The Trend Holds: Bankruptcy Filings Are Up

The June bankruptcy filing numbers are in, and they show a continued upward spiral. Total bankruptcies numbered 37,922, or 17.42 percent above the number posted last June. For the first half of 2023, bankruptcies rose by 17.36 percent over the first six months of last year.

When will these steep increases end? We previously reported on the Justice Department’s U.S. Trustee Program projection of a 75 percent explosion between 2022 and 2024. If that estimate proves correct, bankruptcy filings will fast return to the pre-pandemic normal. But that may be a lot higher than many credit providers imagined just a few months ago.

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Chapter 13 filings continued to set the pace for consumer filings, registering a 19 percent rise over June 2023. A combination of high interest rates, the need to protect a vast increase in home equity values, and the elevated cost of living all seem to be contributing to the expansion in chapter 13.

The number of chapter 7 filings rose by 15.4 percent last month compared to last year. Coping with higher prices and the loss of COVID relief that keep countless families afloat during the pandemic continues to force more borrowers into chapter 7 where a trustee liquidates non-exempt assets in return for a discharge of debts.

Maybe more portentous, chapter 11 filing marched upward in June by more than one-third at 35.7 percent. Small businesses in subchapter V almost DOUBLED by rising 98 percent last month. Businesses large and small face a precarious economic environment and, after years of low filings, now seem to require bankruptcy relief as much as consumers.

One of the potential accelerants that may further fuel the fire of increased bankruptcy filings is student loan debt. Currently, more than 40 million Americans owe about $1.7 trillion in outstanding student loans. The federal government's repayment pause due to the pandemic is ending soon, thanks to a recent debt ceiling compromise mandating repayment resumption from October. This could strain many household budgets.

The Biden Administration's plan to forgive up to $20,000 in student loan debt, or about $430 billion in total, was halted by a Supreme Court ruling in Biden v. Nebraska. The court ruled that the President lacked the authority to cancel payments. Pursuing other statutory justifications to provide relief faces potential opposition and legal challenges.

With student debt relief options dwindling, bankruptcy may become a more popular option, despite the past difficulty in discharging student loans due to the "undue hardship" standard in the Bankruptcy Code. Over recent years, bankruptcy courts have increasingly discharged student loans, and the Department of Justice (DOJ) announced more debtor-friendly standards.

The end of the repayment moratorium and lack of loan cancellation likely means more borrowers exploring bankruptcy relief. Pressures on the DOJ to discharge loans are expected to increase, leading to more student loan bankruptcies.

To the extent that broader national economic developments help drive bankruptcy filings – and they do, at least to some significant extent – the following headlines may be telling: "Get Ready for the Full-Employment Recession" (Wall Street Journal, June 3, 2023); "Struggling Companies That Got Debt Lifelines Are Failing Anyway" (Bloomberg, June 6, 2023); and "Student Loan Pause is Ending, With Consequences for Economy" (New York Times, June 21,2023).

Although Federal Reserve skipped a month in its long-standing hikes in interest rates, most economists expect the rate climb to resume later this summer. In any event, without a reduction in rates, consumers and businesses will continue to pay about twice as much in interest as they did about a year ago.

According to the Wall Street Journal piece referenced above, economic productivity ("output per hour worked") is "cratering." The June 18th online Creditor Corner publication contains interesting commentary about the current business default cycle. Bankruptcy lawyer Bradford Sandler of the Pachulski law firm concludes that business "restructuring professionals will continue to have a busy 2023 that most likely will continue into 2024."

Add to this recent commentary from banking regulators and outside experts suggesting that enhanced banking regulation for mid and even lower-tiered financial institutions is right around the corner. That may be good or bad for the overall economy, but it certainly means greater scrutiny and cost for bank operations.

June bankruptcy filing statistics, and other economic reports, tell "the same old story” we have heard before: bankruptcy filings are climbing at a rate not seen since the Great Recession more than a decade ago. Neither micro (e.g., student loan debt) nor macro (e.g., interest rates) economic data provide signs of a slowdown. Government projections show a return to the 2018-2019 filing rates over the next two years, doubling last year’s filing number. Now may be the time to believe the government experts.

Commentary provided by Clifford J. White, Senior Advisor - Bankruptcy Compliance for AIS.