Who Files for Bankruptcy

While prior papers have examined the impact of state exemption and garnishment laws on the average household, this paper is the first to examine their heterogeneous impact. In my theoretical model, households choose between three options: repayment, bankruptcy, and informal bankruptcy (non-repayment without the benefit of the formal bankruptcy process). The model makes two predictions about the likelihood that a household will file for bankruptcy. First, the model predicts that high asset households are more likely to file for bankruptcy in states with high exemption levels. Second, the model predicts that households with lower incomes are more likely to file for bankruptcy in states with high garnishment rates. These predictions are confirmed using a new household level dataset. The dataset finds, for example, that households with $225,000 in home equity are 1.7 times more likely to file for bankruptcy in a state with a high exemption level, whereas households earning less than $10,000 per year are 1.6 times more likely to file for bankruptcy in a state with a high garnishment rate. Understanding these cross-state differences is crucial as they suggest that a household with a given set of financial characteristics will seek bankruptcy relief if it resides in one state but will have to use alternative consumption smoothing measures if it lives in a different state.