Friday, September 01, 2006

How to Avoid Bankruptcy, Part 1

Copyright © Fred Roper 2006.

Until the changes in bankruptcy law on October 17, 2005, bankruptcies were exploding in prevalence in the US. The credit industry blamed consumer debtor attorneys and claimed there was endemic fraud being perpetrated by debtors. Conventional wisdom has been that bankruptcy is the result of poor financial planning and management. Even now, there are websites that tout the idea that bankruptcy should always be avoided – and that filing for bankruptcy represents a personal failure on the part of the debtor.

The fact is that just isn’t so.

While bankruptcy should be avoided if at all possible -- and that is what this blog post is about -- it is not a personal failure to file bankruptcy. The founding fathers of the United States always intended bankruptcy to be a part of our legal system.

U.S. Constitution
Article 1.
Section. 8.
To establish … uniform Laws on the subject of Bankruptcies throughout the United States;

The Primary Causes of Bankruptcy

One poster on a recent blog wrote: (Bankruptcies have) more to do with increasing consumer credit, working mothers, and declining personal savings rates than it does with the policies of this or any other administration….

This entry does espouse the conventional wisdom, however, as I will explain, it fails to get to the root causes of why there is “increasing consumer credit” “working mothers” and “declining personal savings.”

My personal experience as a consumer bankruptcy attorney leaves a different story:

Over the 5 years I have been practicing primarily bankruptcy law, I have noticed that most consumer bankruptcies are the result of seven (7) primary causes, few of which are effectively within the control of the debtor. Not necessarily in order, I see:

1. Medical bills and related problems (54% according to a Harvard study)

2. Divorce

3. Loss of job, drop in pay, or unexpected increase in living expenses (new family member or job relocation, rising gas prices, etc). This problem will rise in the future as more large companies file for Chapter 11, shedding the company's obligations for health care and pensions. This is a kind of "hidden tax" on the poor and middle class in that the worker is having to shoulder more of the risk and cost that business owners used to shoulder.

4. Overuse of credit (spending money they don’t have, to buy things they don’t need, to impress people they don’t know).

5. Death of a spouse or related bread-winner.

6. Among business owners, an unexpected economic downturn or failure to pay taxes.

7. Drug abuse.

I have not seen as many bankruptcies (but I admit there are some) which are the result of poor spending habits or gross mismanagement of funds (my best guess is roughly 10-15% of all bankruptcies). And I will admit there are even some that are planned by unscrupulous people. But these cases are very rare (maybe 5% of all bankruptcies). Bankruptcy may appear to the debtor as a sign of failure, but it most certainly is not when the cause is beyond the debtor’s control.

Given the primary causes of bankruptcy (chapter 7 or 13) based on my experience, how then can bankruptcy be avoided?

The first thing that can be done to help prevent bankruptcies is not even under the control of the debtor. The answer is also very controversial. What would be the best way to prevent personal bankruptcies (and corporate ones for that matter)?


This will not happen as long as the current crop of lawmakers stay in power in Washington. But if you truly wanted to reduce the number of bankruptcies and their root causes in this country, then creating a national health care plan would be the most effective way to do it.

More on the benefits of a National Health Care system and the effects of the new bankruptcy law in a future post.

1 comment:

Anonymous said...

hi fred--good on ya for addressing the underlying causes of bankruptcies.

keep up the good work--and i totally agree on national health insurance.

charles smith