The Price of Bankruptcy
posted by Dave Hoffman
Credit Slips highlights a very cool new paper, Bankruptcy Spillovers: Distance, Public Disclosure, and Opaque Information. In the paper, Barry Scholnick examines bankruptcy filings in Canada at a micro level. Looking at the postal code of every filer – which code is a much more precise geographic identifier than our zip codes – Scholnick concludes:
“The punch line of my study is that there is indeed a significant impact from the past bankruptcies of neighbors (as defined by the very small Canadian Post Codes) to the probability that an individual in the neighborhood will file . . . I propose, and provide evidence for, the hypothesis that if a defaulter lives in a neighborhood with a large number of previous bankruptcies among the neighbors, then that individual will choose to default via bankruptcy rather than charge-off. This is because more neighborhood bankruptcies will lower stigma or provide more information about the process of bankruptcy.
On the other hand, I show that defaulters who live in low bankruptcy neighborhoods choose to default via charge-off rather than bankruptcy. This is consistent with the argument that low bankruptcy neighborhoods have higher levels of bankruptcy stigma, thus individual defaulters choose to default via charge-off in order to maintain more privacy about their default.”
This paper not only fits within a literature on bankruptcy, but also is a nice match to work by my co-author Tess Wilkinson-Ryan on how mortgage foreclosure and other forms of breach are socially mediated events. Abiding by onerous contracts is unpleasant, but we do it so long as it is socially validated. When it stops being socially normal to stick with terrible deals, we exit them.
October 1, 2012 at 7:15 pm
Posted in: Behavioral Law and Economics
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Responses (5)
A.J. Sutter - October 1, 2012 at 9:37 pm
A couple of points to note:
1. The paper demonstrates nothing more than correlations. Scholnick neither provides nor cites to any qualitative research, such as interviews with defaulting debtors in the areas studied, to back up his point about the causes for the choices made. Had he done so, his point might have been more persuasive.
2. The punch-line of the abstract is “Our [sic] results are consistent with the bankruptcy policy arguments of pro-creditor lobbyists.” In the “Policy Motivation” section of the paper (@6-8), Scholnick remarks:
After noting some methodological issues raised in the papers of Gross and Souleles (2002) and Fay, Hurst and White (2002), he concludes the policy section by noting:
In effect, he is sliding from a correlation to a moral judgment.
Matt - October 1, 2012 at 9:45 pm
I haven’t read the paper, so perhaps this is addressed, but I wonder about a couple of things here. It seems plausible to me, for example, that the frequency of bankruptcies in a neighborhood might well be tracking something other than social norms, such as knowledge of how to apply for bankruptcy and the ability to pay for or get help doing so. Since these things are likely to be strongly correlated with the same sorts of factors that distinguish neighborhoods- social class, education, job backgrounds, race, etc., the the relative frequency of bankruptcy filings verses charge-offs wouldn’t necessarily have anything to do with social norms. At the least, I think this stuff would have to be controlled for, and that’s probably pretty hard to do. In general I’m fairly skeptical that these “natural experiments” control for enough factors in many cases, and this one seems pretty worrisome to me, though perhaps this is dealt with.
I’m also not sure why bankruptcy would be “less private” than a charge-off default. In the case of the people I’ve known who have just stopped paying bills, they have had to deal with bill collectors, collection agencies, repo-men, and the like in a way that seems more obvious and more public than a bankruptcy filing would.
(Here we have a difference from some of Tess Wikinson-Ryan’s work, too, of which I a big fan. In this study, as far as I can tell, people are not abiding by an onerous contract- in either case they have stopped paying, and the issue is rather whether they file for bankruptcy or just give up paying.) Anyway, perhaps all of these issues are dealt with in the paper, but they sound like potential problems from the description here.
A.J. Sutter - October 1, 2012 at 10:26 pm
@Matt: You make a good point about charge-off and privacy, especially since debt collectors may contact debtors at their workplace. The paper also doesn’t address the question of whether people who choose charge-off are under the mistaken impression (at the time of choice) that this relieves them of legal liability for the debt.
Radha Rothrock - October 14, 2012 at 7:24 am
I am a bankruptcy attorney in Ft. Myers, Florida. I have never had a client discuss whether their neighbors filed bankruptcy or not. The decision was driven by their inability to pay their creditors after years of exhausting their savings and retirement accounts. Most of the people who filed were concerned about the stigma; however, that stigma did not necessarily concern their neighbors. It was more of a feeling of self-failure. The feeling generally dissipated within a few months of filing.
The people who didn’t file bankruptcy ended up having more stigma with their neighbors because the process servers served them in front of their neighbors or the repo guy showed up in front of the neighbors.
Jones - May 5, 2013 at 7:03 am
There are many bankruptcy chapter that are registered according to the types of personal bankruptcy, so it depends on the types of case. It will helps great if the bankruptcy tool is used..
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