After Reforms, Huge Losses From Personal Bankruptcies

The number of personal bankruptcy filings in the United States this year passed the one million mark late in September, based on numbers from the American Bankruptcy Institute. More than 4,000 people per day are going bankrupt — that’s one every 20 seconds.

It’s a pace that may soon exceed the flurry of bankruptcy filings that preceded the bankruptcy reform deadline in 2005. The 2005 reform was intended to make consumer bankruptcy virtually impossible, though in fact it reduced it by less than half. Tinkering with the qualifications for bankruptcy turns out not to make much difference when people really don’t have any money left. With consumer income falling, and now with historically high unemployment levels and credit card interest rates, lots of people are finding that they don’t have any money left. If you flip through the bankruptcy headlines, you read about personal bankruptcies that come from business failures. The high-profile personal bankruptcies involve homebuilders, auto dealers, printers, hedge fund managers, and clothing designers whose businesses fell apart, but the vast majority of personal bankruptcies involve consumers.

Ironically, the tighter rules of the bankruptcy reform rarely prevent consumer bankruptcies, but merely delay them until the consumer’s assets are thoroughly depleted. This means that creditors get less, on average, than they did before the reform. Creditors who became more confident in lending to consumers after 2005 (this, of course, added to the credit bubble and subsequent collapse) should have been more cautious instead. Creditors’ two tricks for collecting unpaid debts, seizing assets and garnishing wages, turn out to be not much help. A creditor might get a few thousand dollars by seizing a consumer’s checking account, but usually this means that the consumer’s checks to other creditors bounce, leading to more financial distress and, often, bankruptcy. Attaching a person’s wages almost always leads directly to bankruptcy. Typically a single creditor can take between a fourth and a third of a paycheck, but that is more than half of a consumer’s income after taxes and insurance and almost always forces a consumer immediately into bankruptcy. From the creditor’s point of view, this is a loophole they didn’t anticipate.

Another problem for creditors is that financially distressed consumers are getting more skilled at hiding their assets. Hiding assets is a crime if a consumer is in bankruptcy, but perfectly legal and often necessary for someone who is short of money but doesn’t yet qualify for bankruptcy.

More than 1 percent of U.S. adults have filed for bankruptcy since last year, and another 1 percent will be going bankrupt before the end of next year. This trend will not improve until consumer income starts to increase again, and that may not happen until early in 2012. Until then, the high rate of consumer bankruptcies will eat into the profits and capital of businesses that lend to consumers. The bankruptcy trend is just one of many factors that make a broad economic recovery difficult at this point.

In retrospect, the 2005 bankruptcy reforms can be seen to have destabilized the economy by minimizing the amount recovered by creditors when a consumer goes bankrupt. They made personal bankruptcy a more catastrophic financial event than it was already without reducing its frequency in any useful way. A revision to the bankruptcy code ought to encourage consumers to visit the bankruptcy court earlier, before it is too late for the court to salvage anything.

This Week in Bank Failures

Bank of America is looking for a new CEO. There are reportedly two committees at work, one seeking a highly qualified CEO to start in January, the other to pick an “emergency” CEO in case Ken Lewis’s legal troubles catch up with him before his scheduled retirement in December. All the candidates that have been mentioned so far have proved controversial. Stockholders and industry observers have complained that some have awkward backgrounds, while others are too unfamiliar with the workings of a bank like Bank of America. The “emergency” CEO, if one is needed, would presumably be an insider, a current Bank of America executive who is thought to be untouched by the bank’s legal difficulties. The bank appears to be leaning toward an outsider for the replacement CEO, who might be characterized as interim or permanent, but who should probably not expect a long tenure in either case. If it is true that the bank intends to select an outside candidate for CEO, it is probably a sign that the bank does not think it has the resources to survive the tough financial conditions of the next few years without substantial help from outside.

The FDIC said it had eight bidders for the assets of Corus Bank, which failed a month ago, and the winner in the auction was a group led by Starwood Capital Group. That deal is expected to close as early as next week, with the FDIC retaining a 60 percent share in the loan portfolio, a portfolio that features condo development loans. Real estate observers expect Starwood to undertake a flurry of foreclosures on failed condo projects. The result of that could be to flood the market in several cities with condo units at significantly lower prices, forcing other condo developers to also lower their prices, almost certainly leading some of these other condo projects to fail.

There were no bank closings tonight, leading me to wonder whether the FDIC’s cash flow situation is more dire than it appears on the surface. The number of banks in financial distress only increases week by week, so the gap in bank closings is the result of administrative forces. Besides the obvious cash flow concerns, delays also result as the FDIC’s limited staff is stretched thin by the growing number of problem banks. Computer system maintenance at FDIC scheduled for this holiday weekend may also be part of the reason why the FDIC was not in action tonight.

Instability and Low Interest Rates

Australia has started to raise its interest rates. It is doing so in spite of having one of the highest central bank interest rates among major nations. But at 3 percent, it is the lowest rate ever seen in Australia and is considered an “emergency” rate there, so the increase to 3.25 percent has people breathing a little more easily there, and rightly so.

Super-low interest rates, below about 4 percent, serve to destabilize the economy, pushing investment money out of banks and into high-risk speculative investments. Sometimes, to be sure, that is what you need. You don’t want the economy to be completely stable when it’s in the doldrums — you want to shake it up a bit. But it is easy to underestimate the risks. Keeping interest rates artificially low for an extended period is like setting fire to your car in the hope that this will get the engine going again. It might work, but you’d rather not have to take the risks involved.

That, however, is what the Fed is planning to do. A Fed official hinted this week that the Fed might not raise interest rates in the United States until about two years from now. That, unfortunately, leaves more than enough time for a few well-funded investors to take some huge gambles that could create a worse recession than what we have already seen.

Last year I was calling for an immediate interest rate increase to 4 percent. The Wall Street meltdown of a year ago might have been avoided if interest rates had been kept at sustainable levels in the first place. A year later, the United States is still on the verge of a financial system collapse, and it might not be too late to stay out of trouble by raising interest rates, perhaps over a period of a few months, to 4 percent.

Where Is the U.S. Chamber of Commerce Going?

Is the U.S. Chamber of Commerce turning into an extremist group?

It is a strange question to have to ask about the United States’ largest business lobbying organization. For ages, its political positions were calculated to be bland and inoffensive. The Chamber wouldn’t take a position that would pit large numbers of its members against each other, let alone one that the vast majority of Americans would quarrel with.

But that has been changing. For at least five years, commentators have been warning about corruption in the U.S. Chamber of Commerce and headlines have todl about the Chamber’s increasingly polarized political views. In the past year, the Chamber has showed that it doesn’t mind arguing against the political views of 70 percent or even 90 percent of the public. In political terms, it seems to be turning into the National Rifle Association. One year ago, it staked its reputation on an election-season campaign against unions. This year, it has taken high-profile positions against health care, investors, and now, climate management. This fall, the Chamber is spearheading a lobbying blitz that aims to repeal broad areas of air pollutions laws and bring back the see-no-evil approach to climate change of the early Bush years.

This issue seems to have been the last straw for some Chamber members, leading to a series of high-profile resignations from the group since the middle of September. This kind of issue, by nature, favors some businesses at the expense of others. It is always the case that some businesses are trying to align themselves with the market on one side of the issue, while others try to position themselves to win favor with customers on the other side of the issue. By taking sides and favoring some businesses over others, the U.S. Chamber of Commerce has given up the pretense of broadly representing the views of American businesses. Meanwhile, you only have to check the public opinion polls to see that it does not represent the views of any significant groups of voters.

Lobbyists go where the money is, and the U.S. Chamber of Commerce must have decided that its previous broad pro-business approach wouldn’t be as profitable as representing selected big-money interests. Yet it gains most of its credibility from its 3 million members, and it now finds itself in a race against time, trying to complete its lobbying objectives before its membership fades away. That is not to say that time is running out quickly. The most notable resignation at the U.S. Chamber of Commerce was Nike, which resigned from the board of directors, but maintained its membership in the organization, saying it would use its position as a member to try to change the organization’s policies. Hundreds of thousands of members may take this approach, but they will not keep trying forever. The U.S. Chamber of Commerce, much as it opposes stockholder control of business corporations, is unlikely to yield to the wishes of its members before their patience finally runs out.

Half-Built Office Buildings

Money runs out, and construction comes to an abrupt halt.

This happens from time to time in real estate development projects, but it is happening more than ever this year. The combined effect of a lending crunch, budget cuts, high energy prices, and a collapse in the real estate market make it unusually difficult to get commercial real estate development projects finished. It can take eight years to plan and build an office building or shopping center. Thousands of projects have been called off before construction began. But other projects ran out of money after construction was underway, leaving a partial building sitting awkwardly for months, potentially for years, waiting for new financing to be arranged, or perhaps waiting for a new owner to buy out and redesign the project.

Thousands of commercial real estate development projects have come to be owned by banks. In some cases, the bank foreclosed on a project after construction delays and overruns left the developer out of cash and unable to refinance. In others, the bank and the developer agreed to call off a project after they realized it was no longer economically viable.

It’s a problem for banks, which don’t really want to be in the business of owning real estate. The partially finished buildings are a special problem. In banking terms, they are high-value assets with very low liquidity and no earnings.

The Fed is trying to figure out what it can do about the half-finished commercial real estate development projects that banks already own, or may end up owning over the next two years. One thought is to devise a special kind of financing instrument so that the half-built buildings can be completed quickly. But the Fed does not want to take this approach too far in a real estate market that is already seeing high vacancy rates and falling rents.

Most of the country is seeing commercial real estate more than 10 percent vacant, with rates more like 20 percent in most large city centers. With so much excess space already, it might be better for the real estate market if many of the incomplete buildings could be mothballed for five to ten years, and the construction completed only when the space might be needed. Adding more buildings to an already overbuilt commercial real estate market could further depress rents and put more pressure on building owners and developers.

By some estimates, most of the cities in the United States have more than enough commercial space for the next 10 years. Some local politicians have been calling for a moratorium on new downtown construction until the market gets back into balance. Instead of a moratorium, restrictions on lending for commercial real estate development might be a more flexible approach. A rule preventing banks from lending more than 80 percent of the value of a project, in areas that are already overbuilt, would go a long way toward limiting the kind of real estate speculation that puts banks and developers at risk.