The Paradox of Consumer Credit

Congress designed the 2005 amendments to the federal Bankruptcy Code to decrease consumer bankruptcy filings, but does history suggest that is a reasonable expectation for the new law? Using government data, this paper examines the relationship between household debt and changes in the legal regime on bankruptcy filing rates. First, I find that the components of household debt have different relationships with bankruptcy filing rates over different time frames. Over both the short- and long-term, increased mortgage debt is associated with increased bankruptcy filing rates. Consumer debt, however, has a negative short-term relationship with bankruptcy filing rates but a positive long-term relationship. A run up in consumer credit seems to allow consumers to delay but not avoid bankruptcy. The relationships were statistically meaningful and robust to different specifications of statistical models. Previous amendments to the federal bankruptcy law in 1938 and 1979 did not have any significant effect on bankruptcy filing rates. Rather, after each of these enactments, bankruptcy filings continued to move with overall macroeconomic trends unabated by changes in the legal regime. The 1984 amendments, however, were associated with an increase in filing rates, a rather surprising result given that the 1984 amendments - like the 2005 amendments - were meant to crack down on perceived overly generous bankruptcy laws. Others have noted that the 1984 amendments were followed by an expansion of consumer credit, which the other findings suggest are associated with a long-term increase in the filing rate. Taken together, these findings suggest the 2005 amendments may similarly lead to an expansion of consumer credit and a long-term increase in the bankruptcy filing rate.