American Bankruptcy Institute
Congressional Testimony


September 12, 1996

Testimony of
the American Bankruptcy Institute

on Consumer Debt, Delinquencies and Personal Bankruptcies

before the

Committee on Banking and Financial Services
U.S. House of Representatives


Chairman Leach and members of the Committee, my name is Ford Elsaesser. I am an attorney with the firm of Elsaesser, Jarzabek and Anderson in Sandpoint, Idaho, and a Vice President of the American Bankruptcy Institute (ABI).

ABI is the nation's largest multi-disciplinary organization devoted to research and education on issues related to insolvency. We have over 5,200 members, including attorneys, accountants, judges, bankers, credit managers, trustees, academics and financial service professionals. The ABI is non-profit and non-partisan, and we generally take no advocacy positions before Congress, although we regularly appear to assist Congress' understanding of our nation's bankruptcy laws. We are honored to be here this morning to help examine the implications of recent increases in the rates of delinquency and default on consumer loans as they relate to rising bankruptcy filings.

Bankruptcy Filing Statistics Show Cause For Alarm

Bankruptcy is booming in America like never before. For the first time in the history of the U.S. courts, the number of bankruptcy petitions filed has topped the one million mark, according to data released August 28, 1996, by the Administrative Office of the U.S. Courts.

For the 12-month period ending June 30, 1996, there were 1,042,110 bankruptcy petitions filed, a more than 22 percent increase over the same period 12 months earlier. The figure is more than double the number registered a decade ago when, for the 12-month period ending June 30, 1986, there were 477,856 petitions filed.

Moreover, the trend continues to rise. The number of new bankruptcies filed during the second quarter of this year 297,162 was the highest three-month figure in history. For calendar year 1996, we are projecting between 1.1-1.2 million new cases, far exceeding the previous calendar year mark of 971,517 set in 1992.

Though both businesses and individuals may seek protection under the federal bankruptcy laws, more than 95 percent of the cases are now filed by individuals, many overwhelmed by consumer debt.[1] More than 10 million cases have been filed since the Bankruptcy Code went into effect in late 1979. Between 1984 and 1992, bankruptcies increased by 179 percent, with each year setting a new record. During much of this period, the national economy was expanding rapidly from a recession in the early 1980s. Filings fell off by 10 percent in 1993 and 5 percent in 1994, but increased by over 11 percent last year.

On a per capita basis, filings in the 1980s were about double the level of the 1970s but they have doubled again in just half of the decade of the 90s. This is nearly eight times the rate of the 1930s, a period commonly identified with economic failure. Unlike the 1980s, when bankruptcy filing increases were regionalized in the oil patch, farm belt or East and West Coast real estate markets, today filings are up in every state in America.

The rapid increase in consumer filings during a period of economic growth has no precedent in modern times. The growth in filings in the 198's could be attributed to crashing real estate markets, regional high unemployment, major layoffs in the manufacturing sector and interest rate instability. None of these factors are present today, indicating that the growth in filings may be an "early warning signal," rather than a natural result of a serious economic downturn.

Filings are occurring at a rate of one bankruptcy per 100 households. To illustrate that number in real terms, consider it roughly equal to finding one family in bankruptcy as you drive up and down one aisle of your average crowded shopping mall parking lot this weekend.

Filings Are Driven by Increases in Consumer Debt

Consumer spending is essential to the national economy, accounting for about two-thirds of GDP. Thus cutting back on the availability of consumer credit would likely have an adverse effect on economic growth. But the image of the debt-strapped American household comes into focus when one examines the rising levels of consumer debt. Revolving credit, primarily credit card debt, has been the fastest growing component of consumer debt, averaging annual increases of 20 percent over the past two years, as credit card companies and retailers aggressively competed for business. Consumer debt, at $1.1 trillion in installment credit and $450 billion in revolving credit, has more than doubled in the past decade and is up 44 percent in the last three years alone. As Fed Governor Laurence Lindsey has stated, such levels have far outpaced income gains, making this trend unsustainable. From my experience as a chapter 7 trustee, handling hundreds of personal bankruptcies, I have found that people are not spending income, but are rather spending credit.

Today, consumer credit is as easy to use as it is to obtain. The last holdouts of the cash economy, grocery stores and supermarket chains, now universally accept major credit cards. Cash advances on credit cards can be obtained at or near the growing number of gambling casinos nationwide. Credit cards may now be used to pay everything from the electric bill to state income taxes. The availability of these "conveniences" can have an adverse effect on budgetary discipline on even an "high earning" household.

Indeed, the American Bankers Association has reported on rates of delinquencies in credit card payments not seen in 15 years, and well above the level during the 1990-91 recession. With debt at such a high level, even a small rise in short-term interest rates could have a very depressing effect on consumer spending very quickly.

Losses to major consumer lenders are mounting. Visa U.S.A. reports that net credit charge-offs more than tripled in the nine years between 1987 and 1995 and are projected to nearly double over the next several years. In 1995, bankcard industry losses resulting from personal bankruptcy filings increased 45 percent over the previous year, to $4.7 billion. Visa projects bankruptcy losses will reach nearly $9 billion by 1997.[2]

Moody's Investors Service reports that the June 1996 charge-off rate of account balances written off as uncollectible represented a 50 percent increase on a year-over-year basis and was the highest monthly increase since the 1990-91 economic downturn. June also represented the seventh consecutive month in which the delinquency rate was higher than in the previous month.[3]

An ominous new development is the "surprise" bankruptcy, filed by individuals who are filing for bankruptcy without first having a five- or six-month period of delinquency. So even while the average delinquency ratios may be going up slowly, the charge-off rates are increasing faster, as consumers declare bankruptcy with little warning.

Consumer bankruptcy filings reflect debt pressures on consumer best measured by the debt service payment ratios maintained by the Federal Reserve Board. The [Graph] to come chart shows this correlation. These ratios measure the proportion of household income devoted to repaying consumer debt and mortgage debt each month. We expect that the second quarter data will reflect that we are at a near record level of consumer debt under this measure. The record of bankruptcy filings shows this figure to be an accurate, though lagging, indicator.

As debt payments as a percentage of disposable personal income began to increase in 1983-84 and rose steadily until their peak in late 1989, bankruptcy filings were pulled up correspondingly. As the ratio began to fall (due to less consumer spending and reduced interest rates) from 1990 through the end of 1992, there was a subsequent decline in bankruptcies in 1993-94. But as consumer spending helped pull the economic wagon out of the 1991 recession, there has been both a rise in the debt service payment ratio and a predictable (lagging) rise in personal bankruptcies. Confronted with rising losses on credit cards and more customers declaring bankruptcy, many lenders are tightening up on consumer credit, according to a recent survey conducted by the Federal Reserve.[4] Yet such new restrictions on credit are unlikely to slow the growth in consumer bankruptcy filings over the next 12 months, given the lag time traditionally involved.

The continual increase in the consumer credit rates of default and percentage of charge-offs, when coupled with the surprise filings, are a potentially ominous sign that cannot be overcome by the comfort provided by the high interest earnings traditionally enjoyed by the consumer credit industry. It is worth recalling that the bad real estate loans that generated the savings and loan crisis did not fail overnight, but gradually created non-accruals and charge-offs to an unsustainable level. The tightening of consumer credit is the most obvious, but perhaps the least palatable solution. Not only does the consumer credit industry enjoy high profitability, even with the filing rates; retailers have become "addicted" to consumer credit, particularly for the sale of large ticket items. There are, for example, few home electronics or appliance retailers who do not lead off their advertising with offers such as "six months, same as cash" or "no payments till next year."

A recent survey of consumer debtors, conducted by Visa, showed that the number one reason for filing, cited by nearly 30 percent of respondents, was simply that they were overextended. Other major causes included the loss of a job, medical and health reasons, and divorce or separation. But while each of the latter causes may have been the "last straw" that led to a bankruptcy filing, the fact is that high debt loads create a kind of "at risk" population of consumers who are only an interrupted paycheck away from considering bankruptcy protection. My own experience as a bankruptcy trustee in consumer bankruptcy cases is that consumers are making the decision to file for a chapter 7 bankruptcy quicker and with less forethought or anxiety than in the past. The ease and simplicity of the filing process, together with the lack of any meaningful stigma attached to being a chapter 7 debtor, contributes to this phenomena. In addition, it is often easier for a recently-filed chapter 7 debtor to obtain credit than one who is struggling to pay his or her debts.

Legal and Social Factors Have Contributed

When Congress created the modern bankruptcy Code in 1978, it made bankruptcy a much more debtor-friendly law. Although the amendments to the Code have since attempted to rebalance the equities and provide more creditor protections, the basic pro-debtor framework remains. Bankruptcy provides a unique, automatic injunction against the world by the mere act of filing, with respect to nearly all legal and collection actions against the debtor. In most no-asset chapter 7 liquidation cases the vast majority of consumer cases the debtor will never see a judge, is rarely examined by creditors and may never even set foot in a court before the case concludes with a permanent forgiveness of debts. That broad discharge, while providing the debtor's "fresh start," means that many creditors, particularly unsecured creditors, often receive no distribution at all in a bankruptcy case.

Though it was formerly true that debtors often had difficulty in reestablishing credit, intense competition in the consumer lending marketplace has led to new credit being widely available to individuals without careful regard to their creditworthiness, even soon after they have discharged nearly all of their debts in a bankruptcy.

Over the 18 years of my bankruptcy practice, I have also noticed a profoundly different perception toward bankruptcy, consistent with a larger secular change in attitude toward debt and personal responsibility. Unlike a generation ago, there is no shame in debt any more; the stigma associated with bankruptcy has largely disappeared. To cite but one example, virtually every major car dealer heavily advertises the availability of credit to finance cars for bankrupt debtors. Surprisingly, this is a good business decision by the dealer and the lender. The debtor will pay (and expects to pay) a significantly higher interest rate. In addition, the debtor has "cleansed" his or her balance sheet of credit card and retail credit accounts, therefore is ironically a better risk than a highly-leveraged debtor who is paying all of his or her bills.

Consumers are more aware of the bankruptcy option, made aware in part by a growth in lawyer advertising promising that you may be able to "keep everything" and "pay back nothing." A cultural milestone in the destigmatization of bankruptcy was recently reached with the advent of a brand new gameshow on Lifetime cable television called "Debt." Aired each night, the show features three consumers with high debts competing to answer questions on popular culture. The winner goes home with his or her debts paid off. The losers get a savings bond.

Potential Ways to Reduce Consumer Bankruptcy Filings

Consumer bankruptcies are likely to decline only when the need for this type of remedy declines or when the remedy itself becomes less attractive to potential users.

High yields on credit card loans, which have traditionally far outpaced loan losses, have spurred institutions to rapidly expand credit card lines of credit. High profits have attracted competition for new borrowers. The demographic changes in credit card underwriting, especially among lower income borrowers or new borrowers with no credit histories (e.g., students) should be carefully reconsidered and reversed, if possible. The consumer credit industry has proposed a number of specific reforms aimed at striking a different balance between the right of honest debtors to receive a fresh start and abusive filings. Many of the suggestions are offered with the hope of encouraging greater repayment, such as by (a) providing that all initial consumer bankruptcies be filed under chapter 13, where consumers agree to commit all of their disposable income to pay creditors over a three- to five-year plan period, or (b) by amending the Fair Credit Reporting Act to allow credit bureaus to report bankruptcies only during the limited time of the repayment plan, rather than up to 10 years, as is the case now. Other proposals are directed at limiting the scope of consumer bankruptcy relief, by (a) providing that debts incurred without a reasonable expectation or ability to repay would be deemed non-dischargeable in bankruptcy; (b) providing that all consumer debts and cash advances incurred within 90 days of filing be deemed non-dischargeable; and (c) by giving creditors greater ability to have a bankruptcy case dismissed for proven abuses.

The National Bankruptcy Review Commission, created by the Bankruptcy Reform Act of 1994, has been studying ways to amend the consumer bankruptcy laws. Among the proposals being considered are:

  • Making chapter 13 simpler, more attractive and more beneficial to the debtor than a chapter 7 case (right now, it is far easier for a chapter 7 debtor to obtain new credit than a debtor who is half-way through the payments in a chapter 13 plan);
  • Clarifying the "substantial abuse" section of the Bankruptcy Code to truly implement a means test, and require debtors with net disposable income to participate in chapter 13, rather than chapter 7;
  • Lengthening the time period between chapter 7s, currently six years;
  • Consolidating all consumer cases into a single chapter, with the determination in each case whether the debtor could realistically make significant repayment to creditors. Significantly, however, as long as the consumer credit industry is willing to sustain high rates of defaults and charge-offs, and therefore provide easy credit to consumers who are already highly-leveraged and "at risk," no change in the Bankruptcy Code will effectively reduce the unprecedented rate of consumer filings.

Changes in the statute may lead consumers and consumer debtor lawyers to reconsider alternatives to bankruptcy. Consumer credit counselling should be encouraged as an alternative. And although lawyer advertising is a constitutionally protected form of commercial speech, consumers should be encouraged to educate themselves about alternatives to bankruptcy and should seek knowledgeable and ethical legal counsel, who will act in their client's best long term interest. One way to help distinguish among the best available consumer bankruptcy attorneys is through certification programs. The American Bankruptcy Board of Certification is one such organization that certifies consumer bankruptcy specialists, for the benefit of the consumer public.


Footnotes

[1]Business failures and associated dollar liabilities in the U.S. rose significantly during the first half of 1996 compared to the year-ago period, according to an August 23 report by Dun & Bradstreet. During the first six months, 38,866 U.S. businesses failed, up six percent from the first half of 1995. Dollar liabilities from business failure totaled $17.08 billion, an increase of 51 percent from $11.31 billion in the year-ago period.[RETURN TO TEXT]

[2]"Consumer Bankruptcy: Bankruptcy Debtor Survey," Visa U.S.A. Inc., July 1996.[RETURN TO TEXT]

[3]Edward Bankole, Vice President (author), Moody's Credit Card Index Report, August 23, 1996.[RETURN TO TEXT]

[4]"Banks Tightening Consumer Credit", The Washington Post, August 27, 1996, p. D1.[RETURN TO TEXT]