TheHouseholdBankruptcyDecision

TheHouseholdBankruptcyDecision GraduateSchoolofBusiness AnnArbor,MI48109-1220 DepartmentofEconomics UniversityofMichigan UniversityofChicago ErikHurst ScottFay AnnArbor,MI48109-1220 DepartmentofEconomics UniversityofMichigan Chicago,Illinois60637 MichelleJ.White September1999 1

1.Introduction Personalbankruptcylingshaverisenrapidlysincethe1980's,changingbankruptcy TheHouseholBankruptcyDecision1 morecommon.untilrecently,studyingthehouseholdbankruptcydecisionwasverydicult,becausenohousehold-leveldatasetexistedthatincludedinformationonbankruptcy bankruptcylingscausedlenderstoloseabout$39billion.2butthereislittleunderstand- forbankruptcyeachyearhasrisenfromabout0.3%in1984to1.4%in1998.in1998, ingbyeconomistsofwhyhouseholdsleforbankruptcyorwhylinghasbecomesomuch lings.inthispaper,weusenewdatafromthepanelstudyofincomedynamicswhich includesinformationonbankruptcylingstoestimateamodelofhouseholds'bankruptcy decisions. leforbankruptcyastheirnancialbenetfromlingincreases.themodelpredictsthat anincreaseof$1,000inhouseholds'nancialbenetfrombankruptcywouldresultina 7.4%increaseinthenumberofbankruptcylings.Ourmodelalsopredictsthatifthe1997 NationalBankruptcyReviewCommission'sproposedincreasesinbankruptcyexemption Wendsupportfortheeconomicmodelthathouseholdsaresignicantlymorelikelyto fromarareoccurrencetoonethatisfairlycommon.thepercentofhouseholdsthatles levelswereimplemented,therewouldbea17%increaseinthenumberofbankruptcy householdsaremorelikelytoleiftheheadwasrecentlydivorced.wealsondthat lingseachyearandlenderswouldloseanadditional$5.1billioneachyear.wendlittle supportforthealternativemodelthathouseholdsaremorelikelytoleforbankruptcy whenadverseeventsoccurwhichreducetheirabilitytorepay,althoughwedondthat JimHines,JoeLupton,ArielPakes,GarySolon,NicholasSouleles,FrankStaord,ElizabethWarrenand ananonymousrefereeforhelpfulcommentsandtocitibankandnsf,undergrantnumbersbr96-17712, fornancialsupport.earlierversionsofthispaperwerepresentedatharvard,wharton,chicago,and theamericanlawandeconomicsassociationconference. districts,whichisconsistentwithadeclineinthelevelofsocialdisapprovalofbankruptcy. households'bankruptcydecisionsareincreasinglyinuencedbythelingratesintheir 1WearegratefultoOrleyAshenfelter,JohnBound,CharlieBrown,PaulCourant,AustanGoolsbee, 2Thisgureisbasedonunsecureddebtperbankruptcylingof$28,000(BarronandStaten,1998). 1

2.U.S.PersonalBankruptcy:LawandProcedure 13 anddebtorshavetherighttochoosebetweenthem. TheU.S.hastwodierentpersonalbankruptcyprocedures Chapter7andChapter non-exemptassetsandusestheproceedstorepaycreditors.althoughbankruptcyisa loans,medicalbills,anddamageclaimsaredischarged.debtorsarenotobligedtouseany oftheirfutureearningstorepaytheirdebt,buttheyareobligedtoturnoveralloftheir assetsaboveaxedexemptionleveltothebankruptcytrustee.thetrusteeliquidatesthe Chapter7.UnderChapter7,unsecureddebtssuchascreditcarddebt,installment therighttoadopttheirownbankruptcyexemptions.moststateshaveseparateexemptions forequityinthedebtor'sprincipleresidence(the\homesteadexemption")andforseveral typesofpersonalproperty.ingeneral,states'non-homesteadexemptionsarelow,but matteroffederallawandtherulesareuniformacrosstheu.s.,congressgavethestates theirhomesteadexemptionsvarywidely,fromafewthousanddollarstounlimitedinnine notobligedtorepayanythingtocreditors. states.3ifdebtors'assetsarelessthantheexemptionlevelsintheirstates,thentheyare thedierence.householdsthatleforbankruptcymustalsopaybankruptcycourtling feesandlawyers'fees.theyalsofacepossiblenonpecuniarycosts,includinghigherfuture any,thattheymustgiveup.households'netnancialbenetfromlingforbankruptcyis thevalueofdebtdischargedandtheirnancialcostisthevalueofnon-exemptassets,if Households'nancialbenetfromlingforbankruptcyunderChapter7istherefore borrowingcosts,thecostofacquiringinformationaboutthebankruptcyprocess,andthe torepayaportionoftheirdebtsfromfutureincome,usuallyoverthreetoveyears.the Underit,debtorsdonotgiveupanyassetsinbankruptcy,buttheymustproposeaplan costofbearingthesocialdisapprovaloffriendsandrelatives. plangoesintoeectaslongasthebankruptcyjudgeacceptsit,i:e:;creditorsdonothave therighttoblockrepaymentplans. Chapter13.Chapter13bankruptcyisintendedfordebtorswhoearnregularincomes. alsoexemptclothing,furnitureandhouseholdgoods.2 exemptionin1995forstatesthatdonothaveunlimitedhomesteadexemptionswas$25,000.moststates 3Theaveragevalueofallnon-homesteadexemptionsin1995was$5,000.Theaveragehomestead

nancialincentivetochoosechapter7whenevertheirassetsarelessthantheirstate's exemption,sincedoingsoallowsthemtoavoidrepayingtheirdebtscompletely.4even betweenchapters7and13limitstheamounttheyarewillingtorepayfromfutureincome. whenhouseholdshaveassetsabovetherelevantexemption,thefactthattheycanchoose BecausedebtorshavetherighttochoosebetweenChapters7and13,theyhavea morethantheequivalentof$5,000fromfutureearningsinarepaymentplanunderchapter 13,sincetheywouldonlyhavetogiveup$5,000iftheyledunderChapter7.Debtors Forexample,debtorswhohave$5,000innon-exemptassetswouldbewillingtopayno 3.LiteratureReview onlytokenamounts.bankruptcyjudgesvaryintheirwillingnesstoaccepttheseplans.5 whohavenonon-exemptassetssometimesleunderchapter13,butproposetorepay theaggregatebankruptcylingratebycountyonthebankruptcyexemptionlevelfor household-leveldataonbankruptcylings.inanearlystudy,white(1987)regressed therelevantstateanddemographicvariables.shefoundthatthebankruptcylingrate waspositivelyandsignicantlyrelatedtotheexemptionlevel.6inaninnovativestudy, Attemptstostudythebankruptcylingdecisionhavebeenhamperedbythelackof toreducetheirnon-exemptassetsbeforeling.debtorsmayalsodefaultontheirdebtbutnotlefor bankruptcy,sincecreditorsdonotalwaysattempttocollect.seewhite(1998a)and(1998b)fordiscussion. lingsbycombiningtwodatasources:asampleofhouseholdsthatledforbankruptcy underchapter7intheearly1980'sandarepresentativesampleofu.s.householdswhich DomowitzandSartain(1997)gotaroundthelackofhousehold-leveldataonbankruptcy 13moreattractivetodebtorsbyallowingsometypesofdebts includingsomestudentloansanddebts incurredbyfraud tobedischargedunderchapter13,butnotunderchapter7.debtorsarealsoallowed toleunderchapter13asoftenaseverysixmonths,whiletheycannotleunderchapter7moreoften thanonceeverysixyears.chapter13isalsoattractivetodebtorswhoownhomesandareinarrears 4Debtorsmayshiftassetsfromnon-exempttoexemptcategoriesbeforelingoruseotherstrategies onmortgagepayments,becauseitdelaysforeclosure.in1984,congressadoptedaprovisionintendedto preventhighincomedebtorsfromlingunderchapter7,butlatercourtdecisionsandlackofenforcement andoftherelationshipbetweenchapters7and13. madeitineective.seegross(1986),wellsetal(1991),andwhite(1998a)fordiscussionsofthisprovision 5About70%ofbankruptcylingsoccurunderChapter7.CongresshasattemptedtomakeChapter usingdatafrom1980to1991.theyfoundanegativerelationshipbetweentheaggregatelingrateonthe statelevelandtheexemptionlevel. 6BuckleyandBrinig(1998)didasimilarstudyusingstateratherthancountybankruptcylingrates, 3

foundthathouseholdswithmorecreditcarddebtweremorelikelytoleforbankruptcy. GrossandSouleles(1998)usedadatasetofindividualcreditcardaccountstoexplain includesdetailednancialinformation(the1983surveyofconsumerfinances).they accountholders'bankruptcydecisions.theirmainexplanatoryvariableislenders'rating ofindividualaccountholders'riskinessandtheirmainndingisthat,aftercontrollingfor theincreaseintheaverageborrower'sriskiness,theprobabilityofdefaultrosesignicantly between1995and1997.theyinterpretthisresultasevidencethatthelevelofbankruptcy stigmahasfallen.neitherthedomowitzandsartainnorthegrossandsoulelespapers testedwhetherhouseholds'decisionstoleforbankruptcyarerelatedtotheirnancial benetfromling,whichisacentralgoalofthisstudy.7 van,warrenandwestbrook(1989)examinedthecharacteristicsofasampleofhouseholds thatledforbankruptcyinfourbankruptcycourtdistrictsduringtheearly1980's.based ondescriptiveevidence,theyarguedthathouseholdsleforbankruptcywhenunexpected adverseeventsoccurwhichreducetheirabilitytorepaytheirdebts.sullivanetalalsoarguethathouseholdsdonottakenancialbenetintoaccountinmakingtheirbankruptcy Thereisalsoasociologically-orientedliteratureonthebankruptcylingdecision.Sulli- foundthattheyoftendiscouragedebtorswhohavelessthanaminimumamountofdis- lings.braucher(1993)interviewedbankruptcylawyersinfourbankruptcydistrictsand decisions.wetesttheadverseeventshypothesisinourempiricalwork. chargeabledebtfromlingforbankruptcy,buttheminimumamountvariesacrossdis- tricts.braucheralsonotesthatbankruptcytrusteesineachdistrictsetstandardlegalfees bankruptcylawvaryacrosslocalities,whichmaycausegeographicclusteringofbankruptcy Finally,evidencefromseveralsourcessuggeststhattheadministrationandpracticeof districts,lawyers'incentivestospecializeinbankruptcycasesalsovaryacrossdistricts. forchapter7andchapter13bankruptcylings.becausethesefeesvarywidelyacross largevariationsacrossbankruptcydistrictsintheproportionoflingsthatoccurunder BothBraucherandSullivan,WarrenandWestbrook(1989)havenotedthatthereare (1994)discussesexplanationsforthepro-debtortiltofU.S.bankruptcypolicy.Gropp,ScholzandWhite credit. (1997)investigatetheeectofvaryingstatebankruptcyexemptionsonsupplyanddemandforconsumer 7FortheoreticalmodelsofthebankruptcydecisionincludeseeRea(1984)andDye(1986).Buckley 4

debtorstoleunderchapter13.butpressuretoleunderchapter13couldmakeling Chapter13,whichtheyattributetojudgesorlawyersinparticulardistrictsencouraging iftheyliveindistrictswithhighaggregatelingrates. ourempiricalwork,wetestforwhetherhouseholdsaremorelikelytoleforbankruptcy judgesinthedistrictarewillingtoaccepttokenrepaymentplansunderchapter13.in forbankruptcyeithermoreorlessattractiveoverall,dependingonwhetherbankruptcy 4.DataandSpecication hadeverledforbankruptcyand,ifso,inwhatyear(s).ourdatasetisacombinedcrosssection,time-seriessampleofpsidhouseholdsintheyears1984-1995.werunprobit regressionsexplainingwhetherhouseholdiledforbankruptcyinyeart.8 In1996,thePanelStudyofIncomeDynamics(PSID)askedrespondentswhetherthey morelikelytoleforbankruptcyastheirnetnancialbenetfromlingincreases,that householdsleforbankruptcywhenadverseeventsoccur,andthattherearevariationsin \localbankruptcyculture"whichcausedierencesinlingratesacrosslocalities. Theindependentvariablesareintendedtotestthreehypotheses:thathouseholdsare forbankruptcyastheirnetnancialbenetfromlingincreases.asdiscussedabove, householdi'snetnancialbenetfromlingforchapter7bankruptcyinyeartis: Financialbenet.Considerrstthehypothesisthathouseholdsaremorelikelytole PSIDquestionnairesfortheyears1992-1995.Householdsthatareinthesamplefor1992-95arealso wealthinyeartnetofsecureddebtssuchasmortgagesandcarloans,andeitisthe whereditisthevalueofunsecureddebtthatwouldbedischarged,witishouseholdi's 8Inorderforparticularhouseholdstobeincludedinoursample,theymusthaveansweredallofthe FinBenit=max[Dit?max[Wit?Eit;0];0] (1) fortheyears1992-95becausethepsiddatasetsfor1993-96areonlyavailablein\earlyrelease"form includedforanyoftheadditionalyears1984-91forwhichdataareavailable.weusedabalancedpanel observations.the\earlyrelease"datasetsalsoomithouseholds'stateofresidence.asaresult,weare forcedtoassumethathouseholdsobservedin1993-95stillliveinthesamestatewheretheylivedin1992. ouranalysis,oursampleisrepresentativeofthegeneralpopulation. county-leveldatafortheunemploymentrateandothervariables.becauseweusethepsidweightsfor andnohouseholdweightsareincluded.wethereforeused1992householdweightsforallofthe1993-95 ofthesample(upto1992).thisallowedustoassignhouseholdstobankruptcydistrictsandalsotouse WeusedthecondentialPSIDgeocodestoassignhouseholdstotheircountiesofresidenceineachyear 5

bankruptcyexemptioninhouseholdi'sstateofresidenceinyeart.whenhouseholdi lesforbankruptcy,debtsofditaredischarged,butthehouseholdmustgiveupassets ofvaluewit?eitifitswealthwitexceedstheexemptionleveleit.finbenitmustbe non-negative,sincehouseholdswouldnotleforbankruptcyiftheirnon-exemptassets exceededtheamountofdebtdischargedinbankruptcy.although(1)givesthenancial benetoflingunderchapter7,italsoappliestolingunderchapter13,because as discussedabove householdshaveachoicebetweenthetwoproceduresandtheirnancial benetfromlingunderchapter13iscloselyrelatedtotheirnancialbenetfromling underchapter7. equityinowner-occupiedhomes,equityinvehicles,andpersonalpropertyapplicableto nancialassets,plusthewildcardexemption(whichcanbeusedforanyasset).the householdownsitsownhomeorthesumofthevehicle,personalpropertyandwildcard bankruptcyexemptionvariableeitisassumedtoequalthesumoftheseexemptionsifthe Tocalculatenancialbenet,weobtainedexemptionlevelsbystatefrom1984-95for exemptionsifthehouseholdrents.sincemoststatesallowmarriedcoupleswholefor bankruptcytotakehigherexemptions,weadjusttheexemptionlevelsbytheappropriate amountallowedbythestateifthehouseholdcontainsamarriedcouple.sixteenstates householdownsitsownhome,weassumethatthevalueofthehomesteadexemptionequals alsoallowtheirresidentstochoosebetweenthestate'sexemptionandauniformfederal thefederalexemption.9finally,ifthestate'shomesteadexemptionisunlimitedandthe bankruptcyexemption.forresidentsofthesestates,weusethelargerofthestateor thevalueofthehousehold'shome.10 Federalexemptions.Sincethattime,moststateshavechangedtheirexemptionsonlyrarely.TheFederal mittedstatestoopt-outofthefederalexemptionbyadoptingtheirownexemptions.allstateshaddone exemptionremainedthesamefrom1978untilitwasdoubledin1994. soby1983,butaboutone-thirdofthestatesallowedtheirresidentstochoosebetweenthestateandthe fromthepsid.thepsidaskedquestionsconcerningtheamountofunsecureddebtand 9Inthe1978BankruptcyCode,CongressadoptedauniformFederalbankruptcyexemption,butper- Theothervariablesneededtocalculatenetnancialbenet,DitandWit,aretaken convertingassetsfromnon-exempttoexemptcategorieswherepossible. 10Thisinterpretationassumesthathouseholdstakeadvantageofthevariousbankruptcyexemptionsby 6

valueofhousingequityinyeartplusthevalueofnon-housingassetsfromthemostrecent 1988,1989-93,and1994-95,respectively.Householdi'swealthinyeart,Wit,equalsthe thevalueofnon-housingwealthonlyaspartofthewealthsupplements,whichwereconductedin1984,1989and1994,butitaskedthevalueofhousingequityeveryyear.weuse wealthyearsurveypriortoyeart.thefactthatdataonunsecureddebtandnon-housing 1984,1989,and1994dataonunsecureddebttoconstructDitforeachoftheyears1984- assetsareonlyavailableinveyearincrementsmeansthatourmeasureofnancialbenet containsmeasurementerror.11 modelofthebankruptcylingdecision. Weincludebothnancialbenetandnancialbenetsquaredasregressorsinour thestrategicmodeljustdiscussed.astrictinterpretationofthenon-strategicmodelimpliesthatincomeshouldbenegativelyandsignicantlyrelatedtotheprobabilityoflincialbenetfromlingdependsonlyontheirwealthandisunrelatedtotheirincomes. Conversely,astrictinterpretationofthestrategicmodelimpliesthatthenancialbenetvariableshouldbepositivelyandsignicantlyrelatedtotheprobabilityoflingfor leforbankruptcyshouldallowustodistinguishbetweenthetheories. frombankruptcy.thusaregressionofincomeandnancialbenetonwhetherhouseholds bankruptcy,butincomeshouldbeinsignicantbecauseitisunrelatedtothenancialgain repaytheirdebts.wewouldliketotestthenon-strategicmodelofbankruptcyagainst inadvanceforbankruptcyanddonotrespondtonancialgainindecidingwhethertole. Instead,theyleinresponsetounanticipatedadverseeventswhichreducetheirabilityto Adverseevents.Thenon-strategicviewofbankruptcyisthathouseholdsdonotplan forbankruptcy,butnancialbenetshouldbeinsignicant,becausehouseholds'nan- wealthdatawhichisonlycollectedatveyearincrements.sincecurrentincomeactsas aproxyforthechangeinwealthsincethelasttimethepsidcollectedwealthdata,a betweenthetwotheories.asdiscussedabove,ourmeasureofnancialbenetrelieson 11Seeourworkingpaper,Fay,HurstandWhite(1999),fordiscussionofhowmeasurementerrormight However,mismeasurementofwealthislikelytopreventusfromcleanlydistinguishing signicantlyaectourresults. biasourndingsofthemarginaleectofchangesinnancialbenetonhouseholds'probabilityofling forbankruptcyandatestfortheeectofmeasurementerror.wendthatmeasurementerrordoesnot 7

beevidenceinsupportofeithertheory.12 andthereductioninhouseholdi'sincomebetweenyeart?2andyeart?1ifincomefell, orelsezero.wealsoestimateaversionofourmodelthatexcludestheincomevariables, ndingthatincomeissignicantlyrelatedtotheprobabilityoflingforbankruptcycould butincludesdirectmeasuresofadverseevents. Inourbasecasespecication,weincludeasregressorshouseholdi'sincomeinyeart lingforbankruptcypersistentlymoreattractiveincertaindistricts.butanincreaseina holds'probabilitiesoflingforbankruptcy.asdiscussedabove,therearedierencesinthe waybankruptcylawisadministeredandpracticedacrossbankruptcydistrictswhichmake tioninbankruptcylingrates,whichwerefertoas\localbankruptcyculture,"onhouse- Localbankruptcyculture.Wewouldliketotestfortheimportanceofgeographicvaria- morefavorable.asurveyofrecentbankruptcylersbyvisa,u.s.a.,inc.(1997)found district'slingratemayalsocauseattitudestowardbankruptcyinthedistricttobecome respondentsreportedthattheywereveryapprehensiveoflingforbankruptcybeforehand,butfoundtheactualprocessoflingmuchquickerandeasierthantheyexpected. thathalfofthosesurveyedrstheardaboutbankruptcyfromfriendsorrelatives.also, Thusifhouseholdsliveinadistrictwithahigherbankruptcylingrate,theyaremore likelytohearaboutbankruptcyfromfriendsorrelatives,becausetheirfriends/relatives aremorelikelytohaveled.theirfriends/relativesarelikelytotellthemthatlingfor bankruptcyislesspainfulthantheythink.thisinformationislikelytomakehouseholds allelseequal. morecomfortablewiththeideaofbankruptcyandmayincreasetheirprobabilityofling, holds'bankruptcydecisions,weproceedindirectly.supposebfrjtdenotestheaggregate bankruptcylingrateper10peopleinbankruptcycourtdistrictjinyeart.thereare90 bankruptcydistrictsthroughouttheu.s.13weconstructadatasetofaggregatebankruptcy 12Hurst,LuohandStaord(1998)showthatover35%ofve-yearwealthchangesinthePSIDcanbe Inconstructingmeasuresoflocalbankruptcyculturetouseinthemodelofhouse- explainedbyhouseholdincome,age,education,raceandinitialwealth. Eisenbergforprovidinguswithaprogramwhichassignscountiestofederalcourtdistricts. 13BankruptcycourtdistrictsarethesameasFederaldistrictcourtdistricts.WearegratefultoTed 8

lingratesbydistrictfor1980to1995.denedistrictjtobeavectorof89dummyvariablesforindividualbankruptcydistricts,wherethedistrictcoveringmaineisomitted. isomitted.werunthefollowingregression: AlsodeneTimettobeavectorof15dummyvariablesforindividualyears,where1980 controllingfordistrictj.thecoecientofthedummyvariablefordistrictj,j,equals nationalbankruptcylingrateinyeartandthenationalbankruptcylingratein1980, Thecoecientofthedummyvariableforyeart,t,equalsthedierencebetweenthe BFRjt=+XjjDistrictj+XttTimet+jt (2) overtimeinthenationalbankruptcylingrateandofpersistentdierencesacrossdistricts theaveragedierenceoverthe1980-95periodbetweendistrictj'sbankruptcylingrate dierencesbetweenlingratesacrossdistricts.theresidualjtispurgedofboththetrend inlingrates. andthebankruptcylingrateinmaine,controllingfortimet.thusjcapturespersistent foreachobservationinyeart.thisvariable,referredtoasthe\timeeect,"tests whetherhouseholdsaremorelikelytoleforbankruptcyinyeartifthenationalaggregatebankruptcylingrateinyeartishigher,allelseequal.wealsoenterthevalue ofjfrom(2)foreachobservationinwhichhouseholdilivesindistrictj.thisvariable, Inourmodelofhouseholds'bankruptcydecisions,weenterthevalueoftfrom(2) whichweavoidbecausethenumberofbankruptcylingsinourdatasetisrelativelysmall. dummiesandstate-levelxedeectsintheestimationofhouseholds'bankruptcydecisions, allelseequal.thetimeeectanddistricteectvariablesalsosubstituteforenteringtime referredtoas\districteect,"testswhetherhouseholdswholiveindistrictsthathave Finally,weenterthevalueoftheresidualjtfrom(2)foreachobservationfromyeart persistentlyhigheraggregatebankruptcylingratesaremorelikelytoleforbankruptcy, similartothosereported. iftheaggregatebankruptcylingrateintheirdistrictroseduringthepreviousyear.14all inwhichhouseholdilivesindistrictj,laggedoneperiod.thisvariableisreferredtoas \growtheect."includingittestswhetherhouseholdsaremorelikelytoleforbankruptcy 14Wealsotriedusingthesumoftheresidualsjtoverthelasttwo,threeorveyears.Theresultswere 9

inyeart,weincludethenumberoflawyersper1000populationinhouseholdi'sstateof threeofthelocalbankruptcyculturevariablesarepredictedtobepositivelyrelatedto households'probabilitiesoflingforbankruptcy. causelegalfeesandthecostsofbecominginformedaboutbankruptcytofall.thelawyers residenceinyeart.wheretherearemorelawyerspercapita,thereislikelytobemore competitionamonglawyersandmoreadvertisingofbankruptcybylawyers,bothofwhich Othervariables.Asaninverseproxyforhouseholdi'slegalfeesinlingforbankruptcy bankruptcy.15 percapitavariableispredictedtobepositivelyrelatedtotheprobabilityoflingfor oflingforbankruptcy.weassumethatthiscostisproxiedbyhouseholddemographic characteristics(discussedbelow)andbyaggregatemarketconditions.becausemarkets formortgagesandconsumercreditarenational,weassumethatfutureborrowingcostsdo notdieracrosslocalities.16 Nowconsiderhouseholdi'sdiscountedfutureincreaseinborrowingcostsasaresult prohibitedwagegarnishmentinyeart.whendebtorsdefault,creditorsinmoststates canobtainacourtorderdirectingthedebtor'semployertopaypartofthedebtor'swages directlytothecreditor.ifcreditorsgarnishdebtors'wagesorifdebtorsanticipatethis possibility,thendebtorshaveanincentivetoleforbankruptcyinordertoterminate Wealsoincludeadummyvariablewhichequalsoneifhouseholdi'sstateofresidence oravoidwagegarnishment.thus,wehypothesizethatdebtorsarelesslikelytolefor bankruptcyiftheyliveinstatesthatprohibitwagegarnishment.17 oraccesstocreditforrecentbankruptsacrossdistricts,theywillbecapturedintheempiricalworkbyour borrowerswhohaveledforbankruptcyunderchapter7,sincerepeatbankruptcylingsunderchapter 7areprohibitedforsixyears.Staten(1993)foundinasurveyofrecentbankruptsthat73%wereableto thecountry,butvariesovertime,sothatitiscapturedbythetimeeect. bankruptcy,althoughthetermsoftheloansbecomelessfavorable.somelendersactuallyprefertolendto obtaincreditwithinayearaftertheirbankruptcylings.evenifthereareimportantdierencesinrates 15Anadditionalcostoflingforbankruptcyisthebankruptcycourtlingfee.Thisfeeisuniformacross districteectsvariable. 17WagesofdebtorsinChapter7bankruptcymaynotbegarnishedbecausepost-bankruptcyearnings 16Availableevidencesuggeststhatcreditiswidelyavailabletohouseholdswhohaverecentlyledfor timesthefederalminimumhourlywageperweek,whicheverishigher,beexempt.thus,eveninstates totheprovisionsoftheirrepaymentplans.federallawrequiresthataminimumof75%ofwagesor30 areexempt,whiledebtorsinchapter13bankruptcyareonlyobligedtousewagestorepaydebtaccording 10

inyeart.thesevariablescapturedierencesinmacroeconomicconditionsacrossdistricts orunobservedchangesinwealthorothervariablesthataectthebankruptcydecisionand yearst?1andt,thestandarddeviationofincomepercapitainthestate(calculatedover theperiod1980to1995),andtheunemploymentrateinhouseholdi'scountyofresidence Wealsoincludethechangeinaverageincomeinhouseholdi'sstateofresidencebetween andwhetherthehouseholdheadorspouseownsabusiness.theageofthehouseholdhead holds'decisionstoleforbankruptcy.thesearetheageandagesquaredofthehousehold arecorrelatedwithstateordistricteconomicactivity. islikelytobepositivelyrelatedtotheprobabilityoflingforbankruptcyforrelatively head,thehead'seducationlevel,familysize,whetherthehouseholdownsitsownhome, Finally,weincludeavectorofdemographicvariableswhichmayberelatedtohouse- lebecausetheymustgiveuptheirhomesinbankruptcy.howeverhomeownerswhohave youngheads,sincetheyhaveincreasingaccesstocreditastheygetolder,butnegatively fallenbehindontheirmortgagepaymentscanbenetfrombankruptcy,sinceabankruptcy thathavehomeequitygreaterthanthehomesteadexemptionhaveanincentivenotto relatedtotheprobabilityoflingforolderheads,sincetheyhavemorewealthanddemandlesscredit.thepredictedeectofbeingahomeownerisambiguous.households lingdelaysforeclosure.thebusinessownershipvariableisparticularlyofinterestsince thosewhoownbusinessespresumablyhavegreatervarianceofwealthandarelessrisk aversethanhouseholdsingeneral.bothofthesefactorstendtoincreasetheprobability incentivetole,becausedebtsofthebusinessaredischargedinbankruptcyalongwith unsecuredpersonaldebts.weexpecthouseholdsthatownbusinessestobemorelikelyto oflingforbankruptcy.inaddition,ownersoffailedbusinesseshaveaparticularlystrong leforbankruptcy. thatallowgarnishment,atleast75%ofwagesareexempt.thestatesthatprohibitwagegarnishment entirelyaretexas,pennsylvania,alaska,southdakotaandflorida. othervariablesjustdiscussed.18 forbankruptcyinyeartasafunctionofnancialbenet,nancialbenetsquared,and Ourspecicationisaprobitregressioninwhichweexplainwhetherhouseholdiles 18SeeAshenfelter(1983)andMott(1981)fordiscussionoftheproblemsofestimatingindividual 11

5.Results to1995forbothoursampleandforu.s.householdsoverall.overourperiod,thenational bankruptcylingraterosefrom0.33%to0.88%,withmostoftheincreasecominginthe 1980's.WhilethecorrelationbetweenthenationalbankruptcylingrateandthePSID lingrateis0.67,thepsidlingrateisonlyabouthalfashighasthenationalrate.19 Table1givesthepercentofhouseholdsthatledforbankruptcyeachyearfrom1984 frombankruptcy(finbenit)fortheyearsinwhichthepsidcollectedwealthdata(1984, 1989and1994).About18%ofhouseholdswouldgainnanciallyiftheyledandan additional14%ofhouseholdswouldneithergainnorlose.(mostofthelattergrouphave nounsecureddebtsandnonon-exemptassets.)about10percentofhouseholdswouldgain Table2givesinformationconcerningthedistributionofhouseholds'nancialbenet thanactuallyleseachyear. largerproportionofhouseholdsthereforehasanancialincentivetoleforbankruptcy SurveyofConsumerFinance,whichcontainsmuchmoredetailedwealthdata.Amuch $2,500ormoreiftheyledforbankruptcyandthereforehaveasubstantialincentivetole. TheseresultsaresimilartothosefoundbyWhite(1998a)incalculationsusingthe1992 Table3givesthemeansofothervariablesusedinthebankruptcydecisionmodel. households'participationinsocialprogramswhenparticipationisvoluntary,buttheprogramimposesan Iisthebasecase.ThecoecientofFinBenit,thenetnancialbenetofbankruptcy, isalsostatisticallysignicant(p<0.001),butitisnegativeandsmallerinsizethan ispositiveandhighlystatisticallysignicant(p<0.001).thecoecientoffinben2it Nowturntotheresultsofourbankruptcylingmodel,givenintable4.20Regression reportednobankruptcybutactuallywentbankruptissmallrelativetothenumberofhouseholdswho implicittaxontheearningsofthosewhochoosetoparticipate.however,thebankruptcylingdecision toleunderchapter7. analysisofhausmanandscott-morton(1994)toourdataimpliesthat,ifthenumberofhouseholdswho Chapter7doesnotimposeataxondebtors'futureearnings.FilingforbankruptcyunderChapter13 diersfromthedecisiontoparticipateinincomemaintenanceprogramsinthatlingforbankruptcyunder doesimposeataxonfutureearnings,butthetaxratevariesandisheavilyinuencedbydebtors'option Huber/Whiteprocedure,whichallowserrortermsforthesameindividualtobecorrelatedovertime. actuallydidnotleforbankruptcy,asitpresumablyisinourdata,thentheunderreportingofbankruptcy lingswillleadtoaslightdownwardbiasinourestimatedcoecients. 20WeweightedthedatausingthePSIDfamilyweights.Allstandarderrorswerecorrectedusingthe 19Therewereatotalof254bankruptcylingsinthePSIDdatabetween1984and1995.Applyingthe 12

thecoecientoffinbenit.21thepositivesignandstatisticalsignicanceoffinbenit inmakingtheirbankruptcydecisions.wediscussthemarginaleectsofnancialbenet providesstrongsupportforthehypothesisthathouseholdsrespondtonancialincentives andothervariablesinthenextsection.22 wealthdata,theseresultsdonotallowustodistinguishbetweentheeconomicversusthe proxiesforunmeasuredchangesinwealthfortheyearsinwhichthepsiddidnotcollect negativelyandsignicantlyrelatedtotheprobabilityoflingforbankruptcy(p=0.001 andp=0.004,respectively).becauseincomeandthechangeinincomecouldbeactingas Wealsondthatbothhouseholdincomeandthechangeinhouseholdincomeare sociologicalmodelsofthebankruptcydecision.ofthedemographicvariables,theage ofthehouseholdhead,agesquared,thehead'seducationlevel,andfamilysizeareall statisticallysignicantandallhavethepredictedsigns. tisticallysignicant(p<.001andp=.048,respectively).theseresultsindicatethat havepersistentlyhighbankruptcylingratesandiftheyliveindistrictswheretheling householdsaresignicantlymorelikelytoleforbankruptcyiftheyliveindistrictsthat rateroseduringthepreviousyear. Boththedistricteectvariableandthegrowtheectvariablearepositiveandsta- per1000populationinhouseholds'stateofresidence ourproxyforlegalcosts isalso positivesign,butisnotstatisticallysignicant.thegarnishmentvariableisnegative andstatisticallysignicant.23thedummyvariableforowningabusinesshastheexpected aspredictedandmarginallystatisticallysignicant(p=0.069).thenumberoflawyers Thedummyvariableforwhetherwhetherthehouseholdownsitsownhomeisnegative positiveaspredicted,butnotsignicant.noneofthemacroeconomicvariablesthatwe thismethodisnotwell-suitedtoourdata. datasetdidnotleforbankruptcydespitehavingverylargepositivenancialbenet. amethodforestimatingaconditionallikelihoodlogitwithindividualxedeects,inwhichonlywithinindividualvariationcontributestothelikelihood.butbecauserelativelyfewhouseholdsleforbankruptcy, individualspeciccomponentstothebankruptcydecision.butrunningaxedorrandomeectsmodelon adiscretechoicemodelcanbeextremelyproblematic(seegreene,1993).chamberlain(1980)suggested 21ThenegativecoecientofFinBen2itprobablyresultsfromthefactthatafewhouseholdsinthe lingdecision. 23DomowitzandSartain(1997)alsofoundthathomeowningwasnegativelyrelatedtothebankruptcy 22Wewouldhavelikedtotakeadvantageofthepanelaspectofourdatabydierencingoutpotential 13

assetsgivenupinbankruptcy.inregressionii,werelaxthisrestrictionandtestwhether includedasadditionalcontrolswerestatisticallysignicant.onlythecoecientonthe forgiveninbankruptcymustbeequaltotheeectofanincreaseinthevalueofnon-exempt changeinaveragestateincomehasthepredictedsign. bankruptcydecisions.wethereforeeliminatefinbenitandfinben2itfromthemodel.we thetwocomponentsoffinbenithaveequalandoppositemarginaleectsonhouseholds' RegressionIimposestherestrictionthattheeectofanincreaseinthevalueofdebts substitutedit,whichequalsdebtsforgiveninbankruptcyforhouseholdsthathavepositive nancialbenetfrombankruptcyorelsezero,andmax[wit?eit;0],whichequalsthe ThecoecientsaresimilartothosefoundinregressionIforFinBenitandFinBen2it.The valueofassets(ifany)thatmustbesurrenderedinbankruptcyforthosehouseholdsthat Theresults,giveninregressionIIoftable4,showthatthecoecientofDitispositiveand havepositivenancialbenetorelsezero.wealsoenter(dit)2and(max[wit?eit;0])2. butneitherisstatisticallysignicant.thesetwovariablesarepresumablyinsignicant coecientsofmax[wit?eit;0]and(max[wit?eit;0])2arebothnegativeasexpected, becauseover85percentofhouseholdswhowouldgainnanciallyfrombankruptcyhaveno statisticallysignicantandthecoecientof(dit)2isnegativeandstatisticallysignicant. non-exemptassets,sothattheyhavenon-zerovaluesforonlyafewobservations.because bankruptcy. ofdebtforgiveninbankruptcyhasthesameeectonhouseholds'probabilityoflingas aonedollardecreaseintheamountofnon-exemptassetsthatmustbesurrenderedin thecoecientsofmax[wit?eit;0]and(max[wit?eit;0])2arebothinsignicantin regressionii,wecannotrejectthenullhypothesisthataonedollarincreaseintheamount adverseeventswhichthehouseholdexperiencedduringthepreviousyear:healthproblems incomeandchangeinincomevariablesandintroducingdummyvariablesthatrepresent previouslyworked),andthehouseholdheadbecomingdivorced.24theresultsshowthatall forthehouseholdheadorspouse,spellsofunemploymentfortheheadorspouse(ifs/he InregressionIII,weexploretheadverseeventshypothesisfurtherbyomittingthe adverseeventsvariables. 24Incomeandthechangeinincomeareomittedbecausetheyarehighlycorrelatedwithallthreeofthe 14

variableisstatisticallysignicant(p=0:032).theseresultssuggestlittlesupportforthe sociologicalmodelofhouseholdslingforbankruptcyinresponsetoadverseevents.25the threeoftheadverseeventvariableshavethepredictedpositivesigns,butonlythedivorce morelikelytoleforbankruptcyiftheyhearaboutbankruptcymorefrequently.an andbeinuencedbyhighbankruptcylingratesintheirdistrictsmorequicklythan implicationofthishypothesisisthathouseholdswholiveinurbanareaswillhearabout coecientsoftheothervariablesremainessentiallythesameasinregressioni. householdswholiveinruralareas,becausehouseholdsinurbanareasarelikelytohave Inthediscussionoflocalbankruptcyculture,wehypothesizedthathouseholdsare IVintable4givestheresults.Theyshowthaturbanhouseholdsaremorelikelytolefor bankruptcyiftheaggregatebankruptcylingrateintheirdistrictsroseduringtheprevious eectandgrowtheectvariableswereeachinteractedwiththreedummyvariablesfor whetherhouseholdilivesinanurbanarea,amidsizedcity,oraruralarea.26regression moresocialcontacts.totestthis,wereranaversionofregressioniinwhichthedistrict year,andtheincreaseisstatisticallysignicant.buttherelationshipisinsignicantfor householdslivinginruralareasormidsizecities.incontrast,thepatternisreversedfor persistentchangesindistricts'aggregatelingrates.ruralandmidsizecityhouseholds aresignicantlymorelikelytoleforbankruptcyiftheyliveindistrictswithpersistently highaggregatelingrates,buttherelationshipisinsignicantforurbanhouseholds.thus ruralandmidsizecityhouseholdsonlyrespondtochangesintheirdistricts'lingrates ifthechangespersistovertime.thissuggeststhattrendsinlingratesinparticular urbanhouseholdsrespondquicklytochangesintheirdistrict'saggregatelingrate,but districtsaremorelikelytopropagatethemselvesifthedistrictisurban,becauseurban householdsarelikelytobeinlargersocialnetworksandhavelowercostsofinformation andaruralareaisacountyinwhichthelargestcityhaslessthan25,000people. people,amidsizedcityisacountyinwhichthelargestcityhaspopulationbetween25,000and100,000 providinglegalserviceindivorcecases. acquisition.theotherresultsremainvirtuallyunchangedfromregressioni. 25Thedivorcevariablemaybesignicantbecauselawyersoftensuggestbankruptcyinthecourseof 26Anurbanareaisdenedasacountyinwhichthelargestcityhasapopulationgreaterthan100,000 15

theentireperiod.bothcoecientsarestatisticallysignicant(p=0.002andp<0.001, subperiodand6.38e?5inthelatersubperiod,similartoitscoecientinregressionifor Theresults(notshown)indicatethatFinBenithasacoecientof6.46e?5intheearly wealsoreranregressioniseparatelyonobservationsfrom1984-89andfrom1990-95. Inordertoexaminehowhouseholds'bankruptcydecisionshavechangedovertime, andpositiveinthelatesubperiod,althoughitisnotstatisticallysignicantineither signicant(p<0:001).thegrowtheectvariableisnegativeintheearlysubperiod twosubperiods.intheearlysubperiod,thecoecientofthedistricteectvariableis closetozeroandinsignicant,butinthelatesubperiod,itispositiveandstatistically respectively).however,thelocalbankruptcyculturevariablesdierstronglybetweenthe period.theseresultssuggestthatlocalbankruptcyculturehasbecomeamoreimportant inuenceonhouseholds'bankruptcydecisions,i:e:;householdsareincreasinglylikelytole forbankruptcyifothersintheirregiondoso.althoughwecannotruleoutthepossibility resultsareconsistentwiththehypothesisthatsocialdisapprovalofbankruptcyhasdeclined thatthelocalbankruptcyculturevariablesareservingasproxiesforsomethingelse,our overtime.27 6.Interpretation icalchangesinthevaluesofselectedvariables,basedontheresultsreportedintable4.28 Table5givesthepredictedchangeintheprobabilityofbankruptcyforgivenhypothet- predictsthatthenumberofbankruptcylingsperyearwouldriseby0.023/0.310or7.4%. holds.usingtheresultsofregressioni,wendthattheaveragehousehold'sprobability oflingforbankruptcyrisesby0.023percentagepoints.sincetheaverageprobability oflingforbankruptcyforallthehouseholdsinoursampleis0.310percent,themodel Supposerstthatthenancialbenetofbankruptcyincreasedby$1,000forallhouse- forothervariables.theyarguedthatthissuggestsadeclineinthelevelofbankruptcystigma. tothehypothesizedchangeintheindependentvariable,holdingthelevelofalloftheindividual'sother independentvariablesconstant.wethenaveragedthepredictedchangesinbankruptcyprobabilitiesover allindividuals,usingthepsidfamilyweights.16 27GrossandSouleles(1998)alsofoundthatbankruptcylingshaverisenovertimeevenaftercorrecting 28Wecomputedthechangeineachindividualhousehold'sprobabilityoflingforbankruptcyinresponse

exemptionsrangingfromaminimumof$20,000toamaximumof$100,000.suppose theadoptionofauniformnationalbankruptcyexemptionforpersonalpropertyof$20,000 forhomeownersand$35,000forrenters,withbothexemptionsdoubledformarriedcoupleswholeforbankruptcy.inaddition,stateswouldbeallowedtoadopthomestead TherecentreportoftheNationalBankruptcyReviewCommission(1997)proposed Congressadoptedthesereformsandsupposeallstatesadoptedhomesteadexemptionsof theaveragehousehold'sprobabilityoflingforbankruptcywouldriseby0.053percentagepoints,whichimpliesthatbankruptcylingswouldincreaseby17%.basedon1.1 millionbankruptcylingsin1996,thisimpliesthattherewouldbeanadditional184,000 lingisabout$28,000(barronandstaten,1998),adoptingthenationalbankruptcyre- bankruptcylingseachyear.sincetheaverageamountofdebtdischargedinabankruptcy wouldresultfromadoptingthenbrc'sproposalandweusethesegurestocalculatethe changeineachhousehold'sprobabilityoflingforbankruptcy.29themodelpredictsthat oursample,wecalculatethechangeinthenancialbenetoflingforbankruptcythat $60,000 themidpointoftheallowedrangeundertheproposal.foreachhouseholdin pointsandthenumberofbankruptcylingsispredictedtofallby13%.ifallhouseholdsexperienceda$10,000fallinincome,thentheaveragehousehold'sprobabilityof bankruptcywouldincreasethefollowingyearby0.019percentagepointsandthenumber Nowsupposeallhouseholds'incomesincreasedby$10,000.Themodelpredictsthat viewcommission'sproposedexemptionlevelswouldcauselenderstoloseanadditional theaveragehousehold'sprobabilityoflingforbankruptcywouldfallby0.040percentage $5.1billioneachyear. increasedbyoneyear,thentheaveragehousehold'sprobabilityoflingforbankruptcy ofbankruptcylingswouldincreaseby6%.iftheeducationlevelofallhouseholdheads wouldfallby0.023percentagepointsandthenumberofbankruptcylingswouldfallby highorunlimitedhomesteadexemptions. nancialbenetformosthouseholds,butlowersnancialbenetforhouseholdslivinginstatesthathave benetby$1,000forhouseholdswhosenon-exemptassetsareabove$1,000.theproposedreformincreases bylessthan$1,000foranyhouseholdwhosenon-exemptassetsarebelow$1,000,butincreasesnancial 7.4%.Ifallhouseholdscontainedoneadditionalperson,thentheaveragehousehold'sprobabilityofbankruptcywouldriseby0.031percentagepointsandthenumberofbankruptcy 29Notethatanincreaseof,say,$1,000intheexemptionlevelincreasesthenancialbenetofbankruptcy 17

by0.12percentagepointsandthenumberofbankruptcylingswouldfallby39%.using lingswouldrisebyabout10%.ifallstatesshiftedfromallowingtoprohibitinggarnishmentofwages,thentheaveragehousehold'sprobabilityoflingforbankruptcywouldfall theresultsofregressioniii,ifallhouseholdheads'probabilityofdivorcechangedfrom0 to1,thentheprobabilityofhouseholdslingforbankruptcyinthefollowingyearwould increaseby0.082percentagepointsandthenumberofbankruptcylingswouldriseby 26%Ṅowturntotheresultsforchangesinthelocalbankruptcyculturevariables.The standarddeviationofgrowtheectvariableis0.0054.supposeasingledistrictinasingleyearexperiencedanincreaseinitsbankruptcylingrateof0.0054.thenregression bankruptcywouldriseby0.028percentagepointsinthefollowingyear,sothatthenumberofbankruptcylingsinthedistrictispredictedtoriseby9%.similarly,thestandard Ipredictsthattheaverageprobabilityofhouseholdswholiveinthedistrictlingfor deviationofthedistricteectvariableis0.0093.supposeasingledistrict'sbankruptcy lingrateincreasedby0.0093andremainedatthehigherlevel.regressionipredictsthat riseby0.099percentagepoints,sothatthenumberofbankruptcylingsinthedistrictis theaverageprobabilityofhouseholdswholiveinthedistrictlingforbankruptcywould predictedtoriseby32%.theseresultssuggestthatbothone-timeandpersistentincreases inparticulardistricts'bankruptcylingratescausethosedistricts'futurelingratesto rise. 7.Conclusions newdatafromthepsidonbankruptcylings.wetestwhetherhouseholdsaremore wouldhavetogiveupinbankruptcy rises.wendthattherelationshipisstatistically ofdebtdischargedinbankruptcyminusthevalueofnon-exemptassetsthathouseholds likelytoleforbankruptcywhentheirnancialbenetfromling equaltothevalue Inthispaper,weestimateamodelofhouseholds'bankruptcylingdecisions,using ispredictedtoraisetheaveragehousehold'sprobabilityoflingforbankruptcyby0.023 signicant.anincreaseof$1,000inthenancialbenetofbankruptcyforallhouseholds percentagepoints,whichimpliesthatthenumberofbankruptcylingswouldriseby 18

NationalBankruptcyReviewCommissionwereadopted,therewouldbe184,000additional 7.4%.Ourmodelalsopredictsthatifthechangesinexemptionlevelsproposedbythe1997 bankruptcylingseachyearandlenderswouldloseanadditional$5.1billioneachyear. Wendlittlesupportforthealternativehypothesisthathouseholdsaremorelikelyto leforbankruptcywhenadverseeventssuchasbadhealthandspellsofunemployment occur,althoughwedondthathouseholdsaremorelikelytoleifthehouseholdheadwas \localbankruptcyculture"inmakingtheirbankruptcydecisions.households'probability oflingforbankruptcyincreasessignicantlyiftheaggregatebankruptcylingratein divorcedinthepreviousyear.wealsondthathouseholdsareresponsivetovariationsin theirdistrictsincreaseseitherforasingleyearorpersistently.wendthattheeect explaintherapidriseinbankruptcylingsduringthe1990's. time,whichsuggeststhatareductioninsocialdisapprovalofbankruptcymaypartially oflocalbankruptcycultureonhouseholds'probabilityoflinghasbecomestrongerover 19

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