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Consumer Bankruptcies Rise in Recession

While the bankruptcies of General Motors and Chrysler have drawn attention and headlines around the world, more than a million Americans have quietly filed consumer bankruptcy petitions in the last year.

A woman we'll call Mary made this drastic decision after a slowdown in her work cut her income dramatically.

"If the work had started up again, then I would have taken care of the problem. However, that did not happen," she says. "Bankruptcy was my last resort… I would definitely never want to do that if I had another choice."

More Americans filing for bankruptcy protection

Henry Sommer, board member and past president of the National Association of Consumer Bankruptcy Attorneys, says when an individual files for bankruptcy, they first complete, "quite a hefty amount of paperwork, which gives information about their assets and their debts and their income and some other financial history."

"People are allowed to keep a certain amount of property," says Sommer, "and the rest goes to their creditors. In return, they are relieved of most of their debts."

Despite the social stigma attached to the process, in the first six months of 2009, total consumer bankruptcy filings increased 37 percent over last year.

As Sommer explains, "Bankruptcy has long been a part of American law because America believes in the free market. People take risks. We want businesses to take risks to try and start out, but we don't want people to be burdened with debt for the rest of their lives if things don't work out."

Bankruptcy becoming more common among the middle class

The Institute for Financial Literacy, a non-profit educational organization, released a report on bankruptcy statistics for 2008, the first full year of the recession. Institute founder Leslie Linfield says there was a demographic shift in the kinds of people who filed for bankruptcy last year.

"When you see people with higher income levels, higher education levels, they're married, they're self-employed, and they're the ones who are seeking protection in the bankruptcy court more so than in the prior year - it screams middle class," she says.

Despite that trend, most of those who file are still far from well off. Sommer says, "By and large the vast majority of people who file for bankruptcy are lower-middle-class people working at low wage jobs, people who don't have a lot of income."

While having a lot of debt is always a factor, Sommer says bankruptcy is often triggered by, "medical problems, a divorce, or unemployment. And then because they don't have any savings, then it becomes a big problem."

Medical costs, housing market contribute to increase in filings

The connection between medical expenses and debt should draw the attention of policy makers, Linfield maintains.

"It's very important that people in the debate around health care look for good, solid research numbers. I think when somebody says that 30 percent of the people in our research have indicated that they went bankrupt because of medical bills or illness and injury, that's significant and shouldn't be downplayed."

Changes in the housing market have also increased filings, Sommer says.

"For quite a while people could sometimes avoid immediate financial problems with their credit cards by refinancing their homes and getting home equity loans and things like that to pay off their credit cards," he says. "Now that home values have gone down and a lot of people have no equity in their homes, that option isn't open to them."

Individuals try to rebuild their lives

Individuals like Mary, who find themselves in bankruptcy, will have to think about the changes they need to make to avoid this situation in the future. Mary says she's done, "a lot of soul searching and thinking about how I'm going to live." She's making some very practical adjustments.

"I can't buy clothes anymore, that's out. I don't go to the movies anymore, that's out. I eat less and the kinds of foods I eat are different."

Due to a change in bankruptcy law in 2005, everyone who files for bankruptcy must attend two hours of credit counseling. Policy makers hope that in the long run, this will mean that no individual will ever have to file more than once.