Why Bankruptcy Rates Vary By State

In a previous edition of Insurance Journal (July 20, 2009, “Tackling Client Bankruptcy: How to Help Clients Work Through the Challenges of Business Bankruptcy”), Dean Mortilla, president of NIP Specialty Brokerage, discussed what agents and brokers should know about bankruptcy to advise their clients on insurance. As Mortilla wrote, bankruptcy’s “not just occurring on Wall Street; it’s happening every day on Main Streets across the country.”

According to a recent online poll by Insurance Journal, 24 percent of agents and brokers have had business customers go into bankruptcy in the past two years; another 24 percent have had customers file for personal bankruptcy.

Just imagine if agents could identify which people and which business on which Main Streets are up to their eyeballs in unpaid debt in time to help them. But that’s not easily done.

According to a new 50-state study in the Journal of Law and Economics, bankruptcy rates vary widely from state to state. Alaska traditionally has one of the country’s lowest filing rates – an average of one bankruptcy per 1,000 individuals from 1999 through 2000. During that same period, the rate in Tennessee, the highest bankruptcy state, was nearly eight times higher. Texas had a rate of three per 1,000, but right next door in Oklahoma, the number was double that.

State Laws Have a Big Effect

But the study’s authors, Brigham Young University economists Lars Lefgren and Frank McIntyre, found that bankruptcy rates in states do not reveal much about the people or businesses involved in bankruptcies.

“Press reports on this have often focused on people,” Lefgren said. “What makes the people in high bankruptcy states so different than people in low bankruptcy states? Are they just strange or especially flaky about their debts?”

Not so, the study found.

Statistics suggest that younger people are among the top filers, but there are not many other specific demographics associated with those who file for bankruptcy.

Rather, Lefgren and McIntyre found, state-to-state differences in bankruptcy rates are mostly explained by bankruptcy laws, differences in legal institutions, and broad demographic factors.

“Our findings don’t say much at all about the people involved in bankruptcies,” Lefgren said. “In large part, we found that there are different state policies that affect how people respond to financial crises.”

Lefgren and McIntyre’s found that the best predictor of a state’s filing rate is that state’s wage garnishment law. Some states have laws that make it more difficult for creditors to dip into a delinquent debtor’s paycheck. These states tend to have lower bankruptcy rates, the study found.

“If a state limits a creditor’s ability to garnish wages, it’s easier for the debtor to ignore the debt, creating an informal default rather than a bankruptcy,” Lefgren explained. “But when someone gets slapped with a garnishment, he may be more likely to declare bankruptcy to get out from under it. The result is a larger number of bankruptcies in states where it’s easier to garnish wages.”

Chapter 13 or Chapter 7?

Another factor that increases a state’s bankruptcy rate is the fraction of filings under Chapter 13 of the bankruptcy code, rather than Chapter 7. Chapter 13 bankruptcies put filers on a payment plan; Chapter 7, on the other hand, generally wipes out debt completely. In most Chapter 13 cases, the filers are unable to keep up with the payment plan, so the bankruptcy is dismissed. At that point, the debtor often files for bankruptcy again.

“So in states where people are pushed toward Chapter 13, we have families filing for bankruptcy multiple times,” Lefgren said. “People are being counted in the bankruptcy statistics multiple times for the same debts.”

So in reality, Lefgren said, the bankruptcy rate is not a terribly good indicator of default on debt. The amount of unpaid debt might be fairly similar from state to state, but in one state it goes on the books as a bankruptcy, while in another it remains an informal default. Meanwhile, in many states, bankruptcy rates are inflated by multiple Chapter 13 filings.

South Central States Bankruptcy Filings

Chapter 7 and Chapter 13 Bankruptcy Filings Year Ended March 31, 2009
Source: Administrative Office of the U.S. Courts on behalf of the U.S. Courts

Taken together, garnishment laws and the fraction of Chapter 13 bankruptcies account for more than half of the state-to-state variation in filing rates.

While most state to state variation can be attributed to policy differences, the study found several broad demographic factors that influence bankruptcy rates, such as age and income. Filing rates tend to be higher among those ages 25 to 29, with household incomes between $30,000 and $60,000. States with larger concentrations of younger, middle-class people tend to see higher bankruptcy rates.

Source: Lars Lefgren and Frank McIntyre, “Explaining the Puzzle of Cross-State Differences in Bankruptcy Rates,” Journal of Law and Economics, 52:2. Reported via Newswise.

Top 10 States in Bankruptcy Filings

Bottom 10 States in Bankruptcy Filings

Total, Chapter 7 and Chapter 13 Bankruptcy Filings Year Ended March 31, 2009.
Source: Administrative Office of the U.S. Courts on behalf of the U.S. Courts.