Do Bankruptcy Filing Go Up or Down As Credit Becomes More Available?

One of the best sources of intelligent information on bankruptcy and related topics is a blog by a bunch of law professors called Credit Slips, “A Discussion on Credit, Finance and Bankruptcy.” (Well, OK, it can get a little heady, but they’re professors, after all.)

In a blog called “Debt Causes Bankruptcy (But Sometimes in Counter-Intuitive Ways)” Prof. Robert Lawless, had this to say:

The long-term growth in U.S. consumer bankruptcies closely tracks the long-term growth in U.S. consumer debt. When the financial crisis hit, consumer credit dried up, and outstanding consumer debt experienced unprecedented declines.

There are fewer reasons to file bankruptcy today because there was less borrowing two to three years ago.

Consumer debt also has a profound but perhaps counter-intuitive short-term effect on consumer bankruptcy rates. In the short-run, a decline in consumer credit will lead to a bump in consumer bankruptcy filings.

As people run out of options–as they become less able to put this month’s grocery or utility bills on a credit card–bankruptcy becomes a more attractive option. People can and will continue to borrow to stave off the day of reckoning.

If a lender is willing to extend credit, further borrowing is a rational decision.

The take-away from this: 

1) Most debt is incurred because credit is available. So, more bankruptcies happen when more credit is granted. (The exceptions are debts not based on credit, such as lawsuits for personal injuries or other disputes.)

2) People with debt problems try to avoid filing bankruptcy if possible, so when credit is available to them they will tend to use it instead of filing bankruptcy, or at least will put off filing bankruptcy until they run out of credit. This indicates that people still generally hate filing bankruptcy, avoiding it when they can, even if it often only kicks the can further down the road.

This may sound commonsensical, but shows that the answer to the question in the title is a bit more complicated than it might seem.

The answer is that historically credit availability to consumers has resulted in higher bankruptcy filings, but a short-term increase in credit availability will lower bankruptcy filings on an immediate basis.