Consumer bankruptcies down but debt load is still scary

July 11, 2011, 7:01 PM UTC
FORTUNE — Before last week’s dismal unemployment report, there was some seemingly bright news for U.S. households. Consumer bankruptcies plummeted 8% in the first half of this year compared to 2010, said the American Bankruptcy Institute. Roughly 709,000 Americans declared insolvency.On the surface this augurs well for households — and for the U.S. economy dependent on their spending. Along with declining credit card delinquencies and falling bank loan missed payments, it suggests consumer finances are improving. But the headline hides a scary truth: U.S. households are still precariously indebted. The government is propping up their balance sheets at record levels. And a number of Americans are avoiding bankruptcy by skipping their mortgage payments.

“The number of bankruptcies is still unacceptably high,” says David Rosenberg, chief economist at Gluskin Sheff & Associates in Toronto, who thinks there’s a 99% chance the U.S. is headed for another recession in 2012. “It is not a good number even if it’s fallen from its peak.”

The problem as Rosenberg sees it is that bankruptcies are so high even after the government has undertaken record fixes. The Fed has kept interest rates near zero, allowing at-risk consumers to refinance at favorable rates. The Obama administration’s payroll tax cut boosted paychecks. The Fed’s QE2 bond buying program sent stocks rising. The government’s $800-billion stimulus created jobs. And extended unemployment benefits supported some individuals for up to 99-weeks.

“Maybe the high rollers out there don’t need it,” says Rosenberg of the extended benefits, “but there are a lot of people out there who were relying exclusively on [those]. They can kiss that goodbye.’”

Together, the government’s fiscal support probably added a full percentage point to personal income growth last year. Yet bankruptcies still hover above the levels of 2009 and anytime in recent history.

On top of that, America is going through a new era of strategic default. MF Global economist Jim O’Sullivan says much of the recent drop in household debt— the Fed announced household debt fell at a 2% annual rate in the first quarter —may be the result of people avoiding payments by walking away.

About 15 million households owe more than their house is worth, and many more face that prospect should home prices fall an additional 5% to 10%. Credit agency Experian estimated that 17% of all mortgage defaults in the first half of 2010 were the result of people walking away from their homes. When economists talk about Americans’ improving balance sheets, you rarely hear it’s because people are stiffing their lender.

One positive note is the so-called debt-service ratio— the cost of paying debts. O’Sullivan says it’s at its lowest level since at least 1997. “That’s much lower relative to history than the debt burden is,” he says.

Still, there are reasons to think Americans bankruptcy parade won’t be over anytime soon. In the first quarter, the Fed reported that household debt as a percentage of disposable income declined to 119%, below 2007’s 133% figure but seemingly above healthier levels. Meanwhile, declining home prices may continue to pressure balance sheets and other supports for American households are eroding. Obama is fighting Congress to keep the payroll tax deduction but federal debt protests have made more government fiscal stimulus unlikely.

It’s dangerous to take declining bankruptcies as a sign economy is one the mend. Instead, it may be facing another test. And if it does head down, consumers aren’t in a much better position this time.