The Consequences of Debt and the Tradeoff of Bankruptcy

• In Event: Social Equity and Economic Policies

Abstract

Black households file for bankruptcy at nearly twice their population share, yet systematically receive worse outcomes. Relative to comparable white filers, they (a) are more likely to file under Chapter 13, a less successful form of debt restructuring; (b) are more likely to have their Chapter 13 cases dismissed, largely due to missed plan payments; (c) face higher exposure to judge-ordered wage garnishment; and (d) even when proceedings are successful, they emerge carrying more nondischargeable debt. This paper asks how much of this disparity reflects differences in household finances versus differences in institutions, and what it implies for racial wealth inequality over the life cycle. Since household finances observed at filing are themselves shaped by prior institutional exposure, cross-sectional and event-study methods struggle to separate the two. I develop a life-cycle model of household borrowing, default, wage garnishment, and bankruptcy to quantify how racial differences in income, assets, debt portfolios, wage garnishment exposure, and bankruptcy fees shape filing decisions and debt relief outcomes. The model features endogenous selection between Chapter 7 liquidation and a Chapter 13 repayment plan depending on a household's income, exempt and nonexempt assets, and debt structure, specifically their secured, unsecured, priority, and nondischargeable obligations. I calibrate my model using a sample of bankruptcy cases from the Federal Judicial Center (FJC) Integrated Database supplemented with information from the case and docket records. Preliminary calibration of the model indicates that the observed racial disparity in Chapter 13 vs. Chapter 7 filing and discharge rates cannot be fully explained by differences in income and asset distributions alone, pointing to the importance of wage garnishment exposure and debt portfolio composition. The results will show the extent to which current debt relief institutions reinforce the racial wealth gap over the life cycle. I will evaluate three sets of policy counterfactuals: (i) changes to the attorney and filing fee structure that determine the effective cost of bankruptcy access, (ii) built-in savings plans in Chapter 13 repayment plans to help debtors insure against future shocks while under the plan, and (iii) reforms to nondischargeable debt categories including student loans that disproportionately burden Black filers.

Author

• Sara Elizabeth Canilang, University of Minnesota - Twin Cities
  Presenting Author