Will you go bankrupt before Social Security?

by John Quiggin on February 3, 2005

In his push for Social Security privatization choicepersonal accounts abolition, George Bush is raising the prospect that, some time around 2050, Social Security will go bankrupt. This claim has been refuted quite a few times, so let me raise a different answer.

If you’re a young working-age American, don’t routinely pay your credit card balance(s) down to zero each month, and don’t have top-flight health insurance, it’s odds-on, based on recent experience[1] that you’ll go bankrupt at some point.

About two million people, or one per cent of the working-age population[2], go bankrupt every year, a number that has risen dramatically in recent years. So, given about 50 years in the working-age bracket[3], and ignoring multiple bankruptcies, it’s almost exactly even money that a given person will go bankrupt. But, not surprisingly, the risk isn’t evenly distributed. The two major causes of personal bankruptcy are health crises and credit card debt.

Looking at credit cards, the population is about evenly divided between those who pay off their balance every month, and therefore get almost-free credit, and those who run balances, pay interest and keep the card companies in business. Assuming that the two groups are fairly stable, as appears to be the case the risk of credit-driven bankruptcy is fairly low for the first group, and these are also likely to have safer jobs and better health insurance. In fact, one way of viewing the credit card business is that it needs to extract as much interest as possible from members of the second group before their highly probable resort to bankruptcy.

As I’ve mentioned previously, bankruptcy is now more common than divorce. But because bankruptcy has risen so fast, the number of people who’ve experienced it is much smaller than the number who’ve been divorced. The stigma that was associated with bankruptcy is already declining, and it’s now a private financial issue rather than the public disgrace it once was. By the time Social Security supposedly goes bankrupt in 2050, Uncle Sam will merely be joining the majority of his constituents.

fn1. Of course, if a trend can’t be sustained, it won’t be. But there’s no obvious reason why the current upward trend in bankruptcy should halt, let alone be reversed. So it seems reasonable to assume that the current rate of bankruptcy will at least be maintained in future.

fn2. Children can’t go bankrupt. Retired people can, but bankruptcy rates are fairly low for this group, and are likely to stay low as long as Social Security exists.

fn3. Normally 15-64, but for the purposes of this post, 20-69 fits a bit better.

{ 27 comments }

1

des von bladet 02.03.05 at 12:13 pm

The two major causes of personal bankruptcy are health crises and credit card debt.
[emphasis added, link lost]

Blimey! I knew this Free and Democratic Republic was an Chinese-curse-interesting place to live, but this is really quite extraordinary.

We look forward to an especially rousing chorus of Libertoonian heckling on this one, for sure.

2

Andrew Boucher 02.03.05 at 12:21 pm

Of course there’s little equivalence in the two. When a private person goes bankrupt his lender should normally have factored that into the rate he was charging – in effect, it’s an implicit tax on every other borrower. So theoretically anyway, the lender – if reasonably diversified – does not lose money; he’s being compensated.

If Social Security goes bankrupt, then those who should be getting checks will get nothing. One could say that this is the retired person’s fault – he or she should have diversified to take into account the risk. Of course, that is possible for wealthy people, less so for the poor.

3

Jane Galt 02.03.05 at 12:23 pm

Last time I looked, the two major causes of bankruptcy were health crises and divorce. Credit card debt is apparently a pretty minor contributor.

4

abb1 02.03.05 at 12:38 pm

Hmm, credit card debt as a cause of bankruptcy?

To have bankruptcy you have to have a debt. That it’s a ‘credit card’ debt only means that borrowing on credit cards probably was your last resort kind of borrowing. What seems more important is why you had to borrow in the first place.

5

John Quiggin 02.03.05 at 12:40 pm

As stated here, it’s relatively rare that credit card debt alone causes bankruptcy. But when shocks like divorce or job loss occur, the likelihood of bankruptcy is greatly enhanced by outstanding credit card debt. Since most people are going to experience at least one of these shocks sooner or later, the risk calculation works.

6

Bill Gardner 02.03.05 at 12:45 pm

John,
I would like to read more of your thoughts about the connection between bankruptcies and medical crises (I’d wanted to blog on the Times article, but I knew I lacked the expertise…).

The US does not provide national health insurance. Instead, it provides liberal access to personal bankruptcy. This places the cost of the risk of medical catastrophe to health care providers (who eat the cost of care provided to those who go bankrupt) and the bankrupts (who often lose assets as well as their credit ratings). This creates a large incentive for health care providers to make health care accessible to those who will reliably pay. It also creates a lot of expensive chaos for health care providers when they try to collect from deadbeats.

I think this is inequitable. Is it also inefficient? Can one make the argument that socializing the risk of medical catastrophe through universal coverage would reduce at least some of the transaction costs of providing health care?

7

Jane Galt 02.03.05 at 12:46 pm

Is it really? If people had the health bills, or the divorce bills, and no access to credit, wouldn’t they just have to declare bankruptcy sooner?

8

Michael Kremer 02.03.05 at 1:02 pm

For an interesting (I think) look at the Social Security “crisis” go to my colleague Michael Green’s blog (on the blogroll under philosophers).

9

jet 02.03.05 at 1:03 pm

As long as new credit card companies keep popping up accepting zero percentage on balance transfers, I’ll stave off bankruptcy forever, while living like a king! Too bad the US gov can’t transfer that social security debt to a credit card company, then they could follow my lead.

10

dsquared 02.03.05 at 1:10 pm

Anticipating an objection that will probably be made (because I nearly made it), when John makes the assumption:

ignoring multiple bankruptcies

then this looks like an unsafe assumption to make, because there are material numbers of people who go bankrupt several times and this does skew the overall bankruptcy figures.

However, if you look closely, you’ll see that John’s argument is based on extrapolation from the most recent set of annual bankruptcy reports. It is pretty difficult to file for bankruptcy twice in a single year, so multiple filings will not be a material part of this number.

11

dsquared 02.03.05 at 1:20 pm

Credit card debt is a statistical risk factor in this sense, not necessarily a causal factor. My guess is that carrying a balance on a credit card is proxying for general instability or insufficiency of income; it’s something that people don’t always do out of choice.

12

markus 02.03.05 at 2:00 pm

@d^2
>However, .. you’ll see that John’s argument is based on extrapolation from the most recent set of annual bankruptcy reports. It is pretty difficult to file for bankruptcy twice in a single year, so multiple filings will not be a material part of this number.

I don’t get how this is relevant to the objection. Even if we take for granted that there’s only one bankruptcy per year and person in the data, how does that change the distortion we get from having some people from this years set enter next years data(or the one after etc.)?
For that we would need current numbers corrected for everyone who was already counted in the past.

(Even then, it seems likely or at least not implausible that the contribution of repeat-bankrupcies to the total is likely to increase as the overall number of people who have ever filed bankruptcy increases.)

13

mw 02.03.05 at 2:12 pm

It’s a bit silly to try to say whether bankrupcy is ’caused’ by credit-card debt, vs divorce, vs medical bills, vs the new lack of stigma.

Here’s the thing–people who never pay off credit card bills every month tend to live right up to or beyond their income. They have no savings and nearly all their income is committed to monthly expenses, so any major unanticipated expense can push them over the edge.

But the other half of that equation is that it doesn’t much matter — which seems bizarre, but it’s true. The people who live like this rarely have any significant positive net worth anyway, and what they do have is in the value of their home, if they own one, which is generally protected during bankrupcy (laws vary from state to state). What’s more, newly bankrupt people become more creditworthy than before! (because credit card companies know they cannot file for bankrupcy again for a significant length of time — it is like a temporary recovery of virginity ;)

Note, too, that it is by no means the case that all of the people who live like this are poor.

As an aside, if I had to place my bets, I think there’s a much greater chance for a near-term bankrupcy crisis in the UK than in the US. In the UK, there has been a dramatic run-up in housing prices and people are stretching to buy with low, variable rate mortgages. Combine a bursting of the bubble with a rise in interest rates (neither unlikely events) and look out…

14

Lewis Hyde 02.03.05 at 2:40 pm

My question would be: will the monies is a “personal” retirement account be vulnerable to a bankrupt person’s creditors?

15

abb1 02.03.05 at 2:45 pm

It’s a bit silly to try to say whether bankrupcy is ‘caused’ by credit-card debt, vs divorce, vs medical bills, vs the new lack of stigma.

No, I don’t think it’s silly to put ‘medical bills’ into a separate category. This is something you probably have little or no control over; it’s different than living right up to or beyond your income.

16

KCinDC 02.03.05 at 2:52 pm

MW: The UK housing situation you describe sounds just like what we have in the US. What makes you think the UK is worse?

17

dsquared 02.03.05 at 3:29 pm

On reflection Markus is right; the hazard rate estimate here is likely to be biased downward because it’s not a measure of people entering first bankruptcy, which would be the relevant hazard rate for the individual John’s addressing the post to. However, the linked post on johnquiggin.com reveals that the actual number of bankruptcies is more like 2.2 million than 2m, so unless the repeat bankrupt population is very large indeed as a proportion of the total the qualitative conclusion goes through.

18

Nicholas Weininger 02.03.05 at 3:45 pm

I don’t get why this is post-worthy. People who budget within their means and are well insured against catastrophe are less likely to go bankrupt than those who don’t and aren’t. Film at eleven!

Or if the point is that a large percentage of Americans are as fiscally irresponsible on their own as the federal government is, that’s both obviously true and irrelevant to a discussion of whether the feds’ irresponsibility is bad and what to do about it. Neither individuals nor the government can make the real consequences of profligacy less serious by decreasing its social stigma.

19

Tim Worstall 02.03.05 at 4:06 pm

Purely from memory one can only claim bankruptcy in the US once every 7 years. But the laws do vary from state to state.

20

Ginger Yellow 02.03.05 at 4:12 pm

kcindc, the key point is that the UK mortgage market is almost exclusively floating rate. If interest rates go up, householders’ debt burden increases immediately. It’s not just new buyers and refinancers who are affected. Rates are still at 40 year lows, but many people have taken advantage of that to take out more unsecured debt, and thus are vulnerable to rises in mortgage rates.

21

mw 02.03.05 at 4:18 pm

MW: The UK housing situation you describe sounds just like what we have in the US. What makes you think the UK is worse?

I think the situation in the UK is worse for two reasons. First, it’s my understanding that few people in the UK have fixed-rate mortgages whereas fixed-rate mortgages are typical in the U.S. Second, the U.S. housing market has not experienced the same rapid price increases that the UK market has in recent years.

If the bubble bursts and interest rates rise, then people will be faced with rising mortgage payments they can’t afford and houses they cannot sell for enough to pay off their debt. Bad combination.

22

mw 02.03.05 at 4:29 pm

No, I don’t think it’s silly to put ‘medical bills’ into a separate category. This is something you probably have little or no control over; it’s different than living right up to or beyond your income.

But unexpected medical bills put people into bankrupcy when they are living on the edge–when they have no savings and all their income is committed to expenses.

Medical bills are not the only kind of unexpected financial hit that can have this effect, other would include:

– Divorce
– Legal problems
– An expensive auto or home repair bill.
– A loan to a family member that is not repaid.
– A strike, layoff or other period of unemployment (for most people, strike benefits and unemployment benefits are lower than wages).

23

Ken Houghton 02.03.05 at 4:57 pm

John,

You dropped the ball on what must constitute “bankruptcy” for the two modes to be comparable:

Is one necessarily “bankrupt” if one makes at least 73% of what one spends?

24

abb1 02.03.05 at 5:19 pm

Mw,
I suppose you have a point, but still, things like divorce, unemployment and legal problems are easier to blame on bad personal choices than medical bills. At least arguably.

I always assumed that most of the bankruptcies had something to do with opening a small business or being a day trader or some other gamble, some risk-taking activity. I think the fact that 50% of them are medical care related is quite amazing.

25

jet 02.03.05 at 6:39 pm

abb1,

Some of those medical bills can come from making would should have been good, but ended up being poorly informed choices. For instance, being self-employed and getting your own insurance is a good choice. Not being careful enough to make sure that insurance will cover a $10,000 life-flight is a bad choice. Getting a $10,000 immediately due bill is beyound most people’s means. But then again, if I need the life-flight, bankruptcy doesn’t sound so bad.

26

Jennifer Herzog 02.03.05 at 8:11 pm

“Children can’t go bankrupt. Retired people can, but bankruptcy rates are fairly low for this group, and are likely to stay low as long as Social Security exists.”

Actually, the rate at which the population aged sixty-five and older is filing for bankruptcy is increasing. This increase has been so great that the rate at which the elderly declare bankruptcy has more than doubled over the past decade. The extent of this increase is further evident in the fact that the number of elderly filings is now growing faster than the elderly population.
See Teresa A. Sullivan, Deborah Thorne & Elizabeth Warren, Young, Old, and In Between: Who Files for Bankruptcy?, 9 NORTON BANKR. L. ADVISER 1 (Sept. 2001).

27

John Quiggin 02.03.05 at 8:50 pm

Thanks for pointing to this study, Jennifer. It’s true that bankruptcy rates have risen across the board, but they are still much lower for over-65s. From the study

In 1991 about 0.75 per 1,000 of people 65 and older filed for bankruptcy. By 2002, the number was 2.35, the largest growth rate of any age group during the past decade.

As noted in the post, the rate for the working age population is close to 10 per 1000.

Comments on this entry are closed.