Abstract
In this paper we study the political and economic determinants of the US states’ choices of levels of homestead exemptions, following the 1978 reform of the personal bankruptcy laws. To do so, we develop a political economy model in which homestead exemptions are ex-post beneficial to borrowers who default but ex-ante costly to all borrowers because they increase the cost of borrowing. By assuming that state residents vote on homestead exemptions, we formulate predictions and test them using state-level data. We find that states with higher levels of income inequality prior to 1978 chose to adopt higher levels of homestead exemptions following the bankruptcy reform. This result is robust to controls for other differences across states, including the level of homestead exemptions prior to 1978.
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