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Filing for Bankruptcy? Big Deal!
Last year 1.35 million Americans — more than 1 per cent
of households in the U.S. — declared bankruptcy. If
that figure is not stunning enough, consider this: These
numbers represented an increase of 73 per cent over 1994.
Delinquency rates on credit cards are also rising fast. At a
time when the U.S. economy is so strong, why should that
be happening? The issue is an important one given that
the U.S. Congress is currently debating major changes in
the bankruptcy law.
Economists offer two major explanations. Some blame
the so-called risk effect, in which less creditworthy borrowers
receive more credit than they can handle. Others point
to a so-called stigma effect. This suggests that the social stigma
associated with declaring bankruptcy or defaulting on
credit cards has declined. As a result, borrowers are more
willing to stiff lenders than they were in the past.
Which of these two theories better explains the rising
bankruptcy and default rates? So far that question has been
difficult to answer. In a new study, however, finance professor
Nicholas S. Souleles and his colleague, David B. Gross
of the University of Chicago, draw upon detailed data about
several hundred thousand credit-card users provided by
several credit-card companies. The two researchers attempt
to unravel the issue by studying the users' behavior for
eight quarters between 1995 and 1997.
Their conclusion: even if the behavior of users with similar
risk profiles was tracked, the propensity to default went
up between 1995 and 1997. That implies that the social stigma
attached to filing bankruptcy and defaulting on credit
card debt had declined. In other words, the stigma effect
primarily drove the increase in bankruptcy filings and
delinquencies. "We no longer put scarlet letters on people
if they go bankrupt," says Souleles. He adds that factors like
increased advertising by bankruptcy lawyers might have
also made borrowers more likely to declare bankruptcy.
This research has important implications for credit issuers,
because even a small decline in stigma could spur large
increases in bankruptcies and delinquencies. If that happens,
creditors' losses could significantly increase, which in turn
could increase the cost of credit for borrowers in general.
Nicholas S. Souleles and David B. Gross: Explaining the Increase
in Bankruptcy and Delinquency: Stigma Versus Risk Composition
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