Though the numbers haven’t shown it yet, many are bracing for a spike in personal bankruptcies once coronavirus relief efforts and stay-at-home orders have been exhausted.
How
Based on a review of historical bankruptcy filing rates, there are certainly indications that a wave of bankruptcy filings may materialize. The data analytics firm
Since 2008, bankruptcy filings have increased more or less in tandem with job loss and missed mortgage payments,
There are some legitimate questions, however, about whether this correlation will repeat in the current economic crisis. Unemployment has risen quickly, and to levels not seen since the Great Depression. Mortgage delinquencies have also increased and
But there are countervailing factors as well.
The current unemployment crisis was artificially created by state and local government stay-at-home orders in response to the pandemic. In past business cycles, increases in the unemployment rate resulted from shocks or recessions —not from a deliberate government decision to freeze most economic activity.
In fact, past government policy using fiscal and monetary tools was designed to stimulate job creation. When states and cities reopen, unemployment rates may well decrease. But many expect the post-coronavirus unemployment rate will be elevated for some time.
Mortgage delinquencies may also be a less reliable predictor of bankruptcy filings.
Many homeowners will benefit
Currently, personal bankruptcy filings are actually lower year over year. According to data from the federal courts, there were 186,000 consumer bankruptcy cases in the first quarter of 2019. By contrast,
Perhaps more strikingly, the rate of consumer bankruptcy cases for April of 2020
One explanation could be that some courts have been closed for business, making the logistics of filing for bankruptcy more difficult. Some law offices have also been closed and consumers may be reluctant to declare bankruptcy without meeting with an attorney beforehand. Also, the federal stimulus payments and expanded unemployment benefits may be keeping consumers afloat for the time being.
The current lull seems likely to be unsustainable. Surely, unemployed consumers will burn through savings and exhaust unemployment benefits, and mortgage forbearance cannot continue forever. When that happens, many consumers will seek to wipe out credit card debts or stop a foreclosure from proceeding.
Whether the tight correlation between bankruptcy, unemployment and mortgage delinquencies continues to hold in the next few months is impossible to know with certainty. There are valid reasons to think that this time things will be different.
But it would be very surprising not to see a spike in bankruptcies later this year, especially in states with longer stay-at-home requirements.
So, what should the policy response be? Temporary modifications, like changes made to the Bankruptcy Code in the coronavirus relief bill (the
It’s also important to ensure that any bankruptcy law changes are targeted and not overly broad. For instance, a proposal in the
The House proposal would only benefit homeowners, not renters who often live paycheck to paycheck. In fact, according to additional research from AIS InfoSource, the average amount of home equity protected in bankruptcy is approximately $77,000.
These are uncertain times, and policymakers should expect an increase in bankruptcies. Congress has already made temporary bankruptcy law changes to assist consumers in financial distress. It is imperative that future changes, if any are needed, be temporary and targeted. The current public health crisis should not lead to unfocused policy changes that will increase credit risk and slow the economic recovery.
