The Calm Before the Storm of Bankruptcies

Though the numbers haven’t shown it yet, many are bracing for a spike in personal bankruptcies once coronavirus relief efforts and stay-at-home orders have been exhausted.

Based on a review of historical bankruptcy filing rates, there are indications that a wave of bankruptcy filings may materialize. The data analytics firm AIS InfoSource found a tight historical correlation between bankruptcy filings and increased unemployment coupled with rises in mortgage delinquencies.

Since 2008, bankruptcy filings have increased more or less in tandem with job loss and missed mortgage payments, according to this chart.

There are questions about whether this correlation will repeat in the current economic crisis. Unemployment has risen quickly to levels not seen since the Great Depression. Mortgage delinquencies have also increased and may reach as high as 19%, according to a Black Knight report.  But there are countervailing factors as well.

The current unemployment crisis was artificially created by state and local government stay-at-home orders in response to the pandemic. In past business cycles, increases in the unemployment rate resulted from shocks or recessions —not from a deliberate government decision to freeze most economic activity.

Mortgage delinquencies may also be a less reliable predictor of bankruptcy filings.  Many homeowners will benefit from a mortgage forbearance program as a part of the coronavirus relief bill. For mortgages owned or guaranteed by the federal government, homeowners can miss payments without facing foreclosure. An imminent foreclosure often precipitates a bankruptcy filing, which stops the foreclosure and allows the homeowner to catch up on missed payments.

Currently, personal bankruptcy filings are actually lower year over year. Perhaps more strikingly, the rate of consumer bankruptcy cases for April of 2020 was 46% lower than April of 2019.  This could be due to the fact that courts and law firms have been closed, making filing for bankruptcy more difficult.  Also, the federal stimulus payments and expanded unemployment benefits may be keeping consumers afloat for the time being.

The current lull seems likely to be unsustainable. Unemployed consumers will burn through savings and exhaust unemployment benefits, and mortgage forbearance cannot continue forever. When that happens, many consumers will seek to wipe out credit card debts or stop a foreclosure from proceeding.

Whether the tight correlation between bankruptcy, unemployment and mortgage delinquencies continues to hold in the next few months is impossible to know with certainty.

But it would be very surprising not to see a spike in bankruptcies later this year, especially in states with longer stay-at-home requirements.

Source: American Banker