Personal Bankruptcy

As Jim has pointed out, personal bankruptcies hit record numbers in 2002 and looked poised to do so in 2003. Given that our population increases every year, that's not surprising. Indeed, it wouldn't be surprising if the number of personal bankruptcies set a new record every year. It has no real meaning by itself.

Note that the bankruptcy rate (e.g. bankruptcies per thousand people) doesn't set new records every year. There was a significant increase in the rate during the Clinton years, but that seems to have largely leveled off now. There was also a bit of an uptick during this last recession, but that's typical and also not surprising.

Who loses when someone declares bankruptcy? Each of the players involved has different perspectives and the surprising answer is that from their respective perspectives, nobody loses.

Society and the economy as a whole don't lose. The same assets and wealth exist the instant before and the instant after bankruptcy. It's just redistributed. In fact, society gains because the burden of debt isn't as heavy and stressful to people so they can be more entreprenuerial and live closer to the edge which on average can be argued to allow them to live fuller, more interesting lives.

The party filing bankruptcy doesn't lose. That's why they filed for bankruptcy. Since their debt is erased, their net worth increases when they become bankrupt. Sure, there's significant disruption to their lives, but they were able to enjoy living significantly beyond their means, possibly for many years. After the bankruptcy, they can usually even still get credit, though on worse terms.

So that leaves the lenders. Lenders look at their aggregate portfolio. They have sophisticated statistical tools that predict bankruptcy rates for different classes of borrowers and set their rates accordingly. Some lenders actually court higher risk borrowers because they can charge an interest premium. So from their perspective, the bankruptcies were expected and paid for out of the larger pool of borrowers.

So society wins, the party filing bankruptcy wins, and the lenders win overall. What a deal!