Consumer Bankruptcies on Pace to Hit Pre-Reform Levels in 2009

There were roughly 675,000 consumer bankruptcy filings in the first half of this year, according to data released last week by the American Bankruptcy Institute.

If the current pace continues, more than 1.3 million consumer bankruptcies will be filed this year, a level that hasn’t been seen since 2005, a record-breaking year for consumer bankruptcy protection requests. The record that year was due, in large part, to a change in bankruptcy laws that made it harder for consumers to file and provided some protection for creditors.

The new bankruptcy law led to a large spike in filings just before it took effect, and a sharp drop-off for the next several quarters. There were nearly 2.04 million consumer filings in 2005, and only a quarter of that the following year, according to American Bankruptcy Institute statistics. Annual bankruptcies didn’t surpass 1 million again until last year. The first time consumer bankruptcies had topped 1 million was 1996, at more than 1.1 million. From 1997 through 2004, bankruptcies ranged between 1.2 million and 1.6 million.

The American Bankruptcy Institute reported that the overall June consumer filings total of 116,365 was 40.6 percent higher than the 82,770 consumer filings recorded in June 2008. While the June total represented an increase over the previous year, it was 6.8 percent lower than the total from May 2009. Chapter 13 filings constituted 27.7 percent of all consumer cases in June, a slight increase from May.

But the quarter-over-quarter trend is pointing higher. According to ABI data, there were 316,158 total consumer filings in the first quarter of 2009 and 359,193 filings in the second quarter, a level that roughly mirrors quarterly filing averages seen before the bankruptcy reform legislation was passed in 2005.

The trend prompted ABI Executive Director Samuel J. Gerdano to comment, “We expect that there will be more than 1.4 million new bankruptcy filings by year end.”

The more bankruptcy filings, the harder it is for collection agencies to recover debts, says Dan North, chief economist at Euler Hermes ACI, a trade credit insurance firm. The collection agencies tend to be collecting unsecured debts, which fall behind secured debts when the bankruptcy courts allocate the debtor’s assets.

And debtors have become smarter about protecting their assets, North adds. So if a debtor has disposable income, he’ll put it into an IRA or some other vehicle outside of the reach of the bankruptcy court.

This is likely occurring more often, according to North, who points out that disposable income is increasing at the same time that bankruptcies are. Many consumers are putting that additional disposable income into savings as evidenced by the sharply rising savings rate.

“The bankruptcies will continue after the recession is over,” North added. “Bankruptcies and unemployment will likely continue for a couple of quarters.”

North added that the recession itself could be near an end, but business and consumers alike, who were burned by the economic conditions of the last couple of years, are very unlikely to recover very soon because many had gotten themselves too deep into debt and had nothing to fall back on when real estate-related credit started drying up.