Credit Cards and Bankruptcy

Todd J. Zywicki, George Mason University School of Law

Abstract

From 1980 to 2005 consumer bankruptcy filings increased five-fold. Conventional wisdom holds that a primary cause of rising bankruptcy filing rates was increased household financial distress caused by increased indebtedness caused in turn by increased credit card borrowing. In 2005, Congress enacted the bipartisan Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). The legislation was enacted in response to twenty-five years of rising bankruptcy filings and a perception of widespread fraud and abuse that threatened the fairness and integrity of the system. BAPCPA marked the most profound and far-reaching overhaul of America’s bankruptcy system in over a generation. In the two years since BAPCPA’s enactment, bankruptcy filings have plunged. From over 2 million filings in 2005, filings plummeted to less than 600,000 in 2006 and 800,000 in 2007.

Critics of the legislation argue that the drop in filings will be temporary, as the legislation does not address what they believe to be the underlying cause of the rise in bankruptcy filings in the 1980s and 1990s—excessive consumer debt caused by profligate lending by credit card issuers especially to risky borrowers. This article reviews three hypotheses about the relationship between credit cards and bankruptcy: the substitution model, the “distress” or “overindebtedness model,” and the “strategic model” and concludes that the conventional wisdom is flawed. A review of empirical evidence and available data indicates that in fact the growth in credit card lending has not led to an increase in the consumer debt service ratio or financial distress more generally, suggesting that the rise in credit card borrowing has been primarily a substitution from other traditional types of consumer credit, such as retail store credit, personal finance companies, friends and family, pawnbrokers, and other types of consumer credit.

The article then briefly examines the substitution hypothesis in more depth, describing how a substitution to credit card debt can bring about a rise in consumer bankruptcy filings even holding overall consumer debt obligations constant. Finally, the article examines the rationale and effects of the credit card provisions of BAPCPA for the substitution and distress models. To date, the response of consumers to BAPCPA has been consistent with the substitution model, suggesting that with respect to addressing particular problems regarding the relationship between credit cards and bankruptcy BAPCPA has been accomplishing its stated purposes.