People enter the Manhattan U.S. Bankruptcy Court in New York City
In the fourth-floor courtroom of the U.S. Bankruptcy Court of the Southern District of California, which serves San Diego and Imperial counties (pop. 3.4 million), Chief Judge Peter W. Bowie's docket is overflowing. Bowie has 77 Chapter 13 bankruptcies on his Tuesday calendar, one of which is the case of Juan Flores.
Flores, 55, is the owner and sole proprietor of a local business, Carpet Care 4 Less. Throughout 2007, he saw his income plummet along with the national economy. "My business dropped off by 50%," he says. As his client roster evaporated, Flores started drawing on credit cards and took out a second mortgage to the tune of $57,000 in order to stay afloat. In 2009, out of options and under threat of losing his home of 10 years, Flores filed for Chapter 13 bankruptcy — a reorganization filing under which consumers agree to a plan to make payments of past-due debts to creditors for a three- to five-year period. But now he is behind on his payments again, and Wells Fargo Bank wants to restart foreclosure proceedings.
Cases like Flores' are being brought before judges all across the country, and the number of such legal actions promises to increase. In March, more individuals and businesses filed for bankruptcy than in any month since October 2005, when federal bankruptcy laws were made more restrictive. There were 158,141 U.S. bankruptcy petitions filed last month — a 35% increase over February's figure, according to data compiled by Automated Access to Court Records (AACER). This was a 19% increase over the number in October 2009, the last record-high month.
In the first quarter of 2010, the rate of personal bankruptcy filings in a dozen states increased by double-digit percentages over 2009's monthly averages. "What is surprising is that there are still hefty increases in states like Arizona, California and Florida," says AACER president Mike Bickford, referring to the fact that it might seem that the worst would be over in states hard-hit by the housing bubble. "Intuitively, you would think there might be some leveling off in these states, but that is not the case. In addition, there were large increases in bankruptcy filings in the Midwest, especially Michigan and Illinois."
But many law scholars are not surprised by Americans' mad rush to bankruptcy court. Adjusted for inflation, personal borrowing in the U.S. is 10 times greater than in 1960, according to the Federal Reserve. "Now, consumer credit has dried up," says law professor Robert Lawless, an expert on bankruptcy among sole proprietors and small entrepreneurs at the University of Illinois. "That is why people are ending up in bankruptcy court."
Katherine M. Porter, a bankruptcy expert at the University of Iowa and the University of California, Berkeley's Boalt Hall Law School, says people typically "seriously struggle" with their debt for two years before turning to bankruptcy.
The statistics show that Chapter 7 bankruptcy filings are rising faster than the more complex Chapter 13 filings. While the latter requires individuals to repay a substantial portion of their debt and prevents banks from foreclosing on their homes, Chapter 7 bankruptcy allows a debtor to wipe out his or her debts entirely and get a fresh start. "It is very fast and very deep debt restructuring," says Porter. Since 2005, Chapter 13 filings have dropped from about 35% of all personal bankruptcy filings to 25%, she says. "Systemically, that's a big change."
That change suggests that more home owners are simply walking away from their mortgages, rather than attempting to make payments, especially during a recession with record-high long-term unemployment. "Chapter 13 was designed for regular economic times when people might lose their jobs and fall behind on their mortgage for three to four months, but having found a new job they would be able to use the Chapter 13 process to keep their homes," says Porter, noting that even during normal economic times only 1 in 3 Chapter 13 bankruptcy filings results in the individual's successful meeting of payment obligations.
Under current bankruptcy law, Porter says, bankruptcy courts have "no tools to reduce the principal, stretch out the payments or adjust the interest rate" — that is, since judges can't adjust mortgages to make them easier to pay, people end up ditching them instead.
San Diego resident Flores is still unwilling to give up, though a skeptical Judge Bowie says he is inclined to dismiss the case. "Have you run the numbers to see if he can meet the payments on just unemployment?" Bowie asks Flores' attorney, Larissa Lazarus. The attorney informs the court that her client needs 12 months to catch up with his payments, saying the problem is a back-property-tax issue of $908 a month that will be resolved in nine months. From the bench Bowie says, "I can do nine months, not 12."
Flores, who has run his carpet-cleaning business for 30 years, is relieved. "I just have to work like hell," he says.
A substantial number of cases before Bowie involve a financial institution asking the court for relief from stay, so they can pursue foreclosure against borrowers like Flores. Lenders represented in the courtroom include JPMorgan Chase Bank, Bank of America, Deutsche Bank Trust, Wells Fargo Bank, US Bank and GMAC Mortgage. When a Chapter 13 bankruptcy is ordered and confirmed, lenders must cease any foreclosure proceedings and the delinquent homeowner must begin making regular mortgage payments. But if the debtor cannot keep up the payments, "sooner or later the court drops the bomb," says attorney James Beshears.
To help individuals make their payments, Bank of America announced in March that it would start reducing the principal on some home loans. This, after the banking industry successfully fought off attempts by Democratic Illinois Senator Dick Durbin and others in Congress to pass legislation last spring that would have allowed for mortgage modifications. But since then, it has become clear that without loan modification, many borrowers have no recourse but to accept foreclosure and walk away, says Porter. "I think one reason the economic recovery is slow is that it is taking so long to work through these delinquencies," she says.
According to Jay Brinkmann, chief economist of the Mortgage Bankers Association (MBA), "Loans 90 days or more past due now account for half of all delinquencies, the highest share in the history of the MBA survey."
In San Diego and Imperial counties alone, bankruptcy filings have increased 379%, spiking from 4,210 in 2006, the peak of the housing boom, to 20,193 in 2009. Nationally, more than 1.4 million business and consumer bankruptcy petitions were filed in 2009, up 32% from the 2008 figure, and Samuel J. Gerdano, executive director of the American Bankruptcy Institute, says the number of consumer filings (Chapter 7 and 13) in 2010 will likely surpass those in 2009. If the just-released March numbers are any indication, Gerdano is probably right.