The one-year anniversary of the new bankruptcy law was October 17, 2006. What have we learned in the year since the new law went into effect?

The National Foundation for Credit Counseling recently released a report after one year of experience in counseling consumers under the new mandatory provision that requires a credit counseling session prior to filing bankruptcy.

The first obvious effect of the new law was a steep drop in the overall number of bankruptcies filed on a nationwide basis. From a record high of 2 million in 2005, filings are expected to top out around 600,000 for 2006, a 20-year low. However, we can justifiably shift around 400,000 filings from 2005 into 2006, since about that many extra filings took place right before the deadline when they would otherwise probably have been filed this year. The rate of filings has started to increase again, so “normal” filing levels will probably resume in 2007.

One of the most interesting statistics is the percentage of Chapter 13 versus Chapter 7 filings. Ignoring the skewed data in 2005, Chapter 13 filings typically averaged around 28-29% in prior years. In other words, approximately three out of every ten people filing individual bankruptcy did so under Chapter 13. For 2006, that ratio has climbed to more than four out of ten. However, this is based on a much smaller pool of people, so it’s probably still too soon to state categorically that the new law has caused a shift away from Chapter 7 to Chapter 13.

There is a further important point to be made on the subject of Chapter 13 versus Chapter 7 filings. Quite frankly, Chapter 13 sucks as a solution. Under Chapter 13, you are required to pay back a percentage of the debt (set by the court) over a five-year plan. This is not a very attractive option for most people. It’s one thing to have a bankruptcy on your record if you can at least wipe away the unsecured debts in full. It’s a totally different thing to get stuck with a five-year payment plan PLUS still have the BK on your record. My point here is that no one in the financial media who has commented on the lower filing numbers for 2006 has stated one obvious possibility: What we may be seeing is that people are determining in advance which Chapter they will fall under, and steering clear of bankruptcy if they don’t qualify for Chapter 7! We simply don’t know whether or not this is true, but it certainly makes sense based on the conversations I’ve had on a daily basis with struggling debtors. Virtually no one feels that Chapter 13 is a good solution, and many people are turning to debt settlement instead.

Aside from the above insights and speculations, one set of facts from the NFCC report jumped out at me. Consumers who sought credit counseling because they were required to do so before filing BK reported an average unsecured debt level of $38,472 against average annual income of $26,873, for a ratio of unsecured debt at 1.43 times annual income. Talk about being upside down financially! By way of contrast, “regular” credit counseling clients (who sought counseling because they were having financial troubles and not because they were about to file bankruptcy) reported an average unsecured debt level of $22,597 against average annual income of $31,143. This represents a ratio of unsecured debt at 0.73 times annual income. In other words, credit counseling clearly comes far too late in the process for people who are already seeking to file bankruptcy. Forcing people to have a credit counseling session just before they file for bankruptcy is like a doctor lecturing a patient about proper diet and exercise just before they are wheeled into the operating room for bypass surgery.

One final and very important point. Before the new bankruptcy law went into effect last year, I predicted that it would have no effect on debt negotiation and settlement. I’m happy to report that this has definitely been the case. Comparing settlement results for 2006 versus 2005, there has been no difference at all in the willingness of banks to settle. That’s because the bottom-line financial reasons for settlement are still in place. Simply put, it’s the “bird in the hand” philosophy, where it’s better to cut a financial loss with a known recovery amount than to risk recovering less or even nothing in the future.