by guest blogger Rachel Clattenburg of Public Citizen Litigation Group
Last week, NPR’s Morning Edition described Chapter 11 bankruptcy as one of our economy's “secret weapons.” The story focused on an appliance business in Charlotte, N.C., which was saved after filing for Chapter 11 bankruptcy. The story credits Chapter 11—the Chapter generally used by businesses to reorganize and pay back creditors over time—as one reason the U.S. economy bounced back faster than some others.
Does consumer bankruptcy provide a similar bounce-back effect? A paper published earlier this year tried to figure this out for Chapter 13 bankruptcy protection. In Chapter 13, a personal bankruptcy chapter, the individual keeps her assets and repays creditors from future income over a span of three to five years.
The researchers, exploiting the fact that bankruptcy judges vary in their leniency, compared Chapter 13 filers who were granted bankruptcy protection to nearly identical filers whose cases were dismissed. In the five years post-filing, those granted Chapter 13 protection earned significantly more and experienced increased employment, lower home foreclosure rates, and even lower mortality rates compared to those whose cases were dismissed. The paper suggests that the results may be due to “increased incentive to work and increased economic stability following the receipt of bankruptcy protection.”
So far, so good: individuals, like corporations, get to enjoy the benefits of bankruptcy protection. However, the study examined filings before the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act went into effect. That law made it harder for consumers to file for bankruptcy protection and led to a “large and permanent reduction in bankruptcy filings,” according to a report by the Federal Reserve Bank of New York, which attributed the decline to the increased cost of seeking bankruptcy protection. That report found a “sizeable group of individuals” who were too poor to afford bankruptcy protection.
Preventing abusive filings is one thing, but denying eligible individuals the benefits of bankruptcy protection—benefits the system readily grants to corporations like the appliance store in NPR’s story—is problematic.
The paper on the benefits of Chapter 13 protection is “Debt Relief and Debtor Outcomes: Measuring the Effects of Consumer Bankruptcy Protection”, American Economic Review 105.3 (2015), by Will Dobbie and Jae Song. It can be found here. This article in the Economist discusses this paper and related research. The Wall Street Journal covered the New York Fed’s study here.