Essays on Consumer Credit Markets and Debtor Protections

Pattison, Nathaniel, Economics - Graduate School of Arts and Sciences, University of Virginia
Friedberg, Leora, Department of Economics, University of Virginia
Turner, Sarah, Curry School of Education, University of Virginia
Johnson, William, Department of Economics, University of Virginia

This thesis studies the costs, benefits, and welfare impact of laws that protect debtors when they default. The first chapter evaluates the welfare impact of one of the main debtor protections in the United States: asset exemptions. Asset exemptions shield debtors’ assets from seizure by unsecured creditors, and so provide insurance that increases consumption when debtors default. This default insurance is financed by higher interest rates when debtors repay. I derive a sufficient statistic formula for the welfare impact of increasing exemptions, which captures the benefits to debtors who default either in or out of bankruptcy. I then estimate the key components of the formula. First, using the PSID, I estimate the change in consumption that occurs when debtors default, which determines debtors’ willingness to pay for default insurance. The estimated 5.5% consumption drop upon default implies that debtors are willing to pay, at most, 16.5% over the actuarially fair rate for default insurance. Second, using credit union data and changes in state exemption levels, I show that higher exemptions increase interest rates and decrease recoveries on charged-off debt. The estimates imply that exemptions generate default insurance, but the higher interest rates are marked up 320% over what is actuarially fair. Ultimately, since the actual markup substantially exceeds what debtors are willing to pay, lower exemptions would increase welfare.

The second chapter investigates whether borrowers file more bankruptcies when asset exemption are higher. A higher exemption makes bankruptcy more attractive, but also reduces the supply of credit, so the equilibrium effect on bankruptcy filings is uncertain. The reduced-form literature finds conflicting evidence, generally using cross-sectional variation in exemptions across states. I use panel variation in exemptions, combined with state- and county-level data on bankruptcies, and find that a median-sized exemption increase raises Chapter 7 bankruptcy rates by 3-7%. Event study regressions show that bankruptcy rates rise immediately after an exemption increase and remain high for at least six years, so it is not a temporary effect. I also estimate the effect of exemptions after the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, a major reform of the bankruptcy system.

The third chapter, coauthored with Leora Friedberg and Richard M. Hynes, examines the labor market effects of limiting employers' use of credit reports. Eleven states limit employers’ use of credit reports, and the primary arguments for the bans are that the use of credit reports hinders the financial recovery of those who suffer financial hardship and has a disparate impact on minority employment. Recent papers provide limited evidence that credit report bans help Americans with bad credit, while suggesting that the bans harm minority employment. We use the Survey of Income and Program Participation (SIPP) because it reveals some people who might directly benefit from credit report bans – those who have had recent trouble meeting their essential expenses. The SIPP also reports unemployment spells, so we see job-seeking status. We use double- and triple-difference specifications and find that banning credit checks reduces the unemployment duration of people who have had trouble meeting their expenses by about 25%; we fail to find a statistically significant effect of these laws on people who have not had such trouble. We do not find a statistically significant effect on the unemployment duration of minorities.

PHD (Doctor of Philosophy)
consumer credit, household finance, bankruptcy
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