What Happens When The Money Runs Out?
When Bill Clinton rattled off his list of economic statistics at the Democratic convention last week, there was one that he chose to omit: In 1996, the number of personal bankruptcies in the U.S. for the first time passed the one million mark.
Until the late 1970s, personal bankruptcy was a comparatively rare phenomenon in the U.S. But since 1979, the number of annual personal bankruptcies has risen 400%. It has risen in both good times and bad -- in fact, bankruptcies have actually increased at a faster pace in the boom years since 1994 than they did during either the recession of 1981-82 or that of 1990.
Why are so many more Americans falling into financial distress? To answer that question, the authors of The Fragile Middle Class -- Teresa A. Sullivan, Elizabeth Warren and Jay Lawrence Westbrook -- queried 2,400 of the Americans who filed for bankruptcy in 1991. These people lived in five states (California, Texas, Illinois, Pennsylvania and Tennessee) that together account for nearly one-third of all the bankruptcies in the U.S. From their questionnaires, the authors learned two seemingly contradictory facts.
On the one hand, bankrupts strongly resembled nonbankrupts in age, race, sex, schooling and occupation. The typical bankrupt is not a young, Hispanic high-school dropout. He is much more likely to be white or black and middle-aged, and to have completed at least some college.
On the other hand, the income of bankrupts radically differs from other Americans. The median family income of those who filed for bankruptcy in 1991 was $18,000, about half the national median.
The authors attach considerably more importance to the first fact than to the second, and this decision fuels their book's polemical thrust. They want to argue that bankrupts are a middle-class population and that the troubles that afflict them threaten to wipe out much of the rest of the middle class as well.
Two troubles in particular worry them: the instability of the American employment market and the easy availability of consumer credit. The authors espouse a sophisticated version of nostalgia for the lunchpail economy of the 1950s, when a man took a job as a coal miner at 17 and stayed a coal miner until he retired. He may have earned only 50 cents an hour, but it was a 50 cents an hour he could count on. The modern world, by contrast, is seen as a fearful, lurching place in which downsizing is constantly devouring the white-collared middle class. As its standard of living corrodes, this endangered group strives to keep up appearances by racking up unpayable debts at 18% interest, from credit cards or other easy loan arrangements.
Ultimately, as the authors see it, America's high rate of bankruptcy (relative to population) is the product of America's underdeveloped welfare and regulatory state. In 1980, they note, there were 130 American families in bankruptcy for every 85 in Canada and every eight in England and Wales. That is because those other countries insulate their middle classes from the chanciness of the job market, subsidize medical and disability expenses and make consumer credit relatively more difficult to obtain.
There is wisdom in this explanation, but a problem too: While it's true that the U.S., Britain and Canada vary in the breadth of their welfare guarantees, it is also true that they vary in the onerousness of their bankruptcy laws -- and that America's is by far the laxest.
The authors pass quickly by their own observation that American personal bankruptcies began to rocket upward in 1979, in the aftermath of the 1978 liberalization of the bankruptcy code. "The Fragile Middle Class" is a sequel to their 1989 book about 1981 bankruptcies, "As We Forgive Our Debtors." The authors use their earlier data to argue against the importance of the 1978 legal changes. The median debtor in 1981, they say, was approximately as deeply in debt as the median debtor of 1991. Therefore, they conclude, it is false to suggest that Americans are using the new, more permissive, code casually.
But those who worry about the effects of the 1978 act aren't denying that post-1978 debtors are genuinely in trouble. They are suggesting, rather, that by offering an easier way out, the 1978 act reduced the disincentives to getting into trouble in the first place. Consider here an analogy to deposit insurance for banks. Nobody disputes that the banks that tap the Federal Deposit Insurance Corp. for funds are genuinely insolvent. The question is: If the FDIC weren't there, would so many banks permit themselves to stumble into insolvency?
And yet there is more to this story than moral hazard. Even those who doubt the authors' account of a Golden Age of Stable Jobs have to admit that there is one aspect of American life that is less stable than before: family life. The authors tread lightly here, but their own numbers suggest that divorce, separation and out-of-wedlock childbirth destabilize family finances.
Thus, in 1991, less than 24% of the American adult population over age 25 was separated or divorced. But 39% of debtors in bankruptcy were. And while almost 58% of debtors in bankruptcy identified themselves as "married," this high figure may be deceptive. Many respondents explained that they could still be called married "only because the bankruptcy court is faster than the divorce court." Among women who were divorced within 24 months of their bankruptcies, a majority -- 52% -- cited divorce as the cause of the bankruptcy. (The comparable figure among the men was 31%.)
Even so, "The Fragile Middle Class" is a brief for leaving the present permissive bankruptcy code alone. It is a weighty and powerful brief, but it is not and should not be the last word, either on the origin of this problem or on its solution.
Originally published in the Wall Street Journal.