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ANALYSIS: Shutdown Brings Calm Before the Bankruptcy Storm

May 11, 2020, 10:04 AM

In the three-month period from February to April, Bloomberg Economics’ Recession Tracker reported that the chance of the U.S. economy entering a recession shot up from 28% to 53% to 100%. I generally operate from the perspective that nothing is guaranteed. Nothing is 100%. Yet, here we are. Non-essential businesses are closed. Yet the U.S. Bankruptcy Courts are essential and remain open for business, and bankruptcy analysts, attorneys, and even judges are predicting a sharp increase in filings.

For first quarter 2020, business bankruptcies increased while overall filings went down slightly, but that decrease is only temporary. It is a given that bankruptcy filings will increase. The questions are: 1) By how much? and 2) How quickly?

In March, I was optimistic that we would not see Great Recession-sized bankruptcy filing numbers again, simply because they were so high, and last year’s filing total would need to more than double to even reach peak 2010 levels. Unfortunately, I now think it is possible to reach those numbers, probably within a year of the reopening of the economy.

As was the case in my March article, increased access will continue to play a role in the rise in filings. On March 27, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) became law and included bankruptcy provisions lowering the barriers to entry for small businesses and consumers. Small businesses now qualify to file bankruptcy as small business debtors under Sub-chapter V of Chapter 11 if they have debts of up to $7.5 million, up from approximately $2.7 million. Additionally, individuals may exclude their stimulus payments from current monthly income calculations when determining eligibility to file Chapter 7 bankruptcy. Chapter 13 debtors may also exclude the payments from disposable income calculations. The provisions expire in one year but will likely be put to good use in that time.

The biggest indicator, however, may be the skyrocketing unemployment numbers. According to one former Federal Reserve economist, the U.S. unemployment rate could reach as high as 30% if initial unemployment claims do not slow down. According to the Bureau of Labor Statistics, the adjusted unemployment rate for April 2020 was 14.7%, with more than 23 million Americans on the unemployment rolls. Furthermore, some employees continue to work, but receive less than their full wages. Simply put, more Americans have less money than is needed to pay their bills as those bills come due—the definition of insolvency.

As a result of a virtually overnight jump in initial jobless claims, the prediction for increased consumer bankruptcy filings might just be a matter of simple math. According to the Bureau of Labor Statistics, in October 2009, the adjusted unemployment rates peaked at 10%. In March 2010, just a few months after peak unemployment, consumer Chapter 7 and Chapter 13 bankruptcies reached their highest numbers. 2010 would go on to be a record year for bankruptcy, with 1,531,997 total filings.

Year over year, overall bankruptcy filing rates also tend to rise and fall with the unemployment rate. As the unemployment rate rose from 2007 to 2010, so did the overall bankruptcy filings. Likewise, the bankruptcy filing rates followed suit as the unemployment rate dropped from 2011 to 2018. Although bankruptcy rates started to creep up in 2019, it was only by 0.2%. Total bankruptcy filings for 2019 were still relatively low, with 774,940 filings against an annual unemployment rate of just 3.7%. If the unemployment rate more than quadruples, it stands to reason that the bankruptcy filing rates could easily double.

We do not know for certain what will happen after the economy reopens and the world returns to some state of predictability. With the Great Recession still in its rear view mirror, Congress acted swiftly to provide some aid and relief to the struggling and unemployed. Each week, there are rumors of more relief to come. Once states loosen social distancing restrictions and businesses reopen, some of those currently unemployed should return to work, lowering the unemployment numbers. However, employees of businesses that were already among the “walking wounded” might not have jobs to return to. For unemployed and deeply indebted Americans, any relief might only delay filing, not prevent it. Whatever happens, the unemployment rates will likely remain high and bankruptcy filing rates will probably increase sharply over the next year.

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