The Financial Benefits of Bankruptcy

Earlier this week I wrote about the extensive data that have been made available to me by the Canadian bankruptcy regulator, the Office of the Superintendent of Bankruptcy (OSB). The main element of the database is the balance sheet from every electronically filed consumer bankruptcy in Canada from 2005 to 2010.

One of the first things we (my PhD Student Vyacheslav Mikhed and I) have tried to do with this data is to measure the Financial Benefits of Bankruptcy (FBB) as reflected in the individual filer’s balance sheet.

The idea of FBB is taken from the paper of Fay, Hurst and White (American Economic Review, 2002, specifically page 708) and is simply the idea of measuring how much the bankruptcy filer gains through the discharge of unsecured debt minus the non-exempt assets the filer loses in bankruptcy. The larger the gains through unsecured debt discharged and the smaller the loss of non-exempt assets, the larger will be the financial benefits of bankruptcy to each individual filer.

Our aim is to figure out what this number looks like across the almost 400 thousand bankruptcy filings in our database. When Fay, Hurst and White (2002) calculated FBB, they were only able to use 254 bankruptcy balance sheets (taken from PSID data). To the best of our knowledge, no other authors have calculated FBB, and certainly not with a database as large as ours.

Our measure of FBB across all Canadian bankruptcy filers looks like this:

What is most interesting about this picture is the very wide dispersion of FBB across Canadian filers. FBB can be close to zero for some filers and higher than $100 000 for other filers. We think explaining this picture is very important for understanding when and why individuals file for personal bankruptcy. Why do some filers file when their FBB is low, while others file when the FBB is much higher?

We think that an important part of the story is that FBB only captures what is on the balance sheet of the individual filer on the day of the filing, it does not capture a whole variety of other possible factors that go into the bankruptcy decision that are not reflected on the balance sheet – which we label non-balance sheet factors.

For example, the literature has emphasized the importance of social stigma when filing, which cannot be reflected in a simple balance sheet calculation. Similarly, the literature has also emphasized the importance of forward looking behavior when making the bankruptcy filing decision – for example, how will my bankruptcy today impact my future access to jobs, credit etc. The balance sheet reflects the situation of the filer at the date of filing, and does not reflect forward looking behavior.

What could possibly be happening in the FBB figure above is that the individual will file when the financial benefits of bankruptcy (as measured by the balance sheet data in the figure) exceed the various non-balance sheet costs such as social stigma and fears about future access to credit and employment etc.

For example, an individual with higher stigma related costs of bankruptcy will require higher financial benefits from bankruptcy in order to overcome those stigma related costs and be persuaded to file.

The aim of our ongoing research agenda is to try to test these hypotheses.

Comments

[Ken Doran]

This is certainly a useful analysis, provide that "financial benefits of bankruptcy" is not mistaken for "benefits of bankruptcy." Many debts discharged in bankruptcy would never have been paid/collected anyway, but would have continued to bedevil the debtor for years. This reflects an important part of the fresh start that is at most weakly related to this calculation. Any practitioner can confirm that the need or justification for bankruptcy is not strongly connected to raw asset and debt totals.

[mt]

This was very interesting, thanks.

I think the Admin Office of the US Courts publishes an annual report where they provide some data on aggregate assets and liabilities at time of filing for all filers in each chapter over the course of the year reviewed. However, if I recall correclty, they don't tell you how much was discharged (as opposed to reaffirmed or simply paid.

As for why people wait, I think social stigma is a part of it. I'll throw out some other reasons: Some people, knowing they can't pay anyway, will play chicken with the creditor and wait til they see the whites of their eyes. Some people may gamble that they don't need to get rid of their old debts until they realize they need credit, say for a car. Sometimes a bill comes in at just the wrong moment and is the straw that breaks the camel's back. Then again, a lot of people just plain procrastinate anyway; as they say about bankrupts, they're bankrupt for a reason. There are search costs for finding a lawyer, as most filers don't know one. And then the fee itself has to be funded. In our system, it's critical how you manage your debts and expenses in the last 90 days before filing so sometimes you counsel people to wait.

[PaydayLoansAt company]

Don't you think that too many people can be tempted to file for bankruptcy without even trying to fight with it. I do agree that when you actually see that there is no way out, it is totaly worth taking advantage of your bankrupt situation and probably have a chance for the fresh start. But I won't be surpsire to see more and more people giving up.What can I say, I would really want to see a live example of a bankrupt turning his misarable situation into a somekind of profit