The projected end point for the Great Recession of 2008-2009 has gotten a lot of ink.
[img]678|left|||no_popup[/img]The stock market is posting steady gains. Commodity prices are surging, and the housing sector has displayed growing evidence of stabilization.
Seemingly forgotten amid these positive signs of economic recuperation is a lingering mass of debt that in many instances only can or will be resolved by the bankruptcy courts.
Probing the Dark Side
From January to August, national bankruptcy filings reached 954,911, up from 703,732 in the same period of 2008. In August, filings were up 22 percent compared with August 2008. Most experts expect new bankruptcy filings to top 1.45 million by the end of the year.
According to figures recently published by the American Bankruptcy Institute, approximately 30,000 businesses filed for bankruptcy protection in the first half of 2009, nearly 65 percent more than the same period last year. The number of Chapter 11 business reorganizations was up 113 percent from last year while the level of Chapter 7 business liquidations jumped 57 percent.
After changes to the insolvency laws in 2005, bankruptcy filings significantly slowed. In concert with the massive erosion of wealth precipitated by the plunge in home values, new filings now have nearly matched their pre-2005 levels.
The 2005 reforms were aimed at curbing bankruptcy abuses and to make it harder to erase personal debts. In particular, changes in debt ratios prevented many higher-income people from fully discharging their debts under a Chapter 7 bankruptcy.
With these changes, many higher income individuals and families are being forced to utilize the protections provided by Chapter 11 of the U.S. Bankruptcy Code to reorganize their obligations because they have been effectively locked out of liquidating their debts under Chapter 7.
[img]679|left|||no_popup[/img]Typically, because of its expense and complexity, Chapter 11 debt reorganization has been the exclusive province of businesses. Falling home prices, however, have left many wealthier individuals unable to sell or refinance properties they acquired during the height of the housing boom. Consequently, an increasingly high number of the wealthy are using reorganization under Chapter 11 to keep their creditors at bay.
How Wealth Flipflopped
Most news reports have focused on sub-prime-related defaults and credit abuses that permitted otherwise unqualified buyers to purchase homes. But the upswing in the forced sale or foreclosure of homes valued at more than $1 million has been dramatic. Listings for these higher value homes increased by nearly 27.3 percent in July over October 2008.
In conjunction with the pre-recession surge in home values came an unprecedented expansion in personal wealth and debt. Court statistics have shown that many of the individuals seeking reorganization of their debts under Chapter 11 have multiple homes, luxury car payments and children in expensive private schools.
While the economy was expanding, real estate was a powerful driver of personal wealth. Now it has become a lead weight that is dragging down a disproportionately high number of wealthier income earners.
Unlike equities that can only fall to zero value, real estate can go negative. It is not simply an issue of appraised values falling below the original purchase price. In addition to monthly mortgage obligations, there are ongoing expenses associated with property taxes, maintenance and in the case of condominiums, frequently exorbitant homeowner fees.
Falling compensation and a growing number of job losses among dual income families have been common factors among individuals seeking the shelter of a Chapter 11 bankruptcy.
Although there are not yet statistics to bear this out, it appears that the earnings of many higher income filers can be directly linked to jobs in the financial and real estate industries.
Nationally, the cost of a Chapter 7 bankruptcy usually starts around $1,300 and may go as high as $6,000 By comparison, the fees and costs of a Chapter 11 filing can start at $15,000.00, and escalate to two or three times that amount before the case is complete.
Like businesses, individuals looking to reorganize their debts under Chapter 11 must demonstrate the ability to eventually pay down their outstanding balance, even if the court reduces the level of their obligations. If are they unable to demonstrate their ability to service their future obligations to the satisfaction of the court and, more importantly, the court’s bankruptcy trustee, their cases may be involuntarily converted to a full debt liquidation under Chapter 7.
[img]680|left|||no_popup[/img]Unfortunately, in light of the 2005 changes to the bankruptcy laws, many wealthier filers may be excluded from the protections offered by Chapter 7. Without these protections, these individuals instead will be left to face an unstoppable onslaught of defaults, repossessions and lawsuits from their creditors.
Ironically, a growing number of employers view individual bankruptcy as a factor when considering new hires. In the brokerage industry, a bankruptcy filing becomes a permanent part of the Financial Industry Regulatory Authority’s BrokerCheck report. This means that both potential employers and investors have access to this personal information before they decide whether to hire an individual broker.
Clinically, most academic economists view bankruptcy as a reorganization of ownership and a predicable realignment of otherwise inflated prices. For investors who have retained their liquidity, bankruptcy presents a host of bright opportunities.
But for the individuals and businesses now facing the anguish of bankruptcy or worse, the road to economic recovery will be as long as it is painful.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
