Approaching the wall

The National Post reports on the increase in middle-class bankruptcies in the U.K. and U.S., and notes that Canada may be next in line to see a massive increase in credit card-related bankruptcy:

Recent reports in the United Kingdom and United States indicate that cases of personal bankruptcy among the middle class are on the rise. And with skyrocketing debt-to-income ratios here, Canada could be next.

"The situation has never been so grave," says Laurie Campbell, executive director of Credit Counselling Service of Toronto, Credit Canada, a not-for-profit organization that helps people in financial trouble.

According to statistics released by Britain's Bankruptcy Service, 26,021 people were made insolvent in the second quarter of 2006, a 66% increase over the same period last year. A separate study by a professor at Britain's Kingston University found a staggering 49% of insolvencies to be middle-class people who got into trouble over credit-card debt, compared with 16% of respondents who said they were bankrupt as a result of a business failure.

Similar trends are underway south of the border. A recent U.S. study warns of rising consumer bankruptcy filings in the years ahead -- despite laws passed last year aimed at discouraging them. The Bankruptcy Abuse Prevention and Consumer Protection Act, which took effect last October, aims to curb consumer bankruptcy filings by closing loopholes that allowed for opportunistic filings, serial filings and abuse. The new law also created new responsibilities for those who administer consumer bankruptcies and those who counsel debtors into bankruptcy.

But the study, by a law professor at the University of Illinois, found the law has done little to tackle the problem of growing consumer debt burdens, and suggests that personal bankruptcies will return to levels that existed before it came into place.

In Canada, the number of personal bankruptcies has in fact dropped in recent years, thanks largely to a strong economy and low interest rates. In the second quarter of 2006, for example, the total number of new bankruptcy filings was 9.2% lower than the year before, according to Industry Canada. For 2006 as a whole, filings are down 6.2%.

But those numbers hide a deeper problem. On average, Canadian households owe more than their annual income. In the first quarter of 2006, the debt-to-income ratio reached 120%, the 20th consecutive quarter the indebtedness ratio has risen.

Marvin Zweig, a principal at bankruptcy trustee firm Shiner Kideckel Zweig Inc., warns that as the economy slows and interest rates rise, the number of personal bankruptcies will climb. "The global economy is possibly heading into a soft period. That will include Canada," he says. "You are going to find people who are affected from an income perspective. They will then resort to using their available credit to finance their necessary living expenses. And, it just continues to rise from there."

What's worse, the problem may be even closer at hand than the article suggests, as the economy already appears to be softening. And once the first wave of increased bankruptcies hits, it's all too likely that the effect will be a tightening of credit which in turn restricts the economy even more.

Unfortunately, far too many Canadians have been spending beyond their sustainable means during a boom period...which is bound to lead to problems when the boom comes to an end. And while it may not be too late to change course now, it won't likely be long before individual Canadians and the economy generally run head-first into the current wall of consumer debt.