Published October 1996
Credit Card Bankruptcies - No End in Sight
The record number of bankruptcies filed due to
credit card debt has fueled speculation that banks are going to tighten up their
eligibility requirements. 
However, high profits for banks issuing these
cards tend to indicate that the credit card glut and bankruptcies are not going to go
away.
The American Bankers Association reported in
September that credit card delinquencies had eached a record level of 3.66 percent for the
second quarter of 1996. That is an increase from 3.53 percent from the first
quarter, and from 2.51 percent in 1985. It was the highest ratio since 1974 when the
ABA first began to track such statistics. The last time credit card delinquencies
even approached this level was in 1991 when it was about 3.4 percent.
Personal bankruptcies are at the highest
levels in history. The number should hit a million nationwide this year, with well
over 4,000 filed in Rhode Island. This is in spite of low unemployment and an
expanding economy. Why are so many taking advantage of bankruptcy? If you don't have
much in the way of assets or equity in a home, by filing for Chapter 7 bankruptcy, you can
keep everything you own and liquidate the credit card debt.
The risk of the bad credit rating a debtor
will receive as a result of a bankruptcy becomes less of a burden then the bad credit
rating the debtor receives as a result of delinquent payments and a high debt ratio.
If the debtor faces several years of struggling to pay back his debt load (if he can
pay it at all) he may be better off liquidating his debts and begin rebuilding his credit
without the struggle. The fact is that the penalty for filing bankruptcy is not so severe
if you have little to lose.
The majority of debtors filing for
bankruptcy have experienced unexpected medical costs, job loss, or divorce. These
setbacks caused people to use their credit cards to help them get by. Unfortunately, they
never recover from the setback and are never able to pay back the credit. Other
debtors cannot resist the allure of living a better lifestyle than they can afford by
taking advantage of the liberal credit available. The keep getting new credit cards
to pay off the old ones and then they run up the old ones again. Ultimately they
reach critical mass and are unable to make even the minimum required payments. At that
point, the banks that seemed so friendly at first, allow them no alternative but to file
bankruptcy by refusing to restructure the debt or lower the finance charge.
Banks claim they try not to extend credit
irresponsibly, but clients come in to see me all the time with lines of credit no
responsible banker would approve. Some times their interest payments alone exceed
50% of their disposable income and they continue to receive offers of credit while we are
preparing their bankruptcy petition. Some banks are trying to fight the discharge of
the credit they extend by claiming that debtors obtained the credit fraudulently because
they knew there was no way they could afford it. These bank are faced with the
defense that if they were not sophisticated enough to know the debtor couldn't afford the
credit, how could the debtor be sophisticated enough.
In September, Nancy Judy, a public
relations officer for the American Bankers Association said, "Banks do take very
seriously their role in assessing risk, and they're going to continue doing that."
But the fact is that not only are banks handing out credit to people who are way
over their heads financially already, they're targeting people who just recently filed
bankruptcy. They consider a "fresh bankrupt" as a good risk because they
have just written off all their debt and won't be able to file a total liquidation
bankruptcy again for at least six years.
The question is, will the bankruptcy
courts continue to allow people to file bankruptcy so liberally? There might be some
resistance to the trend initially. However, as long as people can only file once
every 6years, the risk of abuse is low. More importantly, the apparent
"victims" of this trend are the banks. As long as they continue to profit
from the excessive credit they make available, they will not lobby for stricter rules, and
might even lobby against them. Once the banks start sustaining losses or
substantially decreased profits, though, they may take action.
