Private Debt. Two views of debt: bankruptcy and debt service. Since 1980, non-business bankruptcies have increased by over 300%. Should we be worried?
House and Senate passed new rules on bankruptcy filings. According to news
reports, the new law would make it harder to erase debt, and would put
in effect new standards to determine repayment plans. Some consumer groups
have opposed the legislation.
It would probably
come as a surprise to most people, but in each of the last five years over
1 million people have filed for bankruptcy. Since 1980, non-business bankruptcies
have increased by over 300%; and since 1990, bankruptcy filings have increased
While this would
suggest consumers have bitten off more than they can chew, the overall
level of debt service as a fraction of income seems to have been relatively
stable over the past 20 years. So, while it seems as though more and more
people are falling on hard times, on average, people seem to be living within
Most people have
some debt – either through credit cards, car loans, student loans, mortgages
or all of the above. When the load gets too great, many people are forced into bankruptcy.
This can happen for many reasons:
debt levels can become too high; income could fall due to a job loss or some
other reason; or other some expenditures may become necessary (such as
a large medical bill).
suggests that when economic times are good, people will, on average, receive
greater incomes and so bankruptcies should become less frequent. However,
while there does seem to be some cyclicality to bankruptcies, there is
also a long-run upward trend in the number of filings. (See graph).
According to the
American Bankruptcy Institute there were over 1.2 million personal bankruptcies
last year. And, according Lundquist Consulting (as reported
in the NYTimes), bankruptcy filings increased 20 percent in the first
quarter of 2001.
Behind the debate
on bankruptcy laws lie two competing views on the cause of bankruptcy.
One view is that
bankruptcy laws give a second change to people who were simply unlucky
and fell on hard times and can no longer repay their loans. The thought
is that if they could repay, they would, and declaring bankruptcy is therefore
only a last option when everything else fails.
On the other extreme
is the view that people strategically use bankruptcy laws to avoid paying
back loans and credit card debt. According to this view, people might intentionally
run up debt and then use the bankruptcy laws to get out of having to pay
back the money.
The enactment of the new law may
give us a valuable “experiment” that we can use to see if people are responding
to the incentives implied by the bankruptcy laws.
Too much debt?
The above graph
would suggest that consumers have gotten deeper in to debt over the past
20 years. But is this really the case?
The Federal Reserve
the amount of debt payments that households face. The fraction of debt
service relative to personal income shows very little trend over the past
20 years. According to this data – it appears that people are not (on average)
racking up unsustainable levels of debt.