Americans go bankrupt primarily because they spend too much money, according to a study by Ning Zhu at the UC Davis Graduate School of Management. Medical costs also contribute to a lesser extent to bankruptcy, but unemployment and other adverse events have little effect, Zhu found. He notes, however, that when households are already financially stretched by overspending, they become more vulnerable to unexpected costs such as a big medical bill.
Zhu studied all bankruptcy records from the year 2003 in the state of Delaware, compared to the Federal Reserve Board’s national survey of consumer spending for households that had never declared bankruptcy.
Fifty percent of bankruptcies were caused by debt, he found. Bankrupts had higher mortgages, car loans and credit card debt than non-bankrupt households, but on average had half the income. Average credit card debt for bankrupt households roughly equaled their income.
The availability of personal bankruptcy might actually encourage such consumption patterns, because people assume that they can walk away from their debts, Zhu says. In 2005, Congress revised bankruptcy law, making it harder for individuals to seek bankruptcy. The reforms pleased banks and credit companies, but were opposed by consumer advocates. While the full ramifications of the 2005 reforms will take years to emerge, understanding what contributes to personal bankruptcy is key to evaluating the law, Zhu says.
