Friday, January 8, 2010

Not only did U.S. consumer bankruptcies jump by nearly a third in 2009, but bankruptcy analysts expect matters to worsen again in 2010 as the deepest economic downturn since the Great Depression continues to work its way through American households.

Consumer bankruptcy filings exceeded 1.4 million last year compared with 1.06 million in 2008, an increase of 32 percent, according to the American Bankruptcy Institute (ABI), a nonpartisan, independent research and education organization. The ABI relied on data compiled by the National Bankruptcy Research Center.

“A combination of economic stress, including high debt loads, rising unemployment and unsustainable mortgage burdens, left many consumers with little choice but to seek the financial relief of bankruptcy,” ABI Executive Director Samuel J. Gerdano said.

“The future is more of the same,” he said.

Robert Lawless, a law professor at the University of Illinois who has conducted extensive research on consumer bankruptcy, said he expects 1.7 million people will file for bankruptcy this year.

Such a figure would be the second highest on record, trailing only 2005’s total of 2.04 million. The 2005 number is distorted by a rush of bankruptcy filings before a tougher law took effect.

“I think I am going to be very busy for the next five years,” said Claire Ann Resop, a Wisconsin bankruptcy lawyer. “I tell my children, ‘Mommy works in a growth industry.’ ”

Overburdened by huge mortgages, plunging home values, unsustainable credit card debts, tightening credit conditions and soaring joblessness, families have been carrying an “overhang of consumer debt” for a decade or so as a result of a low savings rate and overconsumption.

The resulting “debt bubble,” Mr. Gerdano said, led to a soaring bankruptcy rate.

“The ability to tap into home equity to bridge difficult times is no longer available,” he said, because home prices have plunged since the housing bubble began to deflate in 2006.

In 2006, for the first time ever, total U.S. household debt exceeded personal income, Mr. Lawless noted, leading to more bankruptcies in the short term.

“The biggest determinant of personal bankruptcy is consumer debt, including credit cards, car loans and home mortgages,” he said.

The recession, which began in December 2007, made a difficult situation much worse.

“People can no longer borrow to stave off the day of reckoning, mainly because of the financial crisis, which has been unprecedented in terms of consumer borrowing,” Mr. Lawless said.

Home equity loans disappeared as fast as the equity itself, and credit card companies tightened considerably in the face of huge losses.

“Bankruptcy is often an indicator of what is going on in the real economy,” said Maureen Thompson, legislative director of the National Association of Consumer Bankruptcy Attorneys.

“People are getting laid off and losing their health insurance. Others who are carrying big debts can’t get home equity loans or refinance their mortgages. It has now all come together. People on Main Street are really hurting, and that pain is not going away, despite current economic indicators” that suggest the recession has ended, Ms. Thompson said.

Consumer bankruptcy filings have increased during each of the past three years. In 2009, they reached their highest level since 2005, when more than 2 million people filed for bankruptcy. The Bankruptcy Abuse Prevention and Consumer Protection Act became effective in October 2005.

Fewer than 600,000 people filed for bankruptcy in 2006, in part because the 2005 law tightened the criteria for filing and because many beat the law’s October implementation. Bankruptcies topped 800,000 in 2007 and surpassed the 1 million threshold in 2008.

Chapter 7 of the bankruptcy code provides for “liquidation,” in which the debtor’s property is sold and the proceeds are distributed to creditors. The balance of the unsecured debt is discharged to give honest debtors a fresh start.

The 2005 law made it more difficult for households to file under Chapter 7 and to eliminate their debts, especially if their income exceeded the median level in their state. If a “means test” indicates that a debtor can repay a portion of the restructured debts, Chapter 7 is normally not an option.

The goal of the 2005 law was to steer more consumers to Chapter 13, which requires repayment of all or part of the debts to unsecured creditors. In return, the bankruptcy filers are able to retain some secured assets, such as cars and primary residences, that otherwise would be liquidated. The opportunity to save a home from foreclosure is a major benefit of Chapter 13, although filers are required to make timely mortgage payments that come due under their Chapter 13 payment plan.

To file under Chapter 13, a person must have regular income, Mr. Lawless said. But the explosion of long-term unemployment has meant that many filing for bankruptcy today do not meet that standard. Nearly 40 percent, a record-level proportion, of the nation’s 15.4 million unemployed people have been jobless for 27 weeks or longer.

In the past, 70 percent of consumers filed for bankruptcy under Chapter 7 while 30 percent used Chapter 13, said Mr. Gerdano, of the ABI. Shortly after the 2005 law went into effect, Chapter 13 filers increased to about 40 percent, he said. But now the ratio is back to 70 percent to 30 percent.

“The laws of economic gravity are a lot stronger than the laws of Congress,” Mr. Gerdano said.

“If you cannot outlaw unemployment or uninsured medical expenses or divorce, then you are not going to do anything about rising bankruptcies,” said Ms. Thompson, the representative of bankruptcy lawyers, who said her organization never believed the ratio of Chapter 7/Chapter 13 filings would be changed over the long term.

“The vast majority of people file for bankruptcy as a last resort,” she said. “They try to pay their debts, including the 30 percent credit card interest rates, until they can pay no more.”

Ms. Resop is a bankruptcy lawyer specializing in Chapter 7 cases in Madison and Janesville, Wis., where a General Motors Co. plant shut down a year ago. Her business is up 40 percent to 50 percent over the past six months.

“I see a lot more middle-aged people and households that own real estate filing for bankruptcy today,” Ms. Resop said. “Many of these people, who are in their 50s and 60s, got second and third mortgages to keep up with other bills over the years.” Now, they are being crushed by the collapse of housing equity.

They are filing under Chapter 7, eliminating their debt and surrendering their homes, Ms. Resop said, but they will never replace their relatively high factory incomes.

“This is not a situation where somebody loses his job for a short time,” she said. “I am not seeing short-term income problems that need to be addressed through bankruptcy.”

A surge of middle-class bankruptcy clients this year likely will be knocking on the doors of the New York-based Consumer Bankruptcy Project, which normally serves low-income filers, said the pro bono organization’s director, John McManus.

“We have a very high demand today with a non-emergency waiting list of six months,” Mr. McManus said. “Many of them, unemployed for a long time, will have exhausted their jobless benefits and savings and, unfortunately, even dipped into their pensions, which are protected under the bankruptcy laws.”

The range of bankruptcy filers Ms. Resop represents illustrates the extent to which the housing and mortgage crises have decimated the lives of her clients.

“Developers, architects and real estate investors, who made millions of dollars during the booming years, now have zero incomes, and they can’t liquidate their assets because their houses are worth so much less than their mortgages,” she said.

The housing collapse also has filtered down to the working- and middle-class households. Ms. Resop also is representing “landscapers, concrete guys, log-home builders, plumbers - the list goes on. They’ve all maxed out their lines of credit.”

The foreseeable future is not looking any brighter, analysts say.

“The home is now becoming the biggest problem with regard to debt burdens,” Mr. Gerdano said.

However, home prices likely will resume their decline this year, hitting a trough during the third quarter of 2010, according to forecasts by Mark Zandi, chief economist of Moody’s Housing prices will continue falling in the biggest bubble areas, such as Florida, Southern California, Arizona and Nevada, where the bankruptcy business is booming, Mr. Gerdano said.

The foreclosure epidemic has not reached its peak, according to the projections of Mr. Zandi, who expects foreclosure sales to total 4.8 million between 2009 and 2011. About 25 percent of single-family homes with mortgages have negative equity, said Mr. Zandi, who expects today’s unemployment rate of 10 percent to peak at 10.7 percent in the third quarter, further aggravating the bankruptcy problems.

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