Moral Hazard versus Liquidity in Household Bankruptcy

Abstract

This paper studies the role of moral hazard and liquidity in driving household bankruptcy. First, I estimate that increases in potential debt forgiveness have a positive, but small, effect on filing using a regression kink design. Second, exploiting quasi‐experimental variation in mortgage payment reductions, I estimate that filing is five times more responsive to cash‐on‐hand than relief generosity. Using a sufficient statistic, I show the estimates imply large consumption‐smoothing benefits of bankruptcy for the marginal filer. Finally, I conclude that 83% of the filing response to dischargeable debt comes from liquidity effects rather than a moral hazard response to financial incentives.

Personal Bankruptcy Protection and Household Debt

“…In addition, our analysis of repayment responses to bankruptcy protection complements previous studies on the impact of bankruptcy verdicts on labor markets and financial health (Dobbie and Song 2015;Dobbie, Goldsmith-Pinkham, and Yang 2017;Dobbie et al 2020) and contributes to the literature on strategic filing decisions (Indarte 2023;Argyle et al 2021;Fisher and Lyons 2010).…”

“…They also relate to empirical work that explores the role of bankruptcy changes in startup creation (Cerqueiro and Penas 2017), innovative activity among small firms (Cerqueiro et al 2013), and the use of credit cards in entrepreneurial activity (Chatterji and Seamans 2012;Fan and White 2003). Furthermore, the findings are complementary to previous work on credit card borrowing (Agarwal et al 2015;Souleles 2002a, 2002b) and personal bankruptcy filings and delinquency rates (Gross, Notowidigdo, and Wang 2014;Agarwal, Liu, and Mielnicki 2003;White 2007;Jagtiani and Li 2015;Indarte 2023). 9 Indarte, in particular, connects both the prevailing bankruptcy protection regime and mortgage payments to bankruptcy filing decisions, and finds that, while both contribute, variation in mortgage payments is the dominant factor in the decision to file for bankruptcy.…”

“…Regarding (a), the salience of the bankruptcy protection regime is a question common to the whole of a decades-long bankruptcy reform literature, including Gropp, Scholz, and White (1997), Berger, Cerqueiro, and Penas (2011), Lin andWhite (2001), andHynes, Malani, andPosner (2004). Indarte (2023) estimates a precise response of bankruptcy filing around the homestead protection cap, using a regression discontinuity kink method. This suggests some awareness of the homestead exemption cap among homeowners at risk of bankruptcy, which is a group that is relevant to our sample.…”