COVID Was Supposed to Increase Bankruptcies. Instead, They’ve Gone Down. – Harvard Business School Working Knowledge

Bankruptcy filings in the United States were expected to soar during this years economic recession, induced by COVID-19. Instead, they dropped 27 percent year-over-year through August, driven by an unexpected drop in consumer and small business filings.

The findings defy modern economic patterns. Consumer bankruptcies usually climb alongside unemployment rates as filers seek to discharge debt and get a fresh start, write the authors of the new working paper Bankruptcy and the COVID-19 Crisis.

Historically, the number one cause of consumer bankruptcy filings is job loss. This year, we saw the highest rates of job loss since the Great Depression, says co-author Raymond Kluender, an assistant professor in the Entrepreneurial Management Unit at Harvard Business School. At the same time, we saw a decline in consumer bankruptcy filing ratesand not an insubstantial decline.

So that was very surprising to a lot of people. And I think it raises a lot of questions, says Kluender, who studies the causes of financial distress among American households and how government, private insurance, and credit markets should function to insure those risks.

The papers authors also include Jialan Wang and Jeyul Yang of the University of Illinois, Urbana-Champaign, and Benjamin Iverson of Brigham Young University.

The authors compiled individual bankruptcy filings from January to August using court records through the federal Public Access to Court Electronic Records (PACER) and the Federal Judicial Center (FJC) databases. PACER records bankruptcy filings within 24 hours and FJC keeps historical data.

Researchers looked at filings in three main categories: Chapter 7, used by consumers and small businesses to discharge debts; Chapter 11, used for reorganization generally by larger corporations to pay creditors over time; and Chapter 13, which allows the filer to keep property and repay debts over three to five years.

Personal, or consumer, bankruptcies dropped 28 percent year-over-year. Chapter 11 business bankruptcies climbed 35 percent year-over-year and by 194 percent for corporations with more than $50 million in assets. However, when small businesses are included, total business bankruptcies fell 1 percent.

While media reports have focused on the record number of filings among corporations with more than $1 billion in assets and spikes in filings among retail and dining firms, overall bankruptcy filings are down, the authors write.

Chapter 7 consumer filings fell by more than a third from mid-March through April and continued to stay at levels 20 percent to 30 percent below last year through August. The lower levels are evidence that this isnt a typical recession, the authors report.

The historical relationship between unemployment claims and bankruptcy filings suggested there would have been more than 200,000 additional consumer bankruptcy filings in the second quarter alone. Instead, there were 81,000 fewer. For January through August, there were 139,000 fewer than expected.

The fact that a lot of people didn't have to make those claims could be read as reassuring. But, at the same time, there might be reasons that people didn't have access to the court system at this time, or they couldn't afford to file, Kluender says.

Two big forces may explain the drop in Chapter 7 consumer bankruptcies, Kluender says.

One may be attorney fees. A Chapter 7 filing costs roughly $2,000, a price tag that potentially shuts out consumers and small businesses when they need debt relief the most. Another could be difficulty in accessing the court system itself as the pandemic worsened and most courts moved proceedings online as a public safety measure, Kluender suggests.

Federal aid from the $1.2 trillion stimulus package, known as the CARES Act, also likely helped many unemployed workers stave off bankruptcy. And state and local governments, federal agencies, and companies enacted policies that put a temporary halt to evictions, foreclosures, and other measures aimed at easing financial strain, the authors note.

Consumer Chapter 13 filings, which are designed to save assets like homes, didnt rebound in April. Through August, those filings hovered between 55 percent to 65 percent below 2019 levels, the researchers found. The authors point to looming foreclosures and evictions as a common trigger for Chapter 13 filings, which could point to the importance of moratoria on these proceedings in helping consumers avoid bankruptcy.

Even the number of business filings were fewer than what researchers would normally expect. In the second quarter, for example, there were 645 fewer Chapter 11 bankruptcies than the 5,500 additional filings the researchers calculated would have been filed based on historical norms.

The drop in business bankruptcies is particularly striking given reports of widespread permanent business closure, the authors write. They cite an estimated 73,000 businesses listed on the review site Yelp shut permanently during the pandemic.

So, what should consumers and policymakers do now as benefits from the CARES Act are running out and a second federal stimulus package is stalled in Congress?

Dont be afraid. Think of bankruptcy as another piece of the social safety net, Kluender says.

Large corporations are not afraid to take advantage of the benefits of the generous debt forgiveness or reorganization that we have available through the US bankruptcy system, Kluender says. I don't think small businesses and consumers should be afraid of taking advantage of those benefits as well, if they are right for them.

Policymakers may want to consider making it easier to file for Chapter 7, Kluender says. In a Chapter 13 proceeding, filers are allowed to finance payments to attorneys through the court-approved repayment plan. That helps avoid the problem of paying attorney fees up front.

If you change the way that Chapter 7 operates so you don't have to pay for your bankruptcy attorney at the time where you are in the most desperate need to file for bankruptcy, [the filer] could instead pay filing and attorney fees over time, Kluender says. That could be very beneficial and allow people who currently can't afford to take advantage of the benefits that they're entitled to through consumer bankruptcy.

Rachel Layne is a writer based in the Boston area.

[Image: iStock Photo]

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COVID Was Supposed to Increase Bankruptcies. Instead, They've Gone Down. - Harvard Business School Working Knowledge