Why Bankruptcy Rates Vary By State

In Insurance Journal‘s last issue (July 20; 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 in order to advise their clients. As Mortilla wrote, bankruptcy’s “not just occurring on Wall Street; it’s happening every day on Main Streets across the country.”

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

Imagine if it were possible to 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, while Tennessee is among the highest. Texas has a rate of three per 1,000 residents, but next door in Oklahoma, the number doubles.

But Brigham Young University economists Lars Lefgren and Frank McIntyre found that bankruptcy rates in states do not reveal much about the people.

Lefgren asked, “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?”

No, their study found.

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 differences in bankruptcy rates are mostly explained by bankruptcy laws, legal institutions and broad demographic factors. They found that the best predictor of a state’s filing rate is that state’s wage garnishment law. States that make it more difficult for creditors to dip into a delinquent debtor’s paycheck tend to have lower bankruptcy rates.

“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 explains. “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.”

Another factor that increases a state’s bankruptcy rate is the fraction of filings under Chapter 13 rather than Chapter 7. Chapter 13 puts filers on a payment plan; Chapter 7 generally wipes out debt completely. Lefgren said the bankruptcy rate is not a good indicator of default. Unpaid debt might be a bankruptcy in one state; in another it is an informal default.

Together, garnishment laws and the fraction of Chapter 13 bankruptcies account for more than half of the state variations.

The study did find several broad demographic factors. Filing rates tend to be higher among those age 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 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.