Bankruptcy Exemptions Research Articles

Redistributive Taxation and Personal Bankruptcy in U.S. States

Personal bankruptcy regulation and redistributive taxes and transfers vary considerably across U.S. states and over time. Our hypothesis is that both policies are imperfect substitutes in insuring consumption of risk‐averse agents in incomplete markets. Exploiting data variation over time for 18 U.S. states for the period 1980–2003, we find considerable support for this hypothesis: redistributive taxation and bankruptcy exemptions are negatively correlated, and both policies are associated with more equal consumption growth.

A Spatial Model of the Impact of Bankruptcy Law on Entrepreneurship

This paper employs spatial econometrics techniques to estimate the impact of bankruptcy regulation on small firm formation. The estimation of the model is computationally challenging due to the joint appearance of a lagged endogenous variable and the unobserved heterogeneity which requires modelling of initial conditions as described in Heckman (1981). We test for the joint significance of the state dummy variables in a way that can be viewed as an interesting alternative to the Hausman procedure. This was important for our analysis since, as sometimes happens in finite samples, the estimated variance–covariance matrix was not positive semi-definite. We found that the predicted probability of starting a business is 25% higher in states with higher bankruptcy exemptions than their neighbours relative to states with lower exemptions than their neighbours. Un modèle spatial de l'impact des lois sur la faillite sur la création d'entreprises Résumé La présente communication emploie des techniques d’économétrie spatiale pour évaluer l'impact de la réglementation en matière de faillite sur la constitution de petites entreprises. L'estimation du modèle pose des difficultés sur le plan computationnel en raison de l'apparition conjointe d'une variable endogène décalée et de l'hétérogénéité non observée, qui rend nécessaire la modélisation de conditions initiales, de la façon décrite par Heckman (1981). Nous testons la signification conjointe des variables indicatrices de l’état d'une façon qui peut être considérée comme une alternative intéressante à la procédure de Hausman. Ceci était important pour notre analyse, car, comme nous le relevons parfois dans des échantillons finis, la matrice variance–covariance estimée n’était pas semi-définie positive. Nous en concluons que la probabilité prévisible du lancement d'une affaire est plus élevée de l'ordre de 25% dans les états qui appliquent des exemptions pour les faillites supérieures à celles des pays avoisinants, par rapport aux états qui appliquent des exemptions inférieures à celles de leurs voisins. Un modelo espacial del impacto de la ley de bancarrotas sobre las iniciativas empresariales Résumén Este artículo emplea técnicas de econometría espacial para estimar el impacto de las normativas de bancarrotas sobre la formación de empresas pequeñas. La valoración del modelo es computacionalmente desafiante, debido a la aparición conjunta de una variable endógena rezagada y heterogeneidad inadvertida que requieren la modelación de las condiciones iniciales, como se describe en Heckman (1981). Ensayamos la significancia conjunta de las variables de prueba estatales de una forma que puede percibirse como una alternativa interesante al procedimiento Hausman. Esto fue importante para nuestro análisis, ya que, como ocurre a veces con muestras finitas, la matriz estimada de varianza–covarianza no fue semidefinitiva positiva. Descubrimos que la probabilidad predicha de iniciar un negocio es un 25% mayor en los estados con mayores exenciones de bancarrota que sus vecinos, en relación con estados con menos exenciones que sus vecinos.

Seismic Effects of the Bankruptcy Reform

We argue that the 2005 bankruptcy abuse reform (BAR) contributed to the surge in subprime foreclosures that followed its passage. Before BAR, distressed mortgagors could free up income by filing bankruptcy and having their unsecured debts discharged. BAR blocks that maneuver for better-off filers by way of a means test. We identify the effects of BAR using state home equity bankruptcy exemptions; filers in low-exemption states were not very protected before BAR, so they would be less affected by the reform. Difference-in-difference regressions confirm four predictions implied by that identification strategy. Our findings add to research trying to explain the surge in subprime foreclosures and to a broader literature on household bankruptcy demand and credit supply.

The US bankruptcy law and private equity financing: empirical evidence

The generous personal bankruptcy law in the United States is important to entrepreneurs because failed entrepreneurs can resort to this system to shelter part of their wealth against negative consequences of business failure. Fan and White (Journal of Law and Economics XLVI:543–567, 2003) documented that high bankruptcy exemptions provide incentives for entrepreneurs to start/own new businesses. The partial wealth insurance effect provided by the bankruptcy exemptions also has a significant and negative impact on the entrepreneurs’ access to bank credits (Berkowitz and White, The Rand Journal of Economics 35(1):69–84, 2004; Gropp Scholz and White, The Quarterly Journal of Economics 112(1):217-251, 1997). In this article, we investigate whether and to what extent the US bankruptcy law has any effect on venture capital (VC) investment. Making use of company level information, we document that the amount of venture financing received is negatively related to the bankruptcy exemption levels, and the number of rounds of financing as well as the number of VC funds involved is negatively associated with bankruptcy exemptions. Further, we report consistent evidences based on state level data with regard to the effects of the US personal bankruptcy law.

The Effect of Bankruptcy (Homestead) Exemption Levels on Access to Credit: Evidence from a US Panel

State and federal bankruptcy laws make exemptions for the family home in personal bankruptcy proceedings. There is considerable heterogeneity across the states in the level of this exemption, and those levels have changed reasonably often since 1978. While exemptions protect debtors ex post involved in bankruptcy proceedings, they might also reduce access to credit ex ante for all debtors. The empirical literature testing this hypothesis is mixed. This paper is the first to use a true panel to test this hypothesis, thus helping to avoid the endogeneity problem which potentially plagued the earlier, cross-sectional studies. We find that increasing the homestead exemption level increases credit-rationing in the personal loan market.

The Bankruptcy Abuse Prevention and Consumer Protection Act: Means-Testing or Mean Spirited?

Thousands of U.S. households filed for bankruptcy just before the bankruptcy law changed in 2005. That rush-to-file was more pronounced, we find, in states with more generous bankruptcy exemptions and lower credit scores. We take that finding as evidence that the new law effectively reduces exemptions, which in turn should reduce the demand for bankruptcy and the resulting losses to suppliers of consumer credit. We expect the savings to suppliers will be shared with borrowers by way of lower credit card rates, although credit card spreads have not yet fallen. If cheaper credit is the upside of the new law, the downside is reduced bankruptcy insurance against bad luck. The overall impact of the new law on the average household depends on how one weighs those two sides.

Legal Rules and Bankruptcy Rates: Historical Evidence from the States

Since the early twentieth century, observers have attributed the wide variation in state bankruptcy rates to variation in state legal rules such as garnishment and bankruptcy exemptions. Recent econometric analyses, however, conclude that legal rules do not matter. We explore the impact of legal rules on bankruptcy rates using a new technique - fixed effects vector decomposition - to exploit historical variation in legal rules. The technique allows us to estimate the impact of time-invariant legal rules in a fixed effects framework. We find that the variation in state legal rules explains much of the variation in state wage earner bankruptcy rates for 1926 to 1932.

Entrepreneurship and the Policy Environment

Investigates the effects of marginal income tax ratesand bankruptcy exemptions on entrepreneurship rates. After a discussion ofspatial and temporal trends in United States entrepreneurship, an empiricalmodel is used to estimate state rates of entrepreneurship. A state-level paneldata set that covers the period between 1991 and 1998 is used to evaluate themodel. This panel approach reveals a U-shaped relationship between marginal taxrates and entrepreneurship: at low initial tax levels, an increase in marginaltax rates reduces the number of entrepreneurs; at high initial tax levels, thenumber of entrepreneurs rises. Also, an S-shaped relationship exists betweenthe homestead exemption and entrepreneurship. In other words, an increase inthe homestead exemption from very low or very high levels acts to reduce thenumber of entrepreneurs, while an increase in the middle range acts to increasethe number of entrepreneurs. (SAA)

Entrepreneurship and the Policy Environment

This paper uses a panel approach to examine the effect that the government-policy environment has on the level of entrepreneurship. Specifically, the authors investigate whether marginal income tax rates and bankruptcy exemptions influence rates of entrepreneurship. Whereas previous work in the literature finds that both policies are positively related to entrepreneurship, these results show non-monotonic relationships: a U-shaped relationship between marginal tax rates and entrepreneurship and an S-shaped relationship between bankruptcy exemptions and entrepreneurship.

Bankruptcy exemptions, credit history, and the mortgage market

We develop and test a model of mortgage underwriting, with particular reference to the role of generic credit bureau scores. In our model, scores are used in a standardized fashion, which reflects the prevalence of automated underwriting in industry practice. We show that our model has implications for the debate on the effect of personal bankruptcy exemptions on secured lending. Recent literature has developed conflicting theories—and found conflicting results—seeking to explain how exemptions affect the mortgage market. By contrast, in our model exemptions are actually irrelevant to the mortgage underwriting decision. Instead, our model suggests that since exemptions are correlated with credit scores, some of the previous work's findings of significant effects for exemptions may rather reflect a failure to fully control for creditworthiness. Merging data from a major credit bureau with the Home Mortgage Disclosure Act (HMDA) data set, we confirm these predictions of our model.

Creating a Policy Environment for Entrepreneurs

This paper demonstrates that levels of entrepreneurship can be greatly affected by the general policy environment. Using a state-level panel, we estimate the effects of several policy variables on rates of entrepreneurship and find that bankruptcy exemptions, corporate tax rates, and the level of the minimum wage all affect a state's rate of entrepreneurship. For the median state, these policies reduced the level of entrepreneurship by 10.5 percent. Much of the geographic pattern of entrepreneurship can be explained by policy differences: The low-entrepreneurship states of the Great Lakes and the South tend to have relatively unfriendly policy environments, and the high-entrepreneurship states of the West tend to have relatively friendly policies. On the other hand, although New England states tend to have relatively unfriendly policy environments, they also tend to have high rates of entrepreneurship.

Fresh start or head start? Uniform bankruptcy exemptions and welfare

The 1990s witnessed a historically unprecedented number of personal bankruptcy filings. In response, congressional debate over bankruptcy law has recently led to several proposals aimed at making it more difficult to exempt wealth in a bankruptcy. In this paper, I evaluate uniform exemption policy primarily within the context of the recent congressional proposal H.R. 975. I develop an incomplete markets model where secured and unsecured assets coexist and are treated differentially in a bankruptcy proceeding. I find that exemptions are associated positively with filing rates, equity holdings in bankruptcy, and welfare. I find, however, that exemptions are strongly negatively associated with the availability of unsecured credit. Nonetheless, the welfare effects of exemptions result from changes in borrowing costs, changes in an implicit tax on self-insurance, and most crucially, changes in the level of state-contingency provided by unsecured debt. As a quantitative matter, these effects are resolved in a favor of a minor, but positive, role for exemptions.

Redistributive Taxation and Personal Bankruptcy in Us States

Both personal bankruptcy and redistributive taxes can insure households' consumption risk and both vary considerably across US states. We derive sufficient conditions under which more redistributive taxation makes bankruptcy exemptions less attractive both for the intratemporal insurance and for inter-temporal consumption smoothing. Exploiting data variation over time for 18 US states 1980-2003, we find considerable support for our model's predictions: (i) redistributive taxation and bankruptcy exemptions are negatively correlated; (ii) both policies are associated with more equal consumption growth whereas the effect on unsecured household debt is less clear-cut.

Impact of State Exemption Laws on Small Business Bankruptcy Decision

To provide further insights into the current debate on consumer bankruptcy, this article empirically assesses the impact of state bankruptcy exemption levels on the likelihood of small business owners filing for bankruptcy. We estimate a proportional hazard model of small business bankruptcy using a unique panel data set of over 43,000 small business credit card holders over a two‐year period from May 2000 to May 2002. Overall, our results indicate that for every $10,000 increase in a state's homestead exemptions, the risk of small business bankruptcy increases by 8%. Moreover, we also find that the likelihood of small business owners filing for bankruptcy will rise by 4% with a $1000 increase in personal property exemption levels.

Impact of State Exemption Laws on Small Business Bankruptcy Decision

1. IntroductionSmall businesses are a primary source of employment in the U.S. economy, employing over half of the private sector workforce. Small businesses are responsible for about two-thirds of all net new jobs created. According to the 2002 Small Business Economic Indicators (SBEI),1 over 99.7% of the 5.7 million firms in the United States are classified as small- to medium-sized businesses. Hence, small businesses are a substantial contributor to economic growth in the United States.Small business owners enjoy more flexibility and freedom to capitalize on profitable opportunities than their larger business competitors. Hence, they challenge the larger firms to be more efficient, which is ultimately beneficial to consumers. Unfortunately, small- and medium-sized businesses have a very low survival rate (SBEI 2002). In 2002 (on the heels of the 2001 recession), there were 550,100 small business births and 584,500 small business terminations. Both academics and public policy analysts have become increasingly concerned about the success of small businesses.Recently there has been a surge in small business research, particularly surrounding small business credit supply and demand. Not surprisingly, much of the literature has been focused on changes in lending technologies (relationship2 versus scored3), information processing technologies (soft versus hard),4 loan size considerations,5 and loan type considerations6 as they relate to small business supply and demand. However, very few have actually examined why small- and medium-sized businesses have very low survival rates. Some studies have analyzed the sensitivities of Small Business Administration (SBA) guaranteed loans to macroeconomic changes industry risks, maturity structures (3, 7, and 15 year maturities), as well as lender and debt characteristics (e.g., Glennon and Nigro 2001, 2002; Dunsky and Pennington-Cross 2003). Meanwhile, Agarwal, Chomsisengphet, and Liu (2003) empirically assessed the significant importance of owner and firm characteristics in determining the risk of small business default while controlling for the macroeconomic and industry risks.With bankruptcy filings continuing to rise significantly in recent years, many policy makers are turning their attention to bankruptcy laws. Specifically, Congress is considering reforming personal bankruptcy laws that, if passed, will significantly impact the demand for and supply of both consumer credit and small business funding. White (2001) concludes that this bankruptcy reform could potentially reduce small business ownership but increase the supply of small business credit and, in turn, affect the growth of the U.S. economy.Small business owners have an incentive to file for personal bankruptcy when their indebtedness exceeds the value of their assets because both their personal and business debts can be discharged.7 Though the bankruptcy exemption law is primarily designed for consumers, the personal bankruptcy exemption law is a de facto bankruptcy procedure for small business owners because the debt of a noncorporate firm is the personal liability of the entrepreneur/owner (Fan and White 2003). Hence, investigating the potential impact of the exemption law on small business bankruptcy decisions may provide some insight into how the bankruptcy laws should be reformed.Further, Fan and White (2003) argue that while the expected return to creditors should be lower in states with higher exemption level upon small business shutdown, it is not entirely clear whether lenders will actually shut down a financially troubled small business. While they empirically find that small businesses in high-exemption states are more likely to be shut down, this positive relationship is statistically insignificant. The authors conclude that additional research will be needed to determine if a significant relationship exists (p. …

Bankruptcy Exemptions, Credit History, and the Mortgage Market

We develop and test a model of mortgage underwriting, with particular reference to the role of credit bureau scores. In our model scores are used in a standardized fashion, which reflects the prevalence of automated underwriting in industry practice. We show that our model has implications for the debate on the effect of personal bankruptcy exemptions on secured lending. Recent literature (Berkowitz and Hynes (1999), Lin and White (2001)) has developed conflicting theories - and found conflicting results - seeking to explain how exemptions affect the mortgage market. By contrast, our model implies that when lenders use credit scores in a standardized manner, exemptions should be irrelevant to the mortgage underwriting decision. Merging data from a major credit bureau with the Home Mortgage Disclosure Act (HMDA) dataset, we confirm this prediction of our model. We also show that while ignoring borrower credit quality may make exemptions appear to be significant, once one controls for credit scores then exemptions have no effect on the likelihood that a mortgage application is approved. We confirm this empirically and argue that this may help explain some of the results of the previous literature.

Personal Bankruptcy and the Level of Entrepreneurial Activity

The U.S. personal bankruptcy system functions as a bankruptcy system for small businesses as well as consumers, because debts of noncorporate firms are personal liabilities of the firms’ owners. If the firm fails, the owner has an incentive to file for bankruptcy, since both business debts and the owner’s personal debts will be discharged. In bankruptcy, the owner must give up assets above a fixed exemption level. Because exemption levels are set by the states, they vary widely. We show that higher bankruptcy exemption levels benefit potential entrepreneurs who are risk averse by providing partial wealth insurance and therefore that the probability of owning a business increases as the exemption level increases. We test this prediction and find that the probability of households owning businesses is 35 percent higher if they live in states with unlimited rather than low exemptions.

Bankruptcy and Small Firms' Access to Credit

In this paper, we investigate how personal bankruptcy law affects small firms' access to credit. When a firm is unincorporated, its debts are personal liabilities of the firm's owner, so that lending to the firm is legally equivalent to lending to its owner. If the firm fails, the owner has an incentive to file for personal bankruptcy, since the firm's debts will be discharged and the owner is only obliged to use assets above an exemption level to repay creditors. The higher the exemption level, the greater is the incentive to file for bankruptcy. We show that supply of credit falls and demand rises when non-corporate firms are located in states with higher bankruptcy exemptions. We test the model and find that small firms are 25% more likely to be denied credit if they are located in states with unlimited rather than low homestead exemptions.

The Household Bankruptcy Decision

Personal bankruptcy filings have risen from 0.3 percent of households per year in 1984 to around 1.35 percent in 1998 and 1999, transforming bankruptcy from a rare occurrence to a routine event. Lenders lost about $39 billion in 1998 due to personal bankruptcy filings. But economists have little understanding of why households file for bankruptcy or why filings have increased so rapidly. Until very recently, studying the household bankruptcy decision was very difficult, because no household-level data set existed that included information on bankruptcy filings. In this paper, we use new data from the Panel Study of Income Dynamics, which includes information on bankruptcy filings, to estimate a model of households’ bankruptcy decisions. We find support for the strategic model of bankruptcy, which predicts that households are more likely to file when their financial benefit from filing is higher. Our model predicts that an increase of $1,000 in households’ financial benefit from bankruptcy would result in a 7-percent increase in the number of bankruptcy filings. Our model also predicts that if the 1997 National Bankruptcy Review Commission’s proposed changes in bankruptcy exemption levels were implemented, there would be a 16-percent increase in the number of bankruptcy filings each year. But if the $100,000 cap on homestead exemptions recently passed by the U.S. Senate were adopted, our model predicts that there would be only a negligible effect on the number of filings. We find little support for the nonstrategic model of bankruptcy which predicts that households file when adverse events occur which reduce their ability to repay. Finally, controlling for state and time fixed effects, our model shows that households are more likely to file for bankruptcy if they live in districts with higher aggregate filing rates.

Forum Shopping and Personal Bankruptcy

The dramatic increase in U.S. personal bankruptcy filings of the last fifteen years has focused attention on the wide disparities between different states' personal bankruptcy exemptions. These differences have been criticized both on the grounds of equity and also because they provide an incentive to move to a state with a higher exemption before declaring bankruptcy, that is to "forum-shop." This paper focuses on the latter of these objections. Using data from the Panel Study of Income Dynamics (PSID), we estimate a Nested Logit model of the household migration decision. Our econometric approach specifically avoids the problem of endogenously induced bankruptcy filings by examining the effect of filing propensity, rather than the actual event of filing, on the tendency to migrate to a higher exemption state. We conclude that, while there is indeed evidence that considerations of bankruptcy laws do influence interstate migration, the actual effect is relatively modest. We estimate that, in any given year, roughly 4,500 moves to higher-exemption states are motivated by considerations of differences in bankruptcy laws; by way of comparison, this is roughly one quarter of the magnitude of recent estimates of welfare-induced migration. This suggests that the emphasis on differences in exemptions which has been a feature of recent attempts to reform the bankruptcy code is somewhat exaggerated.