In an interview with News Bureau Business and Law editor Phil Ciciora, University of Illinois law professor Robert M. Lawless, a leading consumer credit and bankruptcy expert, discusses the counterintuitive link between bankruptcy filings, household debt and the economy.
Although the economy has been stagnant for most of 2011, bankruptcy filings are projected to be down by between 10 and 12 percent. Why?
The single biggest determinant of bankruptcy filing rates is debt, which has two different and opposite effects depending on the time frame. In the short run, as consumer credit eases, people are more able to pay for their daily necessities - rent, utilities, medical expenses, groceries - with a credit card or through a payday loan. Thus, consumers can use more borrowing to stave off the day of financial reckoning that much longer. But in the long run, the amount of debt consumers carry is closely related to bankruptcy filings in the sense that, the less debt you have, the less reason you have to file for bankruptcy. If you take a six-month snapshot, as access to credit increases, bankruptcy filings decrease. But if you look over a longer period of time - say, a three-year snapshot - what happens is, as access to credit increases, bankruptcy filings also increase.
Right now, we're in a period where, two or three years earlier, the consumer credit market tightened, and people weren't able to borrow as much. The short-term effect is also pushing bankruptcies lower - relative to last year, it's now a little bit easier for consumers to borrow. So bankruptcies are down for those reasons, not because the economy is suddenly doing better.
Does the drop in bankruptcy filings mean the economy is any closer to a rebound? In general, is it wise to use the number of bankruptcy filings as a proxy for the overall health of the economy?
It can be a mistake to use bankruptcy filings as a barometer for the economy or as any type of economic indicator, for that matter.
Most people would celebrate the economic growth of the 1990s as boom times, but what many people probably don't remember is that bankruptcy-filing rates went through the roof. Credit had been readily available in the early part of the decade. By the late-1990s, people had accumulated these huge liabilities, and when the consumer credit markets contracted slightly, bankruptcy filings soared.
Right now, by any rational measure, we're in very tough economic times, but bankruptcy rates are going down. So, considering the current example and the example from the 1990s, I don't think it is wise to look at bankruptcy filing rates as some sort of measure of the overall health of the economy.
The lower bankruptcy rates, however, are not irrelevant. The fact is that there will be about 150,000 fewer bankruptcy petitions this year, meaning there will be about 200,000 fewer persons who file bankruptcy (about one-third of all bankruptcy petitions are filed by a husband and wife). For those 200,000 persons who otherwise might have found themselves in bankruptcy, the lower bankruptcy rates are something to celebrate.
Debt is a huge part of American society. Do we need better regulation of the consumer credit market?
The consumer credit market is no longer a phenomenon the government can ignore. Consider that, at one point, the automobile wasn't a part of everyday life. But now that it is, the government regulates the usage of automobiles.
The same is true for consumer credit. We no longer live in a time when it is a small part of our lives. Just as we don't regulate the automobile to protect only the driver, consumer debt regulation is there not to just to protect individual consumers but to protect everyone. As our current experience in the U.S. indicates, we all suffer adverse consequences when there is a financial crises caused by over-indebtedness.
Among developed countries, the U.S. has the largest per capita debt load for short-term borrowing such as credit cards. We particularly should be concerned about such short-term borrowing. With mortgage borrowing, at least you have an asset at the end of the loan. Although many Americans use short-term credit for consumption borrowing, it is just that - consumption. You don't have anything to show for it at the end of the day.
To what extent do culture and other attitudes toward money and consumption drive over-indebtedness?
That is a good question. We do not really know for sure. Although one hears all sorts of stories about generational shifts in attitudes toward thriftiness, borrowing and savings, we do not really know whether those attitudes affect over-indebtedness or whether the easy availability of consumer credit changes these attitudes. To put it another way, we do not really know which way the causality runs. If it turns out that culture and attitudes are easily malleable when faced with legal and financial institutions promoting consumer credit, then it is really important for a society to get those legal and financial institutions right.
Along with other colleagues at the University of Illinois, we are beginning a long-term project to understand what attitudes people hold about borrowing and the extent to which those attitudes vary across cultures or across time. We hope our research will help to answer that question.