Who Files for Bankruptcy? State Laws and the Characteristics of Bankrupt Households

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1 Who iles fo Bankuptcy? State Laws and the Chaacteistics of Bankupt Households By MICHLL M. MILLR While pio papes have exained the ipact of state exeption and ganishent laws on the aveage household, this pape is the fist to exaine thei heteogeneous ipact. In y theoetical odel, households choose between thee options: epayent, bankuptcy, and infoal bankuptcy non-epayent without the benefit of the foal bankuptcy pocess. The odel akes two pedictions about the likelihood that a household will file fo bankuptcy. ist, the odel pedicts that high asset households ae oe likely to file fo bankuptcy in states with high exeption levels. Second, the odel pedicts that households with lowe incoes ae oe likely to file fo bankuptcy in states with high ganishent ates. These pedictions ae confied using a new household level dataset. The dataset finds, fo exaple, that households with $5, in hoe equity ae.7 ties oe likely to file fo bankuptcy in a state with a high exeption level, wheeas households eaning less than $, pe yea ae.6 ties oe likely to file fo bankuptcy in a state with a high ganishent ate. ndestanding these coss-state diffeences is cucial as they suggest that a household with a given set of financial chaacteistics will seek bankuptcy elief if it esides in one state but will have to use altenative consuption soothing easues if it lives in a diffeent state. The pevailing wisdo is that state exeption laws and ganishent laws have little ipact on the aveage household. But, exaining thei ipact on the aveage household paints an incoplete pictue to tuly undestand the elationship between state laws and bankuptcy we ust exaine the heteogeneous ipact these laws have acoss households. Indeed, in focusing on the aveage ipact, pio woks lagely ignoed the diffeences state exeption and ganishent laws geneate in the chaacteistics of files acoss states. o exaple, in 3, the aveage bankupt Loyola Mayount nivesity, epatent of conoics, LM ive, Roo 46, Los ngeles, Califonia 945 eail: Michelle.Mille@lu.edu. I would like to thank Randall P. llis, May. Hansen, ik Hust, Richad M. Hynes, Las J. Lefgen, Robet. Mago and ank McIntye fo thei helpful feedback. In addition, I would like to thank attoneys in the Business Reoganization and Restuctuing goup at Jones ay fo thei coents and legal expetise. inally, I a gateful to the seina paticipants at the eican Law and conoics ssociation nnual Meetings, Boston nivesity, Geogetown Law School, Loyola Mayount nivesity, Rutges Business School, and the St. Louis edeal Reseve Bank. ll eaining eos ae y own.

2 household in Tennessee had an annual incoe of $9,57 and assets of $63,4. But in adjacent Noth Caolina, the aveage bankupt household had an annual incoe of $39,85 and assets of $3,3 3 Repot of Statistics Requied by the Bankuptcy buse Pevention and Consue Potection ct of 5, Tables X and X. This pape shows that state exeption laws and ganishent laws do atte when it coes to bankuptcy they play a significant ole in deteining which households will file fo bankuptcy. The public policy iplications ae significant. These findings suggest that a household with a given set of financial chaacteistics will seek bankuptcy elief if it esides in one state but will have to use altenative consuption soothing easues if it lives in a diffeent state. To be sue, it is not clea whethe bankuptcy is the ost desiable fo of consuption insuance although it is costly, it povides households with a fesh stat and encouages paticipation in the wok foce. nd while deteining the optial exeption and ganishent laws is left fo futue eseach, fo the fist tie, this pape shows that by changing its ganishent o exeption laws, states significantly ipact which households file fo bankuptcy. In ode to exploe the heteogeneous ipact of state laws acoss households, I develop a new theoetical odel of bankuptcy. In this odel, households choose between thee options: epayent, bankuptcy, and infoal bankuptcy non-epayent without the benefit of the foal bankuptcy pocess. While it is an ipotant fo of consuption insuance fo any households, only a handful of theoetical odels anticipate the potential fo infoal bankuptcy. The addition of this thid option is paticulaly ipotant hee, because like the bankuptcy option the costs and benefits of infoal bankuptcy depend on state exeption laws and ganishent laws. With

3 these thee options, y odel pedicts that high asset households have a highe pobability of filing fo bankuptcy in states with high exeption levels, and low incoe households have a highe pobability of filing fo bankuptcy in states with high ganishent ates. I test the odel s pedictions with a new household level dataset. I find that while exeption laws have a inial ipact on the aveage household s decision to file fo bankuptcy, they significantly ipact wealthy households. The intuition is staightfowad. The aveage household only has $5, in hoe equity. The diffeence between an exeption of $,, $,, o even an unliited aount is eaningless fo this household, such that the household will not even conside exeption levels when aking the decision to file fo bankuptcy. But fo households with highe assets, these diffeences ae ipotant. o exaple, households with $5, in hoe equity ae.7 ties oe likely to file fo bankuptcy in a state with a high exeption level than in states with a low exeption level. I also find that while ganishent ates have a inial ipact on the aveage household s decision to file fo bankuptcy, low incoe households ae geatly ipacted by such laws. o exaple, wheeas the aveage household which eans $35, pe yea does not show any significant esponse to diffeences in ganishent ates, households eaning less than $, pe yea ae.6 ties oe likely to file fo bankuptcy in a state with a high ganishent ate than a state with a low ganishent ate. I. Institutional Backgound The nited States has two piay pocedues fo pesonal bankuptcy--- Chapte 7 and Chapte 3. In a Chapte 7 bankuptcy, households liquidate soe of thei 3

4 popety. The aount of popety that a household ust liquidate depends on state law; each state has its own exeption laws which potect an individual s unsecued assets both inside and outside of bankuptcy. Thee ae two types of exeption laws: hoestead exeption laws and pesonal exeption laws. Hoestead exeption laws potect a household s esidence o oe specifically, thei hoe equity while pesonal exeptions potect pesonal popety such as jewely and appliances. Like ost epiical woks, this pape concentates on hoestead exeption laws, as they ae substantially lage and oe eadily quantified. s seen in Table, these hoestead exeption levels vay significantly acoss states. Six states loida, Iowa, Kansas, Oklahoa, South akota, and Texas have unliited hoestead exeptions eaning that liteally an unliited aount of hoe equity is potected fo seizue by ceditos. In these states, debtos will not be foced to sell thei house to pay off thei ceditos. On the othe hand, thee states kansas, New Jesey, and Pennsylvania potect less than $, in hoe equity. If a hoeowne in one of these states files fo Chapte 7 bankuptcy elief and has oe than $, in hoe equity, then he ust suende his hoe. The hoe is then sold, and the hoeowne eceives less than $, specifically, $8 if living in kansas, $ if living in New Jesey, and $3 if living in Pennsylvania. The eaining poceeds ae then distibuted aongst the household s xeption laws potect households against involuntay liens o unsecued debts. Howeve, they do not potect households against voluntay liens o consensual secued debts. Thus, exeption laws do not potect households against foeclosue. Pesonal popety exeptions list the type of pesonal popety an individual can potect in bankuptcy. Typically, they efe to categoies of basic necessities, like food, clothes, funishings o tools of tade, but soeties they efe to specific ites, like heds of sheep o ilitay unifos. Howeve, unlike hoestead exeption laws, ost pesonal exeption laws do not place a dolla value on potected assets; as a esult, they ae difficult to quantify. In elawae fo exaple, a household s clothing, jewely, books, faily potaits, piano, leased ogans, sewing achines, buial plot, and chuch pew ae all potected by pesonal exeption laws. Siilaly, in Texas, pesonal exeption laws potect the faily Bible, household pets, two hoses with saddle, blanket and bidle fo each, twelve head of cattle, fowl, and any food on hand fo these anials. sing seveal diffeent calculation techniques, Hynes, Malani and Posne 3 deteined that the aveage pesonal exeption law potects appoxiately $6, of assets. By copaison, the aveage hoestead exeption law potects appoxiately $5, of assets. Given thei size, I a geneally not concened about oitted vaiable bias. 4

5 ceditos and the household s eaining debts ae dischaged fogiven. Most unsecued debts, including cedit cad debts, installent loans, edical debts, unpaid ent and utility bills, tot judgents, and business debts, can be dischaged unde Chapte 7. nde Chapte 7 of the Bankuptcy Code, the debto ay keep all of his futue eanings. ltenatively, in a Chapte 3 bankuptcy, households etain all of thei assets and instead agee to epay soe of thei debts fo futue eanings. 3 ebtos pay thei pojected onthly disposable incoe the diffeence between thei onthly incoe and onthly budgeted living expenses into the Chapte 3 epayent plan. fte aking payents fo thee to five yeas, the case is closed, and any eaining debts ae dischaged. 4 It is ipotant to note that the epayent plan ust copensate ceditos at least as uch as they would eceive unde Chapte 7. 5 o households facing seious debt, thee ae any advantages to filing fo bankuptcy. ist, as entioned above, though the bankuptcy pocess households ae able to dischage uch of thei unsecued debt it is estiated that the aveage household dischages appoxiately $36, of debt upon filing fo bankuptcy Culhane and White 999. Second, the filing of a bankuptcy petition ceates an autoatic stay that iediately pauses all collection effots including foeclosue poceedings and wage 3 In 7, less than 4 pecent of cases wee filed unde Chapte 3 of the Bankuptcy Code. s entioned in the text, the ajo benefit of filing a Chapte 3 is asset etention. But, copaed to Chapte 7, Chapte 3 is an extensive and lengthy pocess--- unde Chapte 3, households ust ake onthly payents fo thee to five yeas. In contast, Chapte 7 cases typically last less than six onths. s shown in Lefgen, McIntye and Mille, the best obsevable pedicto of chapte choice is the consue s attoney; households ae likely to file unde Chapte 3 if they consult a bankuptcy lawye who specializes in Chapte 3 cases. 4 household with incoe below the state s edian incoe level ust ake payents within a thee-yea peiod unless odeed othewise by the Cout, while a household with incoe above the state s edian incoe level ust ake payents within a five yea peiod. 5 nde the so-called best inteests of ceditos test, a cout ay not confi a chapte 3 plan unless it finds that the plan will povide unsecued ceditos with at least as uch as they would eceive if the debto wee liquidated unde chapte 7. See.S.C. 35a4. 5

6 ganishents. 6 The edeal Consue Cedit Potection ct CCP states that 75 pecent of wages o 3 ties the fedeal iniu wage pe week whicheve is highe is potected fo ganishent. 7 Howeve, the CCP allows states to enact thei own ganishent laws, povided that these laws potect a geate potion of boowes wages than the fedeal shae. s seen in Table, five states--- Noth Caolina, Pennsylvania, South Caolina, South akota, and Texas--- cuently pohibit wage ganishent except fo debts elated to taxes, child suppot, fedeally guaanteed student loans, cout-odeed fines o estitution fo a cie the debto coitted. n additional 8 states have thesholds that ae highe than the fedeal law. 8 Howeve, again, once a household files fo bankuptcy, wage ganishent ust stop. Regadless of the financial benefits, bankuptcy is a costly endeavo. In addition to the nealy $3 filing fee, households ust pay attoney fees, which aveage $,83 Palank 8. Moeove, thee ae non-pecuniay costs to bankuptcy, including the stiga of bankuptcy and futue estictions fo the cedit aket. nd finally, households ust eithe fofeit a potion of thei assets as they do in a Chapte 7 bankuptcy o a potion of thei futue incoe as they do in a Chapte 3 bankuptcy. 6 Ganishent can be taken fo any type of debt--- coon exaples include defaulted child suppot, taxes, cout fines, and student loans. Wages, salaies, coissions, bonuses, and incoe fo etieent pogas can all be ganished if a household fails to epay its debts. 7 On ebuay, 7, the fedeal iniu wage was $5.5. Thus, at the tie y saple was collected, at least $ x $5.5 of weekly wages was exept fo ganishent. When an eployee s weekly wages exceeded $54.5 but wee less than $6., only the aount ove $54.5 could be ganished. o exaple, if an eployee eaned $65 in a paticula week, only $5.5 could be ganished. When an eployee s eanings wee $6. o oe in a given week, up to 5 pecent of those eanings could be ganished. o an eployee eaning $5. a week, 5 pecent of his eanings o $6.5 could be ganished while $87.5 had to be paid to the eployee. 8 s shown in Lefgen and McIntye 9 state ganishent and exeption laws ae not coelated. It is not the case that a state potects households fo thei ceditos by passing both high hoestead exeption laws and low ganishent ates. Indeed the coelation between these two laws is.. 6

7 II. Liteatue Review To be sue, nueous papes have exploed the ipact of state laws on bankuptcy. Howeve, ost have focused on the ipact these laws have on the aveage household; none have studied thei heteogeneous ipact. 9 o exaple, using aggegate data, any papes egessed state pilado, auten and Sith 978; Shies and Williason 987; Weiss, Bhandai and Robins ; ishe, distict Buckley and Binig 998, county White 987, o zip code Lefgen and McIntye 9 filing ates on legal vaiables. While ost of these papes found a positive elationship between wage ganishent and bankuptcy, ost did not find a statistical elationship between exeption laws and bankuptcy. dditionally, using household level data, othe studies including awsey and usubel, 4; gawal, Liu, and Mielnicki, 3; ay, Hust, and White, ; and Lin and White, egessed a household s bankuptcy decision on state laws. Most found that high exeption laws and high ganishent ates have a positive, although odest ipact on bankuptcy. The esults pesented in Section V coincide with pio findings--- they show that state laws have a sall, alost insignificant ipact on the aveage household. This pape highlights the heteogeneous ipact of state exeption and state ganishent laws, showing that high exeption law have a lage and significant ipact on high asset households while high ganishent ates have a lage and significant ipact on low incoe households. 9 It should be noted that ay, Hust and White found that the financial benefit of bankuptcy has a positive and significant ipact on the pobability of bankuptcy. inancial benefit is defined as the debt that can be dischaged less nonexept assets a debto loses by filing. nfotunately, with this definition, the heteogeneous ipact of exeption levels cannot be disentangled fo additional units of assets o debts. In othe wods, thei esults ay iply that high exeption laws encouage high asset households to file fo bankuptcy. Howeve, they could also iply that households ae oe likely to file fo bankuptcy if they have high levels of debt. One notable exception is White 987 which found that high exeption levels wee coelated with high bankuptcy ates. Howeve, because the analysis is pefoed at the county level, and the autho did not coect the standad eos fo clusteing within states, Lefgen and McIntye 9 note that it is likely that the pecision of the estiates is ovestated. 7

8 This pape also builds on the theoetical liteatue on pesonal bankuptcy. Wheeas pio papes povide epiical evidence that households choose between epayent, bankuptcy and infoal bankuptcy fo exaple: gawal, Liu, and Mielnicki 3; awsey and usubel 4; Hynes 8; awsey, Hynes and usubel 3, existing theoetical odels Gopp, Scholz and White 997; Nelson 999; dle, Polak and Schwatz ; Wang and White ; theya ; White 5; Li and Sate 6; Pavan 8 lagely ignoe the option of infoal bankuptcy notable exceptions include Chattejee and Godon ; Chattejee ; Han and Li 7; White 998. Given the gowing nube of consues who choose infoal bankuptcy awsey, Hynes, and usubel 3, it is an ipotant coponent to y theoetical odel. Indeed, in 7, when this data fo this pape was collected, 7. pecent of.s. failies epoted to be at least 6 days behind on one of thei loans Bucks et al. 9. III. Model The theoetical odel pesented in this section highlights the heteogeneous ipact of state exeption and ganishent laws on a household s bankuptcy decision. Like Chattejee and Godon, Chattejee, Han and Li 7, and White 998, in this odel households choose between thee options--- epayent, bankuptcy and infoal bankuptcy. In infoal bankuptcy, households do not epay thei loans yet they do not seek foal bankuptcy potection. These households ae subject to both wage ganishent and seizue of thei nonexept assets. This odel expands these pio woks by developing a two-peiod odel of bankuptcy. xpanding the taditional one-peiod odel of bankuptcy to a two-peiod odel is ipotant as it allows a Repetto 998 and Pavan 8 also expanded the one-peiod odel of bankuptcy into a two-peiod odel of bankuptcy. Howeve, neithe pape consideed the ipact of ganishent ates. utheoe, neithe pape included infoal bankuptcy in thei theoetical odel. 8

9 household s assets, debts, and the inteest ate to depend on the state s exeption and ganishent laws.. The Household s Poble In this odel, isk avese households live fo two peiods and axiize thei expected lifetie utility. In the fist peiod, households eceive incoe. Howeve, second peiod incoe is uncetain; is unifoly distibuted between and. In the fist peiod, households choose thei fist peiod consuption C, assets which can be used fo futue consuption, and debt. Lendes chage inteest ate on a loan, which as discussed below, depends on the household s assets and debts as well as the state exeption level and ganishent ate. 3 The household s fist peiod budget constaint is given by C. In the second peiod, the household leans its incoe, and given its assets and debts, decides whethe to file fo bankuptcy. If it files fo bankuptcy unde Chapte 7, the household ust suende nonexept assets and pay a filling fee. ll eaining debts ae then dischaged. Thus, the households consuption is given by C in, - whee epesents the state exeption level and denotes the filing Without bankuptcy, a consue will eithe boow o save; he will not do both. Howeve, when bankuptcy is available, households ay boow and save siultaneously. lthough debt equies paying an inteest ate peiu, the pospect of not having to epay the debt in full lowes this peiu. s will be discussed below, in ode to be consistent with bankuptcy law, assets epesent hoe equity while debt epesents unsecued loans such as cedit cad debts. This odel does not distinguishing between the value of the hoe and the aount of the otgage; in ode to ake this distinction, the odel would need to include an additional choice vaiable. gain, the pupose of this odel is to show how state exeption levels ipact a household s bankuptcy decision. s exeption levels only apply to non-consensual secued debts, this siplification should not be woisoe. dditionally, this odel does not addess consensual secued loans. gain, the pupose of this odel is to show how state exeption levels ipact a household s bankuptcy decision. undaentally, hoestead exeptions do not potect a hoeowne against foeclosue by a otgagee. Hoestead exeptions apply only against involuntay liens o unsecued debts. Because exeptions ae not elevant to consensual secued debt, otgages ae not odeled hee. 3 This set-up assues that assets pay an inteest etun noalized to unity while debts cay a goss inteest ate of. This siplification does not alte y odel s pedictions. 9

10 fee. 4 If the household files fo bankuptcy unde Chapte 3 of the Bankuptcy Code, it ust suende its incoe and pay a filing fee. Howeve, the consue ay keep all its assets. gain, all eaining debts ae then dischaged. Thus, the household s consuption is given by C. 5 Because households ust epay ceditos at least as uch in a Chapte 3 epayent plan as in a Chapte 7 and because ceditos can petition to convet a Chapte 7 into a Chapte 3 if it is in thei best inteest, if a household files fo bankuptcy, its consuption is given by C in[ in,, ]. If the household does not file fo bankuptcy, its second peiod consuption is given by C Q,,,. When the household epays its debt in full Q,,, =. When the household chooses infoal bankuptcy, Q,,,=g ax-,, whee g denotes the state s ganishent ate. Recall that when a consue fails to epay his debts, he is subject to wage ganishent at ate g and ceditos ay sue the household fo his non-exept assets, ax-,. Thus, Q,,,=in[g ax-,, ]. 6 Theefoe in the second peiod, households file fo bankuptcy when in[ in,, ] > Q,,,. 4 In addition to the filing fee, incopoates attoney fees, the stiga of bankuptcy, and the cost of futue cedit aket exclusion. 5 Moe ealistically, when filing unde Chapte 3, a household only suendes a potion of its incoe. s detailed above, households pay thei pojected onthly disposable incoe into the Chapte 3 epayent plan. This is calculated by taking thei pojected onthly incoe and subtacting both actual expenses including spending on taxes, payoll deductions, te life insuance, cout-odeed payents, and utilities as well as standadized expenses including healthcae, housing, utilities, vehicle expenses, and public tanspotation expenses. Theefoe, it ay be oe ealistic to state that when filing unde Chapte 3, a household s consuption is given by C β. Howeve, the siplification does not alte y odel s pedictions. 6 Households who choose infoal bankuptcy ay also suffe fo non-pecuniay epecussions such as stiga o futue exclusion fo the cedit aket. One could wite Q,,, = in[g ax-,-f, ] whee f incopoates the stiga of infoal bankuptcy and the cost of futue cedit aket exclusion. Because f <, this siplification does not alte the odel s pedictions.

11 o desciptive puposes, igue depicts the household s second peiod decisions fo a household with sufficiently lage assets > and sufficiently lage debts >. The vetical axis depicts second peiod consuption while the hoizontal axis depicts all the possible ealizations of second peiod incoe. Consuption can be divided into thee egions. In the left-ost egion, whee <, households choose g infoal bankuptcy--- they do not epay thei debt and, as a esult, ceditos ganish thei wages and seize thei nonexept assets. These households avoid bankuptcy and its high filing fees without epaying thei debts in full. In the iddle egion whee g g < households file fo bankuptcy. In paticula, households with < will file unde Chapte 7 of the Bankuptcy Code while households with < will file unde Chapte 3. inally, in the ight-ost egion whee households epay thei debts in full. With the second peiod decisions detailed above, the household s axiization pobles can be witten as: 7, 8 ax, ax, / g g in, ax, / g in, 7 I assue that the household s utility is only defined ove thei consuption. o an altenative odel see Livshits, MacGee and Tetilt 7. 8 It is ipotant to note that households do not choose thei exeption level. ccoding to Section 548b3 of the Bankuptcy Code, debtos cannot anipulate hoestead exeptions by oving to anothe state. This section states that if a debto oved within the past 73 days, he is bound by the exeption level of the state in which he peviously esided.

12 o this axiization poble, it is clea that an additional unit of debt inceases fist peiod utility and only deceases second peiod utility of the household chooses epayent. Theefoe, the household s fist ode condition with espect to debt is as follows: 9 d =. d Siilaly, while an additional asset deceases fist peiod utility, it inceases second peiod utility if the household chooses infoal bankuptcy with assets below the exeption level, files fo bankuptcy unde Chapte 7 with assets below the exeption level, files fo bankuptcy unde Chapte 3, o epays its debts in full. Thus, the fist ode condition with espect to assets is: / g g d in, * d d [ ax,] d ax, d in, ' * d / g = / g B. The Lende s Poble Lendes ae assued to be isk neutal. Thei zeo pofit condition is given by: ax, [ g ax, ] ax, = / g ax, f whee the fist thee tes epesent patial epayent fo infoal bankuptcy, Chapte 7 bankuptcy and Chapte 3 espectively. The fouth te epesents full epayent and β x d dβ dα dg G x t dt G x x G x x dt 9 dx, =, β, α dx dx dx Leibnitz ule α x α x is used to find the fist ode conditions. β x

13 f is the isk fee ate of etun. If no inteest ate satisfies this equation, lendes will not lend. I assue that lending is liited by <. The lende s fist ode condition with espect to the inteest ate is: d ax, d ax, * [ ]*[ ] = d d The fist te epesents the lende s gain if the household files unde Chapte 7 and has non-exept assets. If a lende inceases the inteest ate, the household will incease its assets. Thus, if the household has nonexept assets and files fo bankuptcy unde Chapte 7, the lende will eceive a highe payent. The second te epesents the lende s gain if the household epays its debts in full. This te epesents two conflicting foces. If a lende inceases the inteest ate, the household will decease thei debts but the household is less likely to epay in full. C. Pedictions about ssets, ebts and the Inteest Rate The fist ode conditions ae totally diffeentiated and Cae s ule is used to solve fo d/d. Because high exeption levels potect assets if the household chooses infoal o foal bankuptcy, lendes ealize lowe pofits. s a esult, lendes will chage a highe inteest ate in states with high exeption levels. Siilaly, the odel pedicts that d/d and d/d. These deivatives indicate that in high exeption states, households will siultaneously accuulate assets and debts; Lehnet and Maki efe to this behavio as boowing to save. High exeption levels potect assets should the household choose infoal bankuptcy o bankuptcy. Thus, unde eithe of these options, households can etain a lage aount of o oe details, see the Matheatical ppendix. 3

14 assets without having to epay thei debts. This ceates an incentive fo households to accuulate additional assets at the cost of additional units of debts. The odel pedicts siila behavio fo households in high ganishent states d/dg and d/dg. household is oe likely to file fo bankuptcy in a high ganishent state. nd because it is pefeable to have high assets and high debts when filing, households in high ganishent states will siultaneously accuulate both assets and debts. utheoe, the odel pedicts that d/dg. In states with high ganishent ates, lendes can ganish a lage potion of the household s incoe. This ceates two opposing effects. Because lendes collect oe when a household chooses infoal bankuptcy, high ganishent ates ceate an incentive fo lendes to lowe inteest ates. On the othe hand, oe households will file fo bankuptcy instead of choosing infoal bankuptcy; these households will epay less debt. This ceates an incentive fo lendes to incease inteest ates. Because this late effect is lage, the inteest ate is highe in states with high ganishent ates.. Pedictions bout Bankuptcy gain, households file fo bankuptcy when in[ in,, ] > Q,,,. o this condition, the odel akes seveal pedictions about the likelihood of bankuptcy: High asset households have a highe pobability of filing fo bankuptcy in states with high exeption levels. o oe details on these calculations, see the Matheatical ppendix. 4

15 Low incoe households have a highe pobability of filing fo bankuptcy in states with high ganishent ates. The likelihood of bankuptcy is deceasing in. The likelihood of bankuptcy is inceasing in. IV. ata esciption To test these pedictions, I use data fo two souces. ata on bankupt households was hand-collected fo bankuptcy petitions while data on contol households cae fo the Panel Study of Incoe ynaics PSI.. Bankuptcy Saple When filing fo bankuptcy, debtos povide the Bankuptcy Cout with detailed ecods of thei finances. These ecods ae then achived on the cout s centalized egistation and billing website, PCR Public ccess to Cout lectonic Recods in a potable docuent file pdf foat. With a subsciption to this website, I ceated a unique dataset of the population of households that filed fo bankuptcy nationwide on ebuay, 7. s entioned in Zhu, thee ae seveal advantages to utilizing cout filing data instead of suvey data. ist, bankuptcies ae undeepesented in publicly available suvey data such as the PSI and Suvey of Consue inance. utheoe, data fo bankuptcy filings yield oe eliable esults than suvey data Thee ae seveal advantages to collecting data fo ebuay, 7. Because I collected data fo 7, I was able to collect a nationally epesentative dataset--- pio to 7 any bankuptcy couts did not use PCR s Case Manageent/lectonic Case iles CM/C syste. Theefoe, it would not have been possible to collect a nationally epesentative saple of cases electonically. ebuay st was selected as a ando date at the beginning of the yea; the bankuptcy petitions collect infoation on the household s incoe fo the pevious two calenda yeas. Thus, fo petitions filed on this date, I likely have accuate incoe infoation. Because y data was collected in 7, y saple consists of data fo cases filed afte the BPCP--- this pape is one of the fist to exaine bankupt households since the Bankuptcy Code was aended in 5. White and Zhu also collected electonic bankuptcy petitions fo households who filed fo bankuptcy afte 5. Thei saple contained 586 households who filed a Chapte 3 bankuptcy in 6 in elawae. 5

16 because households povide infoation unde penalty of pejuy and the household s attoney is equied to veify all financial stateents. Bankuptcy ecods povide an abundance of financial infoation. ist, households iteize thei unsecued debts including cedit cad debts and edical bills. 3 Households also ust ecod the value of thei hoe as well as any secued clais on thei hoe; thus I can calculate the household s hoe equity. 4 In addition, debtos detail thei incoe fo the past two calenda yeas. 5 While bankuptcy ecods contain an abundance of financial infoation, they have liited deogaphic infoation. Cout ecods povide the debto s aital status, and household size. 6 But othe infoation including age and education ae unfotunately, unavailable. Howeve, since I know the file s addess, I use Census block statistics to estiate these deogaphic chaacteistics. 7,8 B. Contol Saple I augent the bankuptcy data with households fo the 7 PSI. 9 ach of the 6,984 households in the PSI details its incoe fo 6 and 4. In addition to 3 In paticula, fo Schedule, I extact infoation on a household s unsecued non-pioity debts. In geneal, these ae the debts which households can dischage in bankuptcy. My esults ae statistically siila when I include unsecued pioity debts fo Schedule. nsecued pioity debts include doestic suppot obligations and unpaid taxes. 4 This infoation was collected fo Schedule. 5 This infoation was collected fo the Stateent of inancial ffais. 6 Infoation on aital status and household size was extacted fo Schedule I. 7 Pio eseach suggests that issing deogaphic data should not be a concen. In fact, ealie woks ague that once financial chaacteistics ae contolled fo, deogaphic chaacteistics ae ielevant. In inteviewing 4 households, Stanley and Gith 97 found that deogaphic consideations did not influence the bankuptcy decision. oowitz and ovaldi 993 confied this esult; they found that ace was statistically insignificant in explaining aggegate filing ates. s shown in the sixth colun of Table 3, y esults do not change when I exclude the iputed deogaphic vaiables. 8 Bankuptcy petitions contain a wealth of othe infoation as well. o exaple, in addition to the vaiables entioned above, gawal, Chosisengphet, McMenain and Skiba ention that bankuptcy petitions include infoation on onthly expenditues, nube of ceditos, and pevious bankuptcy filings. Howeve, as y contol saple does not contain these covaiates, they ae not included in y egessions. 9 Because bankupt households ae not identified in this study, I assue that none of the households in the PSI filed fo bankuptcy. Howeve, because. pecent of all households in the nited States filed fo bankuptcy in 7, soe households in y contol goup ay have filed fo bankuptcy. Cosslett 98 and Lancaste and Ibens 996 develop an estiation pocedue to 6

17 annual easues of faily incoe, the PSI povides a detailed inventoy of the faily s hoe equity and unsecued debts. eogaphic infoation is also povided. C. Suay Statistics Suay statistics, copaing bankupt and non-bankupt households, can be found in Table. Seveal diffeences ae woth noting. Bankupt households eaned ove $, less than non-bankupt households in 6. dditionally, while the aveage bankupt household expeienced a ecent decline in thei incoe, the aveage non-bankupt household ecently expeienced an incease in incoe. 3 Not supisingly, bankupt households ae also chaacteized by lowe levels of hoe equity $9,749 copaed to $,35. nd, bankupt households have highe levels of debt; while households in the PSI have an aveage $,88 of unsecued debt, bankupt households have an aveage $5,885 of unsecued debt. Thee ae also diffeences in thei known deogaphic vaiables--- although less likely to be aied and oe likely to be single o sepaated, bankupt households ae lage. The iputed deogaphic chaacteistics, based off the bankupt household s census block, indicate that bankupt households ae younge. deal with the containated contol goup poble. sing this altenative estiation stategy does not alte y esults as such a sall faction of contols ae containated. s a esult, I assue that none of the households in the PSI filed fo bankuptcy. 3 While the Stateent of inancial ffais collected incoe data on bankupt households fo the pevious two calenda yeas i.e. 5 and 6, the Panel Study of Incoe ynaics PSI collected incoe infoation on non-bankupt households fo 4 and 6. 7

18 V. stiation. Pobability of Bankuptcy To estiate the heteogeneous ipact of state laws on a household s bankuptcy decision, I estiate the following linea pobability odel: 3 PobBankupt = α α High xeption α High xeption*ssets α 3 High Ganishent α 4 High Ganishent*Incoe α 5 ssets α 6 ebt α 7 X α 8 Region ε it whee Bankupt is a duy vaiable equal to one if the household files fo bankuptcy. High xeption is a duy vaiable that equals one if state law potects oe than $4, in hoe equity and High Ganishent is a duy vaiable that equals one if state law allows ganishent up to the fedeal liit. 3,33 ssets ae easued as the household s hoe equity and ebt by the household s unsecued debts. X is a vecto of othe vaiables including incoe, change in incoe, and deogaphic chaacteistics. inally, Region is a vecto of egional duy vaiables. Recall, the odel pedicts that high asset households ae oe likely to file fo bankuptcy in states with high exeption levels α = and α > and that low incoe households ae oe likely to file fo bankuptcy in states with high ganishent ates α 3 > and α 4 <. dditionally, the 3 This pape is otivated by the coss-state diffeences in the chaacteistics of bankupt households. It does not seek to exaine the coss-state diffeences in the chaacteistics of households who choose infoal bankuptcy. Theefoe, y egession exaines the pobability that a household files fo bankuptcy. o a policy pespective, undestanding the coss-state diffeences in the chaacteistics of bankupt households is ipotant because bankuptcy is an expensive fo of consuption insuance. In addition to the filing fees and attoney fees entioned above, bankuptcy iposes a lage cost on ceditos as they ust wite off the debt that households dischage. While infoal bankuptcy can also help households sooth consuption, it aguably iposes a salle cost on society--- households do not pay legal fees o filing fees. In addition, ceditos typically do not wite off the debt o at least do not wite the debts off iediately. utheoe, White 998 agues that infoal bankuptcy often leads to foal bankuptcy. o these easons, this pape focuses on the cossstate diffeences in the chaacteistics of households who choose foal and not infoal bankuptcy. 3 xeption levels ae adjusted based on the faily stuctue. suvey of state exeption laws eveals that one thid of states have exeption levels geate than the ean exeption of $4,. ccodingly, the duy vaiable High xeption equals one if oe than $4, of a household s hoe equity is potected by a hoestead exeption law. Howeve, as shown in coluns III and IV, y findings ae obust to altenative definitions. 33 s discussed in Section I, unde fedeal law, ceditos ay ganish twenty five pecent of wages. Many states, howeve, have placed futhe liits on the ganishent ate. The duy vaiable High Ganishent equals one in states that use the fedeal ganishent liits. Howeve, as shown in colun V, y findings ae obust to an altenative definition. 8

19 odel pedicts that the pobability of bankuptcy is deceasing in assets and inceasing in debts α 5 < and α 6 >. If the saple wee ando, equation could be estiated using a siple linea pobability egession. 34 Howeve, the saple at hand is not ando; instead it is choice-based. 35 Theefoe, as detailed in Manski and Lean 977 equation ust be estiated using weighted exogenous sapling axiu likelihood estiation WSML. By contolling fo the ovesapling of bankupt households, I a able to obtain consistent estiates. Specifically, I weight each te by the invese of the ex-ante pobability that an obsevation is included in the saple. Let Q denote the faction of the population that is bankupt and H denote the faction of the saple that is bankupt. Then each bankupt household is weighted by Q / H and each non-bankupt household is weighted by -Q /-H. Regession coefficients ae epoted in Table 3. ll eos ae clusteed at the state level. In colun I, I estiate the pobability of bankuptcy without any inteaction tes. Like pio woks, I find that neithe state law has an ipact on the aveage household. In colun II, I include the inteaction tes suggested by y odel. In line with y odel s pedictions, while the duy vaiable High xeption is insignificant, it is positive and statistically significant when inteacted with hoe equity. In othe wods, high exeption levels have a statistically significant ipact on high asset households. lso in line with y odel s pedictions, I find that the duy vaiable High 34 Because of the inteaction tes, a linea pobability odel is pefeable to a logit o pobit odel. See i and Noton 3 fo a discussion of inteaction tes in logit and pobit odels. 35 Choice-based sapling aises when selection into the saple is deteined by the dependent vaiable. Like any suveys, I have ovesapled an infequently ade choice. With such a dataset, OLS estiates will be biased and inconsistent Manski and Lean

20 Ganishent has a positive ipact on bankuptcy that declines with incoe. In othe wods, high ganishent ates have a statistically significant ipact on low incoe households. Othe coefficients have the expected signs. The pobability of bankuptcy is deceasing in hoe equity, inceasing in unsecued debts, and deceasing in changes in incoe. In coluns III-V, I show that y esults ae obust to altenative definitions of High xeption and High Ganishent. In colun II, I use the state s actual exeption level a continuous vaiable and its inteaction with hoe equity. gain, the inteaction te has a positive and statistically significant ipact on bankuptcy. Siilaly, in colun IV, I include a continuous vaiable denoting the household s non-exept assets i.e. the household s assets above the exeption level. s expected, the likelihood of bankuptcy is deceasing in non-exept assets--- again, this esult shows that high asset households ae oe likely to file fo bankuptcy in states with high exeption levels. utheoe, in colun V, I show that y esults ae obust to an altenative definition of High Ganishent. In this colun, I ceate a duy vaiable that equals one if the state allows any aount of incoe to be ganished. gain, this duy vaiable has a positive ipact on bankuptcy that declines with incoe. In colun VI, I e-un the egession, using only known deogaphic vaiables--- y esults ae not sensitive to the exclusion of the iputed deogaphic vaiables. dittedly, the epoted coefficients pesented in coluns I-VI, could be biased by spatially coelated vaiables that ae not obseved by the econoetician. o exaple, households in a paticula state could be influenced by the sae social nos, legal cultue, and pefeences to epay debt--- egional fixed effects ay not contol fo

21 these unobseved chaacteistics. To exaine this issue, in colun VII, I e-un y egession with state fixed effects. It is ipotant to ecognize that with the inclusion of state fixed effects I cannot estiate the level effect of state bankuptcy laws. Howeve, the inteaction effects between the laws and vaious household chaacteistics can still be identified. The inclusion of state fixed effects does not alte the coefficients on y inteaction tes. dditionally, it is woth noting that these state fixed effects have little explanatoy value--- indeed thei patial -squaed is only.7. This ipotant obustness check should alleviate any concen that y esults ae diven by state-level oitted vaiables, o even that they ae diven by vaiations in the cost of living acoss states. B. Heteogeneous Ipact coss Households In Table 4, to bette undestand the heteogeneous ipact of state laws on a household s bankuptcy decision, I exaine the likelihood of bankuptcy fo diffeent household goups. 36 o the aveage household, with appoxiately $5, in hoe equity, the pobability of bankuptcy is nealy identical in high and low exeption states. In eithe state, the aveage pobability of filing is appoxiately.5. ndestandably, the diffeence between a $,, $5,, $,, o even an unliited exeption level is eaningless fo this household. This explains why ost pio studies wee unable to find an epiical elationship between exeption levels and bankuptcy. Howeve, high asset households ae geatly ipacted by high exeption laws. s seen in Table 4, I find that households with appoxiately $5, in hoe equity ae.7 36 ll othe factos ae held constant at the ean of the data fo the 6,984 households in the PSI. These esults ae based on y baseline specification, seen in the second colun of Table 3.

22 ties oe likely to file fo bankuptcy in a state with a high exeption level than a low exeption level. Table 4 also confis that low incoe households ae oe likely to file in high ganishent states. In fact, households with incoe below $, ae ove.6 ties oe likely to file fo bankuptcy in a high ganishent state. o these households, whethe they ae subject to 5 pecent, pecent, o no ganishent has a lage ipact on thei bankuptcy decision. Notice howeve, that fo high incoe households, eaning appoxiately $,, the pedicted pobability of bankuptcy is nealy identical in high and low ganishent states. C. Policy Iplications Table 5 gives pedicted changes in the pobability of filing fo bankuptcy that esult fo hypothetical policy changes. Suppose fist that evey state enacts a high exeption level, potecting at least $4, of hoe equity. The odel pedicts that the aveage pobability of bankuptcy would ise by Since the aveage pobability of filing in y saple is.53, the odel pedicts that the nube of bankuptcy filings would incease by 3.8 pecent pe yea. Based on 8,59 bankuptcy filings pe yea in the nited States the figue fo 7, this iplies that appoxiately 3, additional bankuptcy filings would occu pe yea. Given that the aveage household dischages an estiated $36, in unsecued debt Culhane and White 999, this hypothetical policy change would lead to an additional $. billion of debt being dischaged each yea. 37 I calculate the change in each household s pobability of filing fo bankuptcy. Note that the pobability of filing fo bankuptcy does not change fo households cuently living in states with high exeption levels.

23 Next, suppose evey state enacts a high ganishent ate, allowing ganishent at the fedeal liit of 5 pecent. The odel pedicts that the aveage pobability of bankuptcy would ise by Since the aveage pobability of filing in y saple is.53, the odel pedicts that the nube of bankuptcy filings would incease by 4.3 pecent pe yea. gain, based on 8,59 bankuptcy filings pe yea in the nited States the figue fo 7, this iplies that appoxiately 7, additional bankuptcy filings would occu pe yea, o an additional $4. billion of debt being dischaged.. Levels of ebts and ssets The odel also pedicts that households boow to save in states with high exeption levels and high ganishent ates. Recall that because thee is a geate likelihood that households will file fo bankuptcy in these states, thee is a geate likelihood that a household will be able to etain its assets without having to epay its debts. This ceates an incentive fo households to accuulate additional assets at the cost of additional units of debts. To date, no othe bankuptcy pape has addessed whethe debts o assets depend on the state s exeption and ganishent laws. Most ealie woks have assued that a household s assets and debts ae exogenous; thee notable exeptions Repetto 998; Lehnet and Maki ; Pavan 8 exained whethe assets and debts to depend on exeption laws. Howeve, as detailed in the odel above, debts and assets depend on both exeption and ganishent laws. sing data fo the PSI, I exaine whethe assets and debts depend on state exeption and ganishent laws. Independent vaiables include duy vaiables 38 gain, I calculate the change in each household s pobability of filing fo bankuptcy. Note that the pobability of filing fo bankuptcy does not change fo households cuently living in states with high ganishent ates. 3

24 denoting high exeption levels and high ganishent ates, the household chaacteistics detailed above, and egional duy vaiables. Table 6 epots egession coefficients using seeingly unelated egession analysis SR. 39 gain, the eos ae clusteed at the state level. Consistent with the odel s pedictions, the coefficients on High xeption ae both positive and significant, indicating that households boow to save in states with high exeption levels. Howeve, high ganishent ates only appea to ipact household s assets, not thei debts. VI. Conclusion While state exeption laws and ganishent laws ay not ipact the aveage household, this pape shows that they have a significant ipact on soe households. To study the heteogeneous ipact of state laws acoss households, this pape develops an altenative theoetical odel of bankuptcy. The odel pedicts that high asset households have a highe pobability of filing fo bankuptcy in states with high exeption levels and low incoe households have a highe pobability of filing fo bankuptcy in states with high ganishent ates. It also pedicts that households will accuulate oe assets and debts in states with high exeption levels and high ganishent ates. These pedictions ae confied using a newly ceated householdlevel dataset and choice-based estiation techniques. The esults ae obust to a vaiety of specification checks and ae unlikely diven by oitted state-level vaiables. These findings have ipotant policy iplications. Because of state exeption laws and ganishent laws, a household with a given set of financial chaacteistics will seek bankuptcy elief if it esides in one state but will use altenative consuption 39 See Zellne 96. Seeingly unelated egession analysis allows the eo tes to be coelated acoss equations. s debts and assets ae deteined siultaneously, it is likely that the eo te is coelated acoss equations. stiating a set of seeingly unelated egessions jointly as a syste will yield oe efficient estiates than estiating each of the sepaately. 4

25 soothing easues if it lives in a diffeent state. Nueous studies have exained the diffeential use of social insuance pogas including Social Secuity fo exaple Pasons 98 and Medicae fo exaple Baicke et. al 4 acoss households. Given its size, it is ipotant to also ecognize the diffeential use of anothe consuption soothing poga--- bankuptcy--- acoss households. These findings ae also of the upost ipotance fo state govenents; the ajoity of states ake sall inceental changes to thei exeption laws on an annual o biannual basis. They should note that these changes not only ipact the chaacteistics of files, but that they also ipact the potfolio decisions of all households. VIII. Matheatical ppendix This atheatical appendix details the theoetical odel outlined in Section III. Recall that the household s axiization poble is: ax, ax, / g g in, ax, / g in, The household s fist ode condition with espect to debt is: 4 d = d The household s fist ode condition with espect to assets is: β x β x d dβ dα dg G x t dt G x x G x x dt 4 dx, =, β, α dx dx dx Leibnitz ule α x α x conditions. is used to find the fist ode 5

26 ,] ax [, in * ', in *, ax / / = g g d d d d d d g s detailed in Section III, the lende s zeo pofit condition is given by:, ax ], ax [, ax, ax / / f g g g = The lende s fist ode condition with espect to the inteest ate is: ] ]*[ [, ax, * ax = d d d d. Pedictions about ssets, ebts and the Inteest Rate The fist ode conditions ae totally diffeentiated and Cae s Rule is used to solve fo d/d, d/d, d/d, d/dg, d/dg, and d/dg. ] [ ] [ ' *, ax = d d d d d d ] [ ] [ ' *, ax = d d d d d d ] [ ] [ ' *, ax = d d d d d d = ] [ " *, in / g d d dg d g 6

27 ] [ " *, in / 33 = g d d dg d g ] [ " *, in / 3 = g d d dg d g whee " " = d d ' " ' " = d d d d d d ' " ' 3 = d d d d ", ax * ' ",] ax [, in * ", in * " ", ax / / = g g d d d d d d d d g 7

28 = " d d ' d d ' d d " d d 3 = ' " d d d d ax, = * d d 3 d = d 3 d d and 33 = d d B. The Likelihood of iling fo Bankuptcy s detailed in Section III, households file fo bankuptcy when in[ in,, ] > Q,,, whee Q,,,=in[g ax-,, ]. quivalently, households file fo bankuptcy when < in[ in,, ] Q,,,. o this condition I can ake seveal pedictions about the likelihood of bankuptcy. High asset households ae oe likely to file fo bankuptcy in states with high exeption levels. Let Ω = in[ in,, ] Q,,,. Then the pobability Ω that a household files fo bankuptcy is. s shown above, d/d, d/d and d/d ae all non-negative. In addition, all thee tes ae inceasing in assets. Thus, it is easy to see that dω/d is also non-negative and inceasing in assets. 8