EXECUTIVE SUMMARY
Consumer Bankruptcy
1997 Bankruptcy Petition Study
June 1997
Copyright © 1997, Visa U.S.A. Inc.
Three debtor profile
tables accompany this executive summary.
Personal bankruptcies play a significant role in the level of credit
losses experienced by Visa
Members. Those losses reached record levels in 1996 and are continuing
to rise in 1997. More
than one million individuals filed for bankruptcy in 1996, an increase
of more than 25 percent over
the previous year.
Surging personal bankruptcy filings in conjunction with a strong
economy and relatively low
unemployment is a worrisome development. In an effort to understand the
dynamics of
bankruptcy, Visa has periodically analyzed the actual bankruptcy
petitions filed by debtors seeking
relief. One previous study, published in 1988, focused just on the state
of California. In 1996,
Visa launched a more extensive study, drawing data from four states:
California, Illinois,
Massachusetts, and Tennessee. Together with earlier California data,
more than 11,000 petitions
were analyzed for this report.
The reported data are the actual petitions filed by the debtors. As a
rule, these data are
unaudited unless the petition is challenged by a creditor or trustee.
Chapter 7 filers, may have an
incentive to make themselves appear insolvent by overstating expenses
and understating income,
especially when they are filing a "no asset" case. Chapter 13
filers, on the other hand,
have less incentive to appear insolvent because they are planning to
repay all or part of their
outstanding debt. There is some evidence that petitioners who are
homeowners choose Chapter
13 over Chapter 7 bankruptcy because they are trying to save their
homes.
Debtor Profiles
The data showed major differences among the the profile of debtors from
state to state. The most
notable difference is between the profile of a debtor filing Chapter 7
bankruptcy, which discharges
all debt, and that of a debtor filing Chapter 13 bankruptcy, which
offers a repayment plan over a
three to five year period. Complete debtor profiles for Chapter 7 and
Chapter 13 petitioners that
highlight the most significant findings can be found at the end of this
document
Chapter 7 Characteristics
Regardless of the state in which they resided, Chapter 7 petitioners
typically shared the
following characteristics. They were likely
- to have had a decline in income in the year they filed their
petition
- to project that their income will be lower than their expenses even
after the bankruptcy is
discharged
- to be employed or self-employed
- to be a bankcard holder
Chapter 13 Characteristics
Chapter 13 petitioners were likely
- to have had a decline in income in the year they filed (except in
California), although the
drop was not as much as for Chapter 7 holders
- to be homeowners, except in Tennessee where only 29.7 percent owned
their own homes as
compared with 88.6 percent in Massachusetts
- to file plans in which their monthly income was projected to exceed
expenses
- to have very heavy housing expenses, amounting to about half their
monthly expenses
(except in Tennessee)
- to be employed or self-employed
- to have very little unsecured debt
Chapter 7 vs. Chapter 13
The choice of whether to file under Chapter 7 or Chapter 13 is
apparently driven, in most cases,
by whether the filer has any large assets, such as a home, to protect.
Chapter 13 plans typically
allow filers to amortize mortgage arrearages over the life of the plan
and are structured to allow
current monthly mortgage payments to continue. This was especially true
in California and
Massachusetts. By comparison, less than 30.0 percent of the Chapter 13
filers in Tennessee were
homeowners. Like several other states in the southeast, local practice
and custom in Tennessee
strongly favors Chapter 13 filings, regardless of the petitioner's asset
picture. In fact,
approximately 65 percent of filings in Tennessee were for Chapter 13 vs.
about 30 percent for the
rest of the country.
Income Factors in Bankruptcy
The single most important factor affecting an individual's decision to
file for bankruptcy appears
to be a decline in income, coupled with an inability to adjust
lifestyles sufficiently to accommodate
the reduced level of income.
Income Changes
For purposes of analysis, the study divided the petitioners of each
Chapter into two groups, those
who had an increase in income during the filing year and those who had a
decrease. On average
about two-thirds of those who filed Chapter 7 bankruptcies reported that
their incomes had
declined in the year of the filing. The average decline was more than
20.0 percent. By contrast, a
third or more of the petitioners actually saw their incomes increase in
the year they filed,
suggesting that many of these individuals could have filed under Chapter
13.
This highlights a weakness in the current system because it suggests
that many individuals
may be receiving more relief under the bankruptcy code than they
actually need. Today, credit
decisions are generally made on the basis of income, or, at least,
proxies that estimate a
borrower's capacity to repay, while decisions pertaining to bankruptcy
are made on the basis of
asset-to-liability ratios. Unless creditors challenge a filing, the
courts rarely ask whether an
individual has the ability to pay. They simply look at the petitioner's
schedules to determine
solvency.
Bankcard Issues
The study tends to refute two of the most prevalent criticisms leveled
at the bankcard
industry-that the increased use of bank credit cards is largely
responsible for the increase in
bankruptcies, and that financial institutions are making the situation
worse by issuing credit cards
to individuals who would not previously have qualified based on income.
If the first charge were true, there should be an increase in
bankcard debt relative to other
types of debt in the portfolios of bankruptcy petitioners. Time series
data from California indicates
that the share of bankcard debt relative to total debt remained
virtually unchanged between 1988
and 1996 at 14.8 percent.
If the second charge were true, there should be a significant
increase in the proportion of
individuals with lower incomes filing bankruptcy petitions. The data do
not support this either. In
fact just the opposite has happened. Between 1988 and 1996, the
percentage of bankcard holders
filing for bankruptcy who had incomes of $25,000 or less in the year
before they filed for
bankruptcy declined substantially-from 58.9 percent to 48.0 percent.
Meanwhile the percentage of
cardholders with incomes above $45,000 increased from 9.0 percent to
23.1 percent.
Expense Issues
The bankruptcy system is designed to provide a fresh start to
individuals who are unable to pay
their debts. But as noted earlier, there is an incentive for Chapter 7
petitioners to overstate
expenses and understate income. Not surprisingly, the average Chapter 7
filer projected that even
after the bankruptcy is discharged, his or her monthly expenses would
still exceed their income.
This is true whether they reported an increase or decrease in income in
the year of filing. Clearly,
unless they have other sources of income or expectations for additional
income, many of these
individuals could be back in bankruptcy court in a relatively short
time. Alternatively, some
individuals may be receiving more relief from bankruptcy than they
actually need.
The vast majority-over 90 percent-of Chapter 13 filers projected
their post bankruptcy
income would be higher than their expenses, some by a comfortable
margin. There is a small
minority, however, that projected their expenses would exceed their
income. It is not at all clear
how these individuals planned to complete a Chapter 13 plan.
Misuse of the System
The study makes clear that there is a significant minority of Chapter 7
filers deliberately taking
advantage of the bankruptcy system as it is presently constructed. Some
misuse stems from
individuals trying to "work the system" but much of it comes
from the
"one-size-fits-all" approach inherent in the code that tends
to give debtors relief
without regard to the degree of need. Even if such misuse of the system
amounts to only 10
percent (and it is probably much higher), basing the bankruptcy system
on a petitioner's need for
relief could reduce bank credit card losses by more than $1 billion
annually. Today, such losses
must be borne by all other bank credit card holders who do not declare
bankruptcy and pay their
bills on time.
There is ample evidence to suggest that a substantial percentage of
Chapter 7 filers could pay
back all or a major part of their debt over a reasonable period of time,
without undue hardship, if
the system were based on amount of relief needed.
The Internal Revenue Service has established allowable spending
guidelines for various levels
of income for individuals who wish to pay their taxes over a period of
time. If those same
standards were applied to individuals filing for bankruptcy, recovery
rates would nearly triple.
Conclusion
Clearly some changes need to be made to eliminate abuses in the system
and restore an element of
fairness to the process.
In December of 1996, a coalition of credit grantors from all segments
of the industry met with
the National Bankruptcy Review Commission to present an array of changes
to the bankruptcy
code that are needed. The bankcard industry presented several specific
proposals, including:
- Debtors should get only the amount of relief they actually need.
- All consumer debt incurred within 90 days of filing should be
nondischargeable.
- Any debt incurred without reasonable expectation or ability to repay
should be
nondischargeable.
- Fraud should be nondischargeable in Chapter 13.
- All income committed to the plan in Chapter 13 should be distributed
to those creditors who
do participate.
- There should be a definition of the circumstances under which a
Chapter 7 bankruptcy may
be dismissed for abuse.
Any questions or comments regarding this study should be directed to
Steve
Holiga at (415) 432-1164. For copies of the study please contact Visa
Issuer
Risk Management at (800) 922-8277.
|
|
