Unsecured Credit Research Articles

Macroeconomic Effects of Bankruptcy & Foreclosure Policies

I develop an equilibrium model of housing and default to jointly analyze the effects of bankruptcy and foreclosure policies. Heterogeneous households have access to mortgages and unsecured credit and can default separately on both types of debt. I show that the interaction between foreclosure and bankruptcy decisions is crucial for explaining the observed cross-state correlation between default policies and default rates. I use the model to argue that a major recent reform to bankruptcy reduced bankruptcy rates but increased foreclosure rates, and that the Home Affordable Refinance Program reduced foreclosures during the Great Recession.

On the Optimality of Ramsey Taxes in Mirrlees Economies

In this paper, we show that a simple, linear capital tax— the kind used in the Ramsey analysis— can be optimal in a Mirrlees economy with private information. We extend the Mirrlees approach to optimal taxation by studying taxes side-by-side with another institution, rather than in isolation. We consider an implementation in which agents use unsecured credit and personal bankruptcy to obtain insurance. Taxes are levied to fund government expenditures. An optimal tax system consists of lump-sum taxes and a simple Ramsey tax on wealth. In Mirrlees private information environments, optimal capital taxes do not have to be complicated.

Signaling and Indeterminacy of Equilibria in Unsecured Credit and Insurance Markets

Abstract I study strategic behavior under ‘credit-based insurance.' It is assumed that higher consumer credit scores are associated with lower risk for insurable losses. Even when default is costless, some borrowers repay loans as a signal of low risk-type to insurers. There are multiple equilibria and equilibrium refinement techniques have no bite. The equilibrium amount of debt is indeterminate. For low credit scores, equilibrium involves randomization between default and repayment. This can explain the ‘hockey-stick' shape of interest rates observed in several markets. Perfect information about consumer risk-type can lead to credit-market failure and lower welfare.

The IT Revolution and the Unsecured Credit Market

The IT Revolution and the Unsecured Credit Market

Access to Credit after Bankruptcy: Does it Pay to Be a Deadbeat?

Conventional wisdom about individuals who have gone bankrupt is that they find it very difficult to get credit for at least some time after their bankruptcy. However, there is very little non-survey based empirical evidence on the availability of credit post-bankruptcy. This paper makes two contributions using data from one of the largest credit bureaus in the US. First, we show that individuals who file for bankruptcy can indeed get credit very quickly after they file. Indeed, 90% of individuals have access to some sort of credit within the 18 months after filing for bankruptcy, and 66% have unsecured credit. Second, we show that those individuals who are effectively the least punished and can get the easiest access to credit after bankruptcy tend to be the ones who have shown the least ability and propensity to repay their debt prior to declaring bankruptcy. In fact, a significant fraction of individuals at the bottom of the credit quality spectrum seem to receive more credit after filing than before. We interpret the widespread credit access and the difference in credit provision across borrower types as evidence that lenders target at-risk borrowers. By means of a simple stylized model we show that this observation is consistent with a profit maximizing lender whose optimal strategy involves segmenting borrowers by observable credit quality and bankruptcy status and that offers credit contracts to each group. This interpretation is also in line with survey evidence that shows that lenders repeatedly solicit debtors to borrow after bankruptcy, with unsecured credit card being the easiest one to obtain.

Forgive and Forget: Who Gets Credit after Bankruptcy and Why?

Conventional wisdom holds that individuals who have gone bankrupt face difculties getting credit for at least some time. However, there is very little non-survey based empirical evidence on the availabil- ity of credit post-bankruptcy and its dependence on the credit cycle. Using data from one of the largest credit bureaus in the US, this paper makes three contributions. First, we show that individuals whole for bankruptcy are indeed penalized with limited credit access post-bankruptcy, but wend that this con- sequence is very short lived. Ninety percent of individuals have access to some sort of credit within the 18 months afterling for bankruptcy, and 75% are given unsecured credit. Second, we show that those individuals who have the easiest access to credit after bankruptcy tend to be the ones who have shown previously the least ability and least propensity to repay their debt. In fact, a signicant fraction of indi- viduals at the bottom of the credit quality spectrum seem to receive more credit afterling. We interpret the widespread post-bankruptcy credit access and the differential credit provision across borrower types as evidence that lenders target riskier borrowers. Employing a simple theoretical framework we show that this interpretation is consistent with a prot maximizing lender whose optimal strategy involves seg- menting borrowers by observable credit quality and bankruptcy status. This interpretation is also in line with survey evidence that shows lenders repeatedly solicit debtors to borrow after bankruptcy, especially with offers of revolving credit. Finally, we show that ourndings depend heavily on the aggregate credit environment: the ease of credit and limited bankruptcy credit cost observed in the initial period of our data (2003-2004) become much less signicant when we repeat the analyses in 2007, as the recent credit downturn began.

Household Borrowing After Personal Bankruptcy

A large literature has examined factors leading to filing for personal bankruptcy, but little is known about household borrowing after bankruptcy. Using data from the Survey of Consumer Finances, we find that relative to comparable nonfilers, bankruptcy filers generally have more limited access to unsecured credit but borrow more secured debt post bankruptcy, and they pay higher interest rates on all types of debt. We also find that credit access and borrowing costs improve as more time passed since filing. However, filers experience renewed debt payment difficulties and accumulate less wealth, even many years after filing, suggesting that for many bankrupt households, debt discharges fail to generate an effective fresh start as intended by the law. Our estimate also provides empirical guidance for calibrating the equilibrium models of household credit.

Household Borrowing After Personal Bankruptcy

A large literature has examined factors leading to filing for personal bankruptcy, but little is known about household borrowing after bankruptcy. Using data from the Survey of Consumer Finances, we find that relative to comparable nonfilers, bankruptcy filers generally have more limited access to unsecured credit but borrow more secured debt post bankruptcy, and they pay higher interest rates on all types of debt. We also find that credit access and borrowing costs improve as more time passed since filing. However, filers experience renewed debt payment difficulties and accumulate less wealth, even many years after filing, suggesting that for many bankrupt households, debt discharges fail to generate an effective fresh start as intended by the law. Our estimate also provides empirical guidance for calibrating the equilibrium models of household credit.

Comment on: “Unsecured credit markets are not insurance markets” by Kartik Athreya, Xuan S. Tam and Eric R. Young

Comment on: “Unsecured credit markets are not insurance markets” by Kartik Athreya, Xuan S. Tam and Eric R. Young

Unsecured credit markets are not insurance markets

We study the extent to which unsecured credit markets have altered the transmission of increased income risk to consumption variability over the past several decades. We find that unsecured credit markets pass through increased income risk to consumption, irrespective of bankruptcy policy and the information possessed by lenders. If risk sharing has indeed improved over this period, the reasons do not therefore lie in the unsecured credit market.

Default, insurance, and debt over the life-cycle

The widespread use of debt and default suggests that unsecured credit markets play an important role in consumption smoothing. In this paper, I address two previously unanswered questions. First, how does policy towards debt default affect the evolution of consumption and net worth over the life-cycle? Second, how does debt default policy interact with social insurance over the life-cycle? The findings are as follows. First, US default policy appears “lax”, in the sense that it creates severe credit constraints, especially for the young. Second, eliminating default will lower consumption inequality among the young, but will increase it among the old. Third, social insurance alters default risk and, in turn, loan pricing, and therefore matters for purely intertemporal smoothing.

Borrowing During Unemployment: Unsecured Debt as a Safety Net

Over the past two decades, U.S. consumers have increasingly relied on unsecured debt to finance consumption. The growth in unsecured debt has been particularly striking for low-income households. Some researchers have suggested that poor households use this debt to smooth consumption intertemporally, implying that these credit markets effectively serve as a safety net for disadvantaged households. This paper examines whether unsecured credit markets do, in fact, play an important role in the ability of disadvantaged households to supplement unemployment-induced earnings losses. I use panel data from two nationally representative surveys to address the two central questions of this paper. First, I consider whether households rely on unsecured credit markets to supplement temporary shortfalls in earnings. While I find no evidence that low-asset households borrow in response to these shortfalls, I show that households with assets do borrow. ; Among these households with assets, borrowing is particularly responsive to these idiosyncratic shocks for younger and less-educated households. The second question I consider is why low-asset households do not borrow. I provide evidence that they are not supplementing these lost earning via other income sources, showing that consumption falls in response to these earnings shortfalls. I also show that the borrowing and consumption behavior of low-asset households is different from other households. While some other explanations cannot be ruled out, the evidence presented here suggests that low-asset households do not have sufficient access to unsecured credit to help smooth consumption in response to transitory income shocks.

Borrowing During Unemployment

Abstract This paper examines whether unsecured credit markets help disadvantaged households supplement temporary shortfalls in earnings by investigating how unsecured debt responds to unemployment-induced earnings losses. Results indicate that very low-asset households—those in the bottom decile of total assets—do not borrow in response to these shortfalls. However, other low-asset households do borrow, increasing unsecured debt by more than 11 cents per dollar of earnings lost. In contrast, wealthy households do not increase unsecured debt during unemployment. The evidence suggests that very low-asset households do not have sufficient access to unsecured credit to smooth consumption over transitory unemployment spells.

Bank Loan Behavior and Credit Information Sharing: An Insight from Measurement Costs

We find that the measurement cost of creditworthiness is important when considering the behavior of banks. A set of credit infrastructures, i.e. a credit rating system, will help to increase the incentive of the banks to make unsecured credit loans, and thus help financial development. However, since the credit information sharing system is a kind of ‘public good’, it will not come into being endogenously in most cases without the driving force of the government.

Bounds on Repayment Behavior: Evidence for the Consumer Credit Market

How does the punishment for default affect repayment behavior? We use administrative data, provided by the leading Italian lender of unsecured credit to the household sector, to analyze households repayment behavior. Administrative data are particularly well suited to study what factors are responsible for default, but raise a fundamental econometric problem, since they identify the determinants of repayment behavior only for those who are granted credit. To overcome this problem, we provide upper and lower bounds on the determinants of repayment behavior. Moreover, we show how to use the restrictions from the theory to narrow the bounds. Mario Padula gratefulyl acknowledges financial support of the Finance and Consumption Chairin the European Community which enabled this project to be completed. We would like to thank for comments and suggestions at various stages of this project Alberto Bennardo, Giuseppe Bertola, Agar Brugiavini, Richard Disney, John Duca, Burcu Duygan, Luigi Guiso, Michael Haliassos, Stefan Hochguertel, Winfried Koeninger, Tullio Jappelli, Theresa Osborne, Frank Vella and Guglielmo Weber,and many other seminar participants. All remaining errors, are of course our own.

A Quantitative Theory of Unsecured Consumer Credit with Risk of Default

We study, theoretically and quantitatively, the general equilibrium of an economy in which households smooth consumption by means of both a riskless asset and unsecured loans with the option to default. The default option resembles a bankruptcy filing under Chapter 7 of the U.S. Bankruptcy Code. Competitive financial intermediaries offer a menu of loan sizes and interest rates wherein each loan makes zero profits. We prove the existence of a steady-state equilibrium and characterize the circumstances under which a household defaults on its loans. We show that our model accounts for the main statistics regarding bankruptcy and unsecured credit while matching key macroeconomic aggregates, and the earnings and wealth distributions. We use this model to address the implications of a recent policy change that introduces a form of “means testing” for households contemplating a Chapter 7 bankruptcy filing. We find that this policy change yields large welfare gains.

Court-Supervised Restructuring: Pre-Bankruptcy Dynamics, Debt Structure and Debt Rescheduling

We analyze the debt dynamics of corporations that reorganize under Belgian court-supervised restructuring, using a unique sample of small corporations. Small firms systematically accumulate unsecured trade credit and unpaid taxes and social contributions in the running up to bankruptcy-reorganization. First, small firms accumulate overdue taxes and social contributions, pushing the government administration in the unintended role of lender of last resort during the pre-bankruptcy period. Second, we find that the pecking order theory and specific trade credit theories predict the levels of trade credit accumulated during the pre-bankruptcy period very well. Our findings suggest that pre-bankruptcy dynamics strongly affect the debt structure at the moment of initiation of the procedure and in this way the ultimate outcome of the restructuring process.

The Missing Piece of the Puzzle: Perspectives on the Wage Priority in Bankruptcy

Debate about priorities among creditors has extended for over twenty years and, while slowing, hasn't ended in a consensus. Most of the focus of this debate has been on secured credit. Notwithstanding various academic objections, the recent revisions of Article 9 of the UCC strengthened the political commitment to the place of secured credit. The battleground over priority thus shifts to the world of unsecured credit in bankruptcy. Are some of the remaining unsecured creditors more equal than others? The answer is of course yes. Beginning with Section 5 of the Bankruptcy Act of 1841 Congress determined that one sort of unsecured creditors, employees, have statutory priority over other unsecured creditors. Is the wage priority efficient? Or is this priority justified or at least explained by principles outside the sphere of the market? Part I of this working paper summarizes the legal history of the wage priority in bankruptcy beginning with the Bankruptcy Act of 1841. Even though bankruptcy was a Whig political gambit in the election of 1840, I contend that by 1841 the rise of politically active evangelicals also played a role in America's first modern bankruptcy law. I next turn to the Supreme Court's most recent foray into statutory priories, Howard Delivery Service, Inc. v. Zurich Am. Ins. Co. The Court in Howard Delivery concluded that the statutory priority afforded employee benefits did not extend to unpaid premiums for workers compensation insurance. During the course of its analysis the majority passed over without mention the one normative vision that stretched back to 1841: protection of wage earners and their families. Thus in Part III I consider three perspectives on the justification of the wage priority. Market failure contrasting with rational autonomy (the situational and the existential perspectives) are the first two. The third perspective, the normative, considers the justice of a wage priority. This Part examines the religious, cultural, and political matrix of the 1841 Act, focusing on ante-bellum American evangelicals and the Whigs. I argue that religious and political confluences on public morality played a significant role in the creation of the wage priority.

Deal Sponsor and Credit Risk of Asset-Backed and Mortgage-Backed Securities

Gorton and Souleles (2005) and Higgins and Mason (2004) find that sponsors with higher unsecured credit ratings issue credit card securitizations at tighter spreads and have greater market access than lower rated sponsors. We extend this research by examining the performance of securitizations with different types of sponsors in multiple sectors and by discussing the various ways in which sponsors might influence the performance of their securitizations. We measure performance using two metrics, rating downgrade rates and security impairment rates. We utilize a unique dataset, consisting of over 14,000 securitization tranches issued over a 10-year period, covering a wide range of sectors within the asset-backed and mortgage-backed securities markets, and involving over 446 individual sponsors. When all the data is pooled, securitizations issued by investment-grade sponsors appear to outperform those issued by non-investment-grade sponsors, and those issued by banks outperform those of captive finance companies, which outperform those of security firms, which outperform those of specialty finance companies. The prevalence of certain types of sponsors within various asset classes helps explain the wide variation in performance observed across those asset classes. When analyzing relative performance across asset classes, we find weaker performance is strongly associated with having a higher proportion of sponsors that are specialty finance companies. When analyzing relative performance within asset classes, we find the impact of sponsor type is mostly modest or statistically insignificant. The relatively weak nonperformance of securitizations sponsored by specialty finance companies and non-investment-grade firms may be related to their weaker incentives to invest (through conservative asset selection, high quality servicing, or out-right support for troubled transactions)in long-term reputations for issuing strongly performing securities. In addition, in some sectors, if the sponsor is also the servicer and goes bankrupt, the securitization's underlying obligors, themselves, have a weaker incentive or more limited ability to make their debt service payments. Differences in performance may also be related to the tendency of specialty finance and noninvestment-grade sponsors to be more active in sectors that have historically exhibited greater asset volatility. In some of these sectors, sponsors experienced increased competitive pressure over time to grow originations and relax underwriting criteria. As a result, the securitizations of many sponsors operating within these sectors, including those of some banks and investment-grade firms, under-performed relative to securitizations in sectors with relatively few specialty finance and non-investment-grade sponsors.

A Panel Discussion on Dynamics in the Consumer Credit Counseling Service Industry

On July 20, 2001 the Payment Cards Center of the Federal Reserve Bank of Philadelphia sponsored a workshop on the consumer credit counseling service industry. Leading the moderated discussion were four senior executives from regional credit counseling firms associated with the National Foundation for Credit Counseling (NFCC). Jerome Johnson, president and CEO and Ghyll Theurer, program manager represented the Consumer Credit Counseling Service (CCCS) of South Jersey, a program of Family Service Association. James Godfrey, executive vice president, Consumer Credit Counseling Service (CCCS) of Maryland and Delaware, Inc. and Patricia Hasson, president of Consumer Credit Counseling Service (CCCS) of Delaware Valley, Inc. rounded out the panel. The discussions were enriched by the breadth of experiences represented by the panelists who come from a variety of industry and nonprofit backgrounds. The panel discussed the role of credit counseling firms mediating between financially troubled consumers and their unsecured credit card lenders. This paper is a summary of those discussions.