Who Files For Bankruptcy Protection?

There are millions of bankruptcy stories from the past two decades that have repeated some familiar themes about why someone filed bankruptcy. These themes are offered as reasons why people need to file bankruptcy. Poor luck is a favorite. Things were chugging right along and Stanley lost his job. We had a great business and then we got sued because Granny slipped and fell poolside. Or the reliable one of great historical significance since the days of the Old American West- we put all of our money into a sure fire winner and lost everything. Then there is the scam of the century with Bernard Madoff- Bernie made off with investors billions but managed to keep so many of them happy for more than a few years with false returns on their money. Losing five million to Madoff caused one investor to start a new restaurant and one who lost a million to file bankruptcy. What is going on?

It's simple. What we described above are themes, not reasons why people file bankruptcy. Bankruptcy in all cases is a legal maneuver to discharge debt that has become too high in proportion to assets owned and income earnings. The individual's ration of what they owe to what they own has turned upside down: the value of assets has sunk below the value of the debt. Negative outweighs the positive. Selling everything won't cover the amount of money that is owed.

People need to file bankruptcy to eliminate their debt. Debt can be eliminated entirely (Chapter 7) or in part (Chapter 13). And when the debtor is discharged from the bankruptcy process, their ability to receive credit in the form of loans and credit cards will be severely impaired or be made ridiculously difficult to obtain at all. The bankruptcy filing will remain in the financial system's memory for a full seven years. This is not a price too high to pay: people need to file bankruptcy to discharge their debt- in good economic times when credit is flowing or when economic times are tough and credit is drying; the pain remains the same as each individual's relationship to their debt takes on an individual hand-print of the borrower who exceeds their personal, or business, debt to asset ratio and beyond. The debt level can not only overtake asset value- it can overtake the earning power of the individual, ending any remote possibility of retiring at least part of the debt owed.

The stage for bankruptcy filing is set by spending beyond one's means. This is often motivated by fear of not having enough material comfort or luxury. More often it is a result of undisciplined management of wealth creating tools such as a good paying job or a cash-based business. This is tantamount to pouring 50 gallon containers of gasoline into a room where one is standing looking to be secure. Then something lights a match to the sloshing flammable debt- the good job goes away, the cash-based business gets a down the street competitor with a different strategy and cuts earnings in half, or the margin call comes in on the leveraged stock play that can't miss.

The financial wall of cash flow that held back a rising tide of debt gives way as the debt increases and the mortar of fresh cash begins to dry up. Finally, the wall gives way and the debt comes on like a tsunami. Creditors demand to be paid as they feel the pinch of their own management peccadilloes begin to weight them down. People file bankruptcy because they failed to manage their expectations which translated into debt-based spending, where the monthly bill came due month after month; but the payment was a minimum to keep the temporarily available cash level high. And the point of no return finally was met.