The Price of Bankruptcy

Dave Hoffman

Dave Hoffman is the Murray Shusterman Professor of Transactional and Business Law at Temple Law School. He specializes in law and psychology, contracts, and quantitative analysis of civil procedure. He currently teaches contracts, civil procedure, corporations, and law and economics.

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6 Responses

  1. A.J. Sutter says:

    A couple of points to note:

    1. The paper demonstrates nothing more than correlations. Scholnick neither provides nor cites to any qualitative research, such as interviews with defaulting debtors in the areas studied, to back up his point about the causes for the choices made. Had he done so, his point might have been more persuasive.

    2. The punch-line of the abstract is “Our [sic] results are consistent with the bankruptcy policy arguments of pro-creditor lobbyists.” In the “Policy Motivation” section of the paper (@6-8), Scholnick remarks:

    An important motivation for this paper is that the issue of bankruptcy spillovers through stigma and information effects has played a key role in policy debates over bankruptcy regulation, including the debate over bankruptcy reform in the US in 2005. Broadly speaking, pro-creditor lobbyists (e.g. the credit card industry) have tried to make the case that bankruptcy has become more prevalent because of spillovers (caused by lower stigma and increased information about the process of bankruptcy), and thus argue for greater restrictions on the ability of debtors to file. On the other side, pro-debtor lobbyists (e.g. consumer rights groups) have tried to make the case that bankruptcy filing should be made easier, because negative shocks to individuals (unemployment, divorce, health shocks) rather than bankruptcy spillovers are the main reason for increased individual bankruptcy.

    The importance of stigma effects and spillovers between individuals in these policy debates can be seen by the comments of various US Senators, of both parties, in 2005. These include: “Bankruptcy should be difficult, and the moral stigma that used to be associated with bankruptcy ought to be resurrected.” (Senator Grassley); “The explosion in bankruptcy filings has less to do with causes and more to do with motivations. The stigma of bankruptcy is all but gone.” (Senator Hatch); “There has been a decline in the stigma of filing for bankruptcy and appropriate changes are necessary to ensure that bankruptcy is no longer considered a lifestyle choice.” (Senator Kerry); “The social stigma of bankruptcy is gone” (Senator Dodd)). At the same time, then Federal Reserve Chair Greenspan commented that “Personal bankruptcies are soaring because Americans have lost their sense of shame.” (all citations from Efrat (2006, p. 486)).

    After noting some methodological issues raised in the papers of Gross and Souleles (2002) and Fay, Hurst and White (2002), he concludes the policy section by noting:

    This methodological concern played an important role in the 2005 policy debates, and was specifically addressed by Sullivan, Warren and Westbrook (2006. p. 217). These “pro-debtor” authors strongly criticized the spillover findings of Fay, Hurst and White, (2002) and Gross and Souleles, (2002), based on their defining of “social networks” as US states or court districts. It is for this reason that our, more rigorous, tests of the bankruptcy spillover hypothesis have important policy implications. Our data, allows us to specifically address the criticism of Sullivan, Warren and Westbrook, 2006 by testing the bankruptcy spillover hypothesis, where the individual’s social network is defined as near neighbors in areas as small as city blocks. [Emphasis added; footnotes omitted.]

    In effect, he is sliding from a correlation to a moral judgment.

  2. Matt says:

    I haven’t read the paper, so perhaps this is addressed, but I wonder about a couple of things here. It seems plausible to me, for example, that the frequency of bankruptcies in a neighborhood might well be tracking something other than social norms, such as knowledge of how to apply for bankruptcy and the ability to pay for or get help doing so. Since these things are likely to be strongly correlated with the same sorts of factors that distinguish neighborhoods- social class, education, job backgrounds, race, etc., the the relative frequency of bankruptcy filings verses charge-offs wouldn’t necessarily have anything to do with social norms. At the least, I think this stuff would have to be controlled for, and that’s probably pretty hard to do. In general I’m fairly skeptical that these “natural experiments” control for enough factors in many cases, and this one seems pretty worrisome to me, though perhaps this is dealt with.

    I’m also not sure why bankruptcy would be “less private” than a charge-off default. In the case of the people I’ve known who have just stopped paying bills, they have had to deal with bill collectors, collection agencies, repo-men, and the like in a way that seems more obvious and more public than a bankruptcy filing would.

    (Here we have a difference from some of Tess Wikinson-Ryan’s work, too, of which I a big fan. In this study, as far as I can tell, people are not abiding by an onerous contract- in either case they have stopped paying, and the issue is rather whether they file for bankruptcy or just give up paying.) Anyway, perhaps all of these issues are dealt with in the paper, but they sound like potential problems from the description here.

  3. A.J. Sutter says:

    @Matt: You make a good point about charge-off and privacy, especially since debt collectors may contact debtors at their workplace. The paper also doesn’t address the question of whether people who choose charge-off are under the mistaken impression (at the time of choice) that this relieves them of legal liability for the debt.

  4. I am a bankruptcy attorney in Ft. Myers, Florida. I have never had a client discuss whether their neighbors filed bankruptcy or not. The decision was driven by their inability to pay their creditors after years of exhausting their savings and retirement accounts. Most of the people who filed were concerned about the stigma; however, that stigma did not necessarily concern their neighbors. It was more of a feeling of self-failure. The feeling generally dissipated within a few months of filing.
    The people who didn’t file bankruptcy ended up having more stigma with their neighbors because the process servers served them in front of their neighbors or the repo guy showed up in front of the neighbors.

  5. Jones says:

    There are many bankruptcy chapter that are registered according to the types of personal bankruptcy, so it depends on the types of case. It will helps great if the bankruptcy tool is used..

  6. Sandra says:

    I think the subject of the article is that you can be just “infected” by the bankruptcies of neighbors and so have your own business going worse. But of course the main reason is that you are not able to pay the bills and taxes. For such situation you may try getting a loan here It’s an on-line service that matches the potential borrowers with the direct loan lenders, so all the terms and conditions can be discussed individually. The money are transferred through the bank, so it’s completely legal.