Monitoring the Household Sector with Aggregate Credit Bureau Data

Business Economics, Jan, 2000 by John M. Barron, Gregory Elliehausen, Michael E. Staten

Using Aggregate Bureau Data to Model Bankruptcy Filing Rates

Personal bankruptcies in the United States have soared over the past four years. During the twelve months ending December 31, 1998, nearly 1.4 million U.S. households filed for bankruptcy protection, about a half million more households than in 1995. Perhaps more striking is the fact that from 1992 through 1998, one out of every twenty U.S. households filed for bankruptcy, a total of over 5 million. Losses to creditors from personal bankruptcy (debts discharged through bankruptcy proceedings) in 1998 alone exceeded $45 billion. Yet, this dramatic growth in personal financial failures occurred against the backdrop of the most favorable economic conditions since World War II. The apparent paradox of soaring bankruptcies coincident with extraordinarily low unemployment and strong income growth has puzzled researchers and spurred Congress to consider legislative remedies.

Debtor surveys consistently find that the majority of personal bankruptcies are triggered by "insolvency events." Bankrupt debtors cite events such as layoffs, loss of overtime hours, failure of a small business, divorce, extended illness and disability as creating either interruptions in income or unexpected expenses that result in repayment problems. However, an explanation for the rise in bankruptcies that is built around a comparable rise in insolvency events does not seem consistent with the marked improvement in the economic climate since 1992. In addition, a large minority of debtors (twenty-five to thirty percent) cites "buying too much on credit" as the primary cause of their financial woes. [3]

Consequently, two alternative explanations have gained popularity. Critics of the credit-granting industry argue that increasingly lax credit standards over the period have encouraged consumers to run up their debt loads. This is grounded in the observation that individuals have more credit available to them, and more individuals can get credit today than was the case a decade ago. [4] Proponents of this view especially demonize credit card issuers as a driving force behind the escalation in bankruptcies.

In the philosophically opposite camp are those who argue that declining social and economic stigma to filing for bankruptcy has led to more filings in at least two ways. First, declining stigma causes borrowers to live "closer to the edge." If the apparent cost to using the bankruptcy safety net falls, households will be willing to take on more debt relative to their income. Doing so makes them more vulnerable to unexpected income or expense shocks, with a resulting higher frequency of financial problems, delinquency and bankruptcy. Note that the theorized link between rising debt-to-income ratios and a greater frequency of bankruptcy is essentially the same as in the "easy credit" explanation.

Additionally, as the perceived cost of using the bankruptcy safety net falls, borrowers with any given amount of debt become more likely to seek a discharge of their debts through bankruptcy, rather than incur the costs of repayment over time. In other words, the bankruptcy trigger is pulled sooner in the borrower's debt cycle, relative to when filing stigma was higher. [5] Note that this second consequence of declining stigma does not require a concurrent rise in either insolvency events or debt/income, nor does it imply an increase in aggregate delinquencies or other conventional signs of financial problems.