Why Such a Large Drop In Bankruptcy Filings?

As the year closes out, it looks like the final tally for consumer bankruptcy filings for 2006 (the first full post-BAPCPA year) will be about 600,000 or so. Last year the figure was 2 million (in large part because of the pre-BAPCPA spike) and in 2004 it was about 1.5 million. So there has been a drop of roughly 60% from the prior levels.

Moreover, after the post-BAPCPA trough at the end of last year and the beginning of 2006, week-to-week filings have been virtually constant since April, with perhaps a very slight upward trend at most.

I'd be interested in hearing from readers, and bankruptcy practitioners in particular, as to what your experiences suggest about what is going on. The big question, of course, is whether there will be a permanent drop in the trend line on filings over the pre-BAPCPA levels.

Two possible hypotheses that I have heard don't seem to be consistent with the data that I have seen:

1. BAPCPA Hangover: One theory is that the system is still suffering from a BAPCPA hangover, and that everyone who was thinking of filing filed last October before the law went into affect. But this is hard to square with the observation that filing levels stabilized in the spring and have not subsequently bounced back to anything like their preexisting levels. Moreover, even if you add in all of the extraordinary pre-BAPCPA surge in filings (500,000) into 2006, you are still looking at a substantial drop from 2004 or BAPCPA-adjusted 2005.

2. Increased Cost and Complexity: Another theory is that increased cost and complexity of the system is simply making it more difficult for needy filers to get access to bankruptcy even though they need it. But if this is the case, then one would expect to see a spike in "informal bankruptcies," i.e., defaults by struggling consumers who need to file bankruptcy but are unable to do so for some reason. Yet looking at the Federal Reserve's data on delinquency rates and charge offs on consumer loans, there appears to be no increase in delinquencies on consumer loans, as one would expect were struggling consumers unable to get access to bankruptcy, and a drop in charge offs. FDIC data indicates that total chargeoffs appear to have fallen dramatically as well. So this data seems to be inconistent with the hypothesis that there are many struggling consumers out there who need bankruptcy relief but are unable to afford or navigate the new system.

This absence of an upward trend in delinquencies is especially striking given that there are othe forces that would have been expected to manifest themselves in higher delinquency rates regardless of bankruptcy. First, as a result of Fed policy, there was a general upward trend in interest rates for consumers as compared to the past few years. As adjustable rate mortgages and other variable rate consumer loans such as home equity loans and other consumer loans took this into account one would have expected a rise in deliquencies. Second, in January new regulations were adopted that increased the mandatory minimum payment on credit cards. That too should have exerted upward pressure on consumer credit defaults, especially on credit cards. Yet there is still no upward spike.

A third hypothesis is that despite some hiccups, BAPCPA has been working largely as Congress intended so far in diverting various categories of debtors out of bankruptcy while preserving relief for those who need it.

I'd like to hear from you in the Comments and on two points in particular. First, from debtor and creditor pracitioners as to what you think is causing the drop in the filings and in particular how the composition of filers has changed (if at all). Second, I'd be interested in hearing any additional hypotheses other than the three I have described, as to what is going on.

Please keep comments civil and substantive. I am hoping to collect experiences here as a centralized repository for scholars that can be used to generate testable hypotheses about what is going on out there.

Update:

To clarify my bleg just a bit--I'm also looking for impressions as to whether particular provisions of BAPCPA have had an especially strong "bite." For instance, are we seeing a dramatic drop in repeat filings? Cases with suspected fraud? High-income filers? Cases with auto cramdowns (although it appears that chatper 13 filings have risen as a percentage of cases)?

Foreclosures:

In a comment to my earlier post, a Commenter notes that foreclosures have risen dramatically over the past several months. This raises an excellent quesiton, and one that I was actually going to address in my initial post. It may be worth mentioning briefly why I don't view foreclosure numbers as a particularly good metric for measuring financial distress. I thought it might be too distracting to discuss in the initial post, but since it was raised in the Comments I'll go ahead and say a few words here.

Home foreclosures are analytically more complicated than consumer debt delinquencies and charge offs. There are two competing theories of foreclosures. One is a "distress" theory the other is an "option" theory. Under the distress theory, a rise in interest rates could cause an involuntary default and subsequent foreclosure, by making it more difficult to make monthly payments. The option theory views foreclosure as a rational economic "option," which is that when you buy a house using a mortgage you also buy an option to default. When housing prices fall, economic theory predicts that more people will exercise this option to default and permit foreclosure. One would especially expect to see the exercise of such an option for "investment" properties, such as condominiums held as a speculative investment rather than for owner-occupancy. And if the loans are non-recourse, then this makes the option even more valuable. I discuss some of this literature in passing in my article on the bankruptcy crisis.

The empirical difficulty is disentangling the option theory from the distress theory, especially if there is a simultaneous rise in interest rates and fall in housing prices (the two being related, of course). A rise in interest rates would lead to increased foreclosures under a distress theory (because it will be more difficult for consumers to make their monthly payments), whereas a fall in housing prices would lead to increased foreclosures on an option theory.

If interest rates have stabilized, but housing prices have continued to fall, this would be more consistent with the option theory of foreclosure.

To the best of my knowledge, we don't know the extent to which the recent rise in foreclosures is the result of investors exercising their default option to surrender their properties. I have seen reports that some cities that have had the largest rises and falls in residential real estate are also those that had the largest number of speculators, but this seems to be anecdotal.

Certainly consumer debt more generally has this option value built into it, but the value of the option is not as likely to vary over time as for real estate and real estate foreclosures.