Rise in Bankruptcies?

The current business environment may be right for a flurry of bankruptcy activity. On its face, such a statement sounds ridiculous. The US economy is experiencing its longest bull run in history, unemployment is low, companies in the tech sector complain of a lack of quality candidates, the Dow is surging, and construction continues to play a key role on the West Coast. While those indicators suggest a robust economy, bankruptcy is still very relevant.

This article will point to various factors that will likely challenge consumers for the next few years. These challenges are not despite the current economic conditions; rather, the current economic conditions breed these challenges.

Risk Taking

The old adage is that where there is more risk, there is more reward. While risk can be rewarding, risk is also devastating. The financial crisis demonstrates this point. Contrast Lehman Brothers, an American bank, to Japanese banks. Psychological research tells us that Americans and Europeans, on the whole, have an appetite for risk. We are not afraid to make bold moves, even when we understand the implications. Therefore, when it was possible to invest in mortgage-backed securities, Lehman Brothers created a large network of investment. These investments were risky because they were based on the average mortgage holder paying his or her mortgage on a regular basis. Nonetheless, Lehman Brothers created a business based on such investing. It helped bolster profits to record highs in the short term; it destroyed Lehman Brothers in the long term.

By contrast, the Japanese population, according to research, has low risk tolerance. Therefore, Japanese banks were reticent to invest in mortgage-backed securities. While those banks were studying and discussing whether mortgage-backed securities were a good idea, Lehman Brothers fell.

Therefore, high-risk tolerance can lead to financial ruin. When the economy is weak, so is risk tolerance; when the economy is strong, like it is currently, risk tolerance is high.

Take a small LLC as an example of risk taking. Suppose an LLC sees a great opportunity. However, it needs funding and is unable to attain that funding based on the size of the project and the small nature of the LLC. To induce a bank to loan the LLC money, the LLC members agree to provide a personal guarantee to the bank to obtain the loan. In general, an LLC loan is the responsibility of the LLC and not its members. In these circumstances, a bank can recoup funds from the members in the event the LLC is unable to pay because the loan is attached to a personal guarantee. If the business venture is risky and fails, the bank will come collecting from the individual members.

Suppose further that the members borrow significant amounts to fund the venture and the venture fails. The LLC itself may have a few computers, some desks, pens, and a water machine as assets. Its going concern value is now zero. The bank may seek to collect from the member’s houses, cars, and other items of value. The members may be looking to file for bankruptcy as their last option, despite the booming economy.

Stronger Dollar and High Interest Rates

The strengthening dollar is often tied to the strength of the economy. The dollar, as a means of payment, has serious implications when it strengthens: It makes exports more expensive. Say you are involved in selling items on Amazon or Ebay and you have done significant business in Chile. When the dollar was weaker, your Chilean customers could afford your products because the Chilean peso had a good exchange rate with the dollar. Now, their pesos cannot go as far as they used to, causing you to lose business.

In such an environment, it becomes more difficult to succeed at international business. This type of economy can severely limit international trade. As a result, bankruptcies emerge with people who were previously very successful.

Similarly, high interest rates affect how people choose to conduct their business. Home purchases, which have helped fuel the economy, drop due to the higher rates, which equals a larger mortgage bill. Personal loan businesses, which see significant borrowing for home improvement and the like, see less borrowing when monthly payments go up for the same amount of money. This decline in activity then hurts seller, real estate agents, home improvement professionals, and the like. As a result, business slows, causing some people to utilize the bankruptcy code as protection against their creditors.

Facing mountains of debt? Out of options? Contact the Bay-area bankruptcy firm of Melanie Tavare.