in this case, the 1989-1990 real estate
slump in the New England states.
Between the third quarter of 1989
and the first quarter of 1990, the aver-
age sale price of new homes in the
Northeast fell almost 10%. Moreover,
during all of 1989, while new home
sales edged down 4% nationally, sales
plunged 15% in the Northeast. A
depressed real estate market can
have serious financial consequences
not only for homeowners, but also
for other sectors of the economy. If
homes are not selling, housing starts
decline, developers and real estate
brokerage firms are forced out of
the market, and construction-related
industries reduce output and workers.
The end result is that unemployment
increases across sectors, and consum-
ers’ finances are considerably weak-
ened.
A home is often a household’s most
valuable asset for two main reasons:
real estate values are often expected to
appreciate, and a home mortgage
usually represents the largest debt a
household undertakes. In case of
financial need, an individual can al-
ways sell the house to pay other obliga-
tions. However, if the real estate mar-
ket is at a standstill, the debtor in fi-
nancial distress will not liquidate, first,
because the house might just not sell,
and second, because the debtor might
have to sell it at a loss. Many home-
owners have found that bankruptcy
can be a solution to this problem,
especially when legal action has al-
ready been brought against the delin-
quent debtor. It is estimated that over
50% of the individuals filing for bank-
ruptcy are homeowners.3
A delinquent homeowner might resort
to bankruptcy because the filing of a
petition under either Chapters 7 or 13
of the Bankruptcy Code results in the
enactment of an automatic stay, which
protects the delinquent debtor from
foreclosure, at least temporarily.
When debtors file a Chapter 13 repay-
ment plan, they keep all of their assets,
exempt and nonexempt, but forfeit
their incomes for at least three years
for the repayment of all or part of
their debts. Usually a claim secured by
the debtor’s principal residence can-
not be modified. However, in a de-
pressed real estate market, the value of
the house is often less than the mort-
gage claim, which allows the debtor to
use the Chapter 13 “cramdown.” In
this case, the difference between the
mortgage claim and the market value
of the debtor’s house becomes an
unsecured claim, which can be modi-
fied both in amount and duration.
When debtors file under Chapter 7,
they have to liquidate all of their non-
exempt assets, but may retain their
future incomes. In this case, debtors
can keep their home by simply reaf-
firming the claim secured by their
primary residence. Because debtors
are discharged from most of their
unsecured debts under Chapter 7
(except for child support, mainte-
nance, income taxes, and fraudulent
debts which are nondischargeable),
they can then allocate most of their
future income to the repayment of the
mortgage.
During the 1989-1990 real estate
slump, bankruptcy seemed to be the
solution of last resort for many, espe-
cially in those states most affected by
falling real estate values. In 1989 and
1990, personal bankruptcies rose at an
average annual rate of 35% in the
Northeast, compared to averages of
only 7% in the West, 14% in the Mid-
west, and 16% in the South (see Fig-
ure 2). During this period, increases
in the New England states averaged
65%, withjumps averaging over 80%
in Massachusetts and New Hampshire,
and increases of over 40% in Rhode
Island and Connecticut.
For all of 1990, personal bankruptcies
rose 16% to over 700,000 filings. Dur-
ing the first half of 1991, personal
bankruptcies had already climbed to
approximately 440,000 cases, which
indicates that bankruptcy filings by
individuals are still on the upward
trend. The latter increase, however, is
attributable at least in part to the 1990-
1991 recession and is historically com-
parable to increases during other
national economic downturns.
Conclusion
During the last seven years, increases
in personal bankruptcies have been
significantly higher in states affected
by economic downturns. This sup-
ports the view that the upward trend in
personal bankruptcies during the
1980s was not countercyclical, but
reflected an economy in which, at
times, a few states suffered consider-
able economic declines. Moreover,
although these recessions were local-
ized, their effects were often wide-
spread, causing personal bankruptcies
to rise at the national level. Studies
show that other factors, such as the
Bankruptcy Reform Act of 1978 and
the unprecedented increase in con-
sumer debt, indeed exacerbated the
rise in the number of personal bank-
ruptcy filings during the 1980s. Never-
theless, the evidence shows that re-
gional economic shocks also may
cause significant increases in personal
bankruptcies, even during periods of
national economic growth.
—Francesca Eugeni
1 Economic Report of the President, February
1986, p. 133.
2C.A. Luckett, “Personal Bankruptcies,”
Federal Reserve Bulletin, September 1988,
pp. 591-603.
3T. Sullivan, E. Warren, and J.L. West-
brook, As WeForgive Our Debtors: Bankrupt-
cy and Consumer Credit in America, Oxford
UniversityPress, 1989, p. 129.
Karl A. Scheid, Senior Vice President and
Director of Research; David R. Allardice, Vice
President and Assistant Director of Research;
Carolyn McMullen, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
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Federal Reserve Bank of Chicago or the Federal
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