The end of the year 2015 showed the number of bankruptcies filed in the United States was only 48% of the number filed in the year 2009. Good news, right? Well, really, no. Not at all.
Let’s start with a look back at the last 10 years of the United States economy. Go back to 2006 and things were looking pretty good in our economy. We had basically recovered economically from the Post-9/11 terrorist attacks of 2001. The mortgage crisis was still at least a year away. Bankruptcies filed in 2006 were at an all time low, but that was due to the bankruptcy reform bill passed in 2005 – a year that saw a record number of bankruptcies due almost entirely to the impending law change rather than any economic event.
Fast forward to 2007 and we see the start of the mortgage crisis. Bankruptcies begin to increase due to the increase in foreclosures. With 2008’s arrival, we see the mortgage crisis go into full bloom. Residential real estate prices are in free fall, especially in Florida, Nevada and California, but really even in the Heartland we experience a dramatic decline in housing prices. By this point, the banks have begun to severely restrict new loans. As we forge into 2009, commercial real estate prices follow suit and plummet. At this point, both consumer and commercial lending by banks is nearly non-existent.
Credit remained very tight until 2012, when banks finally began (slowly) willing to take a small risk on lending. By mid-2013, the banks were getting back to normal lending practices. So, when we saw the peak of bankruptcies in 2009, which was fueled by the mortgage crisis, it was really a correction of the idiotic sub-prime mortgage lending practices of the early 2000’s. Loose lending led to more bankruptcies. If keeping bankruptcies low were the goal of our economy, it would be easy – just tell the banks to stop lending money so not nearly as loans are out there for people to default on. The problem with this strategy is that the cure is worse than the disease. Without banks lending money, our economy stagnates and unemployment rises. Reasonable lending standards by banks result in new companies being started and new expansions by existing businesses. Not all of those companies are going to survive – that’s how capitalism works: economic Darwinism and the survival of the fittest.
Let’s take a hypothetical 100 loan applications for new businesses, all of which appear to have viable business plans. Of those 100, 20 may become very successful, 40 may become moderately successful, 25 may just barely survive and 15 may end up failing for any of a number of reasons. If would be great if we had a crystal ball and could tell with certainly which 15 will fail and which 20 will prosper tremendously. If we make all 100 loans, then we’ll end up with 15 bankruptcies when those loans go into default as a result of the business failures. However, if we don’t make any of the loans, we miss out on all of the economic benefits created by the 85 companies who will make it, to one extent or another. When banks fail to lend, then new companies don’t start and existing companies don’t expand.
It has been said that you can’t get to second base with your foot stuck on first. The same general principals can be applied to the consumer market. Good, smart use of consumer credit is essential to the growth of the economy: borrowing to buy a house and/or a car within one’s means is a wise financial decision that will yield economic growth for both the borrower and the economy. The problem that created the mortgage crisis was a tremendous lack of oversight of the loans that were being made so that the ratio of good loans to bad was out of balance. The response to that crisis of severely curtailing new loans was not healthy either, however and could not be sustained. That failure to lend is what has caused the drop in bankruptcies every year since 2009. What we need are good lending practices in both the commercial and consumer arenas, which no doubt will result in more bankruptcies when a percentage of those loans inevitably go into default. But, although we’ll see an increase in bankruptcies, with good lending practices we should see overall growth in the economy as well.