Chapter, Selected Years
(As a percentage of total filings)
Chapter 7
Chapter 11
Chapter 13
1980
75.0
0.2
24.9
1985
69.6
0.9
29.5
1990
70.6
0.4
29.1
1997
70.9
0.1
29.0
Source: Administrative Office of the U.S. Courts.
These figures show that Chapter 7 remains the most common procedure,
although the proportion of Chapter 13 cases is somewhat higher than in 1980.
(Congress in 1984 amended the bankruptcy code to encourage more debtors to
choose Chapter 13.) A number of the Chapter 7 filings, of course, represent failed
Chapter 13 cases. No comprehensive data are available on the number of Chapter 13
plans that convert to Chapter 7 before completion of the repayment plans, but some
studies and estimates run as high as two-thirds.5
Who Files for Bankruptcy?
Government statistics on bankruptcy filings are extremely limited. The
Administrative Office of the U.S. Courts collects and publishes data on the number
of filings, divided into business or nonbusiness, and broken down by chapter of the
bankruptcy code and by court district. (Court districts are sometimes identical to
state borders; some states contain up to four districts.) No financial information of
any kind is regularly compiled, although court records include listings of filers’ assets
and liabilities. Thus, trends in aggregate indebtedness, debtors’ wealth and income,
debt-to-asset ratios, and so on are impossible to discern from official figures, as are
the demographic characteristics (other than geographic) of those who file bankruptcy
petitions.
The private and academic studies that attempt to fill this information void have
been sporadic.
6 Among the leaders in research into consumer bankruptcy have been
the Credit Research Center at Purdue University and, recently, some of the major
credit card companies. These studies seek to shed light on the causes of bankruptcy,
but differ in their focus, methodologies, and samples. Because of these differences,
the various studies cannot easily be compared, making them of limited value to
analysis of long-term trends in bankruptcy.
Sullivan,
5
Teresa A., Elizabeth Warren, and Jay Lawrence Westbrook. As We Forgive
Our Debtors. New York, Oxford University Press, 1989. p. 217.
6For an overview of empirical research on personal bankruptcy, see: A Reformed
Economic Model of Consumer Bankruptcy. Harvard Law Review, v. 109, April 1996. p.
1338.

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The discussion of the causes and economic implications of personal bankruptcy
that follows must be read with this lack of empirical data in mind. We do not have
the statistical knowledge that would allow construction of a profile of a typical
bankruptcy, let alone how that profile may have changed. There is a wealth of
anecdotal evidence to support any explanation or theory or policy prescription, but
also to support the opposite view. There are some signs (based on anecdotal
evidence, to be sure) that the definition of a “typical bankrupt” is becoming even more
elusive: bankers and other consumer lenders report a rise in “surprise” bankruptcies,
involving debtors who have shown no signs of financial distress prior to filing for
bankruptcy.
7 This phenomenon suggests that the causes of bankruptcy are becoming
more opaque even to those who have a direct financial interest in understanding and
quantifying them. Who are the average bankruptcy filers? According to Elizabeth
Warren, a bankruptcy scholar who worked with the National Bankruptcy Review
Commission, “they look like your neighbors.” The o
8
ne empirical trend not in dispute
is the rise in bankruptcy filings, shown in the figure below.
Figure 1. Bankruptcy Filings, 1980 - 1997
1600
Personal
1400
Business
1200
1000
800
600
400
200
0
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
Source: Administrative Office of the U.S. Courts.
Table 2 below examines the figures for personal bankruptcy filings in the light
of population growth. The rise in personal bankruptcies remains impressive even
expressed as a rate of filings per 1,000 individuals. The data make clear that
bankruptcy has grown at a pace that cannot be explained by population growth.
Frank,
7
Stephen E. Go Directly to Bankruptcy, Do Not Pass Delinquency. Wall Street
Journal, August 28, 1996. p. C1.
8Ward, Sandra. Bailing Out. Barron’s, June 17, 1996. p. 17.

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Table 2. Personal Bankruptcies, 1980-1997:
Number and Rate per 1,000 Population
Personal Bankruptcies
Personal Bankruptcies
Year
Number
Rate/1,000
Year
Number
Rate/1,000
population
population
1980
287,570
1.26
1989
616,226
2.49
1981
315,818
1.37
1990
718,107
2.87
1982
310,951
1.34
1991
872,438
3.45
1983
286,444
1.22
1992
900,874
3.53
1984
284,517
1.20
1993
812,898
3.15
1985
341,233
1.43
1994
780,455
2.99
1986
449,203
1.87
1995
874,642
3.33
1987
495,553
2.04
1996
1,125,006
4.24
1988
549,612
2.24
1997
1,350,118
5.02
Source: Administrative Office of U.S. Courts; Bureau of the Census.
Explanations for the Rise in Bankruptcy Filings
Explanations for the increase in personal bankruptcy filings since the early 1980s
fall into several categories. These include:
! changes in supply and demand conditions in credit markets;
! changes in labor markets and in society that tend to make household finances
more precarious;
! growing consumer confidence in the strong economy, leading to an increased
willingness to take on debt;
! sociological factors, such as a decline in the stigma associated with debt and
bankruptcy;
! perceptions that current law, beginning with the Bankruptcy Reform Act of
1978, has made bankruptcy too attractive; and
! local factors, which may be legal, sociological, or economic.

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Credit Market Conditions
Since bankruptcy is by definition a situation of excessive debt, trends in
household indebtedness are a logical first place to look for evidence bearing on the
rise in bankruptcies. The Federal Reserve, in its flow of funds accounts, tracks
changes in household liabilities. The two major components of household debt are
mortgages (including home equity loans) and consumer credit (credit card debt —
called revolving credit — and loans for vehicles, education, and other purposes).
These two items account for virtually all household debt. Table 3 shows the amounts
outstanding in these components of household debt at year-end from 1980-1996,
expressed as a percentage of disposable personal (that is, after-tax) income (DPI).
The figures in table 3 indicate that household debt has been rising as a percentage
of disposable income. The two categories of debt equaled 85.6% of DPI in 1996, up
from 60.6% in 1980. Other things being equal, a rise in debt burden relative to
income indicates an increased probability of bankruptcy in the event of an interruption
in income or an unexpected rise in other expenses.
In the literature on bankruptcy, very little attention is devoted to mortgage debt,
even though the amount is three times the amount of consumer debt, and even though
it may be increasingly substitutable for other kinds of debt, in the form of home equity
loans. As noted above, mortgage debt is generally not affected by the bankruptcy
process: it can be neither discharged nor rescheduled by the bankruptcy court.
Therefore, there is no incentive to file bankruptcy for a borrower having trouble
meeting mortgage obligations. However, such a household would likely have other
forms of debt as well, so there may be a correlation between mortgage debt and the
incidence of bankruptcy. That is, if a greater proportion of a household’s DPI must
go to repay mortgage or home equity loans, less income remains to cope with
unexpected financial adversity from other sources.
Consumer credit is much more often cited as a cause of bankruptcy. Table 3
shows that consumer credit as a percentage of DPI reached a post-1980 high in 1996,
but that the increase over 1986 was small. However, the revolving credit, or credit
card, component of consumer credit, which is a central focus of the bankruptcy
debate, has been growing steadily over the 1980-1996 period. Why is credit card debt
singled out, when it represents less than 10% of total household debt? borrower
having trouble meeting mortgage obligations. However, such a household would
likely have other forms of debt as well, so there may be a correlation between
mortgage debt and the incidence of bankruptcy. That is, if a grater proportion of a
household’s DPI must go to repay mortgage or home equity loans, less income
remains to cope with unexpected financial adversity from other sources.
Consumer credit is much more often cited as a cause of bankruptcy. Table 3
shows that consumer credit as a percentage of DPI reached a post-1980 high in 1996,
but that the increase over 1986 was small. However, the revolving credit, or credit

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Table 3. Selected Components of Household Debt as a Percentage
of Disposable Personal Income, 1980-1996
Year
Home Mortgages
Consumer Credit (as % of DPI)
(as % of DPI)
Total
Revolving Credit
1980
43.5
17.1
2.7
1982
41.7
16.1
2.8
1984
42.1
17.9
3.5
1986
49.5
20.3
4.2
1988
54.2
19.8
4.7
1990
58.5
19.1
5.2
1992
59.4
16.9
5.4
1994
61.7
19.2
6.9
1996
64.1
21.5
8.5
Note: Consumer credit consists of car loans, loans for education, boats, trailers, and
vacations, and revolving credit — credit cards issued by banks, stores, and oil
companies.
Source: Department of Commerce, Bureau of Economic Analysis; Federal Reserve,
Flow of Funds.
card, component of consumer credit, which is a central focus of the bankruptcy
debate, has been growing steadily over the 1980-1996 period. Why is credit card debt
singled out, when it represents less than 10% of total household debt?
There are a number of reasons: credit card borrowers are charged relatively high
interest rates, meaning that a dollar of credit card debt requires a higher debt service
payment than a dollar of other debt. Regardless of the total household debt picture,
the use of credit cards has grown in highly visible ways. The credit card industry has
become highly competitive and is characterized by aggressive and ubiquitous
marketing. Finally, it is widely believed that many households in financial distress use
credit cards as a lender of last resort, which means (1) that a large proportion of
bankruptcy filers will have unpaid credit card balances and (2) credit card issuers will
bear much of the loss from debt discharged in bankruptcy proceedings (since credit
card debt is unsecured).
The causal relationship between credit cards and bankruptcy is controversial.
Credit card issuers are among the most vocal of those calling for a “tightening up” of
the bankruptcy code, which they believe creates an incentive for and rewards
consumer behavior that is imprudent at best and fraudulent at worst. Consumer
advocates maintain that lenders, in search of high profits based on high interest rates,
have over saturated the market by sending out billions of unsolicited offers of credit

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each year. In the process, some believe lenders lowered their credit standards to the
point where a dramatic increase in defaults was to be expected. The two sides agree
that excessive credit card debt is related to the rise in bankruptcies, but differ over
whether to blame the supply or demand side of the consumer credit market.9
Why Has Household Debt Risen?
That the number of bankruptcies and the household debt burden have risen
together is not surprising. The question then becomes how to account for the
increase in household debt relative to income. There are two sets of answers: one
set considers various weaknesses in the labor market as sources of financial distress,
while the other views rising debt as a natural result of prosperity and economic
confidence.
Among the explanations of higher consumer debt burdens that involve
weaknesses in the economy are the following:
! Real wages in the United States have been flat since the 1970s as productivity
growth has stalled. Moreover, the aggregate wage figures are said to mask
growing income inequality: substantial gains for some high-income workers are
offset by actual income losses for many lower on the economic ladder. The
losers may go into debt rather than accept a lower standard of living.
! A similar argument applies to workers displaced, or downsized, from high-
paying jobs (in manufacturing, for instance) into low-wage service sector
industries, where much of the recent growth in employment has taken place.
! Many workers (employed and unemployed) do not have health insurance
benefits and cannot afford to pay the full premiums out of their own pockets.
Debt resulting from a serious illness or hospital stay can easily precipitate a
financial crisis.
Each of these scenarios is plausible and no doubt applies to many individual
bankruptcy cases. However, it is not easy to accept any of them (or all together) as
a sufficient explanation for the dramatic rise in bankruptcy filings that has been
observed. Would not the impact of long-term transitions in labor markets have been
cushioned by the decline in the unemployment rate (which was in the 7%-10% range
during the early 1980s, but has fallen in recent years to below 5%)? The relation
between bankruptcy filings and recession is interesting. The latest periods of
economic recession, in 1980-1982 and 1990-1991, were both followed by drops in
bankruptcy filings. It may be that for every household that was cast into bankruptcy
by a job loss or a sales slump caused by recession, several other households took
fright and began to save more and borrow less. In both post-recession periods, the
upward trend in bankruptcy resumes after about two years, as appears in figure 1
above, perhaps as the memories of the recession fade.
For
9
an analysis of credit card debt and personal bankruptcy, see CRS Report 98-277
E, Bankruptcy and Credit Card Debt: Is There a Causal Relationship?

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The high cost of medical care and the lack of universal insurance coverage are
doubtless serious problems, but they are not new problems. Although medical costs
have been rising, they were very high in 1980. To the average family, the bills
stemming from a serious illness or accident were already impossible to meet in 1980
without the aid of insurance. Thus, while many bankruptcies are no doubt attributable
to unforseen medical expenses, it is not clear that the overall health care situation has
worsened sufficiently since 1980 to account for the rise in personal bankruptcy.
Two economists from the Federal Reserve Bank of New York have put forward
an alternative explanation for the rise in household debt burdens and the consequent
increase in debt defaults. They obs
10
erve that two factors seem to dictate the amount
of debt that households are willing to take on: age and wealth. According to the “life-
cycle” theory, individuals in youth and middle-age tend to borrow against future
income to maintain a stable standard of living. The years of heaviest borrowing are
between the ages of 25 and 54; thereafter, incomes generally cease to rise and
individuals begin to work down their debt levels. The second factor is wealth: as
wealth rises, so do spending and the demand for credit. Looking back as far as the
1950s, Morgan and Toll find that these two variables — real net worth per capita and
the share of the population between 25 and 54 years of age — moved in opposite
directions until 1983 when, thanks to the demographics of the baby boom and the bull
market in stocks, both began to rise in tandem. In other words, the two effects on the
demand for debt financing were offsetting until 1983 but have been complementary
since. “This convergence,” they conclude, “has fueled the demand for credit and has
driven up debt burdens, making borrowers riskier.”11

Sociological Factors
Another set of explanations for the bankruptcy increase is grounded not in
economic trends and conditions, but in what might be called sociological factors.
These explanations are based on moral judgements, and many find them persuasive.
The essence of this view is that the shame, or stigma, that formerly attached to debt,
“failure,” and bankruptcy has diminished. As a result, people are now more willing
to borrow more than they can repay and feel less compunction about using the legal
system to walk away from their debts. Moral rectitude, in other words, has lost
ground to immediate economic gratification.
Related and more specific instances of decline in traditional values are also cited.
Divorce and single parenthood push many individuals into poverty, and some of them
end up in bankruptcy court. Losses from legalized gambling are said to figure in a
rising number of bankruptcy cases. Bankruptcy lawyers, who were prevented by
professional codes of conduct from advertising their services until a few decades ago,
come in for a share of blame. Some claim that a significant fraction of personal
bankruptcies involve outright fraud — debtors who go on spending sprees before
filing, who transfer assets to friends or family members to keep them from creditors,
or who file incomplete or misleading documents with the bankruptcy court. (Current
10Morgan, Donald P. and Ian Toll. Bad Debt Rising. Federal Reserve Bank of New
York Current Issues in Economic and Finance, v. 3, March 1997. 6 p.
Ibid
11
., p. 5.

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law allows judges to reject petitions where fraud or abuse has occurred, but the
volume of cases is said to make effective supervision nearly impossible.)
It is difficult to evaluate the role these sociological factors have played in the
increase in personal bankruptcy since 1980. The difference between anecdotal and
statistical evidence is important here. Divorce, for example, will be cited by a number
of respondents to any survey of the causes of bankruptcy, yet the divorce rate in the
general population was higher in the early 1980s than in the 1990s. Other
phenomena, such as gambling and single parenthood, may have become more
common since 1980, but the data we have do not permit statistical testing of their
contribution to the rising bankruptcy rate.
The general argument that people feel less shame about borrowing and not
repaying involves a moral judgement that is not subject to empirical proof or
refutation. It is not implausible, but some skepticism is in order. Every generation
detects moral decay in its successor. Besides, the implicit comparison in these
sociological explanations is not between the present generation and the likes of
Lincoln and Washington, but between current behavior and that of Americans of the
1960s and 1970s, in whom we surely recognize many of our own faults, but who
nonetheless were much less likely to file for bankruptcy.
Local Factors
The preceding attempts to identify causes of the rise in bankruptcy filings assume
that the factors at work are nationwide. Other analysts focus on local factors that
may account for higher rates of bankruptcies in certain states and judicial districts, and
thus inflate the national bankruptcy figures. Higher than average bankruptcy rates
12
have been observed in areas where one or more of these factors occur:
! automobile liability insurance is not mandatory;
! the divorce rate is higher than the national average;
! medical insurance coverage is below average; or
! state law provides generous property exemptions for Chapter 7 filers.
Table 4 illustrates the differences among states in the rate of bankruptcy filings
per hundred households. The table includes the ten states with the highest personal
bankruptcy rates in 1996, the ten with the lowest, and the national average. Several
features of the data are noteworthy. There is a wide range in rates: Tennesseans
were over four times as likely to declare bankruptcy in 1996 than Alaskans. The
variation seems to persist: the top ten states in 1996 had higher than average
bankruptcy rates in 1980 and 1990 as well, while the bottom ten, without exception,
were below average in the earlier years. This suggests that regional differences do
influence the bankruptcy rate independently of national trends. At the same time, the
12See, e.g., Bleakley, Fred R. Debate Mounts Over Rising Bankruptcies. Wall Street
Journal, May 23, 1996. P. A2.

CRS-12
general upward trend in the bankruptcy rate is unmistakable; national factors are
clearly at work, too.
Table 4. Bankruptcy Rates (Filings per 100 Households)
for Selected States: 1980, 1990, and 1996
State
1996
1990
1980
Tennessee
2.22
2.38
0.81
Georgia
1.97
1.70
0.56
Alabama
1.85
1.72
0.77
Nevada
1.59
1.39
0.72
California
1.52
1.04
0.52
Mississippi
1.41
1.23
0.56
Utah
1.35
1.47
0.60
Oklahoma
1.30
1.27
0.43
Virginia
1.30
0.94
0.49
Oregon
1.27
1.10
0.50
U.S. AVERAGE
1.20
0.85
0.41
N. Carolina
0.70
0.50
0.37
W. Virginia
0.70
0.54
0.26
Hawaii
0.64
0.25
0.27
S. Carolina
0.64
0.44
0.12
S. Dakota
0.63
0.59
0.29
N. Dakota
0.62
0.46
0.26
Pennsylvania
0.62
0.40
0.18
Vermont
0.56
0.33
0.17
Maine
0.55
0.39
0.25
Alaska
0.50
0.58
0.38
Source: Bureau of the Census; Administrative Office of U.S. Courts.

CRS-13
Bankruptcy’s Effects on the Economy
The preceding section considered various explanations, based on changes in the
economy, the law, and in society, for the rise in personal bankruptcies. Another side
of the issue is the reverse perspective: what are the effects of current levels of
bankruptcy filings on the economy and society? Can economic growth be sustained
in the face of a million bankruptcies a year?
Sometimes bankruptcy is thought of as a loss to the economy. Borrowers
receive money and purchase goods and services; this is the normal process by which
credit expands economic activity. When loans are not repaid, or goods and services
consumed but not paid for, the supplier of credit suffers a loss of wealth, which may
be borne by its owners, its employees, or others who have a stake in the firm. To
economists, however, this loss represents a transfer payment from creditor to debtor,
which is not the same as a loss of national income or a decline in economic activity.
The distribution of wealth has been affected, but not the amount.
The existence of loan defaults, even in large numbers, is not necessarily an
indication that credit markets are malfunctioning. Extenders of credit do not expect
all loans to be repaid. The price of a loan should reflect the risk of default. Thus, the
common statement, that all borrowers have to pay the costs of bankruptcy in higher
interest rates, is technically not true. In a competitive market, a lender cannot charge
one class of borrowers for the risk represented by another class. A borrower asked
to pay above market rates (which are a function of the risk that borrower represents)
will go to another lender. This is what economic theory has to say about bankruptcy,
but in historical experience credit markets do not always function perfectly.
During the 1980s, many banking institutions came under financial pressure or
failed as a result of widespread mispricing of credit risk in several episodes involving
lending to commercial real estate developers, entrepreneurs in the oil patch, and
issuers of high-yield (junk) bonds. Are consumer loans likely to develop into the next
banking crisis? In 1996, as credit card default rates reached record highs, Congress
held several hearings on this issue, receiving testimony from bank regulators. The
consensus view was reflected in this statement by Federal Reserve Governor Janet
Yellen:
To sum up, the rapid growth in consumer lending by banks, particularly that
involving credit cards, reflects a natural evolution of banking activities toward the
household sector and has generally enhanced consumer convenience and produced
significant profits for banks....[Banks determine] price and reserve [levels] for
credit card loans with the expectation of occasional periods of relatively high rates
of loss. Therefore, unless future conditions deteriorate dramatically, we believe
that the industry is well positioned to absorb any problems resulting from the
competitive consumer underwriting practices of the recent past.13
13Statement before the Senate Committee on Banking, Housing, and Urban Affairs,
Subcommittee on Financial Institutions and Regulatory Relief, July 23, 1996. In: Federal
Reserve Bulletin, v. 82, September 1996. p. 818.

CRS-14
Another concern is that households may change course and begin reducing their
debt instead of accumulating more, causing a decline in consumer spending and a
general economic slowdown. Some speak of a consumer “debt bomb,” with the
potential to trigger a recession or exacerbate a recession caused by other factors.14
Economic research finds, however, that high consumer debt levels in the past have not
predicted more cautious spending behavior. Recent studies suggest that households
increase both debt and spending as their perceptions of their income prospects
improve, and that the current consumer debt burden is not alarming in the context
15
of rising wealth and “a generally healthy economic situation for U.S. households.”16
What Can Be Done?
If reducing the number of bankruptcy filings is to be a policy goal, the many
factors that can be offered as causes of bankruptcy suggest that there may be no single
path of action that will be quick and efficacious. Government intervention can do
little to restore a sense of financial shame, to put real wages on a upward path again,
or to prevent families from breaking up. Achieving universal access to affordable
health care has proven difficult. Government action could certainly restrict the supply
of credit, but this cure might be worse than the disease. As a Federal Reserve official
put it:
From an economic point of view, there is nothing wrong with consumers increasing
their debt, per se....Suffice it to say that there are good reasons for any American
family to take on additional debt and that it would be wrong for a Federal Reserve
Governor to opine that some particular American family is too much in debt.
Individuals know their own circumstances far better than any government
official.17
What can be done is to amend the bankruptcy code. The current law, which
dates from the Bankruptcy Reform Act of 1978, has been criticized almost since its
enactment for being too lenient towards debtors. On October
18
20, 1997, the National
Bankruptcy Review Commission (NBRC), created by legislation in 1994, delivered
a 1498-page report, Bankruptcy: The Next 20 Years, to the Congress, the President,
and the Supreme Court. The NBRC report contains 172 recommendations for
changes in the bankruptcy law. The report does not recommend a through-and-
Epstein, Gene. Bankrupt Theory.
14
Barron’s, February 3, 1997. p. 17.
McCarthy,
15
Jonathan. Debt, Delinquencies, and Consumer Spending. Federal Reserve
Bank of New York Current Issues in Economic and Finance, v. 3, February 1997. 5 p.
16Garner, C. Alan. Can Measures of the Consumer Debt Burden Reliably Predict an
Economic Slowdown? Federal Reserve Bank of Kansas City Economic Review, Fourth
Quarter 1996. p. 74.
Testimony
17
of Lawrence B. Lindsey in: U.S. Congress. House. Committee on Banking
and Financial Services. Consumer Debt. Hearing, 104th Cong., 2 sess. September 12
nd
,
1996. (Serial No. 104-74). p. 12.
See,
18
e.g., Carter, Charlie. The Surge in Bankruptcies: Is the New Law Responsible?
Federal Reserve Bank of Atlanta Economic Review, January 1982. p. 20.

CRS-15
through rewriting of the law, as did the 1970 commission which led to the Bankruptcy
Reform Act of 1978 (which replaced the existing law in its entirety); in the words of
NBRC Chairman Brady Williamson, it does not “disturb the fundamental tenets of
current law.”19
In addition to the NBRC report, several bills before the 105th Congress, H.R.
2500, H.R. 3146, H.R. 3150, and S. 1301, propose amendments to the bankruptcy
code that would affect many of the issues discussed in this report. The last two of
20
these bills, as noted above, have been reported out of the Judiciary committees in
House and Senate in 1998. Major areas of reform that bear upon consumer
bankruptcy, as proposed in these bills and in the NBRC report, are described below:
! Require Chapter 13 Rather than Chapter 7 Filings. This is a shift strongly
supported by lenders, who believe that many debtors file Chapter 7 even
though their income is sufficient to repay at least part of what they owe. H.R.
3150 and S. 1301 introduce the concept of “needs-based” bankruptcy —
Chapter 7 would be available only to those debtors who are too weak
financially to meet a Chapter 13 repayment plan. H.R. 2500 and H.R. 3150
contain a formula that subtracts payments on secured debts, other financial
obligations (child support, alimony, etc.), and living expenses from gross
income to yield a net income figure. If this amount is sufficient to allow the
debtor to repay at least 20% of unsecured debts over the next 5 years, the
debtor must file Chapter 13 and turn over all net income to his unsecured
creditors. S. 1301 does not include the formula, but requires a Chapter 13
filing if the bankruptcy judge determines that the debtor could pay back at least
20% of unsecured debt. In addition, S. 1301 would allow creditors to
challenge a Chapter 13 filing if they believed a debtor had sufficient income to
repay. H.R. 3146 would allow bankruptcy petitions to be dismissed as
“abusive” if debtors were able to repay all of their unsecured debts over three
years, provided that they met a minimum income level (adjusted for family
size). The NBRC report does not include a means test among its
recommendations.
“Needs-based” bankruptcy, in some form, is supported by the credit industry.
A potential drawback is that many Chapter 13 plans confirmed under present law fail,
suggesting that many debtors, who enter Chapter 13 because they feel it is the right
thing to do, simply lack the financial resources to keep up with the payments. A failed
Chapter 13 plan benefits neither debtor nor creditor, and increases the courts’
workload considerably: the petitioner must appear again with a Chapter 7 filing.
Whether the needs test would produce a fairer bankruptcy system depends on the
financial condition of bankruptcy petitioners, about which we have little
comprehensive data.
Review
19
Commission Releases Report Recommending Changes to Bankruptcy Code.
Bureau of National Affairs Daily Report for Executives, October 21, 1997. p. AA-1. (The
report is available on the Internet at: [http://www.access.gpo.gov/nbrc/reportcont.html].)
20 See CRS Report 98-277A, Consumer Bankruptcy Reform: Proposals Before the
105th Congress, by Robin Jeweler.

CRS-16
! Uniform Federal Exemptions. As noted above, the amount of property a
Chapter 7 debtor can keep varies widely according to state law. The NBRC
report calls for national limits on the amount of property that could be
exempted from the bankruptcy estate. The homestead exemption (value of
equity in a home that the debtor could keep, would still follow state law, but
the NBRC calls for a maximum exemption of $100,000 and a minimum of
$20,000. Exemptions for other personal property could not exceed $20,000,
except that debtors who did not claim a homestead exemption would be
allowed to exempt another $15,000 in personal property.
H.R. 3146 would adopt the $100,000 figure as a ceiling on homestead
exemptions under certain circumstances and would establish the existing federal
homestead exemption as a national minimum figure.
H.R. 3150 contains a uniform definition of “household goods” for purposes of
exemption from bankruptcy estates.
H.R. 2500 would create a national commission to study the issue of uniform
levels of exemption, and the appropriate size of those exemptions.
! Integrity of the Bankruptcy System. H.R. 3150, S. 1301, and the NBRC
propose to establish a system of random audits to detect and deter bankruptcy
fraud and call for improved collection and publication of data regarding the
financial condition of bankrupts. An NBRC proposal would increase lawyers’
responsibility for the accuracy of filings submitted by their clients. The NBRC
report also calls for the establishment of a national bankruptcy registry to
prevent abusive multiple filings by single individuals in different jurisdictions.
A serious constraint on improving the efficiency of the system and deterring
fraud and abuse is the high workload. With only 325 bankruptcy judges in the
country, it is estimated that a judge must dispose of the average case in only 35
minutes.21
What makes bankruptcy reform difficult, apart from the complexity of the law
itself, is the lack of comprehensive information about the millions who are filing
bankruptcy petitions. If large numbers of people abuse the system — by borrowing,
spending on luxuries, and walking away from debts rather than living within their
means — legal reforms intended to make bankruptcy more difficult and painful may
be appropriate. If, on the other hand, the rise in bankruptcy filings reflects a rise in
genuine financial insecurity and distress, those same reforms may deprive many
households of the chance to make a fresh start. The law seeks to balance the interests
of debtors and creditors; the bankruptcy numbers have raised the stakes in the debate.
21Testimony of Stephen H. Case before the House Committee on the Judiciary,
Subcommittee on Commercial and Administrative Law. Hearing, 105th Cong., 1st sess, on the
operation of the bankruptcy system. April 16, 1997.