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Investors couldn't be more pleased with the huge rebound in stocks since the market meltdown's March 2009 lows. But back on Main Street America, millions of people are dealing with their own version of financial Armageddon -- and there's no sign that it's letting up.

Bankruptcies on the rise
Earlier this week, the American Bankruptcy Institute reported that the number of consumer bankruptcy filings during 2010 rose to more than 1.53 million, up substantially from the 1.41 million filings in 2009. Those figures appear to contradict the general feeling that the economy is recovering, as the difficulties involved in filing for bankruptcy introduced by bankruptcy reform legislation five years ago has made the process a last resort for desperate borrowers overwhelmed by their debt.

The more surprising fact is that bankruptcy filings have increased every year since 2005, despite the fact that bankruptcy reform was supposed to make filings less common. Provisions like mandatory credit counseling and income restrictions limited access to the most attractive types of bankruptcy filings, encouraging consumers to try to pay back debt without resorting to the bankruptcy courts. Yet the numbers speak for themselves, and it's unclear to what extent a stronger recovery might reverse the tide.

One more moral hazard
One reason for the change could be that the social pressure against filing for bankruptcy has largely disappeared in the wake of the mortgage crisis. With millions of homeowners underwater on their mortgages and many resorting to so-called strategic defaults rather than continuing to throw good money after bad, the stigma of not being able to repay debt is much weaker than it once was.

Perhaps an even bigger influence has been the backlash of negative sentiment against Wall Street and the success of companies in navigating bankruptcy to great success. Just this past year, General Motors (NYSE: GM  ) emerged from bankruptcy, wiping out past shareholders but issuing new shares shortly thereafter that have performed quite well.

General Growth Properties (NYSE: GGP  ) not only managed to get out of bankruptcy without sending its shares to zero but gave investors a big windfall. Brookfield Asset Management (NYSE: BAM  ) , Blackstone Group (NYSE: BX  ) , and legendary investors Bill Ackman and Bruce Berkowitz were just part of a group of investors that beat a rival bid from Simon Property Group (NYSE: SPG  ) and hedge fund Paulson & Co. to provide capital to the real estate company. Since coming out of bankruptcy, General Growth has spun off some of its riskier assets into a new company, Howard Hughes Corp. (NYSE: HHC  ) , which has also skyrocketed in value since its November IPO.

Dealing with the fallout
These aren't the first companies to give investors strong returns after going through bankruptcy; utility PG&E and building materials maker USG are other examples of companies that went through the process without hurting investors. But their prominence has reinforced the idea that bankruptcy laws are meant to be used, and they've inevitably made people more comfortable taking advantage of bankruptcy when necessary.

Unfortunately for consumers, bankruptcy doesn't always solve financial problems as much as the process does for corporations. Many types of debt, particularly student loans, aren't eligible for discharge in bankruptcy, meaning that borrowers still have to pay those loans back even after going through the bankruptcy process.

Lessons for you
Of course, you might figure that you'll never need to resort to bankruptcy. But even for those who are on solid financial ground right now, one financial calamity can wipe away years of careful saving. To protect yourself and your assets, insuring against the most common problems -- major medical bills, damage to your home, and liability from auto accidents and other incidents involving injuries -- is crucial.

In addition, knowing how to shelter your assets from creditors is extremely valuable. For instance, in most states, money in retirement accounts is protected even if you file for bankruptcy. Other assets that qualify for protection vary from state to state, so knowing your own location's particular legal quirks will help you plan for the worst.

Higher bankruptcies and the economic trends that are causing them aren't good for the economy as a whole. But by taking a few careful steps, you can reduce the chance that you'll ever have to go through bankruptcy yourself.

Feeling the crunch from the economy? Take steps to protect yourself. Learn more by clicking here to see the Fool's special report, The 7 Secrets to Salvage Your Retirement Today.

Fool contributor Dan Caplinger refuses to go down without a fight. He doesn't own shares of companies mentioned in this article. General Motors and USG are Motley Fool Inside Value selections. Brookfield Asset Management is a Motley Fool Global Gains pick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy protects you from destruction.

Read/Post Comments (2) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 07, 2011, at 6:46 PM, PEStudent wrote:

    About 60% of those bankruptcies are medically related. But at no point in the "lessons to you" is it mentioned that if you don't scream bloody murder to your Congressman you've haven't learned the real lesson. This is another head-in-the-sand article that ignores the devastating effects of our inefficient healthcare system and it's grabbing 1/6 -on its way to 1/4 of our GDP.

    It's unsustainable, it's breaking the back of our economy, and it makes us less able to compete economically with other nations who've had the political honesty to put their people before special interests.

  • Report this Comment On January 07, 2011, at 9:41 PM, zymok wrote:

    60% of bankruptcies are medically related - according to much hyped and badly flawed studies. In fact, the analysis in these studies lies somewhere between non-existent and pathetically flawed. They are nothing that I would care to base an argument on.

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