Explaining the (Complex) Causes of Consumer Bankruptcy

Journal Issue

Sep 2001

Column Name

Journal HTML Content

In an article published recently on the Internet, Prof. Robert Lawless presented data
showing a tight and positive relationship between annual measurements of consumer debt
level and the numbers of non-business bankruptcies filed in the same year.<a href="#2" name="2a">2</a> From
the perspective of this column, which attempts to characterize bankruptcy questions by
reference to quantitative information, Prof. Lawless's work provides a useful starting
place to consider some problems facing the analysis of the causes of consumer
bankruptcy. There are also lessons to be learned about the relationship between the
causes of bankruptcy and decisions about how the bankruptcy system should operate.

It will come as no surprise that, as a general proposition, consumer bankruptcy
filings fluctuate with debt levels. We would be surprised, in fact, if the opposite
were true. But there is more to the story than that.

In the first place, different measures of consumer or household debt are published
on a regular basis. Everything else being equal, we would expect that any of these
measures would show the expected co-variation with filings. The truth is more
complicated. For example, Prof. Lawless found that annual changes in household debt
service burden measured over a 20-year period did not correlate closely with annual
changes in non-business filings, even though other measures of debt did.<a href="#3" name="3a">3</a> Lawless
concluded that the lack of a demonstrated relationship most likely arose from a
combination of misestimations of household debt burden and insufficient sensitivity in the
methods that he used to test the association between burden and bankruptcy filings.

The question of measurement sensitivity leads to the next point, which is that our
intuition tells us that increases in debt level should be a cause of increased filings.
That means that the debt levels should grow before their effects show up in the
filings. We should expect the tightest relationships between the two factors to occur
when debt levels reported for one year are compared to filing levels of the following
year, or even the year after that. Using such offsets is often referred to as lagging

one variable behind the other.

One study has shown that when bankruptcy filings were lagged one year behind debt
service burden over the years 1981-99, a reasonably clear positive relationship
emerged.<a href="#4" name="4a">4</a> The author of that study, Kim Kowalewski of the Congressional Budget
Office, concluded that "[g]rowth in the filing rate tends to increase (or decrease)
in the year following a greater (or smaller) increase in the debt-service burden.
In particular, the slowdown in the rate's growth during the past few years [late
1990s] corresponds to smaller increases in the debt-service burden."<a href="#5" name="5a">5</a>

We can get yet a closer view of relations between debt levels and filing levels
by comparing percentage changes in both factors and lagging the bankruptcy numbers behind
the debt-level numbers. The figure below demonstrates a tight relationship between
changes in consumer debt levels (not debt service burdens) and filing levels lagged
by two years. The relationship is shown over a 30-year period.<a href="#6" name="6a">6</a>

In sum, in spite of problems of data availability and methods for measuring the
relationship between debt levels and filing levels, the conclusion that the two are
causally related is supported by objective analysis as well as common sense. But that
conclusion still cannot be the end of the story—for two reasons. First, we know that
many consumers with large debts do not file for bankruptcy and that some consumers with
low debts do file, so there must be more to the causes of filing, or not filing,
than debt. Second, accepting that high consumer debt tends to produce bankruptcy
provides an insufficient foundation for answering bankruptcy policy questions. We consider
each of these reasons briefly.

The relatively tight connection between debt levels and bankruptcy rates only moves our
search for answers one step back; for now, we must inquire about the causes of high
debt levels. There are many candidates—e.g., marital break-up, job loss or illness.
Increases in the availability of credit are another factor often cited. In addition,
some have argued that a decline in moral standards (phrased as a reduction in shame
or stigma associated with debt and bankruptcy) has produced both debt and bankruptcy
growth.<a href="#7" name="7a">7</a>

There are also candidates for causes of variations in bankruptcy filing rates that
would not necessarily affect debt levels. These can arise with the law itself,
including, for example, differences between states in their exemption levels and wage
garnishment laws, as well as the provisions of the 1978 Act and subsequent
amendments that have been called more or less "debtor-friendly." And of course, there
are provisions of new legislation pending that are intended to affect both filing rates
and choice of chapter by consumers. Taken all together, this list creates an almost
impenetrable network of interconnected factors that are plausible causes of (or reasons
for) a consumer's decision to file.

Efforts to discern the effect of divorce on bankruptcy filings is illustrative. One
study concluded that divorce rates partially predicted consumer filing rates. The authors
of the study interpreted the relationship using two different theories. One theory was
that divorces cause bankruptcy because the dissolution of the household produces financial
distress. The second theory was that divorce and bankruptcy are both examples of
breaking promises, and that an increase in promise-breaking "across the board" has
produced the increases in both divorces and bankruptcy filings. Although the authors
of the study chose to emphasize the second theory over the first, they acknowledged
that their data, standing alone, could not support their choice.<a href="#8" name="8a">8</a> This interpretive
problem holds for all studies that attempt to assess the effect of changes in shame
or stigma on bankruptcy filings, because there are no direct measures of such changes
(or of the factors themselves); inevitably, their import resides in the judgment of
the analyst. The judgments are not necessarily wrong, but they are always subject to
a different interpretation that is not refutable by the numbers themselves.

This is why studies about the causes of bankruptcy provide ambiguous or insufficient
guidance for answering bankruptcy policy questions. The data always require interpretations
that include a set of assumptions that go beyond the numbers themselves. Given
different assumptions, the numbers will be interpreted differently. If we assume that
there is less shame in society than there used to be, we are likely to interpret
statistics regarding debt, divorce and bankruptcy differently than if we assume
otherwise, but the current data don't prove the assumption either way. Our attitudes
about debtors and about appropriate legal changes are, nevertheless, guided by our
assumptions as well as our interpretations of the data.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> All views expressed in this article are those of the authors, and do not necessarily represent the views of the Executive Office for
U.S. Trustees or the Department of Justice. <a href="#1a">Return to article</a>

<a name="2">2</a> Lawless, Robert M., "The Relationship Between Non-business Bankruptcy Filings and Various Basic Measures of Consumer Debt," <a href="http://www.law.missouri.edu/lawless/bus_bkr/body_filings.htm" target="_parent">www.law.missouri.edu/lawless/bus_bkr/body_filings.htm</a> (Version 1.1, July 18, 2001). <a href="#2a">Return to article</a>

<a name="3">3</a> This is a statistic reported by the Federal Reserve and is, approximately, the percentage of income absorbed by household debt service. <a href="#3a">Return to article</a>

The failure to show a relationship between debt service burden and filings was over the 20-year period from 1980-00. Over the period
from 1993-00, the expected positive relationship could be shown; this discrepancy is currently unexplained. The Federal Reserve states
that the statistic is based on "rough approximations" gathered from several data sources. See <a href="http://www.federalreserve.gov/releases/housedebt/about.htm" target="_parent">www.federalreserve.gov/releases/housedebt/about.htm</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> Kowalewski, Kim, "Personal Bankruptcy: A Literature Review," Congressional Budget Office, September 2000, p. 10. This paper
contains a very thoughtful analysis of the causes of consumer bankruptcy and how different views about them affect policy preferences. <a href="#4a">Return to article</a>

<a name="5">5</a> Id. at 9. <a href="#5a">Return to article</a>

<a name="6">6</a> See Flynn, Ed, and Bermant, Gordon, "On the Evidence of These Numbers: Why Consumers File for Bankruptcy," ABI Journal,
April 2000, p. 22, for an earlier discussion of the significance of this graph. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, F.H., and Brinig, Margaret F., "The Bankruptcy Puzzle," 27 J. Legal Stud. 187, 201-202, 205
(1998)</a>. See Kowalewski, supra n. 4, for a review of the different positions taken on this topic. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… and Brinig, supra n. 7</a>. <a href="#8a">Return to article</a>

Journal Authors

Edward M. Flynn

Gordon Bermant

Journal Date

Saturday, September 1, 2001 - 12:00

Bankruptcy Rule

2001