Bankruptcy Filings and Consumer Behavior

When it comes to the bankruptcy filing rate, fiscal year 2006 (10/1/2005 onward) is turning out to be a very odd period. First, filings surged to historic heights in early October. Then, in the second quarter, filings dropped to the lowest rate since the mid-1980s. An intervening event was the mid-October effective date of an omnibus bankruptcy reform bill, the most extensive changes to the formal bankruptcy law in a generation. Most bankruptcy filers are individuals rather than business entities, so it appears that individuals became sensitive to changes to the Bankruptcy Code and may have altered their plans accordingly. Does this mean that individuals also can be expected to alter their borrowing behavior because of the bankruptcy law changes? Not so fast, say Professors Susan Block-Lieb and Ted Janger in an article just published in volume 84 of the Texas Law Review. 

Block-Lieb and Janger apply insights from behavioral decision research suggesting that individuals’ cognitive limitations, and not strategic behavior, provide an explanation of consumer overextension that is more consistent with consumer credit data. They also consider the possibility that lenders capitalize on these cognitive limitations. Whatever happens with the official bankruptcy filing rate reported by the government, Block-Lieb and Janger warn in their Texas article that “overleverage is here to stay.”