Personal Bankruptcy: The Credit Research Center Report on Debtors' Ability To Pay
Released: 1998-02-09T00:00:00

Letter

Background

Debtors who file personal bankruptcy petitions usually file under chapters 7 or 13 of the bankruptcy code. Generally, debtors who file under chapter 7 of the bankruptcy code seek a discharge of all their eligible dischargeable debts. Debtors who file under chapter 13 submit a repayment plan, which must be confirmed by the bankruptcy court, for paying all or a portion of their debts over a 3-year period unless for cause the court approves a period not to exceed 5 years. The Center report was based on data from 3,798 personal bankruptcy petitions filed principally in May and June 1996 in 13 of the more than 180 bankruptcy court locations. The petitions included 2,441 chapter 7 and 1,357 chapter 13 petitions.

The researchers collected a wide variety of information about debtors’ income, expenditures, and debts from the schedules the debtors filed with their bankruptcy petitions. Because the debtors’ schedules used in the report must be obtained from the case files at each court location, obtaining the data used for the Center report represented a considerable investment of Center time and money. The data are not available from the automated databases maintained by the federal judiciary or the Executive Office of U.S. Trustees, the two principal sources of automated data on bankruptcy cases.

On the basis of the Center report’s assumptions and the formula used to determine income available for repayment of nonpriority, nonhousing debt, the report estimated that about 50 percent of the chapter 13 debtors in the 13 locations combined would have sufficient income, after living expenses, to repay all of their nonpriority, nonhousing debt over a 5-year period; and an additional 19 percent could pay 60 percent or more over the same period. The report estimated that 5 percent of the chapter 7 debtors in the 13 locations combined could repay all of their nonpriority, nonhousing debt over 5 years; 10 percent could repay at least 78 percent, and 25 percent could repay at least 30 percent. The Center report also estimated that about 11 percent of chapter 13 debtors and about 56 percent of chapter 7 debtors were expected to have no income available to repay nonhousing debts.

Study’s Fundamental Assumptions Were Not Validated

The Center report’s analysis was based on data from the initial schedules of current estimated monthly income, current estimated average monthly expenditures, and debts that debtors submitted at the time they filed for bankruptcy. There are two reasons to question whether broad conclusions about debtors’ ability to pay nonhousing debt can be made on the basis of the debtors’ statements of estimated income and estimated expenses at the time of filing for bankruptcy:

The accuracy of the data in the debtors’ initial schedules is unknown, and no empirical study has been done to assess their accuracy. Moreover, debtors may generally amend these schedules as a matter of course at any time prior to final disposition of the debtors’ bankruptcy cases.

The Center report assumed that debtors’ income and living expenses, as reported in those schedules, could be used to satisfactorily forecast debtors’ income and living expenses for a 5 year debt repayment period. However, the report did not include empirical evidence to support this assumption. There is some empirical evidence that this assumption may not be appropriate, at least for a portion of debtors who file for bankruptcy.

Accuracy of Data on Debtors’ Schedules of Income, Expenses, and Debts Not Known

The Center report relied on debtors’ self-reported data on current estimated income, current estimated expenditures, and debts at the time of filing and assumed that these data were accurate. Although the data in the various schedules are the only such information available at the time a debtor files for bankruptcy, the National Bankruptcy Review Commission report noted that “no study has yet been done to test the accuracy of the data as initially reported by debtors,” and it recommended random audits of debtors’ initial schedules. The effect of any inaccuracies in these schedules could be that the debtor’s actual net income is overstated or understated.

The schedules that debtors complete on their current average monthly income and current average monthly expenditures indicate that debtors should estimate their income and expenditures. The data that debtors report in these schedules represent a snapshot in time, and debtors may generally amend their schedules at any time prior to final disposition of their bankruptcy cases. Such amendments were not included in the Center’s analysis. Amendments may be made for a variety of reasons, but there are no readily available empirical data on how frequently schedules are actually amended and the effect of such amendments on the income, expenditures, and debts that debtors report on their initial schedules.

Assumption That Debtors’ Reported Income and Expenses Could Be Used to Satisfactorily Forecast Income and Expenses for 5 Years

The Center report’s analysis assumed that the debtor’s income and expenses, as reported on the schedules filed with the bankruptcy petition, could be used to satisfactorily forecast his or her income and expenses during the course of a 5 year debt repayment period. In other words, the Center report assumed that a debtor’s reported income and expenses would remain uninterrupted and unchanged over the 5 years. This assumption is critical to the report’s estimate of the percentage of nonhousing debt that debtors could repay over 5 years. However, the Center report provided no empirical support for this assumption.

A couple of factors raise questions about the validity of this assumption. First, the Center report provided evidence of instability in debtor income in the year preceding the debtor’s bankruptcy filing. About 77 percent of the 2,441 chapter 7 debtors and about 85 percent of the 1,357 chapter 13 debtors in the Center’s analysis reported having some wage income at the time of filing. However, about 68 percent of the chapter 7 debtors and about 50 percent of the chapter 13 debtors in the Center’s report also reported they had experienced a reduction in income during the 12 months prior to filing bankruptcy. As the Center report noted, it is not surprising that those who file for bankruptcy have suffered a loss of income prior to filing.

Second, there is also some evidence that debtors may experience fluctuating income or expenses in the 5 years following the filing of their bankruptcy petitions. The findings of a 1994 report by AOUSC suggest that at least a portion of debtors could be expected to experience deterioration in their financial circumstances during the 5 years after filing for bankruptcy. AOUSC reviewed the outcomes of 953,180 chapter 13 cases filed between calendar years 1980 and 1988 and terminated by September 30, 1993. AOUSC found that debtors received a discharge in only about 36 percent of all chapter 13 cases terminated. A chapter 13 discharge is generally granted when a debtor successfully completes a court-approved repayment plan. A hardship discharge may be granted to chapter 13 debtors who fail to complete the plan payments due to circumstances for which the debtor should not justly be held accountable. AOUSC found that in about 14 percent of all chapter 13 cases terminated, the debtors were unable to maintain their payments; prior to termination, their cases were converted to chapter 7 liquidation, in which all eligible debts were discharged. The typical case that converted to chapter 7 did so about 2 years after the case was filed. AOUSC also found that about 49 percent of all chapter 13 cases terminated were dismissed, but data were not available on the reasons for the dismissals. The results of the AOUSC report caution against making broad conclusions about debtors’ ability to maintain debt payments over a 5-year period based on the data in the initial schedules alone.

Center Report Did Not Clearly Define the Universe of Nonhousing Debts for Which It Estimated Debtors’ Ability to Pay

There is some evidence in the Center report that the intent of the analysis was to estimate debtors’ ability to pay their eligible dischargeable nonhousing debts—secured and unsecured. However, this is not explicitly stated, and the Center report did not clearly define the universe of nonhousing debts for which it estimated debtors’ ability to pay. The Center report defined the net income that debtors had available to pay nonhousing debts as the debtor’s net annual take-home pay less (1) living expenses (as defined in the report) and (2) payments toward “unsecured priority debt.” As examples of such debts, the report mentioned back taxes and past-due child support. These are examples of debts that are generally nondischargeable in bankruptcy proceedings.

Debtors report unsecured priority debts on Schedule E. However, the debts to be listed in Schedule E can, in some cases, include both debts that are dischargeable and debts that are generally nondischargeable. Moreover, not all nondischargeable debts can be found in Schedule E.For example, certain student loans, debts arising out of drunk driving, criminal restitution, and criminal court fines are not dischargeable in bankruptcy, but such obligations would be appropriately listed as “unsecured nonpriority debt” on Schedule F. The Center report included student loans in unsecured nonpriority debt. However, it is not clear if these student loans represented only loans that were eligible for discharge. Thus, the Center report may not have identified all generally nondischargeable debts for which the debtor would still be responsible following the close of his or her bankruptcy case.

To the extent that the Center report understated nondischargeable debts, it would have overstated the net income that debtors would have available to pay dischargeable nonhousing debts. Conversely, to the extent that the report overstated nondischargeable debts, it would have understated debtors’ net income available to pay dischargeable debts. In addition, to the extent that the report assumed that dischargeable unsecured priority debts would be paid, it would have created a disparity in the report’s treatment of dischargeable nonhousing debts.

Center Report’s Determination of Debtors’ Net Income to Pay Nonhousing Debt Excluded Payments on Nonhousing Debts That Were to Be Reaffirmed

A portion of personal bankruptcy debtors voluntarily agree to reaffirm, or repay, some of their dischargeable debts by entering into a reaffirmation agreement to remain personally liable for reaffirmed debts. According to the Executive Office of the U.S. Trustees, debtors tend to reaffirm secured debt, such as a home mortgage or car loan. By reaffirming these debts and keeping current on the payments, the debtors retain possession of the property secured by the debt. To the extent that debtors maintain their payments on reaffirmed debt, it would reduce the amount of income debtors have to pay eligible dischargeable debts that were not reaffirmed.

The Center report included in debtors’ living expenses the full value of any home mortgage payments the debtors listed in Schedule J. To the extent that the listed home mortgage payments actually represent the full payments required for home mortgage debt, the Center report assumed that debtors had reaffirmed their housing debt. However, the Center report did not deduct from debtors’ income the value of the payments required to pay the nonhousing debts that debtors stated it was their intention to reaffirm. Data provided by the authors of the Center report showed that for 12 of the 13 locations in the report (Dallas reaffirmation data were incomplete), secured nonhousing debt accounted for virtually all the average nonhousing debt that debtors intended to reaffirm. The average percent of total unsecured debt that debtors indicated they intended to reaffirm did not exceed 1 percent in any of the 12 locations.

The effect of deducting from chapter 7 debtors’ income the payments required to repay reaffirmed secured nonhousing debts would be expected to vary across the 13 locations in the Center report because of the wide variation in intended reaffirmations by location. Using data provided by the authors of the Center report, we show in table 1 the percentage of chapter 7 debtors in each of the report’s 13 locations who stated their intent to reaffirm at least some of their secured nonhousing debts, the average percent of total secured nonhousing debt to be reaffirmed, and the average total dollar amount of secured nonhousing debts to be reaffirmed. The percentage of chapter 7 debtors who, according to the Center’s data, stated their intent to reaffirm at least some of their secured nonhousing debt ranged from about 23 percent in Los Angeles to about 73 percent in Indianapolis. The data also showed considerable differences for those locations within the same state. About 23 percent of chapter 7 debtors in Los Angeles reported their intent to reaffirm at least some secured nonhousing debt compared to about 42 percent in San Diego. The average percentage of secured nonhousing debt that chapter 7 debtors stated they intended to reaffirm ranged from about 23 percent in Los Angeles to about 61 percent in Memphis. The average amount of total debt to be reaffirmed ranged from about $1,362 per debtor in Los Angeles to $6,706 per debtor in Memphis. The averages for any specific location may be based on wide variation in the amount of debt that individual debtors stated it was their intent to reaffirm.

Locations in the Report Varied in Indicators of Ability to Pay

The Center report presented data that combined results from all 13 locations on debtors’ available income to pay nonhousing debt. Because the Center report focused on the results from all 13 locations combined, it included little discussion of the considerable variations among the 13 locations used in the study. As previously discussed, Center data not included in the report showed a wide variation across the 12 locations with complete data for chapter 7 debtors’ intended reaffirmations of secured nonhousing debt. Specifically, as shown in table 1, the percentage of chapter 7 debtors reaffirming at least some secured nonhousing debt ranged from about 23 percent to 73 percent, and the average amount of total debt to be reaffirmed ranged from about $1,362 to $6,706. Data provided by the report’s authors showed that the percentage of chapter 7 debtors with at least some income available to pay nonpriority, nonhousing debt ranged from about 32 percent in San Diego to about 67 percent in Dallas.

Other studies have also concluded that there is considerable variation among bankruptcy districts. The National Bankruptcy Review Commission found, for example, that chapter 13 practices “differ dramatically from state to state, district to district, and even from judge to judge in the same district.” The Commission report noted that divergent local interpretations of the chapter 13 system create a situation in which expert legal advice is necessary to develop, confirm, modify, and complete a chapter 13 plan; and debtors in very similar circumstances encounter extremely different chapter 13 systems across the nation.

The AOUSC report on chapter 13 cases discussed earlier found considerable variation in case results among all bankruptcy districts and among the 13 districts included in the Center report. As shown in table 2, the percentage of terminated chapter 13 cases that resulted in the discharge of a successful repayment plan ranged from about 15 percent in Central California (which includes Los Angeles) to about 40 percent in Western Missouri (which includes Kansas City). The percentage of chapter 13 cases that were converted to chapter 7 liquidation prior to termination ranged from about 8 percent in Western Tennessee (which includes Memphis) to about 43 percent in Western Pennsylvania (which includes Pittsburgh).

These variations among bankruptcy districts—for percentage of debtors with at least some income to pay debts, for reaffirmations, and for the final disposition of chapter 13 cases—suggest that one should be cautious in generalizing about debtors across all 13 locations in the Center’s report.

The Method of Selecting Locations and Petitions Does Not Support Generalization of the Report’s Results

The Center’s researchers selected the 13 bankruptcy locations and 3,798 personal bankruptcy petitions without using scientific random sampling techniques. As a result, the national estimates presented in the report’s conclusions were not based on representative probability sampling methods. In addition, standard statistical methods cannot be used to evaluate the likely accuracy of the Center report’s results. Consequently, the methods used in the Center’s analysis do not provide a sound basis for generalizing the Center report’s findings to the annual 1996 filings in each of the 13 locations nor to the national population of personal bankruptcy filings.

Locations Judgmentally Selected

The 13 court locations used in the report were judgmentally selected from large urban areas with a Credit Counseling Center and large bankruptcy caseloads. The locations were also chosen to include variations in other characteristics, such as the growth in bankruptcy filings, the split between chapter 7 and chapter 13 filings, and state-specific asset exemption levels for chapter 7. Indeed, the Center report showed that the courts that were included differed considerably in the total number of filings, the proportion that were chapter 7 and chapter 13 personal bankruptcy filings, and the change in the total number of filings from 1995 to 1996. Neither the court locations nor petitions were chosen with the objective of identifying the range of debts—lowest to highest—that bankruptcy debtors could repay.

The total number of personal bankruptcy petitions filed in 1996 varied greatly among the 13 court locations. To account for this fact, the Center report stated that the sample was weighted so that the report’s weighted estimates that combined information from all locations represented the total filings from these 13 court locations. This means that the Center report’s estimates were strongly affected by those court locations that had the highest number of personal bankruptcy petitions filed in 1996. For example, about 41 percent of all 1996 chapter 7 filings in the 13 court locations were from Chicago and Los Angeles. The 17 percent of the sampled chapter 7 filings from Chicago and Los Angeles were therefore inflated to correctly represent the relative size of the Chicago and Los Angeles locations among the 13 locations. All of the Center report’s weighted estimates, including those labeled as national estimates, were weighted to represent only these 13 locations.

The Center report’s authors provided us with data, not included in the report, that indicated that the predicted abilities of those who filed for chapter 7 personal bankruptcy to repay debts varied considerably among the 13 court locations (see table 3). For example, the percent of chapter 7 debtors whom the report determined had some income available to repay debt ranged from a low of about 32 percent in San Diego to a high of about 67 percent in Dallas. The considerable variation among locations indicates that the repayment rate at other locations, and for the nation as a whole, could differ from the combined, weighted estimate for these 13 locations.

The Center report’s authors stated that its results cannot be generalized to all personal bankruptcy petitions filed nationally because the sample was not designed for this purpose. Consequently, the national estimates presented in the conclusion of the Center report are not supported by the report’s study methods.

Petitions Not Randomly Selected Among Months of the Year or Days of the Month

The Center report states that the sampling procedures used to select petitions from the 13 court locations resulted in a sample that was representative of all petitions filed in those locations. From our review of available information on the report’s sample design, we have determined that statistical probability sampling methods were not used to select the petitions filed within each court location. The Center’s petitions were gathered from several months and generally included the petitions filed in the first few days of the months of May and June (eight locations); June only (three locations); or July only (one location) of 1996. In the remaining location, the petitions were selected by the clerk of the bankruptcy court during April, May, and June 1996. Because the sample procedure for selecting filings within bankruptcy court locations was not random, the characteristics of the petitions drawn may be systematically influenced by variation in the types of filings that can occur (1) in different months throughout the year and (2) for days within the month. Consequently, standard statistical sampling methods cannot be used to determine whether the results in the Center report were likely to be representative of all bankruptcy filings in each of the 13 court locations.

The Center report evaluated the possibility that the petitions from May to July that were included in the analysis might differ from those filed during other months of the year by examining supplementary data for other seasons from Indianapolis. On the basis of the Indianapolis analysis, the authors conclude that “a concern that seasonal differences in petitions could lead to an overstatement of the ability to repay debt across all petitions filed during 1996 is unwarranted.” The Center report provided no basis for judging whether the lack of monthly variation in Indianapolis could be expected in all 13 court locations.

The petitions within each court location were not selected from filings over complete monthly periods and, therefore, could be affected by variations in the characteristics of petitions filed at different times of the month. In a few court locations, because of especially high filing volumes, the sample quotas were reached in the first day or two of the month. For example, our analysis of the Center’s data showed that about 95 percent of the petitions selected in Dallas and Houston, Texas, were filed by the third day of the month. At both of these locations, the petitions drawn had been filed prior to the first Tuesday of the month, the date on which mortgages are foreclosed in Texas. Thus, the petitions used from these two locations may have included a disproportionate number of debtors who sought to avoid mortgage foreclosures under chapter 13. The income and expenses for such filers may vary from those of debtors who filed in these locations later in the month. The report’s authors told us that they planned to sample additional petitions in Dallas and Houston to examine this possibility.

Scope and Methodology

The comments and observations in our report are based on a review of the final version of the Center report, dated October 6, 1997; some additional information we requested from the report’s authors; data and analyses provided by the Federal Judicial Center (FJC) on bankruptcy filings in the 13 locations used in the Center report; telephone interviews with bankruptcy judges and trustees; and our experience in research design and evaluation. On November 13, 1997, we met with Professor Michael Staten, coauthor of the report, to discuss our questions and observations about the report. Following this meeting, Professor Staten and his coauthor, Professor John Barron, provided additional information about the report’s methodology and some additional data that we requested. We received the last of these data on December 23, 1997. The authors declined to provide a copy of the automated database used for their analysis, citing their interest in retaining its proprietary value.

The team that reviewed the report included economists from our Office of Chief Economist and specialists in program evaluation, statistical sampling, and statistical analysis from our General Government Division’s Design, Methodology, and Technical Assistance group. We did our work principally between October 1997 and January 1998 in Washington, D.C.

Comments From Study Authors

Professors Michael E. Staten and John M. Barron, authors of the Center’s report, provided written comments on a draft of this report. (See app. I.) The authors discussed each of the report’s five areas of concern that, together, led to our conclusion that additional research and clarification would be needed to confirm the accuracy of the Center’s report’s conclusions regarding the proportion of debtors who may have the ability to repay at least a portion of their nonpriority, nonhousing debts and the amount of debt such debtors could repay. In discussing the five areas of concern, the authors agreed with some concerns but believed that other concerns were either overstated or unwarranted.

Their specific comments on the concerns raised in this report are discussed and evaluated at the end of appendix I. We focus here on the authors’ major comments and our evaluation of those comments. Basically, the authors disagreed with us over the implications of the concerns we raised. They believe that the sample of bankruptcy cases they examined was large enough and was taken from a sufficiently varied cross-section of cities and courts to (1) reveal a significant number of chapter 7 petitioners with some capacity to repay their debts and (2) suggest a need for policymakers to reexamine whether the current bankruptcy statutes should be changed. They also believe that determining debtors’ ability to pay their eligible dischargeable nonhousing debts, which the Center report did not do, was an interesting but unimportant side issue. Although they agreed that it would be difficult to use their results to estimate with any precision the repayment ability of chapter 7 debtors outside of their sample, they believed that their sample results, regardless of the concerns we found, strongly suggest a widespread substantial repayment capacity. They provided additional data and analysis, not included in the Center’s report, on reaffirmations of secured nonhousing debt to further support their conclusions.

We continue to believe that the concerns we found strongly suggest that additional research and clarification are needed to determine the accuracy of the Center report’s conclusions regarding the proportion of debtors who may have the ability to repay at least a portion of their nonhousing debts and the amount of debt they could potentially repay. We note in this regard that the Credit Research Center is currently conducting additional research with its bankruptcy database, and the accounting firm of Ernst & Young is conducting a study to address the concerns we raise in this report. The Center commented that the study clearly indicates a widespread and “substantial” repayment capacity across all 13 locations in the study. We agree that the data and indicators used by the Center showed that the percentage of debtors in each location with at least some positive net income available for debt repayment was not so small as to be negligible. However, the assumptions, data, and sampling procedures used in the Center report raise questions concerning the accuracy and usefulness of the report’s estimates and require the reader to use caution in interpreting the types of firm conclusions found in the Center report. For example, the Center’s estimate of the percentage of debtors who have at least some capacity to pay included all debtors whose monthly net income after expenses was greater than zero, whether that amount was $1 or $1,000. We were not able to conclude, as the Center did, that there is a “substantial” repayment capacity in every city because (1) we do not have a basis for determining how much repayment capacity should be considered substantial; and (2) we cannot conclude that the petitioners’ net income, as derived from data in their initial schedules, can be accepted as an accurate estimate of debtors’ net income available for debt repayment for the following 5 years.

Several factors suggest to us that those debtors with at least some capacity to pay would not be able to repay as much debt as the Center report assumed. For example, historically only about one-third of chapter 13 debtors have completed their repayment plans, suggesting that for two-thirds of debtors something changed between the time the plans were confirmed by the bankruptcy court and the time the actual repayment plan was to be successfully completed. To the extent that debtors are unable to maintain their debt repayments for the full 5-year period assumed in the report, the amount of debt repaid would be less than that assumed in the report. In addition, the Center’s estimates of repayment capacity do not include any provision for the administrative costs of administering a repayment plan. In fiscal year 1996, 14 percent of the payments from chapter 13 debtors was used to pay administrative and legal costs.

The Center report provided an estimate of the potential repayment capacity of debtors who have filed for bankruptcy to pay their nonpriority, nonhousing debts. We do not agree with the Center that identifying the universe of dischargeable debts that a debtor may have the capacity to repay is an interesting, but unimportant, side issue in assessing a debtor’s ability to repay his or her nonhousing debts. It is the debtor’s total eligible dischargeable debts that represent the potential loss to creditors if the bankruptcy court grants the debtor a discharge of all his or her eligible dischargeable debts. The Center report did not attempt to identify this universe of debts in its analysis. Creditors are not at risk in the bankruptcy process for debts that are nondischargeable or debts that the debtor reaffirms. Similarly, creditors are not at risk through the bankruptcy process for the dischargeable debts of those debtors whose bankruptcy cases are dismissed. With few exceptions, these debtors remain personally responsible for all their debts. The relevant universe of debtors who pose a risk of nonpayment to creditors through bankruptcy are those who complete the bankruptcy process and receive a discharge of all or part of their eligible dischargeable debts. The Center report did not attempt to estimate the capacity to pay of this universe of debtors. Instead, the Center’s assessment of capacity to pay included those debtors who may have received a discharge plus those debtors whose cases were dismissed and did not receive a discharge. Consequently, the Center report’s universe of debtors included debtors who remained responsible for their eligible dischargeable debts because their cases were dismissed.

The Center agrees that the Center report’s findings were not based on data from a nationally representative scientific, random sample. The Center comments that the researchers did not intend to obtain a nationally representative sample and that much useful information can come from samples that are not nationally representative. Although decisions with nationwide implications could be based on evidence from selected locations, we believe that the assumptions, data, and methods used in the Center report require that its conclusions—which, in some cases, are stated as broad national estimates—be interpreted with caution.

The additional data provided in the comment letter are helpful; but, as discussed in our comments at the end of appendix I, we did not have the database used for these analyses to verify the results. More importantly, these new data do not resolve many of the concerns we raise in this report. For example, the weighting methodology used to develop the weighted estimates presented in the new tables is the same methodology used for the Center report’s other estimates and is subject to the same limitations we discussed in our report. As with the Center’s other estimates, the assumptions used in the new analyses assumed that 100 percent of debtors’ discretionary income and 100 percent of the proceeds from the sale of the debtors’ nonexempt assets would be used to repay debt. In practice, administrative costs would reduce the amount paid to creditors.

Thus, notwithstanding the comments and additional information provided by the Center report’s authors, we continue to believe that more research would be needed to verify and refine the Center report’s estimates of debtors’ repayment capacity to better inform policymakers.

We are providing copies of this report to the Chairman and Ranking Minority Member of the Senate and House Committees on the Judiciary; the Chairman and Ranking Minority Member of the Subcommittee on Commercial and Administrative Law, House Committee on the Judiciary; and to the authors of the Credit Research Center report. We will also make copies available to others upon request.

If you have any questions, please call me at 512-8777.

Comments From the Credit Research Center

The following are GAO’s comments on specific issues included in the letter dated January 21, 1998, from Professor Michael Staten, on behalf of himself and his coauthor, Professor John Barron. Other issues discussed in the letter have been included in the report text.

GAO Comments

1. The authors agreed that there is a need to validate debtors’ income, expenses, and debts in developing assumptions of future income and expenses but stated that a researcher currently has no recourse but to accept what the debtor advises the court under oath at the time the petition is filed. We understand that researchers must use the best available data and that, currently, verifiable data on debtors’ income and expenses during bankruptcy have not been developed. However, our intent was to indicate that the Center report should have discussed how the use of data from debtors’ initial schedules could affect the Center report’s results and, thus, how those results should be used. In this case, it seems the researchers could have used more recent data, at least for some debtors, because debtors may amend their initial schedules at any time prior to the final disposition of their bankruptcy cases. Such amendments could alter the estimated income, estimated expenditures, and debts that debtors reported on their initial schedules. We recognize that obtaining these amended schedules would have required additional time and resources. However, we believe that the importance of these data to the overall conclusions in the Center’s report would justify such an effort.

The authors also said that to the extent there is a bias in the debtors’ initial schedules, it would be expected that the debtors would understate their capacity to repay debt. Although this may seem logical at first glance, it is important to note that there are no empirical data on the accuracy of the data reported in debtors’ initial schedules. Nor is there any empirical basis for assuming that debtors would consistently attempt to understate their capacity to pay their debts. In fact, there is no empirical basis for assessing whether debtors generally overstate or understate their capacity to repay on their initial schedules or the general amount of the overstatement or understatement. There may be several reasons why some debtors would actually overstate their capacity to pay. For example, some people may simply not want to admit how serious their financial situation has become in order to protect certain assets. Also, mistakes could be made in the schedules used in the Center’s analysis, which are not easily interpreted by debtors who might proceed without legal or financial assistance. For example, in Los Angeles, a location whose data contributed significantly to the Center’s final weighted estimates, Center data showed that about one-third of debtors reported they had no lawyer. Through mistakes in filling out the schedules, debtors could report information that would have the effect of either overstating or understating their capacity to pay their debts. 2. The Center stated that its calculations provided a benchmark of debtors’ ability to pay that could easily accommodate whatever assumptions about possible income changes the reader wished to make. It also agreed with us that incorporating a cushion into a chapter 13 repayment plan to guard against income interruptions or unexpected expenses seemed to be a prudent step.

We agree that the Center report provided a baseline estimate of debtors’ ability to pay that would change as the report’s basic assumption—that debtors’ income and expenses would remain unaltered for 5 years—changes. However, the Center provided no estimates based on alternative assumptions of repayment capacity, and without the Center’s database, it is not possible for anyone to estimate the effect of such alternative assumptions on the Center report’s estimates of debtors’ potential repayment capacity. Since many economic factors can change in a debtor’s financial situation during 5 years, it would seem prudent to base any policy decisions on a wider range of assumptions than the somewhat optimistic set of assumptions used in the Center study. For example, the assumption that debtors’ reported income and expenditures would remain unchanged for 5 years had the effect of providing optimistic estimates of debtors’ repayment capacity in two ways: (1) it did not allow for situations where the debtors’ income decreases or expenses increase, thus discretionary income available to pay debt was assumed to remain unchanged for 5 years; and (2) 100 percent of this discretionary income was assumed to be used for 5 years to repay debt, when in fact a portion of the debtors’ discretionary income would be used to pay the expenses of administering the debtors’ repayment plans.

There is some additional evidence that the Center’s assumption that debtors’ income and expenses would remain unchanged for 5 years may be optimistic. For example, the AOUSC report discussed on page 8 of our report showed that only about 36 percent of chapter 13 debtors completed their repayment plans. The reasons for this low completion rate are unknown, but it illustrates the high level of discrepancy between the amount that debtors could potentially repay, based on the data and assumptions used in the Center report, and what has actually occurred over a 10-year period. In addition, in virtually all cases, creditors do not receive 100 percent of debtors’ payments under chapter 13 repayment plans. Fiscal year 1996 data from the Executive Office of U.S. Trustees showed that 14 percent of payments were used to pay the debtors’ lawyers, the chapter 13 trustees’ statutory operating expenses in administering the plans, and other administrative expenses. 3. The Center said that it believes it has clearly identified the universe of debts for which it estimated debtors’ ability to pay as all “debts not secured by real estate, without drawing a distinction between secured vs. unsecured, priority vs. non-priority, or dischargeable vs. non-dischargeable.” The Center commented that the distinction between dischargeable and nondischargeable debts is simply “an interesting side issue.” The Center said that such distinctions between categories of debt were not necessary if the report’s intent was to assess debtor’s overall ability to meet their obligations. The Center also said that unsecured priority debt was not included in the base of total unsecured debt for many of the repayment calculations, because the report assumed that unsecured priority debt would be paid before unsecured nonpriority debt.

We do not agree that the distinction between dischargeable and nondischargeable debt is just an interesting side issue. The distinction is important if the Center’s data are to be used for considering the need to alter existing bankruptcy statutes. It is the debtor’s total eligible dischargeable debts that represent the potential loss to creditors if a debtor is granted a discharge of his or her eligible dischargeable debts. The Center did not attempt to identify this universe of debts in its analysis. Creditors are not at risk in the bankruptcy process for debts that are nondischargeable in bankruptcy or for eligible dischargeable debts that the debtor reaffirms. Total dischargeable debts are total debts less total nondischargeable debts. As discussed on pages 9 and 10 of our report, the Center report may not have fully identified all eligible dischargeable debts, because it excluded data on unexpired leases from Schedule G, such as automobile leases. Thus, the Center did not identify that universe of debts for which creditors are at risk in the bankruptcy process.

As we note on pages 9-10 of our report, to assume that all unsecured priority debts would be fully paid over 5 years but that no other class of nonhousing debts would be fully paid creates a disparity in the treatment of nonhousing debts that does not reflect actual bankruptcy practice. In chapter 13 repayment plans, secured debts would ordinarily be paid before or concurrently with unsecured priority debts. Consequently, the Center report’s calculations did not provide an estimate of the amount of unsecured nonpriority debt that could be repaid. If the Center report’s purpose was simply to identify debtors’ overall ability to pay nonhousing debts from net income after reported expenses, then the report should have included unsecured priority debt with all other nonhousing debts—secured and unsecured—and calculated debtors’ ability to pay the resulting total nonhousing debt. 4. The Center agrees with us that its calculations of debtors’ ability to repay their nonhousing debts did not consider the payments required to pay the nonhousing debts that debtors stated it was their intent to reaffirm (repay). The Center notes that the February 1997 testimony of law professors Marianne Culhane and Michaela White before the National Bankruptcy Review Commission stated that about 50 percent to 60 percent of intended reaffirmations (the data used in the Center report) actually result in signed reaffirmation agreements in which debtors reaffirmed their debts. Thus, they noted it is possible that the number of final reaffirmations could be less than that reported in debtors’ statements of intent.

We agree that the number and dollar value of debts that debtors ultimately reaffirm could be more or less than those found in debtors’ statements of intent. We believe that this further supports our overall conclusion that the results in the Center’s report should be viewed with caution. In September 1997, professors Culhane and White reported updated results of their study, which were based on debtor reaffirmations in only 7 of the 90 bankruptcy districts, and thus must be considered illustrative, not conclusive. Nevertheless, the reaffirmation report’s findings provide additional evidence that one should be cautious in interpreting conclusions based solely on debtors’ initial schedules, such as schedules of income and expenses as well as reaffirmations. For example, the reaffirmation report found that debtors filed fewer reaffirmations than indicated in their statements of intent and that the debts that debtors ultimately reaffirmed were often quite different from those that debtors stated it was their intention to reaffirm. The reaffirmation report and the Center’s data indicated that debtors rarely stated their intention to reaffirm unsecured debts. However, the reaffirmation report found that debtors in fact ultimately reaffirmed unsecured debts as well as debts that were not listed in their initial schedules at all. The reaffirmation report also noted that court records provide an incomplete picture of reaffirmations, because debtors may also sign reaffirmations with creditors that the creditors fail to file with the court, as required.

In addition, the reaffirmation report reinforces our concern that local court bankruptcy practice and rules may affect the data that debtors report on their initial schedules and in the data found in debtors’ court files generally. For example, the reaffirmation study found that the number of final reaffirmation agreements filed with the bankruptcy court in each district appeared to be affected by governing court decisions for the districts studied. In two districts, the debtor could keep property, such as a car, by simply maintaining ongoing contractual payments on the property. Thus, it was not necessary for the debtor to file a reaffirmation agreement with the court in order to keep the property. In two other districts, court decisions required the debtor to file a reaffirmation agreement or surrender or redeem the property. The number of final reaffirmation agreements was lower in those districts that did not require a reaffirmation agreement in order for the debtor to keep the property. However, the report said that the data did not permit an empirical evaluation of the extent to which such controlling court decisions affected the number and type of reaffirmations that debtors in the report ultimately filed with the bankruptcy courts. 5. The Center comments included data and analyses, not previously provided, that the Center said address the impact of reaffirmations on debtors’ ability to pay their nonhousing debts. These new analyses are based on weighted data for the 13 locations included in the Center’s study. We cannot assess the accuracy of the data in the tables because we do not have the database used to develop these tables and, therefore, cannot replicate how the new estimates were derived. However, we do have some overall observations on these new data.

First, the weighted data are based on the same weighting methodology used for the Center report’s other estimates and, therefore, are subject to the same limitations of that weighting methodology that we noted in our report. The weights are heavily influenced by filings in two locations—Chicago and Los Angeles—which accounted for about 41 percent of all bankruptcy filings in the 13 locations.

Second, the tables presented in the comments need clarification in their presentation. For example, table 1 of the comments does not indicate that all dollar amounts in the table are averages, which they are. The table also does not clearly indicate that the amount of nonhousing debt shown is the total amount of nonhousing debt—secured and unsecured—less unsecured priority debt.

Third, the assumptions underlying the data in table 2 are not explained. For example, line “D” of table 2 is supposed to represent the amount of unsecured nonpriority debt that could be paid over 5 years from future income after liquidating all of the debtor’s nonexempt property, if any. The calculation appears to assume that (1) when surrendered and liquidated, the collateral would bring 100 percent of the value of the collateral, as listed in the debtor’s initial schedules; and (2) 100 percent of the proceeds realized from the liquidation would be used for repaying the debt secured by the collateral. We found no basis for either of these assumptions. For example, when a debtor’s nonexempt assets are liquidated to pay creditors, the asset may bring more or less than the value of the collateral as listed in the debtor’s schedules. Moreover, there are usually expenses associated with liquidating a debtor’s nonexempt assets, such as statutory bankruptcy trustees’ commissions and appraiser or auctioneer fees. Such expenses would reduce the amount paid to creditors because these costs would be paid before any remaining proceeds were distributed to creditors.

The data in the new tables are subject to the same limitations as other estimates of debtors’ ability to pay included in the report. The tables are based on the assumptions, used throughout the report, that debtors’ income and expenses would remain unchanged over a 5-year period and that 100 percent of a debtor’s discretionary net income will be used for debt repayment. As previously discussed, both logic and available evidence would suggest that these are not realistic assumptions. For example, the Center provided us data, not included in its report, which showed that the majority of nonhousing secured debt was vehicle debt. The data in the new tables 2 and 4 provided with the Center’s comments assumed that the debtor’s automobile would be sold, and no replacement obtained. The absence of an automobile could very well affect a debtor’s employment and, thus, a debtor’s future stream of income. 6. The Center’s comments noted that it would be difficult to estimate with precision debtors’ ability to pay their nonhousing debts in any location other than the 13 locations included in the Center report. On the other hand, the Center concluded that debtors’ data in all 13 locations showed a substantial repayment capacity, despite the great diversity in the characteristics of the 13 locations, such as unemployment rates and the percent of total personal bankruptcy cases that were chapter 7 cases. The Center stated that this showed that substantial repayment capacity is a widespread phenomenon, whether or not the report’s findings are applicable to other locations.

We agree that the Center’s data show that some debtors who file for bankruptcy under chapter 7 may have some capacity to repay their debts. But, from a policymaking standpoint, the more relevant questions are whether the Center report’s findings provide a reasonable estimate of that repayment capacity and whether the Center’s defined universe of debtors and debts used to estimate repayment capacity was appropriate for assessing the need for a change in current bankruptcy laws. As previously discussed, we believe the Center’s universe of both debts and debtors may not be the appropriate ones for assessing whether current bankruptcy statutes should be changed. In answering these questions, it is also important to note that the data used for the Center report were based on information debtors provided at a single point in time—the time they filed for bankruptcy—regardless of whether or not they completed the bankruptcy process and received all or part of the relief they sought in filing for bankruptcy. Thus, the report included data from debtors who may have withdrawn their petitions voluntarily, had their petitions dismissed by the court, or who received bankruptcy court discharges of all or part of their eligible dischargeable debts. For example, in Los Angeles, of those chapter 7 petitions filed on the same days of May and June 1996 as those petitions used in the Center sample, about 5 percent had been dismissed by September 30, 1996. For chapter 13 petitions, more than 30 percent had been dismissed during the same period. In contrast, not more than about 4 percent of chapter 7 and 13 petitions in San Diego had been dismissed within 90 days. Because the report’s findings include debtors who did and did not receive a discharge of their eligible debts, the report’s findings cannot be used to reach conclusions about the most relevant public policy question—the potential ability to pay of debtors who received a discharge of all or part of their eligible dischargeable debts. 7. The Center agreed with our general conclusion that scientific, random sample methods were not used to select the bankruptcy petitions used in the Center’s analysis. However, the Center said that the lack of a scientific, random sample did not necessarily diminish the usefulness of the Center report’s findings. The Center commented that it did not intend to obtain a nationally representative probability sample and agrees that it did not use a scientific random sampling methodology to select the 13 bankruptcy locations or the bankruptcy petitions used in the analysis. The Center also states that most social science research is conducted with samples that are not nationally representative probability samples and concludes that much useful information comes from samples that are technically less ambitious than the standard that we applied.

Our evaluation assumed that the Center report may be used for important policymaking on a national scale. As a result, we believe that it is appropriate to inform the Committee that the Center report’s data do not meet scientific standards for estimating the characteristics of bankruptcy debtors for the United States as a whole or for all bankruptcy debtors in each of the 13 locations. 8. The Center discussed our observations on its methods of selection for each of the three steps at which petition selections were made without probability selection methods.

The Center agrees with us that the 13 locations were not selected using probability selection techniques and, thus, may or may not be representative of the remaining courts in the United States. The Center commented that nonprobability samples have been used in some previous studies of bankruptcies, including a study by GAO, and that the purpose of the Center study was to form and test hypotheses about potential causal factors. The Center also stated that the study has potential value for policymakers because the large sample from a varied cross-section of courts identifies significant numbers of petitioners with some capacity to repay debts and because there was a finding of substantial repayment capacity in every city in the study despite the great diversity in city/court characteristics.

We agree that this diverse set of 13 locations demonstrates that based on the data and assumptions the Center used, the Center’s indicators of debtors’ ability to repay debts are found at greater than negligible rates at all locations. However, we also concluded that users of the Center data should consider the variation among locations and the lack of a national estimate as limitations. The important variations between the studied cities might be of importance for some policy purposes. In addition, we cannot confirm the Center’s conclusion that there is a “substantial” repayment capacity in every city, because we do not have a basis for determining how much repayment capacity should be considered to be substantial and because, as explained above, we can not conclude that petitioners’ reports of income on bankruptcy petitions can be accepted as an accurate estimate of income for the following 5 years. 9. The second sampling issue on which the Center commented was what the Center referred to as seasonality—the fact that the Center’s petitions were filed in the spring and summer months and might not be representative of petitions filed at other times of the year. The Center stated that ample evidence from previous researchers and supplemental testing in the Center study suggest that the potential bias from focusing only on cases filed in the spring and summer months is negligible. The Center cited as evidence the findings from two previous studies and the Center’s analysis of Indianapolis petitions from its current study.

The Center and we agree that the study petitions were drawn from a limited part of the year. We did not have a sufficiently strong basis to conclude that seasonality factors could or could not have possibly affected the Center report’s estimates of the debtors’ repayment capacity. The two previous studies cited in the Center’s comments do not address the effect of season on the debtors’ ability to repay debts but only examined the number of chapter 7 and chapter 13 bankruptcy filings by season. The results of the Center’s analysis do show that season of the year did not affect estimates of the ability to pay in one city, Indianapolis. We agree that we do not have a strong theoretical reason for expecting a seasonal effect. However, in the absence of evidence from more than one location, and in view of the fact that the present study is strongly concentrated by season, we continue to believe that the season in which the petitions were selected should be considered a limitation in interpreting the results from the study. 10. The third sampling issue addressed in the Center comments was the time of the month from which the Center’s petitions were drawn. The Center agrees that the bankruptcy petitions used in the study were generally drawn from days early in the month. The Center explains that the petitions were drawn from the beginning of the month to maintain tight control over the petition selection procedure and to minimize uncertainty about the characteristics of cases that were not studied. The Center maintains that Texas is the only one of the 13 locations where there is evidence or reason to believe that cases early in the month might differ from those late in the month. In Texas there were a disproportionate number of past-due home mortgage chapter 13 petitions early in the month, and the Center said it was now drawing additional cases in Texas. In addition the Center notes that although chapter 13 petitions might differ by time of month in Texas, it is not clear why the characteristics of the chapter 7 cases would differ over the month. The Center also notes that the study did not find differences in the values of variables that measure ability to pay at the one location, Indianapolis, that could be tested with the data from the Center study.

We believe that the differences among petitions at different times of month in Texas should be considered. Those debtors who file for chapter 13 early in the month to prevent a mortgage foreclosure may have different financial characteristics from chapter 13 debtors filing later in the month. The only clear evidence of the absence of a time-of-month effect comes from a single court in Indianapolis. We are concerned that there may be other court-specific factors of which we are unaware. For example, working with the Federal Judicial Center, we learned that mortgage foreclosures early in the month also could affect the type of filings early in the month in Atlanta. Although the Atlanta filings for this study did not happen to be concentrated at the beginning of the month, the Atlanta example indicates that it is difficult to exclude time-of-month effects. Thus, we believe that the lack of representativeness by time of month should be considered in evaluating the study.

The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent.

U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537.

Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touchtone phone. A recorded menu will provide information on how to obtain these lists.