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Review of Economic Dynamics 18 (2015) 32–52
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Review of Economic Dynamics
www.elsevier.com/locate/red
Labor market upheaval, default regulations, and consumer
debt ✩
Kartik Athreya a,∗, Juan M. Sánchez b, Xuan S. Tam c, Eric R. Young d
a Research Department, Federal Reserve Bank of Richmond, United States b Research Department, Federal Reserve Bank of St. Louis, United States c Department of Economics and Finance, City University of Hong Kong, Hong Kong d Department of Economics, University of Virginia, United States
a r t i c l e i n f o a b s t r a c t
Article history:
Received 4 February 2014
Received in revised form 11 August 2014
Available online 26 August 2014
JEL classification:
D9
E21
K35
Keywords:
Delinquency
Personal bankruptcy
Unsecured debt
Job separation
Job finding
In 2005, reforms made formal personal bankruptcy much more costly. Shortly after,
the US began to experience its most severe recession in seventy years, and while
personal bankruptcy rates rose, they rose only modestly given the severity of the rise
in unemployment. By contrast, informal default through delinquency rose sharply. In the
subsequent recovery, households have been widely viewed as “deleveraging” (Mian and
Sufi, 2010; Eggertson and Krugman, 2012) via the largest reduction of unsecured debt seen
in the past three decades. We measure the relative roles of recent bankruptcy reform and
labor market risk in accounting for consumer debt and default over the Great Recession.
Our results suggest that bankruptcy reform likely prevented a substantial increase in formal
bankruptcy filings, but had only limited effect on informal default from delinquencies, and
that changes in job-finding rates were central to both.
© 2014 Elsevier Inc. All rights reserved.
1. Introduction
During the Great Recession and in the subsequent recovery, households have defaulted on consumer (non-mortgage) debt
at high rates, and have also been widely viewed as “deleveraging” (Mian and Sufi, 2010; Eggertson and Krugman, 2012;
Guerrieri and Lorenzoni, 2011). Deleveraging is an interpretation consistent with the largest reduction in the volume of
unsecured debt in the past several decades. Fig. 1 shows that between 2009 and 2012 credit card debt decreased by about
$160 billion.1
Perhaps the defining characteristic of the Great Recession has been the effect it has had on the labor market experiences
of US households. Fig. 2 displays the paths taken by two series that convey the increase in volatility experienced by the
typical household in an essentially self-explanatory manner.
✩ We thank various seminar and conference participants, and especially the anonymous referee and our discussants, Dean Corbae, and Ay ̧se Kabukcuoglu,
for insightful comments. The views expressed here are solely those of the authors and not necessarily those of the Federal Reserve Banks of
Richmond or St. Louis or the Federal Reserve System. Young thanks the Bankard Fund for Political Economy at the University of Virginia (Grant No.
122534-ey2d15-ER00562-31750) for financial support.
* Corresponding author.
E-mail addresses: kartik.athreya@rich.frb.org (K. Athreya), sanchez@stls.frb.org (J.M. Sánchez), xuanstam@cityu.edu.hk (X.S. Tam), ey2d@virginia.edu
(E.R. Young).
1 Source: http://www.newyorkfed.org/microeconomics/hhdc.html#2013/q3.
http://dx.doi.org/10.1016/j.red.2014.08.001
1094-2025/© 2014 Elsevier Inc. All rights reserved.
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K. Athreya et al. / Review of Economic Dynamics 18 (2015) 32–52 33
Fig. 1. Deleveraging.
Fig. 2. Labor market upheaval.
Lastly, along with household deleveraging and labor market risk, recent years have seen (perhaps naturally) a substantial
rise in overall default on unsecured consumer debt. Moreover, the data show a shift in the relative importance of formal
bankruptcy and informal “delinquency” as pathways to default. Fig. 3 shows how delinquency (measured as a fraction of
total consumer debt) and bankruptcy rates have evolved over the eight years from 2004 to 2012. As for default related
patterns, an event whose importance we will evaluate is the “The Bankruptcy Abuse Prevention and Consumer Protection
Act” (BAPCPA), enacted in late 2005. Importantly, this act altered the relative costs of delinquency and bankruptcy in favor
of the former. At an aggregate level, we see from the figure that immediately prior to the enactment of BAPCPA, there was
a sharp spike in bankruptcies followed by a sharp collapse. Intuitively, this is related to the advancement of filings prior to
the increase in bankruptcy costs by all those close to the margin.
The very large change in labor market risk faced by households during the Great Recession and subsequent recovery,
and the immediate precedent of the 2005 bankruptcy reform, together created conflicting forces that certainly complicate
any purely empirical analysis of the data described above. This is especially true of any more narrow analysis of the effect
of the fairly novel bankruptcy reform. In particular, the relative costliness of delinquency fell as a result of the reform,
while the share of households faring poorly in the labor market rose, both of which could, all else equal, be expected to
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34 K. Athreya et al. / Review of Economic Dynamics 18 (2015) 32–52
Fig. 3. Defaults in credit market.
increase default rates while shifting the form of default away from formal bankruptcy. At the same time, those households
not experiencing immediate misfortune in the labor market faced stronger incentives to increase their net asset position to
deal with greater ambient labor market risk. For some, this change would come from lowering debt (deleveraging), while
for others, precautionary balances would grow. At the same time, costlier bankruptcy, all else equal, could be expected relax
supply-side constraints and encourage household borrowing, just as would the increased proportion of households trying to
smooth through labor-market-related misfortune in a recession. As a result, it is entirely possible that deleveraging during
the Great Recession might well have been more substantial, were bankruptcy reform not enacted shortly prior to it.
In this paper, our aim is to answer the following question: How much did changes in labor market risk (as measured
by job separation and finding rates), along with recent bankruptcy reform, alter the paths of bankruptcy, delinquency, loan
pricing, and unsecured credit use over the Great Recession? In particular, to what extent can these forces help us understand
observed deleveraging? In other words, how do the forces of job separation and job finding that yield the paths seen in
Fig. 2 matter for the credit market outcomes seen in Figs. 3 and 1?
Recent empirical work suggests that it might well have done so. Morgan (2012) estimates an empirical model of aggre- gate bankruptcy filings using income and unemployment aggregates. His findings suggest that the filing rate observed after
the recession was substantially lower than would have been predicted by the behavior of aggregates alone. In other words,
the regime does appear to have changed.2 In addition, Lawless et al. (2008) document the “missing bankrupts,” the roughly
800,000 households who were predicted to file pre-reform but who did not.
We proceed by extending the life cycle model of Athreya et al. (2012) to allow for aggregate fluctuations in labor market
risk. The resulting model is novel in being the first, to our knowledge, to allow for bankruptcy, delinquency, and business
cycles simultaneously; specifically, we add an aggregate shock that moves between “steady state,” “expansion,” “recession,”
and “crisis” and alters the job finding and job separation rates, with durations that roughly capture the experience of the
US during the period 2004–2011. As a result, we are the first to provide a transitional account of the effect of bankruptcy
policy on observed default behavior.3 We first calibrate our model to represent the economy before BAPCPA, corresponding
to the year 2004. We then compute the model’s predictions for the paths of labor market and credit market variables in
response to BAPCPA being announced one period in advance and then enacted, along with the observed movements in hiring
and separation rates. To execute the latter experiment, we parameterize the model to match the dynamics of employment
and unemployment duration by exploiting the mechanical relationship between these objects and the job finding and job
separation rates. We then ask what would have happened if BAPCPA had not been implemented.
Our model’s main implication is that BAPCPA likely prevented a substantial increase in bankruptcy filings, but had only
a limited effect on the observed path of delinquencies. Thus, the reform appears to have “worked” – in the narrow sense
that it did not encourage households to find alternative routes to default and still reduced default overall, given the path of
2 He also finds that the ratio of Chapter 7 “liquidation” bankruptcies to Chapter 13 “reorganization” bankruptcies reverted very quickly to the pre-reform
level. This reversion suggests that the reform did not lower Chapter 7 bankruptcy – whereby unsecured debts are fully discharged – by merely diverting
borrowers into Chapter 13.
3 Our model of delinquency is related to, but distinct from, the recent model of Benjamin and Mateos-Planas (2012), who focus on steady states, and
Gordon (2013), who studies only bankruptcy but with aggregate shocks. Chatterjee and Gordon (2012) also have an alternative debt relief procedure, but it
involves voluntary wage garnishment; see also Chen (2013).