Personal bankruptcies in the United States have increased dramatically,
rising from 1.4 per thousand working age population in 1970 to 8.5 in
2002. We use a heterogeneous agent life-cycle model with competitive
financial intermediaries who can observe households’ earnings, age and
current asset holdings to evaluate several commonly offered
explanations. We find that increased uncertainty (income shocks,
expense uncertainty) cannot quantitatively account for the rise in
bankruptcies. Instead, the rise in filings appears to mainly reflect
changes in the credit market environment. We find that credit market
innovations which cause a decrease in the transactions cost of lending
and a decline in the cost of bankruptcy can largely accounting for the
rise in consumer bankruptcy. We also argue that the abolition of usury
laws and other legal changes are unimportant.
Here is the paper. Here are non-gated versions.
You can argue that a low failure rate in anything is proof that not enough people are trying things. If no business ever failed, the implication is no business ever takes a risk, and the economy as a whole isn’t performing as well as it could. Similarly, though many sub-prime borrowers who are now going through forclosure, there are many more who are enjoying the benefits their initial sub-prime gave them, and thriving in ways they wouldn’t have otherwise.
To summarize, the problem isn’t that bankruptcies are now too high. The problem was that in the past they were too low.
pawnking — I’m not sure if someone *able* to make the mortgage payments on 10% interest loan is enjoying
much of a “benefit” to begin with
Re: usury laws: Aren’t they necessarily irrlevant as per the put-call parity theorem? (You linked a neat
paper a while back explaining all the ways to circumvent usury laws by equivalently expressing them
as option exchanges.)
More rope = more hangings. Caveat emptor.
On what basis do you claim that prior bankruptcies were too low? Buying a house has historically been a form of long-term investing, and for many, their primary form. A failure had sever effects.
Anne has it exactly right.
King,
Both factoids can be true. A person with a lot of debt due to voluntairy borrowing is in bad financial
state to withstand a genuine unexpected crisis. It might be genuine duress that finally sends someone
into bankrupcy. However had they had more savings and less borrowing to begin with, a simillar unexpected
medical problem would not lead to bankrupcy.
Asif, that Harvard study is a poster child for, shall we say, advocacy scholarship. It was written by Elizabeth Warren and others to oppose the new bankruptcy law by portraying the majority of the bankrupt as completely innocent victoms of happenstance. The fact that Krugman quoted it uncritically speaks volumes about how shrill and unscholarly _he_ has become, but that’s another story.
Don’t take my word for anything. Read the study. http://tinyurl.com/4e2bm .
How do we get even close to 1/2? Let me count the ways…
1: If you bankruptcy appears to have been caused by problem gambling, it is medically induced.
2: If your bankruptcy appears to have been caused by birth of a child, it is medically induced.
3: If your bankruptcy appears to have been caused by addiction to alcohol or another [illicit, street] drug, it is medically induced.
4: Everything is self-reported. Despite the fact that these documents are public records, she made no attempt to verify anything.
5: If you had $1000 in uncovered medical bills over the past two years, _no matter what other bills you had and how many plasma TVs you bought over the same two years and what taxes you had to pay_, your bankruptcy was classified as medically induced.
For this report to have come close to being scholarship there would have needed to be a control group. She should have taken a thousand people from the general population, ascertained that none of the control group had filed for bankruptcy, and asked them the sat many of them had lost two weeks or more from work over the last couple of years — that’s one good case of influenza and a cold — or had $1000 of co-pays and the like over the past few years or had had children. I may travel in the right circles but about 15% of my friends have borne or have had their wives bear or have adopted children recently, and none of my friends has gone bankrupt.
Sun, it’s probably true that “something happens” to most people who go bankrupt. Some number of people would go bankrupt even if unsecured credit were not available. However, the excess rates in times of easier credit can only be explained by people embrittling their financial picture by voluntary borrowing.
-dk
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