Personal bankruptcy occurs when a court of law approves and grants the person’s (debtor’s) petition or application to legally declare an inability to pay and satisfy monetary obligations (debts) to those owed monies (creditors) for the purpose of eliminating or reducing those debts. In contrast to ongoing income-providing social safety nets, such as welfare or unemployment insurance, to prevent individuals from entering into poverty, bankruptcy has historically been viewed as a means to provide debtors in financial hardship who cannot pay their debts a chance for a fresh start. For example, a person has debts that include credit cards, car loans, a mortgage, and medical bills; loses his or her job; depletes his or her savings; and can no longer meet these debts. The debtor applies to, and seeks the protection of, the bankruptcy court to wipe clean, or at least reduce, those debts. On the opposite side of bankruptcy are creditors and other providers that will not be paid for goods or services already provided, with the result that paying consumers bear the costs of those who cannot, through higher loan and credit card interest rates and prices. Bankruptcy petitions, or filings, have tripled on an annual basis over a 10-year period, culminating in 1.6 million filings in the year 2004.
Social scientists and public policy makers are interested in personal bankruptcy for several reasons: whether or not the factors that contribute to and cause bankruptcies can be identified and somehow lessened; bankruptcy’s relationship to other social concerns such as job volatility, income, and family life; the bankruptcy process and its ensuing result as to its fairness, role, and inter-relationship with other social safety nets; and its costs to business in terms of lost revenue, all of which affect social and economic stability.
The factors that contribute to bankruptcy are varied and inter-related. Excessive debt is increasingly a primary factor but is usually not sufficient on its own to trigger a bankruptcy. When coupled with major adverse events like job loss, disability, loss of health care, or other income disruption and additional shocks such as increased medical expenses from illness or injury, the potential for bankruptcy increases significantly. Divorce can also contribute to bankruptcy potential in two-income households that split and become separate economic entities trying to maintain a similar living standard. These factors create a financial vulnerability that increases as individuals save less, reducing their own personal safety net. The vulnerability is compounded as means-based social safety net programs, such as unemployment insurance, health care, and welfare, are restricted due to public policy. Resulting middle-class stability is threatened, and choice of bankruptcy as the final safety net increases in incidence. Research shows that 80 percent of bankruptcy filings result from adverse events like job loss, illness, injury, or divorce and those who filed for bankruptcy were predominantly middle class, with earnings above the bottom 20 percent and below the top 20 percent. This is in contrast to the stereotypical bankrupt debtor who is often viewed as a so-called deadbeat, unwilling to meet his or her debts.
The factors that create personal financial risk and vulnerability are consistent in modern societies, but how a society deals with these risks varies. If the risks are to be socialized and borne collectively, stronger safety nets—before the last resort of bankruptcy—are implied, coupled with laws that restrict bankruptcy. Such is the case in the United Kingdom, with its generally regarded wider safety nets and similar consumer debt levels relative to the United States yet with lower levels of bankruptcy. If the financial vulnerability is to be borne individually, which is consistent with the U.S. open market-based society, bankruptcy remains the final safety net that must distribute debt relief and a fresh start opportunity.
In the United States, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was passed into federal law and is the most significant change in personal bankruptcy since 1978. As personal stigma regarding bankruptcy has lessened and consumer debt has grown, the act was passed to prevent so-called abuse and fraud bankruptcies by debtors who borrow heavily without regard to meeting scheduled obligations while retaining the historical intent of providing those in true financial hardship a second-chance start. The act’s most significant provision both limits debtors’ ability and makes it more difficult for debtors to completely wipe clean all debts (referred to as a Chapter 7 filing), than previously allowed. It also requires those debtors who can afford to make some payments to do so while having the remaining debts erased (referred to as a Chapter 13 filing). Under a
Chapter 13, the court stops creditors from seizing income and assets of the debtor and assists in devising a repayment plan for up to 5 years. The result is that creditors receive some of the debts owed and more than if the debtor had been allowed to file under Chapter 7. The determining factor of whether a debtor can file under Chapter 7 or is required to file under Chapter 13 is the individual’s income level relative to the median income in the state in which he or she resides and excess income after allowable expenses. If the debtor’s income exceeds the median income of the debtor’s resident state and the debtor has excess income above allowable expenses of $100, that person must file under Chapter 13. The result is that the choice of filing is means-based testing that is consistent with other means-based programs like welfare and unemployment insurance. The means test, however, will not prevent debtors from overextending their credit and may not do much to decrease the need to seek bankruptcy relief as the skills and knowledge required to avoid bankruptcy are not addressed.
- Dickerson, A. Mechele. 2001. “Bankruptcy and Social
- Welfare Theory: Does the End Justify the Means?” Paper presented at the Workshop on Bankruptcy, Association of American Law Schools, St. Louis, MO.
- Fisher, Jonathan D. 2001. The Effect of Transfer Programs on Personal Bankruptcy. Washington, DC: Bureau of Labor Statistics.
- Kowalewski, Kim. 2000. Personal Bankruptcy: A Literature Review. Washington, DC: Congressional Budget Office.
- Sullivan, Teresa A., Elizabeth Warren, and Jay Lawrence Westbrook. 2000. The Fragile Middle Class: Americans in Debt. New Haven, CT: Yale University Press.
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