Bad News and Bankruptcy

One of the most contentious debates of the past two decades has been the argument over whether  consumer debtors file for bankrutpcy largely because they have run out of other options following significant financial disruptions, such as job loss, medical problems and family break up.  Teresa Sullivan, Jay Westbrook argued this position in Fragile Middle Class based on 1991 studies of the families that filed, and Tyagi and I add more data on the the point using 2001 data in Two-Income Trap.  Fay, Hurst & White analyzed PSID data and concluded that debtors were more strategic, filing when it was economically rational to do so and not when triggered by other events.  (Fay, Hurst, White, The Household Bankruptcy Decision, 92 American Economic Review 706 (2002))

Now comes Jonathan Fisher at the Bureau of Labor Statistics with a new paper that analyzes the same PSID data the earlier economist team used.  Fisher has several interesting findings, but two are highly relevant to the negative-event/strategic debates.  The first is that people do not file when they could best maximize their benefits.  If debtors behaved like the rational maximizers beloved by all economists, then they would have filed for bankruptcy at least a year earlier.  Instead, they held off, kept paying and filed only later.   Fisher concludes that something else held these people back (could it be stigma?).  He suggests that they filed only when it was clear that they were in a deep enough hole that things were never going to get better. 

Fisher also noted that White has a problem with the fact that about 17% of the population would benefit from bankruptcy, but only about 1.5% actually file.  But Fisher made an interesting observation about the benefit-but-not-file group:  they were in a lot better financial shape than the benefit-and-file group.  While Fisher doesn't push any conclusions about this, the finding is consistent with a picture of debtors who do not want to file for bankruptcy, no matter how attractive bankruptcy might seem to an economist.  Instead, these people file only when the pressure from their creditors are greater and the likelihood they can ever pay these debts off is smaller.

The PSID data pose substantial challenges.  For example, there is gross under-reporting of bankruptcy filings (.42% in PSID when national rate was .89%). This means either the sample isn't representative of Americans generally or people are concealing their bankruptcy filings even as they fill out PSID questionnaires.  ("Bankruptcy?  Me?  No way!") 

The paper has many nuggests, but the headline finding goes right to the question about who uses the bankruptcy system.