Wednesday, November 5, 2008

The Effect of a Decrease in Credit Availability on the Number of Future Bankruptcy Filings

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

National bankruptcy filings in October 2008 increased significantly, a much greater month-to-month increase than in the previous few months. Using the average daily filing rate (more accurate than raw monthly comparisons), after month-to-month increases in July of 2.4%, in August of 2.4%, and in September of 2.0%, the increase in October was 7.9%. With more than 108,000 total petitions filed, this was the first month since the 2005 amendments with more than 100,000 filings. (Please look at this website a few days from now for a Bulletin on the bankruptcy filing numbers specifically for Oregon.)

Besides these numbers reflecting that economic problems are rapidly moving from Wall Street to Main Street, what is the role of decreases in the availability of consumer credit? Intuitively, a reduction in credit--such as the shut-off of home equity lines of credit and reductions in credit card credit limits--force borrowers into filing bankruptcy because they do not have the cash-flow cushion to get past temporary financial problems or to delay the inevitable for those with more long-term problems. But what if there is a long-term reduction in credit? What effect would that have on bankruptcy filings in the future?

According to The Paradox of Consumer Credit, by Robert M. Lawless, a professor at the University of Illinois College of Law, first, empirical data supports the above inclination that, in the short-run, decreases in credit availability increase bankruptcy filings. But in the long-run, bankruptcy filing rates increase with greater credit availability. Does that mean that potential long-term reductions in credit availability mean long-term reductions in bankruptcy filings?

In his introductory review of the scholarly literature in his article, Professor Lawless starts by noting that "the literature overall tells a story of rising bankruptcy rates going hand-in-hand with rising consumer debt. . . . . Long-term macroeconomic trends might outweigh any effects that changes in the federal bankruptcy law have on filing rates." But his study's
principal finding is that consumer credit has a paradoxical effect on bankruptcy filing rates. Despite previous data and intuition that rising consumer debt walks hand-in-hand with rising bankruptcy filing rates, increases in consumer debt are associated with short-term decreases in bankruptcy filing rates. The effect likely stems from desperate borrowing by financially strapped consumers postponing the day of reckoning. Like many short-term effects, this one also loses in the long run, as mounting consumer debt catches up with consumers and eventually leads to higher long-term filing rates.
Professor Lawless does not directly ask about the effect of long-term reduced credit availability on bankruptcy filings, and thus far I have not been able to find any study facing that question. But if it is true, as many studies have shown, that increased credit availability in the long run leads to increased filing rates, is it not logically sensible to infer that decreased credit availability would eventually lead to decreased filing rates?

I recognize that the extent of the availability of consumer credit in the long-term is highly speculative. But given the financial upheavals of the past few months and the related rapid constrictions in virtually every credit market, from local to international levels, it seems unlikely that in the next few years consumer credit will again became as freely available it had become during the last decade or two. Therefore, IF consumer credit remains tight or becomes even more so, after a few years of increased bankruptcy filings as tighter consumer credit reduces consumers' financial cushions, thereafter as total consumer debt decreases so will the bankruptcy filing rate.

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys