PAGE ONE Economics. TEACHER EDITION Middle School Version. Bankruptcy: When All Else Fails

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1 TEACHER EDITION Middle School Version Page One Economics is an informative accessible essay on timely economic issues. The Teacher Edition provides the essay; student questions with answers; and additional lesson ideas for classroom, extra credit, or makeup assignments. National Standards and Benchmarks are on page 11. April 2018 Bankruptcy: When All Else Fails Kris Bertelsen, Ph.D., Senior Economic Education Specialist

2 Bankruptcy: When All Else Fails Kris Bertelsen, Ph.D., Senior Economic Education Specialist GLOSSARY Bankruptcy: A legal process for declaring that a person is unable to pay his or her debts. The process may involve a courtsupervised process of selling the bankrupt person s belongings to pay part of the debts owed to creditors. Budget: An itemized summary of estimated income and expenses for a given period. A budget is a plan for managing income, spending, and saving during a given period of time. Contract: An exchange, promise, or agreement between two parties that is enforceable by law. For example, a car buyer agrees to pay the amount financed at an agreed-upon interest rate for the length of the contract. Credit report: A loan and bill payment history kept by a credit bureau and used by financial institutions and other potential creditors to determine the likelihood that a future debt will be repaid. Credit score: A number based on information in a credit report, which indicates a person s credit risk. Debtor: A person or organization that owes an amount of money. Human capital: The knowledge and skills that people obtain through education, experience, and training. Bankruptcy is about financial death and financial rebirth. Bankruptcy is the great American story rewritten. 1 Elizabeth Warren, U.S. Senator Not overspending can help life go more smoothly. Still, many people have trouble with money. In fact, about 800,000 people filed bankruptcies in 2017 (see the table for a breakdown of bankruptcy filings). 2 Hopefully you will always be able to pay your debts. If you can t, though, it is good to know there are options if you need serious financial help. Personal Finance Basics First Things First Earning Income When it comes to being ready to pay your bills, it is wise to start with personal income. You earn income by applying your knowledge and skills to your work. Economists call this human capital. Most often, when you raise your skill level and reach a higher education level, you earn a higher income. Also, you will face lower unemployment. 3 Of course, this also depends on what you study and the job market. Budgets Once you are earning income, making a budget is a great idea. You can use a budget as a tool to help keep your finances in order. A budget is a list of your likely income and expenses for a time period. Budgets are usually done monthly. Budgeting can help you set goals. It can help you plan for big purchases, and it can help you cut spending when needed. Budgeting can also help you be ready for any sudden bills. When Financial Problems Happen Having a budget can help you form good personal finance habits. Good habits include saving part of your income and paying bills on time. Unfortunately, people can find themselves in tough financial positions even when living within a budget. There are many reasons for financial problems. Sometimes problems are brief and the setbacks are minor. You may need a new laptop because of damage that cannot be fixed. Other times, people April 2018 Federal Reserve Bank of St. Louis research.stlouisfed.org

3 Federal Reserve Bank of St. Louis research.stlouisfed.org 2 Nonbusiness Bankruptcy Filings by Year Fiscal year Total nonbusiness bankruptcies Chapter 7 nonbusiness bankruptcies Nonbusiness Chapter 7 filings as a percentage of total nonbusiness filings Chapter 13 nonbusiness bankruptcies Chapter 13 nonbusiness filings as a percentage of total nonbusiness filings ,085, , % 269, % , , % 307, % ,004, , % 350, % ,344, , % 393, % ,538,033 1,105, % 430, % ,417,326 1,001, % 413, % ,219, , % 372, % ,072, , % 340, % , , % 310, % , , % 300, % , , % 296, % , , % 294, % Total 12,775,578 8,680, % 4,081, % SOURCE: U.S. Courts. Just the Facts: Consumer Bankruptcy Filings, accessed March 12, Table F-2 for the 12-month periods ending September 30 for have long-lasting, tragic financial issues. For example, big medical bills from a car accident may prevent them from going back to work. Late Payments Financial trouble often catches people when they do not expect it. Little things like birthday gifts and spending money for a trip can impact a person s budget. Bigger issues like fixing a car, paying medical bills, or not being able to work can be very hard on a person s budget. In fact, sometimes there is no way to get through financial trouble. Paying your bills late may not always be your fault. For example, if you owned a business, you could end up waiting for a client to pay for services you had provided. You could be affected by that person s slow payment. If you did not have enough savings to pay your bills while waiting for payment, you could fall behind on your own payments. Whether late payments are your fault or not, they can have harmful effects. These may include late fees added to the amount already owed. Also, there can be harmful effects on a person s credit score. This depends on how late the payments are. A person s payment history and credit score are listed on a credit report. It lists all the credit activity a person has had. It also lists how well they have paid back the money owed. 4 A credit report is like the list of classes and grades found on a transcript. A credit score is a number based on information in a credit report. This shows a person s credit risk. A low credit score means it will be harder to get credit. This is like how a low grade point average on a transcript makes it harder to get into technical college or a university. There are different types of financial trouble. Credit card debt is the most common. If you cannot make one or two payments, it is best to contact the creditor or credit card company. You should try to explain the situation and make a plan to pay them. This may raise your interest rate and may harm your credit score. Ignoring a creditor s calls will not make things get better. The issue will not go away. Creditors are in business to make money. Your late payments make it harder for them to pay their own creditors. And you signed a contract to obtain the credit. When creditors do not get payments on time, they may use legal action to collect the money you owe.

4 Federal Reserve Bank of St. Louis research.stlouisfed.org 3 Collections If you have stopped making payments, then you should contact your creditors and make plans to pay them. If you do not, they will likely turn your accounts over to a debt collection agency. A collection agency will contact you. It will try to get you to pay back the money. The Federal Trade Commission (FTC) watches over debt collection agencies. The FTC makes sure collection methods are legal and fair. 5 It is best to pay any debt on time if at all possible. Sadly, even when people are trying their best by having a good plan and using a budget, there can be trouble. Some people end up with debt so large that they can never pay it back. The debt is so big that they will not be able to live a basic lifestyle without hardship. Sometimes people use all of their common options and still cannot pay their debt. When this happens, they have the choice of legal protection in the form of bankruptcy. Of course, there are many reasons for bankruptcy. These include medical expenses, job loss, too much or risky use of credit, separation or divorce, and unexpected expenses (e.g., natural disasters). Filing a Bankruptcy Case Bankruptcy can offer debtors some protection from creditors under federal law. Debtors are persons or organizations that owe an amount of money. Bankruptcy gives them a chance to review their status and options. A major goal of the federal bankruptcy laws is to give debtors a fresh start. These laws were enacted by Congress. The Supreme Court made this point in a 1934 decision: [I]t gives to the honest but unfortunate debtor a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt. 6 Bankruptcy is a federal civil case with certain laws. A bankruptcy judge decides how a debtor s money and assets should be spread out among creditors. The costs and the twists and turns of filing for bankruptcy are major. It requires careful thought and advice. People usually get advice from an experienced bankruptcy lawyer. The minute a debtor files bankruptcy, an automatic stay starts. The automatic stay is an injunction. An injunction is a legal ban, an order. It is meant to stop all actions by creditors and debt collection agencies right away. But this does not always happen. Sometimes it takes an action by the debtor s attorney to stop some collection agencies. Stopping them may even take a lawsuit. There are many types of bankruptcy cases. The types of bankruptcy are called chapters. Two common types that people file are Chapter 7 and Chapter 13. Chapter 7 bankruptcy is a case where a debtor s property is liquidated, or sold. A trustee is chosen to take over a debtor s property. Any items of value may be sold to pay creditors. The debtor may keep some personal items, but this can depend on where the debtor lives. Some states let the debtor keep real estate. That is, sometimes real estate is exempt, or free, from collection. There are some exceptions, but after any non-exempt assets have been spread out among creditors, any remaining debt is discharged, or forgiven. The debtor will never have to repay those debts. The discharge is a court order that is final. This court order stops the creditors named in the bankruptcy forms from taking any collection action on discharged debts. This includes legal action and any communication. Creditors may not call, write letters, or make any type of contact. Some debts cannot be discharged. These include nearly all taxes, student loans, child support, and alimony (payments to a former spouse). Also included are court fines and criminal restitution (paying a victim of crime back), along with personal injury caused by driving drunk or driving under the influence of drugs. 7 People filing for Chapter 13 can usually keep their property, but there are conditions. To qualify for a Chapter 13 case, the debtor must have some kind of steady income. The bankruptcy court must approve a repayment plan and budget. This plan can be for a period of up to 60 months. The repayment plan helps the debtor pay a percentage of debts for as long as the plan lasts. The court chooses a trustee. The trustee collects monthly payments from the debtor and pays creditors. The trustee makes sure the terms of the repayment plan are current. When all the payments are made under the plan, some debts will have been paid in full. The remainder of other debts will be discharged. These other debts might include credit card debts. Consequences of Bankruptcy Choosing to file bankruptcy should be taken seriously. It is a hard choice with lasting consequences. For example, bankruptcy can stay on your credit report for up to 10

5 Federal Reserve Bank of St. Louis research.stlouisfed.org 4 years. That will affect your ability to get credit. It will also be harder to get a lower interest rate. 8 Filing bankruptcy can also affect how easily you get a job or find a place to live. Employers that require security clearances often run credit checks on job applicants before offering a job to someone. These employers include, banks, financial service providers, certain IT companies, and government agencies. They will check their current employees credit as well. Banks and mortgage brokers always get credit reports. This can affect how much you can borrow from them. This can then affect the part of town where you can afford to buy a home. Conclusion Most people should not file for bankruptcy. Lowering the chance of bankruptcy starts with good financial preparation. Preparation includes raising your human capital to earn a higher income. It also includes making and living on your budget, saving money, and paying your bills on time. If disaster strikes, it is important to know that bankruptcy is an option, but a last resort. n Notes 1 Warren, Elizabeth. Frontline interview, September 20, 2004; accessed March 1, U.S. Courts; accessed March 5, U.S. Department of Labor, Bureau of Labor Statistics, Employment Projections; accessed March 5, Federal Trade Commission. Credit and Your Consumer Rights. accessed March 1, Federal Trade Commission. Debt Collection. media-resources/consumer-finance/debt-collection, accessed March 1, Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934) U.S.C. 523 and Federal Trade Commission (2018, see footnote 4). A special thanks to Shaun K. Stuart, an attorney advisor at the Bankruptcy Clerk s Office, Missouri Eastern Bankruptcy Court, St. Louis, for her assistance with this article. Please visit our website and archives at for more information and resources. 2018, Federal Reserve Bank of St. Louis. The views expressed are those of the author(s) and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System.

6 Federal Reserve Bank of St. Louis research.stlouisfed.org 5 Name Period Federal Reserve Bank of St. Louis Page One Economics : Bankruptcy: When All Else Fails After reading the article, select the best answer to each question. 1. A is helpful in keeping your finances in order and preventing trouble with money. a. budget b. bankruptcy c. credit report d. background check 2. A person s payment history can be found in a a. budget. b. contract. c. credit score. d. credit report. 3. What is bankruptcy? a. Several bills are due and the person is forced to make a payment plan to cover them. b. This month s budget is not balanced because of a major car repair. c. A person is late on two to three credit card payments. d. It is a legal process for declaring that a person is unable to pay his or her debts. 4. A debtor is a. an exchange, promise, or agreement between two parties that is enforceable by law. b. a person or organization that owes an amount of money. c. a person, financial institution, or other business that lends money. d. a tool you can use to help keep your finances in order. 5. Bankruptcy cases are handled at the level of court. a. city b. county c. state d. federal

7 Federal Reserve Bank of St. Louis research.stlouisfed.org 6 6. Which of the following statements is true? a. Once an automatic stay is in place, creditors may start contacting debtors. b. Bankruptcy protection gives creditors legal support to collect what is owed them. c. All debt can be included in a bankruptcy case. d. Once a debt is discharged, the debtor will never have to repay it. 7. Which of the following is a main difference between Chapter 7 and Chapter 13 bankruptcy cases? a. Chapter 13 requires a regular income and allows the debtor to keep his or her property. b. Chapter 13 is a liquidation case. c. Chapter 7 is for businesses and Chapter 13 is for individuals. d. Chapter 7 requires a regular income and allows the debtor to keep his or her property. 8. An increase in human capital usually leads to more income. a. True b. False 9. Which of the following statements is true? a. The long-term concerns of bankruptcy are so few that filing a case is usually a good first option. b. A trustee is assigned to all bankruptcy cases just to contact creditors and stop collection actions. c. A bankruptcy can stay on a person s credit report for up to 10 years and affect many parts of life. d. The main benefit of bankruptcy is that removing or reducing debt makes it easier to get credit. 10. Which of the following statements is true? a. Banks and mortgage brokers never get credit reports for employees. b. One possible result of bankruptcy is not being able to get certain jobs. c. Government agencies that run security checks are less likely to order credit reports. d. Banks cannot reject your loan because of your credit report or credit score. 11. Filing for bankruptcy protection is a serious decision, and most people consult an experienced attorney. a. True b. False

8 Federal Reserve Bank of St. Louis research.stlouisfed.org 7 Teacher s Guide Federal Reserve Bank of St. Louis Page One Economics : Bankruptcy: When All Else Fails After reading the article, select the best answer to each question. 1. A is helpful in keeping your finances in order and preventing trouble with money. a. budget b. bankruptcy c. credit report d. background check 2. A person s payment history can be found in a a. budget. b. contract. c. credit score. d. credit report. 3. What is bankruptcy? a. Several bills are due and the person is forced to make a payment plan to cover them. b. This month s budget is not balanced because of a major car repair. c. A person is late on two to three credit card payments. d. It is a legal process for declaring that a person is unable to pay his or her debts. 4. A debtor is a. an exchange, promise, or agreement between two parties that is enforceable by law. b. a person or organization that owes an amount of money. c. a person, financial institution, or other business that lends money. d. a tool you can use to help keep your finances in order. 5. Bankruptcy cases are handled at the level of court. a. city b. county c. state d. federal

9 Federal Reserve Bank of St. Louis research.stlouisfed.org 8 6. Which of the following statements is true? a. Once an automatic stay is in place, creditors may start contacting debtors. b. Bankruptcy protection gives creditors legal support to collect what is owed them. c. All debt can be included in a bankruptcy case. d. Once a debt is discharged, the debtor will never have to repay it. 7. Which of the following is a main difference between Chapter 7 and Chapter 13 bankruptcy cases? a. Chapter 13 requires a regular income and allows the debtor to keep his or her property. b. Chapter 13 is a liquidation case. c. Chapter 7 is for businesses and Chapter 13 is for individuals. d. Chapter 7 requires a regular income and allows the debtor to keep his or her property. 8. An increase in human capital usually leads to more income. a. True b. False 9. Which of the following statements is true? a. The long-term concerns of bankruptcy are so few that filing a case is usually a good first option. b. A trustee is assigned to all bankruptcy cases just to contact creditors and stop collection actions. c. A bankruptcy can stay on a person s credit report for up to 10 years and affect many parts of life. d. The main benefit of bankruptcy is that removing or reducing debt makes it easier to get credit. 10. Which of the following statements is true? a. Banks and mortgage brokers never get credit reports for employees. b. One possible result of bankruptcy is not being able to get certain jobs. c. Government agencies that run security checks are less likely to order credit reports. d. Banks cannot reject your loan because of your credit report or credit score. 11. Filing for bankruptcy protection is a serious decision, and most people consult an experienced attorney. a. True b. False

10 Federal Reserve Bank of St. Louis research.stlouisfed.org 9 Additional Resources Econ Lowdown of the Federal Reserve Bank of St. Louis provides numerous economic education resources for teachers to use with their students. These include lesson plans, online modules, interactive whiteboard lessons, podcasts, and videos. These free resources are available at Use the Econ Lowdown classroom resources listed below to help teach about topics related to this issue of Page One Economics. To register your students for the online courses, on the Econ Lowdown website (linked above), click the TEACHERS button to create or access your account and visit the Instructor Management Panel. Cards, Cars, and Currency Curriculum Unit Cards, Cars, and Currency is a curriculum unit that challenges students to become involved in three specific areas of personal finance: credit cards, debit cards, and purchasing a car. The unit is divided into five lesson plans. The activities in each lesson plan are designed to address problem-solving, critical-thinking, and higher levels of learning, using real-world scenarios. With a focus on responsibility for personal financial decisions, students will be able to identify the bottom line of financial decision making: income kept or lost. Making Personal Finance Decisions Curriculum Unit This curriculum teaches valuable personal finance lessons grounded in economic theory. The curriculum is divided into 10 themed units, with each unit containing two lessons. The 20 individual lessons use a variety of teaching strategies designed to engage students in the learning process and equip them with the knowledge and skills necessary to make informed personal finance decisions. Lesson 3A: Investing in Yourself Students perform calculations with half the class given information to make the task easier to demonstrate the importance of human capital in increasing a person s productivity. They then look at the wages for various occupations and consider the role of human capital in explaining the differences in those wages. Lesson 5A: Making a Budget It Is All Spending! Students discover that all elements of a budget are essentially spending on goods and services. They are shown a process for establishing a budget. Lesson 5B: Budget Trade-Offs A Penny Here and a Penny There Students participate in an activity that illustrates that budgeting is really an allocation problem. They must decide how to allocate limited income among many alternatives, which requires trade-offs. For the activity, students are given pennies representing monthly personal income to allocate for their living expenses to purchase goods and services for housing, food, transportation, and so on. Tools for Teaching the Arkansas Economics and Personal Finance Course This resource includes 20 sessions, or modules, for teaching economic or personal finance content, for example, scarcity and demand. Each session includes a description, talking points (also on PowerPoint slides), lessons or links to lessons, and suggested resources and is aligned with the Arkansas Economic Standards and Common Core State

11 Federal Reserve Bank of St. Louis research.stlouisfed.org 10 Standards. The course is designed with flexibility for teachers to use it in its entirety or to select individual sessions or lessons. Tools for Teaching the Missouri Personal Finance Competencies This resource includes 5 sessions, or modules, for teaching personal finance content. Each session includes a description, talking points (also on PowerPoint slides), lessons, and links to resources and is aligned with the National Financial Literacy Standards and the Common Core Standards. The course is designed with flexibility for teachers to use it in its entirety or to select individual sessions or lessons. Understanding How a FICO Credit Score is Determined Continuing Feducation Video Series, Episode 1 Episode 1 of the Continuing Feducation Video Series, Understanding How a FICO Credit Score is Determined, provides a short overview of credit scores how they are determined and why they are important. To provide students with online questions following each video, register your class through the Instructor Management Panel.

12 Federal Reserve Bank of St. Louis research.stlouisfed.org 11 Standards and Benchmarks Common Core State Standards Grades 6-12 Literacy in History/Social Studies, Science, and Technical Subjects History Social/Studies Key Ideas and Details CCLS.ELA-LITERACY.RH.6-8.1: Cite specific textual evidence to support analysis of primary and secondary sources. CCLS.ELA-LITERACY.RH.6-8.2: Determine the central ideas or information of a primary or secondary source; provide an accurate summary of the source distinct from prior knowledge or opinions. Craft and Structure CCLS.ELA-LITERACY.RH6-8.4: Determine the meaning of words and phrases as they are used in the text, including vocabulary specific to domains related to history/social studies. National Standards for Financial Literacy Standard 2: Earning Income Income for most people is determined by the market value of their labor, paid as wages and salaries. People can increase their income and job opportunities by choosing to acquire more education, work experience, and job skills. The decision to undertake an activity that increases income or job opportunities is affected by the expected benefits and costs of such an activity. Income also is obtained from other sources such as interest, rents, capital gains, dividends, and profits. Benchmarks: Grade 8 5. Investment in education and training generally has a positive rate of return in terms of the income that people earn over a lifetime. Standard 4: Using Credit Credit allows people to purchase goods and services that they can use today and pay for those goods and services in the future with interest. People choose among different credit options that have different costs. Lenders approve or deny applications for loans based on an evaluation of the borrower s past credit history and expected ability to pay in the future. Higher-risk borrowers are charged higher interest rates; lower-risk borrowers are charged lower interest rates. Benchmarks: Grade Lenders make credit decisions based in part on consumer payment history. Credit bureaus record borrowers credit and payment histories and provide that information to lenders in credit reports. 6. Lenders can pay to receive a borrower s credit score from a credit bureau. A credit score is a number based on information in a credit report and assesses a person s credit risk. 7. In addition to assessing a person s credit risk, credit reports and scores may be requested and used by employers in hiring decisions, landlords in deciding whether to rent apartments, and insurance companies in charging premiums. 8. Failure to repay a loan has significant consequences for borrowers such as negative entries on their credit report, repossession of property (collateral), garnishment of wages, and the inability to obtain loans in the future. 9. Consumers who have difficulty repaying debt can seek assistance through credit counseling services and by negotiating directly with creditors. 10. In extreme cases, bankruptcy may be an option for consumers who are unable to repay debt. Although bankruptcy provides some benefits, filing for bankruptcy also entails considerable costs, including having notice of the bankruptcy appear on a consumer s credit report for up to 10 years.