YBK: When the 2005 Bankruptcy Reform Act was signed by the President on April 20, one of the predictable consequences was that we would see a surge in bankruptcy filings before the law would go into effect six months later. A similar increase occurred in March and April, 2001, when the same bill almost passed both houses of Congress. Sure enough, since the media first began to focus on the bill as it was winding its way through Congress, in early March, filings have gone up dramatically nationwide, as people delinquent on their debts attempt to get in before the laws become more stringent. Bankruptcy petitions went up 60% in the month immediately after the Senate passed its version, setting a monthly record of 165,459, and were 8.5% higher than they were the previous March. In April, that record was broken: 170,130 people sought bankruptcy protection, a 16% gain from the previous year.

As an attorney who has practiced bankruptcy law for over a dozen years, there has been plenty of anecdotal evidence I can attest to, from a hiring surge at local firms specializing in creditor representation to an increase in inquiries from potential clients, who ask if they can still file bankruptcy “before it’s too late”. One of the ironies of the passage of the recent law is that it has proven to be a boon to bankruptcy professionals, both in the form of higher filings before it goes into effect, and the potential to provide clients with more billable services afterward.

This trend can be seen throughout the country, In Colorado, bankruptcy filings were up 24% from a year ago in March and April; in Iowa, a 25% increase; in Ohio, one district reported a surge of 16% in April, and a 27% increase for the month of May. In Utah, a state whose filing rate has been almost twice that of the national average since 2000, Chapter 7 filings nearly doubled their yearly total in March and April alone, even though the total number of bankruptcies remained steady. And in Hawaii, filings for the month of May were up almost 35% from the numbers for the previous year.

In the federal district in which I practice, the Central District of California, the increase has been more modest; a 3.4% rise in March and April of this year, compared with the same period last year. In terms of bankruptcy filings, the Central District has traditionally had the highest figures in the nation, as well as being on the cutting edge of some of the more innovative forms of bankruptcy fraud. Due largely to the high percentage of immigrants, who are more susceptible to the entreaties of “paralegals”, petition mills and other such scum, the numbers out here were high to begin with, and it has only been in the last 5-6 years that the numbers began to inch downward thanks to more aggressive enforcement of anti-fraud laws by the Justice Department.

Looking inside the numbers, however, a very scary picture emerges. While the total number of filings has remained stable in the Central District, the number of Chapter 7 petitions (the most basic type of bankruptcy, disfavored by the new law) since March has skyrocketed. The increase in filings from the first two months of this year to the next two months, which was approximately 33%, as well as the increase from 2004 (8% over the past two months), has been staggering, with what had been a steady downward trend over the past three years reversing itself overnight. Since that same downward trend continued with Chapter 13 filings, which remain down almost 45% for the year so far, it’s clear that people are opting to file under Chapter 7 in droves rather than seeking the repayment alternative favored under the recent law. And although the official figures for May, 2005, aren't out yet, preliminary calculations indicate that total filings for last month are up close to 17% for the month, with Chapter 7 filings coming in even higher.

So what does it all mean? Well, Chapter 13 filings in the LA area have decreased by almost 2/3 since 2000, a result of the real estate boom lifting the relative wealth of homeowners, who file most such bankruptcies. When a medical emergency strikes, or a job is lost, or credit card debt becomes too onerous, homeowners have the option of borrowing on the equity of their homes, and averting the need to seek bankruptcy protection.

Not filing bankruptcy at a time when personal debt first becomes onerous has a very beneficial impact on the economy; it means that the costs incurred by creditors writing off bad debts aren’t passed along to consumers in the form of higher interest rates and late filing fees. A 1998 study concluded that in order to maintain the same level of profitability, a credit card company needs to pass along the costs incurred by a single bankruptcy on up to 46 billpayers, in the form of higher penalties for late-payments and overcharges. That study notes that those penalties disproportionately effect people who are already in a precarious debt situation, and, in turn, leads to a cycle where filing a Chapter 7 bankruptcy becomes a preferable option.

But with residential foreclosures beginning to rise, and adjustable rate interest loans becoming increasingly harder and harder to remain current, the possibility that the “housing bubble” might finally burst may be at hand. If it does burst, or if enough people behind on their mortgages think it’s about to burst before the new law goes into effect, the potential for a bankruptcy panic in September and October of this year may come to pass. A "Perfect Storm", in which the combination of a sluggish economy, overextended credit, mortgage defaults, a housing bubble, and the certainty that after October 17 it will be impossible for many people to escape the burden of their debts, would create an economic Chernobyl that will wipe out the economy.