Economy Outlook 2010 – Bankruptcy Filings Increase First Half of 2010

economy-bad-news On the heals of recent negative job numbers reported by the U.S. Department of Labor, comes news that bankruptcy filings increased by 14 percent during the first half of 2010. Does this bode well for the economy or is this one of the signals of a recession coming back to haunt us?

Unfortunately, as is always the case when it comes to finance and the economy, the answer is complicated. The most important thing to notice is that the first half of 2010 includes January through March of 2010 which are the months of this year that came before the stock market started recovering. Those months also came before the some lending started loosening back up. They also came before job numbers started going up suggesting that more people will not need to file for bankruptcy if they can make their loan payments with the salary from their new job.

However, it would be foolish to dismiss the news of increasing bankruptcy filings as a non-event. It is just as important to note that the 14 percent increase in filings being reported is as compared to the first half of 2009 when bankruptcy filings were not exactly at all time lows. In fact, the first half of 2009 was very bad for bankruptcy filings already. To actually increase over that number, things in the economy had to be really bad.

What does high bankruptcy filings mean for the economy overall, and does this signal a stock market downturn or a coming recession or even depression?

Bankruptcies Get Worse Economic Outlook for 2010 Gets Clearer

The bad news, of course, is that if people are filing for bankruptcy that means that financial institutions will suffer losses due to those bankruptcies. Furthermore, plenty of the bankruptcies from “irresponsible” borrowers who were clearly overextended in order to buy real estate – remember how “fix and flip” was the easy way to get rich just a few years ago – and those who just overspent and never had any real chance of paying back their loans without selling their house to get the equity, already filed for bankruptcy months ago. That means that these bankruptcies are the “hard” ones, the bankruptcies that come from people who have lost their jobs being out of work for so long that they had choice and no other way to make it work.

Now, for the good news.

Americans in general have far too much debt and far too little savings. This so-called savings deficit is a big problem. Furthermore, for many Americans who have been jobless for too long, there is almost no way they could get out of the hole they are in even if they got a new job paying what they used to make tomorrow. Finally, the U.S. real estate market has bottomed out or is only declining slowly in all but the most overheated real estate bubble markets.

Doesn’t sound like good news does it?

Here is where the good news for the economy is.

As has been widely reported, banks and financial institutions took government stimulus dollars and bailout money to shore up their own balance sheets and did very little additional lending. That means that a majority of debts being wiped out by bankrupt borrowers are old loans instead of new ones. That means that a lot of these debts have already been written off or assigned very low values on the bank’s balance sheets. In other words, this isn’t going to make things any worse for them than it already was.

With that being the case, at least for the short term, there is little concern for the banking sector as bankruptcies rise, so long as they come to an end soon. This is where the good news comes from.

As bankruptcy filings accelerate, they clear out the pipeline of possible bankruptcy filers that might otherwise come later. Banks will find that the profits they managed to squeeze out earlier this year are gone, however, when they come back, there will be much less potential danger overhanging them.

On the other side of each bankruptcy filing is a person or family that no longer has to pay off debts that had grown so unmanageable that they could have choked off 100% of discretionary spending from that family for years. In the aggregate, this would be much worse news for the economy than high bankruptcy numbers now. While bankruptcy is a huge blow it is a one time event from which recovery, albeit a slow one, begins immediately.

Many bankruptcy filers are baby boomers approaching retirement. These people have gotten the very pleasant surprise that, in most cases, retirement accounts such as IRA accounts and 401k accounts cannot be touched in bankruptcy. These same borrowers will also find out that as long as they make their mortgage payments, they are also very unlikely to lose their home during bankruptcy, because a certain percentage of equity is considered untouchable by creditors, as well. Having borrowed against this equity earlier, and with home values dropping, many filers will find themselves well under the equity limit.

Add it all up, and you have a large collection of people who will actually find themselves in a pretty decent position as the economy turns around. Those without jobs will find employment again, and those with them will find their paychecks much easier to stretch to make ends meet without all of those credit card payments. In other words, it will take a lot less economic improvement to put these households back to “normal.”

In short, higher bankruptcies and accelerating filings will cause pain in the short-term, but may be just what the doctor ordered for the economy for next year and beyond.

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