Once upon a time, personal bankruptcy was a rare and shameful event. No more. Despite a booming economy, we're also experiencing a bankruptcy boom. In 1998, a record 1.4 million Americans declared bankruptcy; that was almost triple the number in 1988 (550,000). Although Congress is considering bills to curb the bankruptcy boom, they may not pass or -- if they do -- may not work.
It's no mystery how so much bankruptcy can mix with so much prosperity. As a society, we have made it ever easier to borrow. The credit card, once reserved for the affluent, is becoming almost universal. In 1995, about two-thirds of households had one. Meanwhile, we have also made going bankrupt ever easier. The predictable result feeds on itself: As more people go bankrupt, it becomes more socially acceptable.
People see bankruptcy -- debt forgiveness -- as an easy way to improve their finances or, more broadly, as a legitimate social policy. Lawyers aggressively advertise bankruptcy services; typically, the cost of filing a bankruptcy petition is an upfront fee of $550 to $800. Similarly, bankruptcy becomes an informal welfare program for the lower middle class. Women's groups especially oppose congressional efforts to tighten the bankruptcy law, because about 40 percent of bankruptcy filers are single women.
The debate is casually cast as a showdown between greedy creditors and helpless children, even though legislation wouldn't affect most debtors. By various studies, it would force only between 3 percent and 15 percent of bankrupts to pay more to creditors. The trouble with leaving bankruptcy law too lax is that it encourages overborrowing -- behavior that hurts borrowers and society. Credit losses may cut the profits of lenders; but they're also passed on to other borrowers as higher interest rates or fewer loans.
Most personal debtors file under Chapter 7 of the Bankruptcy Code. This requires them to show they can't pay their debts from income. In theory, they must then sell possessions to satisfy creditors. In practice, this is a sham. People can exempt some property (amounts vary by state), and this often covers all they own. With "no assets," they have many debts canceled. Generally, debtors must pay home mortgages; otherwise, lenders can take the house. Ditto for car loans. By law, most taxes, student loans, child support and alimony must also be paid. But other unsecured debts -- credit card loans, store charges, medical bills -- can be erased.
Bankruptcy petitions are usually processed quickly in token hearings. I recently attended a session in Alexandria, Va. Thirty-five cases were scheduled for the morning. Most took a few minutes. Though creditors can contest petitions, few do. The process is so simple it's a wonder that more people don't use it. Economist Michelle White of the University of Michigan estimates that at least 15 percent of households might profit from bankruptcy: The debts that could be canceled exceed property that could be seized.
Of course, most bankrupts aren't wealthy. In 1998, the median income of those filing was about $23,000 (meaning half were above, half below). On my day in Alexandria, Salvador Garcia (not his real name) seemed typical. He's a hospital driver and listed his income at $24,000 before taxes. He sends about $200 a month to a daughter in the Philippines and says his expenses (rent, food, clothes) take almost all his income. His car was repossessed after he missed lease payments, says his lawyer. He has $22,376 in unsecured debt -- $20,015 in loans from two finance companies and the rest split between two credit cards.
A suit by a finance company to attach his wages apparently triggered the bankruptcy petition. In one survey, 49 percent of bankrupt debtors blamed collection agencies for causing them to file. "The main reason people go bankrupt is lax credit," says Leon Demsky, Garcia's attorney. "It's easy and tempting. People always anticipate something will work out: They'll get a raise, they'll win the lottery, the wife will get a better job."
Credit is clearly peddled with gusto. In 1998 credit card companies mailed 3.45 billion solicitations, estimates BAIGlobal, a market research firm. The response was 1.2 percent, or 41 million cards. "People move from card to card," says Pete Hisey, editor of Credit Card News. They shop for lower interest rates.
But there are credit checks, and though cards are visible, they represent 10 percent or less of consumer debt, says Stuart Feldstein, president of SMR Research Corp. Home mortgages are the largest share. The real problem, Feldstein argues, is that aggressive merchandising leaves people with unused cards. In 1998, 45 percent of card accounts were inactive. Cards become the last line of defense. "If you have a [financial] problem -- resulting from divorce, medical bills, gambling -- more and more people have a card they can yank out," he says.
Lax credit alone, though, didn't cause the bankruptcy boom. Ever since Congress liberalized the bankruptcy law in 1978, filings have risen. If only easy credit were to blame, bankruptcy rates around the country would be fairly uniform. They aren't. Georgia's rate (nearly 8 per 1,000 residents) is more than twice South Carolina's (3 per 1,000); Virginia's rate (6 per 1,000) is twice nearby Delaware's (3 per 1,000). Lending isn't so uneven; this suggests that lawyer ads and word of mouth play a role in spreading bankruptcy.
All the controversy over the congressional bills is misleading. These proposals would only slightly tighten the law. In general, they try to force bankrupts with more than median income (about $53,000 for a four-person household and $39,000 for a two-person household) to make some payments to creditors. This is why so few people would be affected. A better proposal from economist White would require modest repayments by most bankrupts. It isn't being considered, and Clinton may even veto the congressional plans.
There's a message here. Bankruptcy is becoming a matter of convenience and calculation. Repaying what you borrowed was once an important part of the nation's moral code. It is increasingly less so.