Consumer Default Research Articles

Dealing with consumer default: Bankruptcy vs garnishment

What are the positive and normative implications of eliminating bankruptcy protection for indebted individuals? Without bankruptcy protection, creditors can collect on defaulted debt to the extent permitted by wage garnishment laws. The elimination lowers the default premium on unsecured debt and permits low-net-worth individuals suffering bad earnings shocks to smooth consumption by borrowing. There is a large increase in consumer debt financed essentially by super-wealthy individuals, a modest drop in capital per worker, and a higher frequency of consumer default. Average welfare rises by 1% of consumption in perpetuity, with about 90% of households favoring the change.

The Way into Bankruptcy: Market Anomie and Sacrifice Among Portuguese Consumers

Portugal ranks among the EU27 countries with higher levels of consumer indebtedness. Contrary to the trend observed in countries with similar indebtedness rates, Portugal has one of the lowest rates of consumer default. Previous studies (e.g., Frade et al. 2006) have identified three strategies that have contributed to keep levels of credit default low: reliance on savings, financial support from relatives and friends, and cuts in household expenses. These strategies have been widely used for the last decade and have been strained since the very beginning of the global financial crisis in 2007. We argue that these three strategies are near to collapse and consequently the levels of consumer default will rise steeply in the next years. The savings rate in Portugal has been declining over time, and the social networks are limited in their action due to the current crisis that affects everyone. In this article, we advance the hypothesis that sacrificing living standards is rooted on collective beliefs about the current economic crisis in Portugal and trust in political and market agents in line with the Theory of Market Anomie (Karstedt and Farrall 2006). The conclusions are based on macroeconomic statistics and on the results of a Web survey of 1244 Portuguese households, which focuses on attitudes towards the financial crisis, trust in political and economic institutions, and strategies to cope with the crisis. The results show that trust in financial companies (banks and insurance companies) and in the European Parliament promotes a sense of empowerment to contribute to the country economic restoration. This attitude induces citizens to avoid default by sacrificing living standards. But in the current austerity context, with low levels of trust in political institutions and detachment of the economy, consumers will be less prone to sacrifice. In this scenario, credit default and insolvency is expected to rise especially in those households most exposed to unemployment and to cuts in social benefits. This reality puts a huge and growing pressure on bankruptcy procedure, civil courts, and economic and social policies. Some adjustments should be made to the Portuguese Bankruptcy Code by facilitating and simplifying the bankruptcy regime in order to accommodate the increase in insolvency cases. But the improvement of the insolvency procedure will not resolve the situation of financial distress if the structural causes persist, such as unemployment and deterioration of salaries, and cuts in social benefits. A reform of the Bankruptcy Code facilitating and simplifying the bankruptcy regime should be coupled with measures that boost the economy and stimulate the labour market. Otherwise, Portuguese households will not have the resources necessary to benefit from the bankruptcy process and regain the control over their financial lives.

THE DETERMINANTS OF HOUSEHOLD DEBT DEFAULT

In this paper, we study household debt default behavior in Chile using survey data. Previous research in this area suggests financial and personal variables help estimate individual and group probabilities of default. We study mortgage and consumer default separately, as the default decisions and overall borrower behavior are different for each type of debt. Our study finds that income and income-related variables are the only significant and robust variables that explain default for both types of debt. Demographic or personal variables are affected by only one type of debt but not more. For example, the level of education is a factor that affects mortgage default, whereas the determinants of consumer debt default include the age of the household head, and the number of people within the household that contribute to the total family income. We find that the probability of default decreases as the family income increases, and that our estimations are consistent with other studies similar to ours.

Evaluating Default Policy: The Business Cycle Matters

Legislation dealing with consumer default has consistently struggled with an important trade-off: more debt forgiveness directly benefits households but indirectly makes credit more expensive. Complicating the issue is that part of the risk households face is aggregate risk. This paper asks, How does aggregate risk affect the consequences of eliminating or restricting default? I find aggregate risk substantially reduces the welfare benefit of eliminating default, but its effect on restricting default depends crucially on the restrictions in place. In a calibrated general equilibrium life-cycle model, eliminating default results in an ex-ante welfare gain of 1.8% of lifetime consumption in steady state. Once the business cycle — the type of aggregate risk considered in this paper — is added, this gain drops to .5%. With or without aggregate risk, eliminating default greatly expands credit availability; however, when a protracted recession is possible, households use less credit unless they have a default option. While aggregate risk reduces the welfare gain of eliminating default this is not necessarily true for restricting default. A policy that pushes earnings-rich households into partial debt repayment (like a major 2005 reform) generates a gain of 2% with or without the business cycle. Moreover, with the policy instituted, eliminating default produces a welfare loss of .1%, which aggregate risk deepens to 1.5%. The reform improves credit markets while still preserving most of the insurance value of default. A different type of policy that restricts default to only be in recessions or expansions sharply reduces welfare relative to always allowing default (a loss of 1.4%) or never allowing it (a loss of 1.9%). The policy introduces uncertainty that makes credit expensive and keeps households from relying on the default option.

The Changing Pecking Order of Consumer Defaults

In the wake of the recent housing and financial crisis, many have argued that consumers are defaulting on their mortgage for strategic reasons, either because they are underwater or to preserve access to credit from other types of debt products, in order to maintain their consumption of other essential goods. In this paper, we examine the extent to which non-prime mortgage borrowers prioritize payments on their monthly mortgage over credit card debt obligations over a nine year period (2001-2009). Before the recent financial crisis, our default order data suggest that consumers were eight times more likely to prioritize payments on mortgage debt over credit card payments. As of late 2008, in contrast, the similar consumers were just as likely to default on mortgage debt as on credit card debt. Our results reveal that important explanations for the observed changes in the pecking order of defaults include: strategic mortgage default behavior among consumers with low and negative housing equity; illiquidity in the form of available credit; the rising costs of servicing mortgage debt; and the greater penetration of non-traditional mortgage products. These results support the importance of strategic consumer behavior, but also emphasize that the changes in the pecking order of defaults have come about because of ability-to-pay considerations.

Dealing with Consumer Default: Bankruptcy vs. Garnishment

What are the positive and normative implications of eliminating bankruptcy protection for indebted individuals? Without bankruptcy protection, creditors can collect on defaulted debt to the extent permitted by wage garnishment laws. The elimination lowers the default premium on unsecured debt and permits low-net-worth individuals suffering bad earnings shocks to smooth consumption by borrowing. There is a large increase in consumer debt financed essentially by super-wealthy individuals, a modest drop in capital per worker, and a higher frequency of consumer default. Average welfare rises by 1 percent of consumption in perpetuity, with about 90 percent of households favoring the change.

Household Leverage and the Recession of 2007–09

This paper shows that household leverage as of 2006 is a powerful statistical predictor of the severity of the 2007–09 recession across U.S. counties. Those counties that experienced a large increase in household leverage from 2002 to 2006 showed a sharp relative decline in durable consumption starting in the third quarter of 2006—a full year before the official beginning of the recession in the fourth quarter of 2007. Similarly, counties with the highest reliance on credit card borrowing reduced durable consumption by significantly more following the financial crisis of the fall of 2008. Overall, the statistical model shows that household leverage growth and dependence on credit card borrowing as of 2006 explain a large fraction of the overall consumer default, house price, unemployment, residential investment, and durable consumption patterns during the recession. The findings suggest that a focus on household finance may help elucidate the sources of macroeconomic fluctuations.

PENERAPAN METODE CREDITRISK+ DALAM PENGUKURAN RISIKO KREDIT KENDARAAN BERMOTOR (KASUS PADA PT X)

Identify and measure credit risk by using a method in accordance with the characteristics of finance companies is one of a prudent first step in minimizing potential losses. Potential losses can be seen from the Non Performing Loan (NPL) and recovery rate of the company. Credit risk measurement remains important as preventive and anticipatory measures for a finance company in managing the potential consumer default in fulfilling their obligations. By using 36 months of credit risk in motor vehicles (2006-2008) which includes the number of units of motor vehicles, the amount of exposure, collectability and recovery rate can be calculated expected Loss, unexpected loss and economic capital. Results showed that both the expected Loss and unexpected loss from year to year increase. Also with the economic capital increases annually. However, if the economic value associated with authorized capital owned by PT "X" each year, it can be concluded that the capital is still sufficient to cover possible losses caused by credit default unexpected losses. Testing the model using back testing and Likelihood Ratio, indicates that during the observation period the number of adverse events "X" with the level of losses that exceed the value of the vehicle financing credit VaR is still below the threshold amount of loss that can be tolerated. In other words the risk measurement method using a motor vehicle financing CreditRisk+ is acceptable and accurate enough to measure the risk of motor vehicle financing PT "X".

Time Varying and Dynamic Models for Default Risk in Consumer Loans

SummaryWe review the incorporation of time varying variables into models of the risk of consumer default. Lenders typically have data which are of a panel format. This allows the inclusion of time varying covariates in models of account level default by including them in survival models, panel models or ‘correction factor’ models. The choice depends on the aim of the model and the assumptions that can be plausibly made. At the level of the portfolio, Merton-type models have incorporated macroeconomic and latent variables in mixed (factor) models and Kalman filter models whereas reduced form approaches include Markov chains and stochastic intensity models. The latter models have mainly been applied to corporate defaults and considerable scope remains for application to consumer loans.

The Subprime Crisis and the Link between Consumer Financial Protection and Systemic Risk

This Article will appear in a May 2009 symposium issue of the Florida International University Law Review on the global financial crisis. This Article argues that the current global financial crisis, which was first called the “subprime crisis,” demonstrates the need to revisit the division between financial regulations designed to protect consumers from excessively risky loans and safety-and-soundness regulations intended to protect financial markets from the collapse of financial institutions. Consumer financial protection can, and must, serve a role not only in protecting individuals from excessive risk, but also in protecting markets from systemic risk. Economic studies indicate it is not merely high rates of defaults on consumer loans, but also unpredictable and highly correlated defaults that create risks for both lenders and investors in asset-backed securities. Consumer financial regulations can mitigate these risks in three, non-exclusive ways: (1) by reducing the level of defaults on consumer loans, (2) by making defaults more predictable, and (3) by reducing the correlation of defaults. The Article argues that: “predatory lending” can constitute a collective action failure by lenders; consumer behavioral biases may frustrate predictions of consumer defaults; but consumer financial rules that take into account these biases and address the “menu design” of consumer loan choices may not only protect consumers, but make the risk of consumer defaults more predictable. The Article also draws tentative conclusions on the implications of the link between consumer protection and systemic risk for the institutional reform of financial regulation by: arguing against federal preemption of state consumer regulation; and providing a rough analysis of regulatory reform proposals for creating either a single financial regulator or a “Twin Peaks” model of separate regulators for consumer protection and systemic risk regulation.

Household Leverage and the Recession of 2007 to 2009

We show that household leverage is an early and powerful predictor of the 2007 to 2009 recession. Counties in the U.S. that experienced a large increase in household leverage from 2002 to 2006 showed a sharp relative decline in durable consumption starting in the third quarter of 2006 – a full year before any significant change in unemployment. Similarly, counties with the highest reliance on credit card borrowing reduced durable consumption by significantly more following the financial crisis of the fall of 2008. Overall, our estimates show that household leverage growth and dependence on credit card borrowing explain a large fraction of the overall consumer default, house price, unemployment, residential investment, and durable consumption patterns during the recession. Our findings suggest that a focus on household finance may help elucidate the sources macroeconomic fluctuations.

A note on coarse classifying in acceptance scorecards

Traditionally, in credit and behavioural scoring one assumes that as all consumers have essentially the same product, its features will not affect whether the consumer defaults or not. Hence, one coarse classifies the characteristics concentrating only on the default ratio. As products and their operational features become customized for each individual (the very purpose of acceptance scoring), then decisions like whether the customer will accept the product or not must depend on the features offered. This paper investigates how one can deal with this dependency when coarse classifying the characteristics.

The Cost of Being Late: The Case of Credit Card Penalty Fees

This paper is the first in the literature to examine the determinants of US credit card penalty fees, which in 2004 amounted to $13 Billion, in a credit card market that had $800 Billion debt outstanding. Standard theory states that the price of debt should be related to default risk, yet many critics of credit card fees - including former presidential candidate John Kerry - have argued that credit card penalty fees reflect banks' market share. In this paper we examine, theoretically and empirically, credit card penalty fee pricing. Using a unique data set we find that credit card penalty fees are positively related to consumer default risk, measured at both the bank level as well as the macro level. However, we also find evidence that penalty fees are positively related to measures of bank market share. Our finding that fees are increasing in customer risk, supports the position of defenders of penalty fees such as banks. However, our finding that fees are increasing in market share is consistent with rent extraction, and the concerns expressed by politicians and regulators.

A portfolio view of consumer credit

To compute risk-adjusted returns and gauge the volatility of their portfolios, lenders need to know the covariances of their loans’ returns with aggregate returns. We use unique credit bureau data to measure individuals’ ‘covariance risk’, i.e., the covariance of their default risk with aggregate consumer default rates, and more generally to analyze the distribution of credit, including the effects of credit scores. We find significant heterogeneity in covariance risk across consumers. Also, the amount of credit they obtain significantly increases with their credit scores, and decreases with their covariance risk (especially revolving credit), though the effect of covariance risk is smaller.

A Portfolio View of Consumer Credit

This paper takes a portfolio view of consumer credit. Default models (credit-risk scores) estimate the probability of default of individual loans. But to compute risk-adjusted returns, lenders also need to know the covariances of the returns on their loans with aggregate returns. Covariances are independently relevant for lenders who care directly about the volatility of their portfolios, e.g., because of Value-at-Risk considerations or the structure of the securitization market. Cross-sectional differences in these covariances also provide insight into the nature of the shocks hitting different types of consumers. We use a unique panel dataset of credit bureau records to measure the of individual consumers, i.e., the covariance of their default risk with aggregate consumer default rates, and more generally to analyze the cross-sectional distribution of credit, including the effects of credit scores. We obtain two key sets of results. First, there is significant systematic heterogeneity in covariance risk across consumers with different characteristics. Consumers with high covariance risk tend to also have low credit scores (high default probabilities). Second, the amount of credit obtained by consumers significantly increases with their credit scores, and significantly decreases with their covariance risk (especially revolving credit), though the effect of covariance risk is smaller in magnitude. It appears that some lenders take covariance risk into account, at least in part, in determining the amount of credit they provide.

Consumer Default of Delinquent Adjustable‐Rate Mortgage Loans

An examination of the default behavior of delinquent Canadian rollover mortgage borrowers suggests that borrower ability‐to‐pay considerations are relevant to the default decision. They are, however, secondary to housing equity considerations. Results from both ratio and linear‐additive specifications suggest that a ratio specification conceals the independent effect of income and wealth variables.

Borrowing, Short-Sales, Consumer Default, and the Creation of New Assets

There appears to be some confusion in the literature on asset-pricing models about the role of default-risk in short-selling and borrowing by consumers. For example, in the Sharpe-Lintner ([16] [9]) model it is usual to assume that all consumers are able to borrow or lend without restriction, at the riskless rate of interest. This assumption has been recognized to involve an inconsistency in the theory, because with personal borrowing there is always a positive probability of default with the S-L assumptions, so that the consumer's bond (as seen by any lender) is not a perfect substitute for the safe asset.