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Bankruptcy and the Crisis: Why so Few?

By Alan White

Many thanks to Bob for the invitation to guest blog here.  Those who follow Bob's postings on bankruptcy filing numbers will have seen that U.S. consumer bankruptcy filings have been plodding upwards steadily, but only to roughly where they were before the BAPCPA bubble back in 2005.  One of the inscrutable mysteries of the financial crisis of 2007-??, which is after all a housing and consumer debt crisis, has been how few bankruptcies have been filed.  Somehow, historically unprecedented levels of consumer debt and loan defaults have not produced the surge in bankruptcy filings one would expect.

American households tripled their mortgage debt from $3.5 trillion at the end of 1996 to $10.5 trillion at the end of 2007.  Median income, meanwhile, rose by about 40%.  While credit card and other unsecured debt grew less dramatically, that is only because homeowners used mortgage refinancing to soak up quite a bit of credit card debt.  All this debt growth came to a screeching halt in early 2008, after subprime mortgage lenders were wiped out by early payment defaults, and the bond market, spooked by losses at Bear Sterns and elsewhere, suddenly lost its appetite for mortgage-backed securities.  

Unable to recycle their loans any longer, homeowners and consumers defaulted.  Debt defaults for consumers and homeowners are now running at two to five times their pre-crisis levels.  Each quarter for the past two years, the Mortgage Bankers Association has announced new all-time highs for mortgage default or foreclosure rates.  Through previous business cycles the combined rate of foreclosures and 90-day delinquencies has rarely exceeded 2% of all mortgages; it now stands at 9.7%, and will probably exceed 10% in the second quarter numbers due out this week.  Credit card charge-off rates for banks have been hovering around 10%, compared to their usual 3% to 5% range in the recent past.  So debt, and debt defaults, are much, much higher than they have been at any time since the 1978 Bankruptcy Code.  But filings are not.   
  
The Treasury Department estimates that there are 1.6 million homeowners nationwide who are 60 days delinquent, and are otherwise candidates for workouts through the Administration?s HAMP program.  Chapter 13 filings, the logical choice for homeowners trying to work out mortgage debt, are running at 25% of filings,so we can expect perhaps 400,000 Chapter 13s for calendar 2010.

The gap between Chapter 13 filings and distressed mortgage borrowers looks even greater when you consider that not all Chapter 13s are filed to deal with foreclosures; some Chapter 13 debtors are not even homeowners.   Perhaps Chapter 7s are being filed by distressed mortgage debtors to help with a graceful exit, but bankruptcy is clearly not playing a central part in deleveraging the American homeowner.

While there may be good reasons for this disconnect between bankruptcy filings and the debt crisis, including the presence of a shadow consumer bankruptcy system (about which more later) this does raise the old question, ?if bankruptcy is the solution, what is the problem??    Or, ?if not now, when??

Full post as published by Credit Slips on August 18, 2010 (boomark / email).