Consumer Bankruptcy: A Fresh Start

Abstract

Consumer bankruptcy provides partial insurance against bad luck, but, by driving up interest rates, makes life-cycle smoothing more difficult. We argue that to assess this trade-off one needs a quantitative model of consumer bankruptcy with three key features: life-cycle component, idiosyncratic earnings uncertainty, and expense uncertainty (exogenous negative shocks to household balance sheets). We find that transitory and persistent earnings shocks have very different implications for evaluating bankruptcy rules. More persistent shocks make the bankruptcy option more desirable. Larger transitory shocks have the opposite effect. Our findings suggest the current US bankruptcy system may be desirable for reasonable parameter values. (JEL D14, D91, K35)

Consumer Debt Repayment Behavior as a Precursor to Bankruptcy

“…One of the objectives of bankruptcy is to create the proper incentives for consumers to work and accumulate skills when they find themselves in a situation where the benefits of working hard are reduced by their debt burden (Livshits et al 2004). Four bankruptcy procedures or chapters have been established with this objective in mind: Chapters 7, 11, 12 and 13 (Goch et al 2006).…”

Fresh Start or Head Start? The Effects of Filing for Personal Bankruptcy on Work Effort

“…Existing empirical studies have looked into the effects of personal bankruptcy law on consumption (Filer and Fisher (2005) and Grant (2005)), the supply of and demand for credit (Gropp et al (1997) and ), mobility (Elul and Subramanian (2002)), and savings (Repetto (1998)). In addition, a growing number of theoretical studies use calibration and simulation exercises to evaluate the effects of changes in bankruptcy laws on the welfare of the economy in general equilibrium settings (e.g., Athreya (2002), Chatterjee et al (2002), Li and Sarte (2006), and Livshits et al (2006)). These studies focus squarely on the risk-sharing aspect of the bankruptcy law by either leaving out the labor market completely or modeling it in a minimal way.…”

Credit and self-employment

“…,y N g. Let ðX,BðXÞ,oÞ be a probability space where B(X) is the Borel sÀalgebra on X, and o is the measure of agents on the state space. Thus, for each C 2 BðXÞ, oðCÞ is the fraction of agents whose individual states lie in C. We follow Chatterjee et al (2007) and Livshits et al (2007) and fix the risk-free rate on savings at q s . The individual agent's policy functions, which solve the dynamic programs in (11)-(27), along with the stochastic process of endowments, induce a stochastic process for the individual's state.…”

“…Relatedly, Lawless and Warren (2005) report that up to 20% of bankruptcy filings are attributable to self-employed filers, while their population share has been measured to be between 7% and 13%. Given these estimates, and given that in the overall population, Livshits et al (2007) target a Chapter 7 bankruptcy rate of 0.68% of the population annually, while the overall US Chapter 7 filing rate by households in the past decade has been around 1.25% (if one includes all filings, including those triggered by ''expenditure shocks'' that we do not use here) a reasonable target for overall bankruptcy rates will therefore be one in the range of 0.68-2%. 19 In addition to targeting the bankruptcy rate of the self-employed, we also aim to make the benchmark model produce reasonable measures for the unconditional mean of debt discharged in bankruptcy.…”