Are Debtors Rational Actors? An Experiment

Abstract

In 2005, Congress – motivated by the assumption that debtor’s were acting rationally and strategically – changed bankruptcy law to reduce individual discretion. The new law, the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”), forced debtors through a cookie-cutter series of steps designed to reduce bankruptcy filings and to develop more national uniformity. Judicial discretion was sharply curtailed, and practicing lawyers were burdened with extensive, detailed obligations that drove up costs and pushed many out of bankruptcy practice altogether. In other words, the burdens and costs associated with bankruptcy were substantially increased in order to deter filings. Bankruptcy provides a natural experiment to empirically test the strength of the Rational Actor model upon BAPCPA was based. Over the past twenty-seven years, millions of American families have filed for personal bankruptcy, each going through a uniform federal process in their own local communities. A decade ago, empiricists discovered wide variations were reported among filing rates and chapter choices, and those variations remained stable over time. Interestingly, these variations could not be explained by any salient external factor, such as variations in income, unemployment, or exemption laws. Bankruptcy filing choices, in other words, were largely due to “unseen or overlooked influences,” suggesting that a simple Rational Actor model could not fully explain debtor behavior. In spite of these findings, Congress rooted its bankruptcy reform efforts in the assumption that debtors were acting strategically and rationally. The passage of BAPCPA was expected to radically alter bankruptcy filing patterns, and the question remained whether these filing patterns would be consistent with Congress’s assumption that debtors were acting rationally and strategically. My data indicate that, while BAPCPA did reduce bankruptcy filings across the board, unexplained local variations in filing patterns remain, casting doubt upon the simplistic Rational Actor assumptions behind BAPCA.