The Household Bankruptcy Decision

Personal bankruptcy Ž lings have risen from 0.3 percent of households per year in 1984 to around 1.35 percent in 1998 and 1999, transforming bankruptcy from a rare occurrence to a routine event. Lenders lost about $39 billion in 1998 due to personal bankruptcy Ž lings. But economists have little understanding of why households Ž le for bankruptcy or why Ž lings have increased so rapidly. Until very recently, studying the household bankruptcy decision was very difŽ cult, because no household-level data set existed that included information on bankruptcy Ž lings. In this paper, we use new data from the Panel Study of Income Dynamics, which includes information on bankruptcy Ž lings, to estimate a model of households’ bankruptcy decisions. We Ž nd support for the strategic model of bankruptcy, which predicts that households are more likely to Ž le when their Ž nancial beneŽ t from Ž ling is higher. Our model predicts that an increase of $1,000 in households’ Ž nancial beneŽ t from bankruptcy would result in a 7-percent increase in the number of bankruptcy Ž lings. Our model also predicts that if the 1997 National Bankruptcy Review Commission’s proposed changes in bankruptcy exemption levels were implemented, there would be a 16-percent increase in the number of bankruptcy Ž lings each year. But if the $100,000 cap on homestead exemptions recently passed by the U.S. Senate were adopted, our model predicts that there would be only a negligible effect on the number of Ž lings. We Ž nd little support for the nonstrategic model of bankruptcy which predicts that households Ž le when adverse events occur which reduce their ability to repay. Finally, controlling for state and time Ž xed effects, our model shows that households are more likely to Ž le for bankruptcy if they live in districts with higher aggregate Ž ling rates.