Bankruptcy Filings Will Be the Lowest Since 1995 -- Here Is a Reason...

In June, I said we are on track for just over 900,000 bankruptcy filings for 2014. The latest data are in from Epiq Systems, and that 900,000 figure remains the best estimate for the calendar year. We have had 556,875 total bankruptcy filings this year, and in 2012 and 2013, the last five months added 39.5% more filings. That gives an estimate of abut 907,000 filings for 2014.

Year-over-year declines remain large. There were 77,489 total bankruptcy filings in July or 3,521 filings per business day, a 11.7% decline from the previous year.

As the chart shows, the number of bankruptcy filings will be the lowest in the last seventeen years -- indeed the lowest since 1995. Those of you paying attention at home might point out that 2006 and 2007 appear to be lower, but these were the years around the passage of the 2005 bankruptcy amendments. If we average 2005 - 2007 for a more accurate picture, there were 1.1 million filings per year.

Whenever I post these updates, someone will ask the reasons for the decline. Well, I have studied individuals who file bankruptcy, and I have arrived at the sort of conclusion that only can come from academic study -- people who file bankruptcy are heavily indebted.

Bankruptcy is all about the household balance sheet, specifically the right-hand side of the balance sheet. No debt, no bankruptcy. And, it has to be debt that a bankruptcy filing will help.

Overall debt levels are deceiving. Total consumer debt (not including mortgages) is about $3.1 trillion. which seems like an increase from 2006 when it was $2.4 trillion. Since 2006, however, the Fed has been separately reporting student loans, and that figure has been growing as a percentage of total consumer debt. Of course, a bankruptcy filing can do very little for student debt because of the strong presumptions against nondischargeability.

The punch line is that if you subtract student loan debt and adjust for inflation and population growth, the consumer debt for which bankruptcy is most effective has fallen about 20% since 2006. "Bankruptcy" is not a synonym for "financially distressed." Rather, it is a legal act with legal consequences, and those consequences have become less beneficial for U.S. households.  There is less debt that can be discharged in bankruptcy, lowering demand for bankruptcy filings.

Sometimes, I get push back about the relevance of unemployment rates. Sure, rising incomes and with full employment can dramatically lower the need for a household to file bankruptcy, but a crushing debt service -- perhaps from an medical crisis -- can overwhelm an income that was perhaps satisfactory for the debt that previously existed but not for the new obligations. Unemployment and income play a role, but the main factor driving the bankruptcy rate down is the lack of household debt, especially debt that can be discharged in bankruptcy.