The last two decades have seen a massive increase in both consumer credit and personal bankruptcies. Policymakers and academics have attempted to understand the sources of these trends and the causal link between them. As part of this debate, there has been much discussion about whether bankrupt individuals are (or should be) excluded from credit markets, and whether these individuals have gone bankrupt due to demand side factors, such as income and employment shocks, or as part of a general trend of increased credit supply. Gross and Souleles (2002) argue that demand side factors play a more important role than those on the supply side by showing that the changes in default rates are not caused by changes in the risk composition of borrowers.
More recently, Dick and Lehnert (2009) have suggested that increased bankruptcies are a consequence of increased competition in the banking sector. They argue that improved credit scoring algorithms have helped banks compete and have increased lending to riskier households, which has led to a rise in bankruptcies. In this paper, we seek to refine the supply-side story to better understand the consequences of filing for bankruptcy by studying the availability of credit to households post-bankruptcy. Understanding the consequences of filing provides insights into the incentives and determinants to file. This question is important for understanding the implications of the credit card legislation recently signed into law, which limits the penalizing strategies banks have previously used to generate significant income, particularly from riskier borrowers.
Our results provide the most detailed picture to date of credit access for post-bankruptcy consumers. We have three principal contributions to the literature. We find broadly that credit availability does decline, but that the average decline is relatively small and short lived. Second, the lowest quality borrowers seem to face the smallest decrease, and in some cases see an increase in credit. To accompany these results, we develop a simple theoretical framework to show that this pattern is a logical, and profitable, strategy for lenders to follow.
Third, our results provide confirmation and support for the Dick and Lehnert (2009) story regarding supply changes in the provision of credit being related to bankruptcy; in particular, we show that as credit supply tightened by the end 2007, access to credit post bankruptcy decreased, reducing the ex-ante incentives to file. We also provide a refinement to the Dick and Lehnert (2009) explanation in that we find low quality borrowers have both the greatest relative increase in credit post bankruptcy and the largest difference in access between high and low credit supply periods. This suggests that the link between expansion of credit and bankruptcy may operate principally through extension of credit to low credit quality borrowers rather than to all borrower types.
While there have been many theoretical studies analyzing these questions, there is very little empirical evidence, especially regarding facts about credit access post-bankruptcy. The economics literature, in particular, the macro-quantitative models of bankruptcy mostly assume an exclusion penalty where individuals are not allowed to borrow post-bankruptcy for a given period of time. The legal literature on the other hand suggests that there is relatively easy access to credit, relying principally on survey evidence. We discuss both these lines of research in detail in the section below.
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