PERSONAL BANKRUPTCY: 

A LITERATURE REVIEW

September 2000
NOTES

Shaded areas in figures represent recessions as defined by the National Bureau of

Economic Research. The areas extend from the peak to the trough of the recessions.

Annual data on personal bankruptcy filings end on June 30 of the year indicated.

Other annual data refer to calendar years.

Numbers in the text and tables may not add up to totals because of rounding.
PREFACE

The sharp rise in personal bankruptcy filings between 1994 and 1998, a period of

economic expansion, has renewed a long-standing debate about bankruptcy laws.

One side of that debate ascribes a significant share of the rise in filings to the current

law and to a lessening of the stigma associated with filing for bankruptcy. The other

side of the debate argues that the rise primarily reflects an increase in financial

distress within the consumer sector. This Congressional Budget Office (CBO) paper

reviews the available data and evaluates the empirical research on personal

bankruptcy. It was prepared at the request of John Conyers Jr., Ranking Democratic

Member, House Committee on the Judiciary; Jerrold Nadler, Ranking Democratic

Member, Subcommittee on Commercial and Administrative Law of the House

Committee on the Judiciary; and Representatives William D. Delahunt and Martin

T. Meehan.

Kim Kowalewski of CBO’s Macroeconomic Analysis Division prepared the

paper under the supervision of Robert Dennis. At CBO, Coleman Bazelon, Doug

Hamilton, Arlene Holen, Debbie Lucas, Angelo Mascaro, John Peterson, David

Torregrosa, and Christopher Williams offered helpful comments, and David Arnold,

Ezra Finkin, John McMurray, and Michael Simpson provided capable research

assistance. Thanks are due to Ian Domowitz of Pennsylvania State University,

Stanley Longhofer of Wichita State University, Dean Maki of the Board of

Governors of the Federal Reserve System, Preston Miller of the Federal Reserve

Bank of Minneapolis, and Tim Muris and Todd Zywicki of George Mason

University's School of Law for their comments on earlier drafts. Special thanks go

to Melissa Jacoby of the Beasley School of Law at Temple University for sharing her

expertise on countless occasions regarding personal bankruptcy and the law, and to

Marilyn Miller of the Administrative Office of the U.S. Courts for promptly filling

requests for data on bankruptcy filings. Kevin Brown of the Federal Deposit

Insurance Corporation kindly supplied and explained the data on commercial banks.

Leah Mazade edited the paper, and Christine Bogusz proofread it. Verlinda

Lewis-Harris typed the paper and prepared the manuscript for final publication.

Annette Kalicki prepared the electronic versions for CBO’s World Wide Web site

(www.cbo.gov).

Questions about the analysis may be addressed to Kim Kowalewski at (202)

226-2776.

Dan L. Crippen

Director

September 2000

CONTENTS

SUMMARY vii

THE FUNDAMENTALS OF PERSONAL BANKRUPTCY LAW 1

Debt Collection and Insurance

Basic Provisions of Chapter 7

Basic Provisions of Chapter 13

TRENDS IN PERSONAL BANKRUPTCY FILINGS 4

The Personal Filing Rate in the Postwar Period

The Personal Filing Rate and the Household Sector’s

Risk of Default

FACTORS LEADING TO PERSONAL BANKRUPTCY 11

Macroeconomic Factors 

Legal Incentives to File for Bankruptcy

The Stigma of Bankruptcy

THE ABILITY OF CHAPTER 7 FILERS TO REPAY THEIR DEBTS 23

Means-Testing Proposals from the 105th and 106th Congresses

Studies Estimating Debt-Repayment Capacity Under the Proposals

Implications of the Studies’ Estimates

Uncertainties Surrounding the Estimates

HOW PERSONAL BANKRUPTCY AFFECTS 

THE SUPPLY OF CREDIT 31

Creditors’ Responses to Personal Bankruptcy Provisions

The Impact of Personal Bankruptcy on Creditors’ Losses

Explaining the Recent Decline in Personal Filings
vi PERSONAL BANKRUPTCY: A LITERATURE REVIEW

APPENDIXES

A. Problems with the Data on Personal Bankruptcy Filings 41

B. The Stigma Variables Used by Fay, Hurst, and White 45

REFERENCES 47

TABLES

1. Parameters for the Means-Testing Proposals Examined by the Studies 25

2. Disposition of Chapter 13 Cases, 1984-1991 31

3. Average Losses and Recoveries per Bank on Bank Credit Cards 35

FIGURES

1. The Personal Filing Rate for Bankruptcy, 1948-1999 6

2. The Personal Filing Rate and the Debt-to-Income Ratio of 

the Household Sector, 1948-1999 8

3. Growth in the Personal Filing Rate and the Debt-Service

Burden of the Household Sector, 1981-1999 10

4. Profitability Measured as the Return on Assets and Net Losses for 

Commercial Banks Specializing in Credit Card Lending 36

5. The Delinquency Rate on Credit Card Loans at Commercial Banks 38

A-1. Joint Personal Bankruptcy Filings 43
SUMMARY

During the economic expansion of the 1990s, the rapid increase in the rate of filing

for personal bankruptcy focused attention on the nation’s bankruptcy law. Between

1994 and 1998, the personal filing rate—specifically, the number of nonbusiness

bankruptcy cases filed annually per million adults—rose about 75 percent to a

historic high of 7,148 (or about 0.7 percent of the United States’ adult population).

Yet at the same time, the economy was expanding at a healthy pace, and the civilian

unemployment rate was falling. That apparent contradiction renewed a long-standing

debate about how big a role bankruptcy law and other factors may have played in the

personal filing rate’s climb.

Personal bankruptcy law is intended to help people who cannot pay their debts.

By filing under Chapter 7 of the law, people may generally avoid repaying many

kinds of debt in full. The law also allows them to keep specified amounts of certain

assets (known as exempt assets) and all future income for a “fresh start” in life after

bankruptcy. 

Consequently, bankruptcy law creates an incentive for people to increase their

borrowing because they know that they will not be impoverished if they have trouble

with debt. The magnitude of the incentive, as well as the choice of bankruptcy for

solving financial problems, depends on the extent of the benefits that a person

receives from bankruptcy. A law that allowed an ample fresh start would give people

a greater incentive to borrow than would a law with a smaller fresh start. Indeed, a

lenient law creates a greater temptation for people to borrow more money than they

could possibly repay over a reasonable period of time. Such a law would also give

people a greater incentive to choose bankruptcy rather than other ways of solving

their problems. In fact, a more lenient law gives people with few assets but the

capacity to repay some of their debts out of future income a stronger incentive to use

bankruptcy to escape debt repayment altogether.

Bankruptcy law also creates an incentive for lenders to reduce the supply of

credit and raise the cost of borrowing. Losses stemming from bankruptcy, like losses

from other defaults on loans, encourage lenders to boost their interest rates, tighten

other standards and terms for lending, and reduce the availability of loans. People

typically respond to those changes by borrowing less, which diminishes their

exposure to debt-repayment problems and makes them less likely to file for

bankruptcy.

Advocates on one side of the debate about the effects of current bankruptcy law

believe that its incentives explain a large part of the filing rate’s upswing and its

continued high level. They argue that Chapter 7 makes it too easy and too attractive

for people to avoid repaying their debts. Such advocates contend that a significant

number of debtors file for a Chapter 7 bankruptcy even though they are likely to have

sufficient income in the future to repay a sizable portion, if not all, of their debts.
viii PERSONAL BANKRUPTCY: A LITERATURE REVIEW

Also contributing to the higher rate of filing, say some observers, is a lessening of the

stigma that society has traditionally associated with bankruptcy.

Many people who consider current law too lenient argue for a means-testing

provision that would restrict the way a person could file for bankruptcy. The

provision would prohibit people who exceeded certain thresholds for income and

debt-repayment ability from filing under Chapter 7 of the law; their options would

be to withdraw their petition or to file under Chapter 13 of the law, which encourages

them to repay more of their debts out of future income. (Under that provision, people

set up a court-approved plan to repay a specific amount of debt over three to five

years, after which they may stop repaying the remaining debts covered under the

plan.)

Advocates on the other side of the debate about current bankruptcy law see the

higher personal filing rate as largely reflecting an increase in financial distress within

the household, or consumer, sector of the economy. They contend that such distress

stems from adverse circumstances that batter people’s finances or from honest

mistakes that people make in managing their money. Some proponents of that

position attribute most of the rise in the personal filing rate to lenders, particularly

bank credit card lenders, who, they say, have overburdened people by extending

credit recklessly. Many observers on this side of the debate argue against a meanstesting provision for personal bankruptcy law.

The debate attests to the difficulty that policymakers have in designing a

bankruptcy law that promotes the common good. Most people would probably

approve in theory of a law that prevented consumers from intentionally cheating

creditors by running up debt and then using bankruptcy to escape repayment. The

challenge for lawmakers is to develop provisions that catch only the cheaters,

because the distinction between them and people who, in society’s view, deserve a

fresh start is not always clear-cut. A more exacting law might lower borrowing costs

and increase the availability of credit, but it could also deny a fresh start to deserving

individuals. Conversely, a more lenient law that expanded the fresh start and allowed

more cheaters to walk away from debts might raise the costs of borrowing and reduce

the supply of credit. 

Evidence about how much borrowers and lenders respond to the incentives in

bankruptcy law would help policymakers as they work to redesign it. How much do

those incentives affect people’s decisions to borrow money and to declare

bankruptcy? What percentage of debts “discharged” (or forgiven) in bankruptcy

could actually be repaid? How much do lenders adjust the cost and availability of

credit on the basis of changes in their bankruptcy losses? Answers to those questions

would give policymakers vital clues about the possible inefficiency of current law.

In its search for those answers, the Congressional Budget Office (CBO)

reviewed the available data and evaluated existing studies on personal bankruptcy.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW ix

1. See, for example, the National Bankruptcy Review Commission (1997).

2. Bermant (1999) discusses other gaps in the data about people who file for bankruptcy.

Overall, CBO found that those sources generally offered only limited guidance.

Although economic reasoning can identify the direction of borrowers’ and lenders’

responses to incentives in bankruptcy law, empirical research has made only a little

progress in estimating the magnitude, and hence the significance, of those responses.

Estimates of potential debt repayment by Chapter 7 filers under various proposals

with a means-testing requirement suggest that some filers might be using bankruptcy

to escape from their debts. The potential repayments by those filers are uncertain;

they might amount to as much as several billion dollars. Repayments of that

magnitude would contribute to a lower cost and a greater availability of credit, but

the exact changes are unclear.

Many analysts who have studied the current bankruptcy law agree that some of

its provisions could, indeed, be improved.1

 However, this paper does not analyze

alternative proposals for changing the law, nor does it indicate areas in which the law

might be reformed. Moreover, following CBO’s standard procedures, it does not

present recommendations about policy.

Available Data on Bankruptcy and Related Topics

A lack of data hinders any attempt to analyze the effect of bankruptcy law on

borrowers and lenders. The official statistics collected by the Administrative Office

of the U.S. Courts are insufficient to determine how well the bankruptcy system is

working. For example, such basic information as the total amount of debt discharged

in personal bankruptcy is lacking, and the data on personal bankruptcy filings have

several problems that limit their usefulness (see Appendix A).2 Data on individual

filers are scanty as well, and for good reason: collecting such data would require not

only a large sample of personal bankruptcy petitions but also direct questions to the

consumers themselves—a complex, expensive undertaking. Data on related topics,

such as the stigma associated with a bankruptcy filing, simply do not exist. And

public information on the cost and availability of credit for consumers is fragmentary,

which makes it difficult to estimate how much lenders adjust the quantity and price

of the credit they offer in response to their bankruptcy losses.

What the available data do indicate is that, from a historical perspective, the

rapid rise in the personal filing rate from 1994 to 1998 is unusual but not

unprecedented. The rate has also risen, in some cases rapidly, in other economic

expansions since the end of World War II. In the broadest of terms, the personal

filing rate follows the risk of default within the household sector, measured as either

the sector's debt-to-income ratio or its debt-service burden (the ratio of household

debt payments to disposable personal income). Indeed, increases in the risk of
x PERSONAL BANKRUPTCY: A LITERATURE REVIEW

3. Luckett (1988) briefly reviews some of that research.

4. In general, studies show that rates of filing for bankruptcy tend to be higher in states with stricter laws for

wage garnishment. See, for example, Stanley and Girth (1971) and Ellis (February 1998).

default within the household sector typically precede increases in the personal filing

rate, which suggests that at least some of the major factors behind the rise in personal

bankruptcies during the 1990s are the same factors that increased the household

sector’s risk of default.

Empirical Research on the Factors Leading to Personal Bankruptcy

The empirical literature on personal bankruptcy is voluminous, but researchers have

made little progress in judging the relative importance of the factors that lead people

to file. Economists would generally agree that the health of the economy and of the

household sector and other aspects of the demand for and supply of credit are key

macroeconomic factors that underly the broad trends in the risk of default within the

household sector. Consequently, they might also be expected to significantly affect

the personal filing rate. Empirical studies do not, however, consistently find such

effects.

Not surprisingly, studies of individual filers indicate that a person’s financial

health affects his or her chances of going bankrupt. Such research has shown that

people from all walks of life experience financial difficulty for a variety of economic

and personal reasons, including large medical bills following a serious illness or

accident; divorce; loss of income as a result of unemployment or a drop in overtime

hours; and what is generally termed poor debt management, which may cover several

underlying factors.3 However, for the most part, the studies do not examine the

specific factors that might motivate a person to file for bankruptcy rather than resolve

financial distress in some other way. (For example, one impetus toward filing may

be the desire to avoid wage garnishment.)4

 Because the sources of financial difficulty

shed little light on how people respond to the incentives in bankruptcy law, those

studies are not reviewed in this paper.

Research to estimate how the incentives in bankruptcy law affect personal filings

has had limited success. Perhaps the clearest finding from such studies is that

consumers generally file under the chapter of the law that best suits their financial

circumstances. Another result from a study of consumers suggests that the

probability of filing for bankruptcy generally increases with bankruptcy’s financial

benefits. Other studies have had less success in identifying the role played by

bankruptcy law incentives. For example, studies of the estimated impact of the

Bankruptcy Reform Act of 1978, which instituted major changes in the law, found

effects ranging from negligible to substantial. Research has also produced mixed
PERSONAL BANKRUPTCY: A LITERATURE REVIEW xi

results about how provisions for exempt assets affect personal filing rates measured

at the state level.

Several studies maintain that the social stigma associated with filing for

bankruptcy plays a significant role in determining the filing rate, but at best, those

findings are merely suggestive. Because direct measures of stigma do not exist, the

studies used other variables as proxies—that is, to approximate the effects of stigma.

However, the proxy variables did not isolate stigma’s influence on the filing rate.

Some of those variables were related to economic factors in addition to stigma, and

some proxies measured only an unexplained change in filing rates over time. Other

proxies were open to interpretation. Consequently, the studies probably overstated

the effects of stigma.

Studies Simulating Proposals for a Means-Testing Provision in Bankruptcy Law

A clearer indication of how people respond to the incentives in bankruptcy law

comes from several studies that simulated recent legislative proposals for a meanstesting requirement. The requirement would prohibit Chapter 7 filings (but not

filings under Chapter 13) by people whose incomes were above certain thresholds

and who could repay a minimum percentage or amount of their nonpriority unsecured

debt (for example, credit card debt) over a five-year period. (Little nonpriority

unsecured debt is repaid in bankruptcy.) As noted earlier, advocates of a meanstesting requirement argue that current law gives people a strong incentive to file for

bankruptcy to avoid debts that they could afford to repay. The studies' estimates of

the number of filers whose income and debt-repayment capacity would have

exceeded the means-testing thresholds provide one indication of the possible

magnitude of the incentive’s effect.

The studies suggest that a small percentage of Chapter 7 filers could repay a

substantial portion of their nonpriority unsecured debt. A very small percentage—typically no more than 5 percent—of filers could repay 100 percent or more of

that debt; larger percentages—but typically no more than 15 percent—of filers had

the means to repay at least 20 percent or 25 percent. (The results depended on the

study and the specific proposal being examined.) In particular, a study of H.R. 833,

the Bankruptcy Reform Act of 1999, estimated that 10 percent of Chapter 7 filers in

1997 could repay at least 25 percent or $5,000 of their nonpriority unsecured debt

over a five-year period. Another general finding from the studies was that the

amount of nonpriority unsecured debt repaid by people exceeding the means-testing

thresholds would amount to no more than a few billion dollars. (Researchers who

simulated the effects of H.R. 833 estimated repayment of $3 billion, or 8.6 percent,

of the total amount owed by Chapter 7 filers in 1997.)

Although the studies agree in a broad sense that some filers could repay a

substantial portion of their debts, they differ in their estimates of the percentage of
xii PERSONAL BANKRUPTCY: A LITERATURE REVIEW

filers who would not be allowed to file under Chapter 7 and the amount of debt they

might repay. The varying provisions of the means-testing proposals and researchers’

differing assumptions about the amount of income that filers could keep for living

expenses while repaying their debts accounted for most of the differences; the

remaining variation (probably only a small part overall) reflected differences in the

samples of filers that the studies used. The proposals adopt the standards for living

expenses that the Internal Revenue Service uses in tax collection cases. But

researchers in the studies CBO examined interpreted those standards—and the

expenses they covered—in varying ways, which raises the question of how different

bankruptcy judges would rule on the allowances and consequently how much debt

could actually be recovered. Another area in which the studies differ is in their

assumptions about information that was unavailable to researchers, such as a filer’s

monthly payments on secured debts like mortgages.

The amount of debt repayment that a means-testing requirement might generate

is uncertain for other reasons. For instance, the studies assume that filers would

complete their Chapter 13 repayment plans. Yet the available data indicate that a

significant fraction of consumers who filed Chapter 13 plans in the past did not make

all of their scheduled payments. (Why those plans fail is not clear.) Another

unknown factor clouding debt-repayment estimates is how people would respond to

a repayment plan that stretched out for five years and committed a substantial

proportion of their income to paying down debt. Some filers might decide that

repayment was too burdensome and so work less or hide income to reduce their

payments. Other filers might take on more debt and find themselves back in financial

trouble. Alternatively, if a means test was in place, some consumers might not file

at all and would make a greater effort to repay their debts.

Empirical Research on How Bankruptcy Affects the Supply of Credit

In theory, a stricter bankruptcy law ought to lower the average cost of credit and

increase its availability (particularly in the case of unsecured credit). One study, in

fact, found that in states with low asset exemptions, households owning few assets

faced lower interest rates on auto loans and held more debt than did similar

households in states with high asset exemptions. The same study also found that the

probability of a household’s being denied credit (of any kind) or being discouraged

from applying for a loan was lower in states with lower asset exemptions. 

But there is little empirical evidence showing how the supply of credit has

responded to past changes in bankruptcy law provisions. Some data indicate that, at

least for credit card lenders, losses related to bankruptcy are large enough to affect

their decisions about lending. It is unclear, though, exactly how the cost and

availability of unsecured credit for consumers would change as a result of a meanstesting requirement for Chapter 7 filing.
5. Bankruptcy law also helps creditors by providing a collective forum for debt collection that is based in

large part on their rights and priorities under state law (Jackson 1986).

THE FUNDAMENTALS OF PERSONAL BANKRUPTCY LAW

Bankruptcy law is a debt-collection law that insures people to some extent against the

inability to repay their debts as they fall due. The vast majority of people file for

bankruptcy under either Chapter 7 or Chapter 13 of the bankruptcy law (specifically,

title 11 of the U.S. Code). (Certain consumers can also file under Chapter 11 or

Chapter 12.) Chapter 7 is used by about 70 percent of filers; it provides for "straight

bankruptcy," or the liquidation of assets. Chapter 13, entitled "Adjustment of Debts

of an Individual with Regular Income," is a court-sponsored debt-refinancing plan.

Debt Collection and Insurance

The procedures by which creditors can collect debts are laid out in state commercial

law as well as in bankruptcy law. State commercial law outlines the process for

staking a claim to what is owed; it also ranks those claims and details the “remedies”

available to creditors to satisfy or collect them. State law for debt collection is a

"grab law," based on the notion of first come, first served. Accordingly, the creditor

that first stakes a claim to particular assets of a debtor is entitled to be paid first

(Jackson 1986). The legal remedies for creditors, such as foreclosure on and the sale

of property, allow them to collect what they are contractually owed, and from the

point of view of state law, debtors are required to repay debts in full, regardless of the

circumstances. But debtors sometimes default on their debts, and grab law makes no

provision for sharing the risk of such defaults—either among creditors or between

debtors and creditors. That results in an inefficiency; in other words, society would

be better off with provisions for sharing default risk. The inability of borrowers to

shift such risk also creates what is known as an adverse selection problem for

creditors: risk-averse consumers will shy away from borrowing, leaving creditors

with a group of riskier borrowers.

Bankruptcy law can better allocate the risk of default for the economy in

comparison with the allocation provided by state commercial law. Most important,

bankruptcy law spreads default risk among borrowers and lenders by providing

borrowers with some insurance against their inability to repay their debts. The

insurance “payoff” for borrowers is the opportunity to receive a discharge (or

forgiveness) of their debts and to keep certain assets to start life afresh after

bankruptcy. As a result, that insurance gives people an incentive to increase their

borrowing because they know they will not be impoverished if they cannot repay

their debts. Society benefits from this aspect of greater risk spreading because it

allows people to better plan their consumption—they can finance it when they desire

it most rather than when they have the cash to pay for it.5
2 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

6. A brief summary of the changes made by BRA-78 appears in Domowitz and Eovaldi (1993). 

7. The growth of the market for consumer credit in Europe during the 1980s, which was followed by

recession in the early 1990s, prompted many European nations to modify their consumer bankruptcy laws.

See Niemi-Kiesilainen (1997).

In the long run, borrowers pay the cost of the insurance provided by bankruptcy

law. To recoup their losses from bankruptcy, creditors will raise the cost of

borrowing by using a combination of stricter standards and terms on their loans, such

as higher interest rates, larger down payments, and restrictions on the supply of

credit. Essentially, the premium borrowers pay for the insurance coverage of

bankruptcy is that additional cost of borrowing. In the short run, creditors will share

some of the risk of default if their loan losses are greater than expected. Moreover,

if the law is tightened, creditors are likely to profit—at least temporarily (see the later

discussion).

The strength of the law’s incentive to borrow and the cost of borrowing depend

on the magnitude of the fresh start. The greater the fresh start, the greater are the

incentive to borrow and the cost of borrowing. A larger fresh start also gives people

more incentive to use bankruptcy, rather than other means, to solve their financial

problems and escape debt repayment. Consequently, a bankruptcy law with a

generous fresh start may promote greater risk spreading, but it can also raise the cost

of borrowing by expanding the fresh start and making it easier for people to walk

away from debts that they could afford to repay.

The difficulty of achieving a desirable trade-off between the benefit of risk

sharing and its cost helps explain several changes to bankruptcy law since the late

1970s:

o The Bankruptcy Reform Act of 1978 (BRA-78) was the first overhaul since

1898 and the first major revision since the Chandler Act of 1938 introduced

the wage-earner Chapter XIII plan, precursor to the current Chapter 13.6

BRA-78 had several goals: to modernize bankruptcy law following the

tremendous growth of consumer credit in the post-World War II period, to

improve the fresh start for personal filers, and to reform a bankruptcy court

system that many people viewed as inefficient and unfair (Jeweler 1997).7

o The Bankruptcy Amendments and Federal Judgeship Act of 1984 sought

in part to curtail alleged abuses of bankruptcy law by reducing bankruptcy’s

benefit for consumers (Kowalewski 1985).

o The Bankruptcy Reform Act of 1994 made a host of changes in the

bankruptcy code; among other things, it doubled the dollar value of federal

asset exemptions (which had not been adjusted for inflation since 1978) and

included provisions to curtail bankruptcy fraud.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 3

8. The definition of a claim is very broad under the bankruptcy code. All possible legal obligations—to

banks, finance companies, public utilities, hospitals, divorced spouses, and governments, for example—are

within the purview of the bankruptcy court, including claims that are unliquidated or contingent. Thus,

the term "creditor" covers any entity with a legal claim on the debtor that arose before the bankruptcy case

began. It also covers some claims that arise afterward.

Basic Provisions of Chapter 7

Under Chapter 7, the administrator of a bankruptcy case, who is known as the trustee,

oversees the liquidation, or sale, of a debtor’s nonexempt assets and the distribution

of the proceeds to creditors. Only creditors with “allowable” claims in the case

receive a share of those proceeds, which are distributed after the trustee's expenses,

other administrative costs, and priority claims have been paid.8 Unless the court

finds that the debtor was dishonest or engaged in wrongdoing, it discharges (forgives)

all allowable claims on the person and his or her assets except for nondischargeable

claims (for example, many kinds of taxes) and any debts covered under reaffirmation

agreements (in which the person specifically agrees to repay one or more debts). The

debtor keeps the value of the assets designated as exempt under the law (the fresh

start discussed above) and may not receive another discharge under Chapter 7 for six

years.

Although bankruptcy law is federal in scope, provisions designating exempt

assets appear in both federal and state law. BRA-78 introduced federal exemptions

but allowed states to “opt out” of using the federal limits and continue using their

own. Today, 35 states do not use the federal exemptions; in the remaining states,

residents may use either the federal or the state exemptions. Both federal and state

exemptions cover broad categories of assets including primary residences; motor

vehicles; various kinds of personal property, such as household goods and clothing;

and the tools of a person’s trade. However, the particular types of assets that may be

exempt and the dollar values of those exemptions vary widely.

The homestead exemption is a good example of how dollar values for asset

exemptions differ among the states. Georgia allows bankrupt consumers to keep only

$5,000 of equity in real property used as a residence; Florida, in contrast, allows an

unlimited amount of equity in as much as one-half acre in a municipality or 160

contiguous acres elsewhere (King 1998). The federal dollar limit on the homestead

exemption is currently $16,150 and is adjusted for inflation every three years. 

Basic Provisions of Chapter 13

Chapter 13 helps people avoid liquidation of their assets by requiring them to repay

their debt out of future income. To qualify for a Chapter 13 discharge, debtors (with

the exception of stockbrokers and commodity brokers, who are covered by separate

provisions) must have a regular income, and their unsecured (such as credit card) and
4 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

9. Chapter 7 filings may be dismissed for several reasons, including a judgment that discharging debts would

be a “substantial abuse” of the law’s provisions. The antiabuse language has been interpreted by the courts

to authorize dismissal if debtors are able to pay part or all of their debts out of future income.

10. Jeweler (1997) discusses differences between Chapters 7 and 13 in the definition of dischargeable debts.

secured debts must total less than $269,250 and $807,750, respectively. The debt

limits are adjusted for inflation every three years. 

Under Chapter 13, the debtor works with the trustee and submits a plan to the

court to repay outstanding debts over three (or, in some circumstances, five) years.

The plan must satisfy three criteria:

o First, although the plan may call for less than full repayment of certain

debts, creditors must receive at least as much as they would have received

if the consumer had filed for bankruptcy under Chapter 7 and liquidated his

or her nonexempt assets. 

o Second, the trustee and all unsecured creditors must agree to the plan. If

one of them objects, the debtor must use all of his or her income in excess

of reasonably necessary living and business-related expenses for debt

repayment. 

o Third, the court must determine that the plan has been filed in “good faith”;

otherwise, the plan may be dismissed.9

When the payments are completed, the consumer receives a discharge from all

debts that the plan covered. A Chapter 13 filing has three advantages (relative to a

Chapter 7 filing) that encourage people to use it: debtors retain all of their property,

not just their exempt assets; a greater variety of claims can be discharged; and

consumers may be able to repay less than they owe on certain secured debts.10

TRENDS IN PERSONAL BANKRUPTCY FILINGS

The rapid increase in the personal filing rate between 1994 and 1998, despite the

vigor of the nation’s economy, is unusual but not unprecedented, given that the rate

has risen during previous periods of relatively strong economic growth as well as

recession. In fact, for the most part, the rate has trended upward since the end of

World War II. What accounts for the growth in personal bankruptcy filings, both

before 1994 and, more specifically, between 1994 and 1998? On the surface, the

upswing in the filing rate mimics the trend in the risk of default for the household

sector. Yet because households have some control over that risk, changes in its trend

do not completely explain changes in the personal filing rate. As discussed later, the

current policy debate is about what underlies the ascending trends in both measures.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 5

The Personal Filing Rate in the Postwar Period

The personal filing rate has risen during all but one economic expansion of the

postwar period (see Figure 1). Indeed, although the rate has often increased

especially sharply during recessions, much of its postwar growth has occurred in

good economic times, not in slowdowns. Between 1948 and 1967, the rate climbed

in every year except 1962, when it fell slightly after a jump in 1961. Between 1967

and 1979, the rate varied within a modest range, following a more cyclical

pattern—rising during a recession, falling immediately afterward, and then rising

later in the expansion. The rate has trended strongly upward in the 1980s and 1990s,

with modest declines following recessions. The rate fell in 1999, though it remains

high.

The break in the personal filing rate displayed in Figure 1 shows that after 1979,

the rate is not strictly comparable with the rate before that year. The reason is that

the Bankruptcy Reform Act of 1978 introduced joint husband-and-wife bankruptcy

petitions. (Before the law was enacted, a husband and wife had to file separate

petitions.) Comparing the number of filings before and after 1979 is difficult because

analysts do not know how to adjust the data to account for the joint filings (see

Appendix A). CBO chose to indicate the break when appropriate and, after 1979, to

use the number of nonbusiness bankruptcy filings to calculate the personal filing rate.

The Personal Filing Rate and the Household Sector's Risk of Default

Changes in the personal filing rate tend to mirror changes in the risk of default in the

household sector. A household's risk of default generally rises when:

o It takes on additional debt,

o Interest rates on its floating-rate debt rise,

o Its income falls, or

o Its extraordinary or other living expenses rise.

Analysts typically use two ratios to measure the household sector's risk of default:

the debt-to-income ratio and the debt-service burden. Yet neither of those measures

is a perfect indicator of default risk. Both fail to incorporate changes in extraordinary

and other living expenses, and the debt-to-income ratio does not encompass interest

rate changes on floating-rate debt or the effects on monthly payments of refinancing

debt.
6 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

FIGURE 1. THE PERSONAL FILING RATE FOR BANKRUPTCY, 1948-1999

SOURCES: Congressional Budget Office; Administrative Office of the U.S. Courts; Department of Commerce, Bureau of

the Census.

NOTES: The personal filing rate is the number of nonbusiness bankruptcy cases filed per million adults age 20 and older.

The data are plotted on a logarithmic scale.

A break occurs in the personal filing rate between 1979 and 1980 because the data are not strictly comparable. The

break represents the introduction of joint husband-and-wife filings allowed by the Bankruptcy Reform Act of 1978.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 7

11. The data on debt come from Board of Governors of the Federal Reserve System (2000). Consumer credit

includes installment and noninstallment debt. Home mortgage debt includes home-equity loans.

12. The close correlation should not be taken to mean that debt is the cause of bankruptcy. Of course, debt

is necessary for bankruptcy, but saying that it causes bankruptcy begs the question of what factors explain

the debt holdings of households. Those factors are discussed later in this paper.

13. Consumers’ expectations about their income prospects also affect their decisions about saving, as discussed

in Congressional Budget Office (1993).

14. The incentives in bankruptcy law and the stigma associated with filing for bankruptcy probably do not

affect the risk of default across the business cycle.

Debt-to-Income Ratio. This ratio is measured as the sum of consumer credit plus

home mortgage debt divided by disposable, or after-tax, personal income.11 It

compares the level of the major types of debt held by the household sector with a

measure of the sector’s ability to repay that debt. A larger amount of debt relative to

income indicates a larger amount of default risk; that is, as more households have

more debt relative to their repayment ability, more of them are more likely to face

financial difficulties arising from any source.12

The risk of default, according to this measure, can mount because households

take on more debt relative to their income or because their income falls relative to

their debt. In economic expansions, households generally take on debt at a greater

rate than the rate at which their income expands; most analysts think the reason is

that households feel confident about their income prospects and their debt-repayment

ability.13 At the same time, creditors are more willing to lend because they feel more

confident that they will be repaid. By contrast, in recessions, creditors are less

willing to lend. Households, for their part, take on debt more slowly, but the growth

rate of their income drops off even more sharply. Just after recessions, the debt-toincome ratio may fall for a while because households’ incomes pick up before

households and creditors become confident enough about their financial futures to

resume more normal patterns of borrowing and lending.14

Both before and after 1979, the broad trend in the personal filing rate follows the

trend for the debt-to-income measure (see Figure 2). Given the break in the data for

the personal filing rate, one cannot conclude that the relationship remained the same

in the two periods. Nevertheless, the increase in the personal filing rate between

1994 and 1998 is broadly consistent with the rise in the household sector’s default

risk during that period.

Generally, an increase (or decrease) in the risk of default precedes an increase

(or decrease) in the personal filing rate. For the year ending June 30, 1998, for

example, the rise in the personal filing rate reflects the rise in the risk of default at the

end of calendar year 1996. The lag may occur because loans typically do not go into

default immediately and because people may try to resolve their financial problems
8 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

FIGURE 2. THE PERSONAL FILING RATE AND THE DEBT-TO-INCOME 

RATIO OF THE HOUSEHOLD SECTOR, 1948-1999

SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis and Bureau of the

Census; Federal Reserve Board. 

NOTES: The personal filing rate is the number of nonbusiness bankruptcy cases filed per million adults age 20 and older.

The data are plotted on a logarithmic scale.

The debt-to-income ratio, which is plotted with an 18-month lag, is the ratio of the sum of consumer credit plus

home mortgage debt to disposable (after-tax) personal income.

A break occurs in the personal filing rate between 1979 and 1980 because the data are not strictly comparable. The

break represents the introduction of joint husband-and-wife filings allowed by the Bankruptcy Reform Act of 1978.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 9

15. The series is described at www.federalreserve.gov/releases/housedebt/about.htm.

before filing for bankruptcy. The lag appears to be the same both before and after

1979.

Some analysts dispute the correlation between the personal filing rate and debtrelated measures of the household sector's default risk. Their arguments, however,

are based on less useful measures of that risk. Chimerine (1996) and Feldstein

(1998), for instance, do not believe that the rise in personal bankruptcy filings during

the mid-1990s is related to growth in the debt holdings of the household sector.

However, the measure Chimerine uses covers only consumer credit; it excludes home

mortgages and home-equity loans, which are substantial components of household

debt. Indeed, many people have taken equity out of their homes to support their

consumption, using such loans as a substitute for consumer credit (Canner, Durkin,

and Luckett 1998). One of Feldstein's arguments against the idea that debt

contributed to the surge in filings is that the nominal-dollar value of debt is not

closely related to personal bankruptcy filings. That finding is not surprising because

the amount of outstanding debt presumably rises when creditors believe that they will

be repaid. Thus, the ratio of debt to income, rather than the nominal-dollar amount

of debt, better measures the household sector’s vulnerability to financial problems.

Debt-Service Burden. This measure is the ratio of the household sector’s debtservice payments to disposable personal income, as computed by the staff of the

Board of Governors of the Federal Reserve System. Debt-service payments are the

principal and interest payments on consumer credit and home mortgages (the two

debt variables used in the debt-to-income ratio). According to that measure, the risk

of default increases as debt-service payments rise relative to income. Because no

comprehensive statistics exist on actual debt-service payments by households, the

Board of Governors’ staff estimate the payments using data on the average terms for

new loans and a variety of assumptions for the period since 1980. The staff consider

their estimates to be a “rough approximation” that is useful for indicating changes in

(rather than levels of) the household debt-service burden.15

The relationship between growth in the personal filing rate and the change in the

household debt-service burden, plotted with a one-year lag, is shown in Figure 3.

Growth in the filing rate tends to increase (or decrease) in the year following a greater

(or smaller) increase in the debt-service burden. In particular, the slowdown in the

rate’s growth during the past few years corresponds to smaller increases in the debtservice burden. 
10 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

FIGURE 3. GROWTH IN THE PERSONAL FILING RATE AND THE DEBT-SERVICE 

BURDEN OF THE HOUSEHOLD SECTOR, 1981-1999

SOURCES: Congressional Budget Office; Department of Commerce, Bureau of the Census; Federal Reserve Board.

NOTE: The debt-service burden, which is plotted with a one-year lag, is the ratio of the household sector’s debt-service

payments to disposable (after-tax) income.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 11

16. Some analysts have also cited greater awareness among consumers of the benefits of bankruptcy—stemming perhaps from advertising by lawyers or discussions with family members and friends who

have filed for bankruptcy—as another factor in the rate’s upward trend. Given the lack of data on that

factor, however, an evaluation of its importance is difficult.

FACTORS LEADING TO PERSONAL BANKRUPTCY

The current debate over revising personal bankruptcy law centers on the reasons for

the personal filing rate’s jump between 1994 and 1998 and its continued high level

since then. Some observers believe that the high rate, occurring in a strong economy,

indicates that many consumers are filing for bankruptcy even though they could repay

a substantial portion of their debt. Those observers argue that a significant

proportion of recent filings stem from various legal and social factors—in particular,

an overly lenient personal bankruptcy law and a weakening of the stigma that has

traditionally been associated with bankruptcy. Other observers maintain that growth

in the filing rate largely reflects a household sector that has become heavily indebted

and unable to manage its debt burden, as a result of financial troubles brought on by

bad judgment or bad luck.16 The debate comes down to the empirical question, What

is the relative importance of the various factors leading to personal bankruptcy?

Empirical research has made only limited progress in supplying an answer. The

close correlation during the postwar period between the default risk of the household

sector and the personal filing rate suggests that macroeconomic factors underlying

the risk of default play a large role in what happens to the rate nationally.

Economists would generally agree that those factors include measures of the

financial health of the household sector and other aspects of the demand for and

supply of credit. Because of possible methodological problems, however, empirical

studies do not consistently find that macroeconomic factors significantly affected the

filing rate. 

Mixed success also characterizes attempts to estimate how much the incentives

in bankruptcy-related federal and state law, as well as various social factors,

influence the personal filing rate. Those elements complement the macroeconomic

factors by providing additional explanations of credit demand and supply. But

measuring such elements accurately has proved difficult, if not impossible. The

clearest finding on how consumers respond to the incentives in bankruptcy law

comes from research comparing filers under Chapter 7 with those under Chapter 13.

Those studies suggest that consumers file for bankruptcy under the chapter that best

suits their circumstances. Moreover, some evidence suggests that the probability of

filing for bankruptcy rises with the financial benefits of filing. Research using the

personal filing rate measured at the national, state, and circuit court levels is split,

however—some studies found that bankruptcy law affected the filing rate, and others

did not. Several studies attempted to analyze whether changes in the stigma

associated with bankruptcy had affected people’s propensity to file. But those
12 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

studies were hampered by the use of proxy variables (discussed below) that do not

isolate stigma’s effects.

Macroeconomic Factors

Broadly speaking, the trends in the risk of default and indebtedness in the household

sector reflect trends in the sector’s economic health and in the supply of credit

available to households. The 1946-1967 period, which encompassed the baby-boom

years (1946 to 1964), was a time of rapid family formation. Consumers were

optimistic about the future because of low unemployment, low inflation, strong

household balance sheets, and the rapid growth of real (adjusted for inflation)

disposable personal income per capita. Consequently, lenders accommodated

consumers’ robust demands for credit, and indebtedness rose rapidly to finance

spending for housing and consumer durable goods. With greater indebtedness (and,

presumably, larger debt-service payments) relative to income, personal bankruptcies

rose as well.

In contrast, overall household finances generally deteriorated from about 1968

through 1982. The period was marked by economic turbulence as a consequence of

food and energy price “shocks” and rising inflation, two deep recessions on top of a

slowdown in the trend growth of real disposable personal income per capita, and

postwar highs in short- and long-term interest rates. Consumers lowered their

expectations about future economic conditions and grew cautious about accumulating

debt. Debt-financed purchases of houses and consumer durable goods slowed,

possibly also because the surge in family formation and the baby boom were over.

The personal filing rate was strongly correlated with the business cycle during this

period, as external forces dominated changes in family finances.

After 1982, the financial picture of the household sector brightened. A strong

economic recovery, rising stock market, and sharp drops in energy prices, inflation,

and interest rates bolstered the sector’s general financial health. Consumers’

expectations about their future prospects soared. With the baby-boom generation

entering its own family-formation phase, spending for housing, furniture, and other

consumer goods expanded, as did home mortgage and consumer debt. At the same

time, consumers increasingly used general-purpose credit cards as a substitute for

cash. As the indebtedness and default risk of the household sector increased, so did

personal bankruptcies.

The recession at the beginning of the 1990s and the slow recovery from it kept

a lid on the demand for credit by consumers and potential home buyers for several

years. But economic conditions in the household sector had improved again by the

second half of the decade. Employment gains came quickly as the economy began

to grow more rapidly; by the late 1990s, the civilian unemployment rate had fallen

to levels not seen in over two decades. Interest rates also fell while inflation
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 13

17. Chapter 4 of Congressional Budget Office (1993) reviews the possible reasons for the decline in personal

saving. See also Gokhale, Kotlikoff, and Sabelhaus (1996) as well as summary comments on that paper

in the same volume. Neither analysis examines the role that changes in bankruptcy law or in the stigma

of bankruptcy might play in the drop in the national personal saving rate.

18. As discussed later, creditors' efforts to tighten their lending standards might explain why personal

bankruptcy filings stopped rising in 1998.

19. See Getter (1996).

20. See, for example, Ausubel (1991); Canner and Luckett (1992); Evans and Schmalensee (1993); and Ellis

(March 1998).

remained under control, and household wealth was boosted by impressive gains in

the stock market. That confluence of favorable developments bolstered consumer

confidence and expectations about the future and probably contributed to the rise that

occurred in household indebtedness and default risk.

The preceding explanation of the broad trends in the demand for credit by

households and in the risk of default in the household sector is based on a widely

accepted theory of consumer spending behavior, the life-cycle model. Accounting

for variations in the household sector’s debt holdings more precisely is difficult,

however, because the literature offers few models of total household indebtedness.

That limited understanding of indebtedness mirrors economists’ lack of knowledge

about the factors that influence the rate of personal saving in the United States.17 The

saving rate fell in the mid-1980s and dropped considerably in the 1990s—at the same

time that household indebtedness and personal bankruptcies were rapidly rising.

Home mortgage and consumer lenders, of course, share responsibility for the rise

in the household sector’s risk of default. Lenders affect that risk through their terms

and standards of lending: lenient terms and standards encourage borrowing, which

raises default risk.18 Indeed, lenders have made credit more widely available,

particularly in the past two decades—a period encompassing changes in bankruptcy

law and alleged reductions in the stigma attached to bankruptcy. That wider

availability stemmed from deregulation of credit markets, technical innovations, tax

policy, and competition among lenders.19 For example:

o The Supreme Court’s 1978 decision in Marquette National Bank of

Minneapolis v. First of Omaha Service Corporation allowed a nationally

chartered bank to extend credit at the maximum interest rate of the state in

which it was chartered rather than at the maximum rate allowed by the

borrower’s state. That decision spurred many states during the early 1980s

to raise or eliminate the maximum rates of interest (usury ceilings) that

lenders could charge consumers, which contributed to the rapid growth of

credit card lending in the 1980s.20
14 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

21. One example of the effect of advances in information processing, the tremendous growth in solicitations

for bank credit cards, was documented by Ausubel (1998) in a hearing before the Senate Committee on

Banking, Housing, and Urban Affairs. The use of credit-scoring models is discussed in Staten (1993), who

notes that creditors increased their lending to riskier borrowers throughout the 1980s.

22. Economists have long recognized that imperfections in credit markets may prevent some creditworthy

consumers from obtaining credit at any cost. The percentage of those so-called credit-constrained

consumers in previous years has been estimated at between 15 percent and 45 percent of the population

(see, for example, Perraudin and Sorensen, 1992). Once constraints on credit are relaxed, those consumers

readily increase their borrowing and, consequently, their chances of financial trouble.

23. See Board of Governors of the Federal Reserve System (1995 and January 1997) for data on 1983 to 1992

and 1992 to 1995, respectively. See also Black and Morgan (1999).

o The elimination of ceilings on interest rates for deposits in banks and thrift

institutions ended the flow of funds out of those institutions when market

interest rates rose above the ceilings. The change helped to stabilize the

availability of funds for borrowers.

o The Tax Reform Act of 1986 eliminated the tax deductibility of interest

payments on consumer loans, which spurred growth in the market for

home-equity loans. Those loans cost less than consumer loans because

their interest rates are lower and interest payments are tax-deductible. 

o Advances in information processing and in financial management

techniques have reduced the costs of marketing and servicing a large

portfolio of loans. They have also allowed lenders to price and manage risk

better by using “credit-scoring” models (to evaluate prospective borrowers)

and loan securitization (to sell some of their loans to others).21 For

example, high loan-to-value home-equity loans (for up to 125 percent of a

homeowner’s equity) have become widely available.

The increased availability of credit has made individuals and homeowners better

off. By increasing the risk of default in the household sector, however, it has also

contributed to a higher incidence of personal bankruptcy. Consumers who formerly

could not get the credit they wanted have found it much easier to obtain in the past

20 years.22 Indeed, evidence compiled by the Board of Governors of the Federal

Reserve System indicates that borrowing increased broadly throughout the population

during the 1980s and the first half of the 1990s.23 To the extent that the increase in

indebtedness of the household sector reflects borrowing by consumers who

previously found credit difficult to obtain, that indebtedness would be more the result

of the greater supply of credit than of changes in attitudes toward debt and

bankruptcy. (That would be true even if more marketing of credit had changed

consumers’ attitudes.) Evaluating that possibility, however, requires additional

research.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 15

24. The results of Fay, Hurst, and White's study may be misleading if some of the respondents who said they

filed did not receive a discharge of their debts.

25. The figure probably refers only to those who filed under Chapter 7.

Legal Incentives to File for Bankruptcy

A considerable amount of research has examined whether the incentives contained

in federal and state law have driven up bankruptcy filings. Many studies have

investigated BRA-78's effect on the personal filing rate; others have developed

simple measures of the value of asset exemptions to judge how those exemptions

affect personal filing rates among the states and the probability of filing among

individual consumers. Still other studies have looked at whether incentives affect a

person’s choice of a Chapter 7 or Chapter 13 filing.

Such research has encountered considerable difficulty in identifying the

incentives’ effects, in part because many of them are extremely difficult to quantify.

The results of studies of how BRA-78 affected the personal filing rate range from no

effect to a substantial one; studies that searched for a relationship between asset

exemptions and personal filing rates among the states also have mixed findings.

Nevertheless, there is some evidence that the probability of filing for bankruptcy and

the choice of the bankruptcy chapter under which to file depend on the benefits of

filing. Moreover, simple comparisons of the characteristics of people who file for

bankruptcy suggest that they respond to the law’s incentives by filing under the

chapter that best suits their circumstances.

How Differences in the Benefits of Bankruptcy Affect the Probability of Filing. Fay,

Hurst, and White (1998) found evidence suggesting that people do respond to the

incentives in bankruptcy law, although their results are weakened by the small

number of filers in their sample. Their study used data from households participating

in the University of Michigan’s Panel Study on Income Dynamics from 1984 to

1996; the 1996 “wave” of the study asked respondents if they had ever filed for

bankruptcy and if so, when.24 The researchers found that the probability of filing

increased as the value of bankruptcy's benefits rose to $9,000; thereafter, the

estimated probability did not change. (Fay, Hurst, and White defined “benefits” as

the difference between respondents’ unsecured debt and their wealth after subtracting

the value of exempt assets allowed by their state.) However, only 254 of the

thousands of households in the study had ever filed for bankruptcy.25 Gross and

Souleles (1998) note that estimating probabilities from models with such small

samples can give misleading results.

Indeed, the small number of filers in the sample may be responsible for several

puzzles in Fay, Hurst, and White's results. For example, the researchers divided the

variable for benefits into five separate variables representing different ranges of

benefits. Yet only two of the five coefficients for the variables were statistically
16 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

26. The relative number of nonbusiness Chapter 7 and Chapter 13 filings varies widely among the states. In

calendar year 1998, for example, Chapter 13 filings accounted for about 28 percent of personal filings

nationwide; in Rhode Island, they were only about 5 percent, but in Tennessee and North Carolina, they

were about 58 percent. Because those differences persist over time, some observers attribute the

differences in chapter usage to differences in legal culture among the states and among the localities within

a state. See, for example, Sullivan, Warren, and Westbrook (1989) and Braucher (1993).

significant. Furthermore, the estimated overall effect of the benefit variables was

different over time. The researchers found the expected positive effect on the

probability of filing in the first half of their sample (1984 to 1989) but only a small

and negative effect in the latter half (1990 to 1995). Those results, if taken at face

value, would imply that the incentives in bankruptcy law were encouraging personal

filings in the second half of the 1980s but discouraging them in the first half of the

1990s. Alternatively, they may simply indicate that such a small sample of filers is

unlikely to yield stable results.

How Incentives Affect the Choice of Bankruptcy Chapter for Filing. Another way

researchers have looked for the effects of the incentives to file for bankruptcy is by

examining whether people choose the chapter under which they file on the basis of

available asset exemptions. The general hypothesis of such studies is that a high

level of asset exemptions creates an incentive for people to file under Chapter 7

rather than under Chapter 13.26

Domowitz and Sartain (1998) examined a very small sample of personal filers

in the early 1980s and found that bankruptcy asset exemptions affected people’s

choice of chapter. They estimated that, all else remaining constant, a 50 percent drop

in exemption levels would increase the probability of a person’s choosing Chapter

13 over Chapter 7 by between 18 percent and 25 percent.

Other studies exploring the impact of asset exemptions on chapter choice yield

mixed results. For example:

o The General Accounting Office (1983) found that as a group, states that

opted out of the federal exemptions in the early 1980s experienced slower

growth in Chapter 7 filings than the group of states that permitted use of the

federal exemptions. However, the GAO researchers also found

considerable variation in filings by state, which led them to conclude that

they could not make a “definitive assessment of the impact of Federal

exemptions on decisions to file bankruptcy” (p. 34).

o White (1987-1988) used a model based on county-level data in 1981 and

found that asset exemptions significantly affected chapter choice.

According to the model, higher exemptions raised Chapter 7 filings and

lowered Chapter 13 filings. However, few economic variables are
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 17

27. See Carter (1982), Kowalewski (1982), General Accounting Office (1983), Peterson and Aoki (1984),

Shepard (October 1984, Winter 1984), Boyes and Faith (1986), Shiers and Williamson (1987), Domowitz

and Eovaldi (1993), Bhandari and Weiss (1993), and Domowitz and Tamer (1997).

measured at the county level; consequently, White’s results may also reflect

other differences among counties that are not included in her model.

o Bork and Tuck (1994) found no correlation between state homestead

exemptions and the number of Chapter 13 filings. 

o Sullivan, Warren, and Westbrook (1994, 1997) compared filing rates by

chapter and argued that differing asset exemptions within and among the

states did not appear by themselves to explain a person’s choice of

bankruptcy chapter. The 1994 study examined a very small sample of filers

in 1991; the 1997 study simply compared filing rates among bankruptcy

court districts.

o Buckley and Brinig (1998) found that higher asset exemptions lowered

Chapter 7 filing rates among the states over the 1980-1991 period.

The mixed findings in these studies could have several roots. All of the studies

had to grapple with the sizable difficulty of developing measures that summarized

the myriad exemptions in federal and state law. In addition, many of them may have

failed to adequately control for differing economic conditions and levels of default

risk among the states. Furthermore, as several researchers noted, the studies failed

to take into account the reactions of creditors to different limits on asset exemptions.

For example, Gropp, Schulz, and White (1997) found that households in states with

high exemptions were more likely than households in states with low exemptions to

be denied credit or be discouraged from applying for a loan. 

Several studies of individual filers indicate that people file under the chapter that

best suits their circumstances. Both the General Accounting Office (GAO), in a 1983

study, and Barron and Staten, in a 1997 study, found that Chapter 13 filers, on

average, had higher income, more assets, more secured debt, and less unsecured debt

than did Chapter 7 filers. That finding suggests that the bankruptcy code steers some

consumers who can repay a portion of their debts into filing under Chapter 13 rather

than under Chapter 7.

How BRA-78 Affected the Personal Filing Rate. Empirical studies examining the

act’s impact on the personal filing rate do not provide a consistent or satisfying

picture.27 Several problems help explain the studies' limitations: 

o The difficulty of measuring the magnitude of the changes in incentives to

file for bankruptcy;
18 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

28. The difficulty of explaining the behavior of the personal filing rate and the impact of BRA-78 is illustrated

by the two models of personal filings described in Shepard (ibid.). The models use slightly different

periods and several different explanatory variables, and they deliver different results. For example, one

model found that the unemployment rate had a significant effect, and the other did not. The two studies

conclude that BRA-78 increased personal filings, but whether one model is more accurate than the other

or, indeed, whether either model is accurate is difficult to determine.

o The lack of data on other potentially important variables such as advertising

by lawyers and the stigma associated with filing for bankruptcy;

o BRA-78's introduction of joint filings; and

o Inadequate treatment of macroeconomic effects.28

One major problem confronting all of the studies is quantifying the changes that

BRA-78 made in the incentives to file for bankruptcy. The legislation was a major

overhaul of bankruptcy law that affected a wide assortment of provisions. Many

observers agree that BRA-78 made filing for personal bankruptcy more attractive,

which should have encouraged filings by consumers. But quantifying and comparing

the effects of many of those changes with effects under the previous law range from

difficult to impossible.

For example, the studies do not clarify how much filing incentives changed

when federal asset exemptions were introduced. Initially, the federal exemptions

were more generous than the exemptions being used in many states, and by the end

of 1982, 35 states had opted out of using them. Whitford (1997) argues that as a

result, the incentives to choose bankruptcy to solve financial problems were not much

changed after BRA-78's passage because so many states continued to use their own

exemptions. Shuchman and Rhorer (1982), however, contend that such incentives

did change because a number of states raised the value of their exemptions when they

opted out of using the federal standards. The authors claim that most of those states

“revised their state exemption laws—many for the first time in 50 years or

more—making them more generous to debtors and more suited to the times” (p. 2).

But Shepard (October 1984) claims that the opt-out states set their exemptions “at less

liberal levels” compared with the federal exemptions (p. 425). Thus, sometime after

enactment of BRA-78, the asset exemptions of the opt-out states may have been

higher than they had been before, but they may not have been as high as the federal

exemptions in place when the states opted out.

Because of the difficulty of quantifying changes in incentives under BRA-78,

the studies estimating the law's effect use a technique that probably biases their

results in favor of finding an effect. The studies typically assumed that any increase

in the personal filing rate that their models could not explain was due to BRA-78.

The problem with that approach is its sensitivity to the specification of the models:

the effects of an error in choosing the explanatory variables or in the relationship
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 19

29. That result is suggested by Figure 2. If one ignores the break, BRA-78 appears to have had little impact

on the personal filing rate—an observation confirmed by regression results.

between those variables and the personal filing rate may be mistakenly attributed to

BRA-78.

For example, the studies excluded two factors whose effects may be confused

with those of BRA-78—namely, advertising by lawyers and the stigma associated

with filing for bankruptcy. There are no quantitative statistics on either of those two

factors, and thus their effects cannot be directly measured. Research attempting to

estimate stigma’s effects is discussed in detail later. Lawyers were allowed to

advertise for the first time in 1977, which may have encouraged filings by increasing

consumers’ awareness of the benefits of bankruptcy. Advertising may also have

intensified competition among bankruptcy lawyers, which could have lowered

consumers’ legal costs for filing. However, the extent to which stigma or legal

advertising encouraged personal bankruptcies is unknown because the estimated

effects of those factors are commingled with those of BRA-78.

Properly accounting for joint bankruptcy filings is another serious problem in

all of the BRA-78 studies. The majority of those that did not adjust for the joint

filings found that the law had no statistically significant impact.29 Yet all of the

studies that doubled the number of joint petitions to make the personal filing rate

comparable before and after the law’s enactment found that the law raised the rate.

As discussed in Appendix A, doubling probably overstates the law’s effects.

Domowitz and Eovaldi (1993) found that BRA-78 had little effect as long as the

adjustment for joint petitions was not too great. Without additional research to

collect the necessary information to adjust for the joint filings, determining the law’s

effect on the personal filing rate is impossible.

In the case of effects arising from macroeconomic factors, the studies may have

failed to find them consistently because of methodological inadequacies. None of the

studies carefully separated the effects of factors affecting the demand for credit from

those affecting supply. Moreover, to capture macroeconomic effects, a number of

studies used cyclical factors, such as the unemployment rate, instead of factors with

strong rising trends. Cyclical factors do not generally contain rising trends but tend

to move up and down around a fairly steady level over time. Yet as Figure 1 on page

6 indicates, the major movement in the personal filing rate throughout the postwar

period has been upward. The studies might have been more successful in estimating

macroeconomic effects if they had used appropriate macroeconomic factors with

rising trends. Or the studies might have better identified macroeconomic effects if

they had explained the growth in the filing rate rather than its level.

Ellis (March 1998) compared personal bankruptcy filings in Canada with those

in the United States to argue that BRA-78 did not significantly affect U.S. filings.
20 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

30. Personal filing rates among the states vary widely. In 1997, for example, the top five states in filings per

thousand residents (adults and children) were Tennessee (9.6), Georgia (8.2), Nevada (7.8), Alabama (7.7),

and Mississippi (6.9). The bottom five were Vermont (3.0), South Carolina (2.9), South Dakota (2.9),

North Dakota (2.8), and Alaska (2.0). For the United States as a whole in 1997, the filing rate per

thousand residents was 5.0. Rankings among the top states in filings per capita are fairly stable over time.

Over the 1962-1974 period, for example, the top five states, from highest to lowest, were Alabama,

Nevada, Tennessee, Oregon, and Arizona. See Apilado, Dauten, and Smith (1978).

Her comparison rested on the fact that although Canada is similar to this country in

a number of ways, it did not change its bankruptcy law between the late 1970s and

the early 1990s. Hence, comparing personal filings in the two countries might

suggest how BRA-78 affected the personal filing rate in the United States. Ellis

found that personal filings in Canada, like those here, rose rapidly in the 1980s; she

concluded that the changes in U.S. bankruptcy law had had little effect on the nation's

personal filing rate. That conclusion may be too strong, however, because the study

does not account for other factors that may affect personal filings in the two

countries.

How Differences in State Asset Exemptions Affect the Personal Filing Rate. Studies

of the relationship between asset exemptions and personal filing rates at the state

level have yielded conflicting results.30 Researchers expected higher filing rates in

high-exemption states than in low-exemption states because the benefits of

bankruptcy to borrowers are greater when exemptions are high. In general, results

from the studies did not confirm that effect, probably as a consequence of the

problems discussed earlier in relating exemptions to the choice of chapter under

which to file. For example:

o Apilado, Dauten, and Smith (1978) found mixed results for the exemption

variables in their model of state filing rates.

o Woodward and Woodward (1983) examined the effect on state personal

filing rates of differences between asset exemptions established for the

bankruptcy process and exemptions that applied if an individual resolved

financial problems outside of bankruptcy. The difference can exist, for

example, if a state allows residents to choose between the federal and state

exemptions when filing for bankruptcy but requires residents to use the

state exemptions when resolving financial problems outside of bankruptcy.

Woodward and Woodward failed to find higher rates of personal filing in

states in which bankruptcy exemptions were greater than the exemptions

available outside of bankruptcy.

o Shepard (October 1984) compared the personal filing rates of opt-out states

with those of other states for 1979 and 1980 and claimed that the

differences in asset exemptions did not have a significant impact. He did

find, however, that the average growth of the personal filing rate for the
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 21

31. Fay, Hurst, and White (1998) found that an even larger percentage of households would benefit from

filing.

opt-out states was less than that for states that allowed the federal exemptions.

o Shiers and Williamson (1987) examined filings by state in 1980 and found

that lower homestead exemptions were associated with higher personal

filing rates. The reason, they asserted, is that creditors loosen their lending

standards and terms when exemptions are low.

o Pomykala (1997) observed that personal filings grew at a slower rate in the

opt-out states than in the states that allowed federal asset exemptions after

the dollar value of those exemptions doubled in 1994.

o Ellis (February 1998) did not find a close relationship between homestead

exemptions and state filing rates. Like Shiers and Williamson, she

reasoned that lenders probably compensated by changing their lending

standards and terms.

The Stigma of Bankruptcy

Analysts who are puzzled over the rise in the personal filing rate have turned to

various social factors for a possible explanation. Prominent among them is the

stigma that has traditionally been associated with filing for bankruptcy. If, as some

observers argue, there has been a weakening of that stigma, people should be less

reluctant to borrow money in the first place and, when faced with financial

difficulties, less reluctant to file for bankruptcy (because they would suffer less

embarrassment among their family and friends).

A finding by White (1997) suggests the potential importance of stigma. White

analyzed a national sample of households and estimated that at least 15 percent of

them could benefit from filing for bankruptcy, given their assets and debts and the

exemptions in their states.31 Yet the personal filing rate represents only about 0.7

percent of the adult population, leading White to suggest that many eligible

households did not file either because they could get the benefits of bankruptcy

without going to bankruptcy court or because they were waiting for a more

advantageous time to file. An alternative explanation is that other factors—such as

stigma—might be keeping households from filing.

Several studies claim to have uncovered evidence that a lessening of stigma has

encouraged some people to file for bankruptcy. At best, however, that evidence is

only suggestive because no objective measures of stigma exist. How much stigma

is currently associated with bankruptcy and how or why it may have changed are
22 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

32. The difficulty of looking for the effects of changes in attitudes is highlighted in the work of Calder (1999),

who reviews the history of attitudes about the American public's thriftiness. He argues that the notion that

the American consumer has become a spendthrift, living on consumer credit, is not a new phenomenon

but goes back to just after the Civil War. He also contends that the notion has grown stronger since World

War II.

33. The sample used by Fay, Hurst, and White contains hints that some of the stigma of bankruptcy still exists.

Their sample, like the one used by White (1997), indicates that the percentage of people who would benefit

from filing for bankruptcy is much greater than the percentage of actual filers. Moreover, the personal

filing rates for all but one year in their sample are considerably less than the national rates. That may

reflect a stigma effect in light of the fact that their sample was collected in face-to-face interviews.

unknown. As a result, studies typically rely on proxy variables to estimate stigma’s

effects. Some of those variables appear to include economic and possibly other

effects apart from stigma; others only capture an unexplained change over time. The

following studies considered bankruptcy stigma:32

o Yeager (1974) argued against a lessening of stigma, although his test was

inconclusive. He did not attempt to measure the change in stigma or

estimate its effect but simply pointed to the stable relationship over time

between the personal filing rate and the household debt-to-income ratio as

indicating that a change in bankruptcy stigma was unlikely. Although

Figure 2 on page 8 suggests that Yeager’s conclusion holds up for the past

20 years and the previous 30, his simple test is inconclusive because it

neither examines the possible effect of lessened stigma on the debt-toincome ratio nor considers other factors that might have offset such an

effect.

o Visa U.S.A. Inc. (1996) claimed that a reduction in stigma and changes in

other social factors contributed to the rise in personal bankruptcy filings

between 1981 and 1996, but its claim has no empirical content. Visa’s

model for explaining the personal filing rate used a variety of

macroeconomic factors and a proxy variable that, Visa maintained,

captured the effect of the social factors. But the proxy was constructed

simply to follow the trends in the personal filing rate and thus could

provide no independent explanation of the rate's behavior (Kowalewski

1997).

o The study by Fay, Hurst, and White (1998) mentioned earlier claimed to

have found evidence that a reduction in the stigma of bankruptcy

contributed to consumers’ growing propensity to file for bankruptcy in the

first half of the 1990s. Their evidence, however, is not convincing. Both

of the variables that the researchers used as proxies for stigma contain

economic effects in addition to any possible effects from stigma (see

Appendix B).33
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 23

o Gross and Souleles (1998) claimed that a lessening of stigma was

responsible for a significant increase in the propensity to file for bankruptcy

between 1995 and 1997. Their sample consisted of observations over time

from several hundred thousand credit card accounts issued by a number of

credit card lenders, including variables that measured each account’s credit

risk (risk of default). Consequently, their study was able to look for

changes in the propensity to file for bankruptcy after considering the

accounts' risk characteristics. Gross and Souleles found that the bankruptcy

rate for the accounts was higher than the credit-risk variables could explain

and asserted that the reason was a lessening of stigma. Their proxies for

stigma, however, were simple binary variables (known as dummy

variables) that bore no necessary relationship to stigma. As a result, their

conclusion critically rests on how well their model explains the accounts'

propensity to file for bankruptcy. Since their explanatory variables were

unlikely to fully capture the underlying riskiness of the accounts and the

propensity to file, the effect they attributed to stigma is likely to be

overstated.

o Buckley and Brinig (1998) contended that the strength of stigma and other

social norms, rather than economic factors or incentives in the bankruptcy

law, were the most important elements in the rise in the personal filing rate

at the county level between 1980 and 1991. But their conclusions rest

heavily on their particular interpretations of the proxy variables they used

for social norms. For example, they used the divorce rate as a proxy for the

social stigma attached to promise-breaking, but divorce may also be a cause

or consequence of the financial troubles that lead to bankruptcy. They also

used the percentage of the population over age 65 as a proxy for

conservative attitudes, but the effects registered by that variable may simply

reflect the fact that the elderly population had a relatively small percentage

of people who needed or wanted to assume debt. As a final example,

Buckley and Brinig used migration to capture the strength of social

networks, but that proxy may instead reflect differences in household

incomes and finances among counties.

THE ABILITY OF CHAPTER 7 FILERS TO REPAY THEIR DEBTS

People who advocate tightening the bankruptcy code to make it less beneficial for

debtors argue that it allows many of them to discharge debts that they could in large

part repay. A handful of studies have examined that contention by estimating how

much debt Chapter 7 filers could possibly repay over a five-year period. Most of the

studies simulated one of several means-testing bills that have been considered by the

House. In general, those bills would prevent a Chapter 7 filing by people whose

income exceeded a certain threshold and who had the capacity to repay at least a

minimum percentage or amount of their nonpriority unsecured debt. (Nonpriority
24 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

unsecured debt includes, for example, credit card and medical debt. Little of it is

repaid in bankruptcy.)

The studies all suggest that a small percentage of Chapter 7 filers could repay

a substantial portion of their nonpriority unsecured debt. A very small percentage

(typically no more than 5 percent) of filers could repay all of their debt. Larger

proportions of filers (but typically no more than 15 percent) had the means to repay

at least 20 percent or 25 percent of their debt (depending on the specific proposal

being examined). The studies’ estimates of the dollar amount of debt that could be

repaid amounted to as much as several billion dollars.

The different estimates reflect differences in the legislation that the studies

examined and different assumptions about the money for living expenses that

bankrupt consumers would be allowed to keep during the repayment period. All of

the recent means-testing proposals call for using the living expenses that the Internal

Revenue Service (IRS) allows for tax collection purposes. But researchers have

interpreted those standards differently, which has led to different assumptions about

what constitutes a reasonable allowance. They have also made different assumptions

about information (such as the filer's monthly payments on secured debt) that is not

currently available from bankruptcy petitions. How the various bankruptcy courts

would rule on the allowances and, consequently, how much debt could be recovered

in practice are both unclear.

Means-Testing Proposals from the 105th and 106th Congresses

Recent means-testing proposals all share three general tests, although the parameters

of the tests are slightly different. Those differences have a noticeable impact on the

studies’ estimates of how much debt could be repaid. A person who “passed” all

three of the tests below would be barred from filing a Chapter 7 bankruptcy:

o The filer’s income met or exceeded a certain percentage of the median

income of households with the same number of members;

o The estimated percentage of nonpriority unsecured debt that the filer could

repay over a five-year period met or exceeded a specified minimum; and

o The dollar amount of nonpriority unsecured debt that the filer could repay

met or exceeded a specified minimum.

The studies focused on three needs-based proposals: H.R. 3150, the Bankruptcy

Reform Act of 1998, initially introduced in the 105th Congress; H.R. 3150 as passed

by the House; and H.R. 833, the Bankruptcy Reform Act of 1999, as introduced in

the 106th Congress (see Table 1).
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 25

34. Priority claims consist largely of taxes and certain other debts owed to governments, as well as alimony,

maintenance, and support claims.

TABLE 1. PARAMETERS FOR THE MEANS-TESTING PROPOSALS EXAMINED BY

THE STUDIES

Test H.R. 3150

as Introduced

H.R. 3150

as Passed

H.R. 833

as Introduced

Minimum Income 75 percent of the 

national median

income for families of the same

size

100 percent of the

national median income for families

of the same size up to

four members; median

income for a family of

four used for larger

families

100 percent of the

national median income

for families of the same

size up to four

members; larger

families use median

income for a family of

four plus an extra $583

for each additional

family member over

four

Minimum Percentage of

Nonpriority Unsecured

Debt That Could Be

Repaid Over Five Years 20 percent 20 percent

25 percent or $5,000,

whichever is less

Minimum Dollar Amount 

of Nonpriority Unsecured

Debt That Could Be 

Repaid Over Five Years $50 per month $50 per month

$5,000 or 25 percent,

whichever is less

SOURCE: Congressional Budget Office.

Estimating a filer’s capacity for debt repayment requires information on his or

her monthly income, living expenses, and secured and priority debt payments.34

Income data come from the filer’s bankruptcy petition. The proposals define living

expenses according to the IRS’s collection financial standards (the categories are

“National Standards,” “Local Standards,” and “Other Necessary Expenses”).

Currently, people do not report their payments on secured debts on bankruptcy

petitions; if one of the proposals became law, however, the form of the petition

presumably would be changed to record them. The calculations required to estimate

a debtor’s repayment capacity assume that the filer’s income and expenses do not

change during the five-year period. If they do, the filer can petition the court for

changes in the debt-repayment amount.
26 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

35. Ernst & Young (February 1998) also simulated H.R. 3150, but that work was superseded by its March

1998 study, which used a better sample of Chapter 7 filers.

36. A broader critique of the Barron and Staten study appears in General Accounting Office (February 1998

and March 11, 1998).

Studies Estimating Debt-Repayment Capacity Under the Proposals

Four studies simulated versions of the means-testing proposals to estimate the

capacity of individual Chapter 7 filers to repay their nonpriority unsecured debt.35

Another study of repayment capacity, by Barron and Staten (1997), did not simulate

a recent proposal but simply estimated the amount of nonhousing debt that Chapter

7 filers could repay. That study does not directly apply to the current debate because

it focused on a different measure of repayment ability. The relevant measure is the

difference between the losses to creditors under Chapter 7 and the losses creditors

would have experienced if the consumer had filed instead under Chapter 13. In many

cases, that measure largely corresponds to the amount of nonpriority unsecured debt

that a consumer would repay under Chapter 13, which is, indeed, the focus of the

needs-based proposals.36

The four studies produced a moderate range of estimates of the number of filers

under Chapter 7 who would be denied its benefits and the amounts they would have

to repay.

o Ernst & Young (March 1998) simulated H.R. 3150 as introduced.

Researchers estimated that 15 percent of the Chapter 7 filers in the study’s

sample passed the means tests and could, on average, repay 64 percent of

their nonpriority unsecured debt—in total, $4 billion. Only 5.7 percent of

the filers could repay 100 percent of their nonpriority unsecured debt.

o Culhane and White (1999) based their estimates on the version of H.R.

3150 passed by the House. They found that only 3.6 percent of filers

passed all three tests; those filers, on average, could repay about 75 percent

of their nonpriority unsecured debt, or approximately $0.9 billion. Culhane

and White estimated that only 1.3 percent could repay all of their

nonpriority unsecured debt.

o The March 1999 Ernst & Young study simulated H.R. 833 as introduced.

Researchers estimated that 10 percent of the Chapter 7 filers in their sample

passed the tests and could repay an average of 53 percent of their

nonpriority unsecured debt. Their estimate of the total amount that could

be repaid was $3 billion, or 8.6 percent of the total amount owed. Only 4

percent of filers could repay all of their nonpriority unsecured debt.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 27

37. Bermant and Flynn discuss some of the problems in implementing the IRS guidelines, as does Wedoff

(1998).

38. Culhane and White computed their total by multiplying their figure for average nonpriority unsecured debt

($35,613) by the number of nonbusiness Chapter 7 filers in 1997 (957,117) and then inflating that figure

by 5.3 percent, the growth in the consumer price index for urban consumers between 1995 and 1997. The

Ernst & Young figure was provided by one of the authors of the 1999 study, Gautam Jaggi.

o Bermant and Flynn (1999) used the higher of the income thresholds

contained in H.R. 3150 and a similar bill (S. 1301 of the 105th Congress)

to examine repayment capacity when different percentages of income above

the median value are applied to debt repayment. Bermant and Flynn did not

use the IRS standards to compute allowable living expenses because they

found the standards difficult to implement. Instead, they assumed that all

income below the median would be used for living expenses and repayment

of secured debt.37 The researchers focused on the portion of income above

the median and subtracted business expenses, estimated tax liabilities,

support and alimony payments, and priority debt payments, after which

only 15 percent of the filers in their sample had income remaining for

repayment of nonpriority unsecured debt. Under the assumption that all of

the remaining income above the median would be assigned to debt

repayment, unsecured creditors would receive about $3.8 billion; if lower

percentages of income—specifically, 75 percent, 50 percent, and 25 percent

above the median—were assigned to repayment, creditors would receive

$3.2 billion, $2.5 billion, and $1.4 billion, respectively. Bermant and Flynn

believe that less than 5 percent of the Chapter 7 filers in their sample could

repay 100 percent of their nonpriority unsecured debt.

Some of the differences in the results of these studies reflect their varying

samples. The March 1998 and March 1999 studies by Ernst & Young used a

national, stratified, random sample of about 2,100 consumers filing under Chapter

7 in 1997, whereas Culhane and White used a smaller sample of 1,041 Chapter 7

cases from 1995 collected from only seven federal judicial districts. Bermant and

Flynn used a sample of 1,955 Chapter 7 no-asset cases filed by consumers in late

1997 and early 1998 that they drew from every federal judicial district. Because the

studies do not provide comparable descriptive statistics for their samples, it is

difficult to evaluate how differences in the samples might have affected the results.

However, it seems likely that such differences were not a major reason for the

different estimates of repayment capacity. For example, the Ernst & Young and

Culhane and White samples imply similar values for total nonpriority unsecured debt

owed at the national level: $35 billion for Ernst & Young and $36 billion (in 1997

dollars) for Culhane and White.38
28 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

39. See the statement of Richard M. Stana, Associate Director, Administration of Justice Issues, General

Government Division, General Accounting Office, before the Subcommittee on Commercial and

Administrative Law of the House Committee on the Judiciary, in General Accounting Office (March 17,

1999). Stana also notes that the Ernst & Young and Culhane and White studies treat student loans

differently. See General Accounting Office (June 21, 1999) for a comprehensive discussion of the

differences among the various studies.

Most of the variations in the estimates arise from the studies’ different

assumptions, some of which simply reflect different versions of the bills.39 One

obvious distinction between the March 1998 Ernst & Young study and Culhane and

White’s research is the percentage of median income used for the test: Ernst &

Young used 75 percent, and Culhane and White used 100 percent. Ernst & Young

completed its study before H.R. 3150 was amended to incorporate the higher figure.

Culhane and White state that if Ernst & Young had used 100 percent of median

income, 11 percent rather than 15 percent of the Chapter 7 filers in the Ernst &

Young sample would have met all of the means tests.

If all of the studies had used the same set of values for the income test, the

differences among them would be smaller. The General Accounting Office (June 21,

1999) notes that the value set used in Ernst & Young’s March 1998 study is the

lowest (in 1997 dollars). The other three studies use the same values for family sizes

up to four. For larger families, Culhane and White’s values are the lowest, and

Bermant and Flynn’s are the highest.

A key variation in the assumptions involves one category of the living expenses

allowed to filers—the transportation allowance. The standard that the IRS uses in tax

collection cases has allowances for vehicle ownership and operating expenses and for

the costs of public transportation. The ownership allowance caps the amount of debt

and lease payments for a consumer—as long as he or she is obligated to make such

payments. If the consumer owns the vehicle outright, the IRS does not provide an

ownership allowance. But Culhane and White did so, noting that a significant

number of the cars owned by filers in their sample were at least five years old at the

time of filing and would need major repairs or replacement during the five-year debtrepayment period. In contrast, Ernst & Young followed the IRS standards and

assigned the ownership allowance only to filers making lease or debt payments on

vehicles. Culhane and White reported that if they had used Ernst & Young’s

transportation allowances, the percentage of filers in their sample who met the means

tests would rise to 6.8 percent, nearly double their estimate of 3.6 percent.

The studies also differ in their treatment of nonhousing secured debt.

Researchers had to make assumptions about the monthly contractual payments due

on that debt because their source of data (filers’ bankruptcy petitions) did not include

them. Ernst & Young amortized such debt over two years, assuming a 9 percent

interest rate on the loans. Culhane and White used the same 9 percent rate but a fiveyear period, citing the proposal’s repayment span as the relevant amortization period.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 29

40. A better length for the amortization period is probably somewhere between two and five years. Five years

is probably too long—many filers may have already been repaying the loans for some time before they

decide to file for bankruptcy. But two years may be too short, particularly because there may be past-due

payments on those debts that ought to be taken into account in estimating repayment capacity.

41. Whether the benefits of a lower cost of borrowing exceed the various costs of implementing and

administering a means-testing requirement is beyond the scope of this paper.

The longer amortization used by Culhane and White increased filers’ estimated

interest payments on secured debt—which reduced (compared with Ernst & Young's

estimate) the capacity of filers to repay nonpriority unsecured debt.40

Implications of the Studies’ Estimates

The findings of all of the studies suggest that a small percentage of people may be

avoiding debts that they could afford to repay. The clearest indication comes from

the studies' estimates of the proportion of Chapter 7 filers who could repay 100

percent of their nonpriority unsecured debt—that figure is typically no more than 5

percent. What is less certain is whether other filers with lower incomes or with less

capacity to repay such debt also intended to avoid repayment. No sharp line divides

those who need bankruptcy to relieve difficult financial problems from those who

simply want to avoid repaying their debts. If the means-testing proposals are viewed

as providing practical, reasonable criteria for separating people who file for

bankruptcy out of need from people who file to avoid debt repayment, then the

studies’ results suggest that the majority of people file out of need.

Although the percentage of filers who would be prevented from filing under

Chapter 7 is not large, the reduction in creditors’ losses might be great enough to

have a noticeable impact on the standards and terms of unsecured borrowing. Ernst

& Young’s estimate of $3 billion in potential repayments over five years is about

one-half of 1 percent of the total amount of revolving and noninstallment debt in

1997. If creditors did, in fact, recover that much additional debt under a meanstesting requirement in the future and they channeled all of it into the interest rate on

future loans, they could lower the rate by as much as one-half of a percentage point.41

Uncertainties Surrounding the Estimates

How much debt would be repaid to nonpriority unsecured creditors under the meanstesting proposals is difficult to determine. One problem is how the different federal

district courts would determine filers’ allowable living expenses. Flynn and Bermant

(1999) argue that the IRS standards for living expenses “are subject to legitimate

differences of interpretation and need to be supplemented by judgment calls during

the calculations” (p. 30).
30 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

42. Not all of the estimated repayments would necessarily reduce losses by creditors because the studies could

not account for debts that filers voluntarily repaid through reaffirmation agreements with creditors and

those agreements were not available to researchers. (Reaffirmations are voluntary agreements by

borrowers to repay at least some of their overdue debt.)

Another problem is that the studies may overstate the amount of debt that could

be repaid because they assume that all filers will complete their repayment plans

successfully within five years.42 But experience shows that some filers do not do so.

Between 1984 and 1991, an average of 36 percent of consumers filing Chapter 13

cases successfully completed their scheduled payments and received a discharge from

their remaining debts (see Table 2). The rest of the cases were either dismissed or

converted to Chapter 7 cases or did not receive a discharge for some other reason.

Nevertheless, the success rate of Chapter 13 plans is probably greater than 36 percent

because some of the dismissed cases may represent multiple filings by the same

debtor or “face filings” that may have been dismissed before their plans were

confirmed (see Appendix A for more details). 

Whether the current success rate among Chapter 13 filers would apply to filers

under the means-testing proposals is unclear. The characteristics of successful

Chapter 13 plans are unknown—they might require fewer payments than would plans

under the proposals. In addition, some filers might not make all of the scheduled

payments in their plan. They might decide that the plan was too burdensome and

reduce how much they work, or they might hide income to reduce their payments.

Or they might take advantage of allowances for charitable contributions or add to

their monthly expenses by leasing or financing a vehicle. (Culhane and White

discuss those loopholes.) And if filers had access to new credit while they were

making payments under a repayment plan, they might take on additional debt that

would doom any chance of their plan’s succeeding. Consequently, the number of

successful Chapter 13 plans or the amounts repaid under successful plans could be

lower than the studies assumed.

Alternatively, payments to creditors under a means-testing requirement might

be greater than the studies estimate. Many would-be filers who would have to use

Chapter 13 under such a requirement might decide not to file at all and instead

continue making their debt payments. Some filers would experience gains in income

during the repayment period that might go toward debt repayment. And some

consumers might respond to the incentives of a tighter bankruptcy law by borrowing

less money, thereby lowering the potential losses of creditors. However, if many

low-risk consumers decided to borrow less, the riskiness of lenders’ loan portfolios

might increase, which could temporarily hurt profits.

A further question concerns the accuracy of the data on consumer bankruptcy

petitions. A number of observers have noted that filers have an incentive to overstate

expenses and understate income. Yet all of the needs-based studies used the dollar
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 31

43. Creditors could not simply raise interest rates because that would tend to increase the percentage of

borrowers in their loan portfolios who would be more willing to risk defaulting on their loans. That result

is known as the adverse selection problem.

TABLE 2. DISPOSITION OF CHAPTER 13 CASES, 1984-1991 (In percent)

1984 1985 1986 1987 1988 1989 1990 1991 Average

Dismissed 52.3 49.8 48.2 48.3 50.9 51.1 49.7 49.7 49.9

Converteda 13.2 14.9 14.9 14.6 13.6 13.0 13.0 12.7 13.6

Discharged 34.2 34.9 35.6 35.6 35.2 35.7 37.1 37.3 36.0

Otherb 0.2 0.4 1.3 1.5 0.3 0.3 0.3 0.2 0.5

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

SOURCES: Congressional Budget Office; Administrative Office of the U.S. Courts.

NOTE: As of December 31, 1997, some of the Chapter 13 cases filed during these years were still active. The figures for

1984 to 1988 update the original numbers appearing in Michael Bork and Susan D. Tuck, “Chapter 13

Dispositions,” Working Paper 2 (Administrative Office of the U.S. Courts, Washington, D.C., October 1994). The

updated figures for 1984 to 1987 are virtually identical to the Bork and Tuck numbers.

a. Chapter 13 filings that were converted to Chapter 7 cases.

b. Chapter 13 cases in which either a discharge was denied, waived, revoked, or not applicable, or the case was transferred

to another district.

figures from the petitions. If those figures were, indeed, inaccurate, filers’ repayment

capacity might be greater than the studies have estimated.

HOW PERSONAL BANKRUPTCY AFFECTS THE SUPPLY OF CREDIT

In theory, bankruptcy law can affect the supply and cost of credit, particularly

unsecured credit such as credit card lending. An actual or an expected boost in

bankruptcy losses will encourage creditors to employ some combination of stricter

lending standards and terms—such as higher interest rates, larger down payments,

and a smaller supply of credit, at least for borrowers who pose greater risks. Those

strategies can help stave off greater losses from bankruptcies.43 As Ausubel (1997)

notes, the converse is also true: stricter bankruptcy provisions give creditors an

incentive to relax their lending standards and terms, which encourages borrowing and

raises the chances that more borrowers will default and file for bankruptcy.
32 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

44. Could loan losses from personal bankruptcies be passed on to consumers through other markets—say, the

market for consumer goods and services—in the form of higher prices? Loan losses are not likely to affect

the general level of prices in the economy, although some retailers might raise their prices if they and all

other retailers in the market suffered losses on their own in-house credit plans. In general, consumer

lenders and retailers operate in separate markets; the costs of “producing” consumer loans are different

from the costs of producing goods and services. Even for an integrated retailer like Sears, which markets

its own credit card, the two markets are distinct. If Sears loses money on its credit card business, it cannot

recoup the losses by raising the prices of its merchandise because it will put its goods at a competitive

disadvantage compared with those of other retailers. And if it tightens its credit card lending, some of its

borrowers will move to other sources of credit (because Sears accepts other credit cards) or shop

elsewhere. Sears’ profitability will fall if its loan losses are unexpectedly high. In that case, profitability

can improve only if Sears reduces the costs of its credit card operation.

45. According to the means-testing studies, creditors would have earned as much as several billion dollars in

extra profits had a means-testing requirement been in place in 1997.

Consequently, over the long run, borrowers bear the costs of bankruptcy-related

(and other) loan losses.44 If creditors cannot distinguish which borrowers are poor

credit risks, they will charge all borrowers—not simply the riskiest—more for loans

and make less credit available overall. Over the short run, lenders may bear most of

the costs of unexpected loan losses until they tighten their lending terms and

standards. Taxpayers also shoulder some of those losses because the losses are taxdeductible. (Taxpayers pay for the bankruptcy court system as well.) Moreover,

individual lenders who suffer unexpectedly large losses may not be able to recoup

them by charging more for loans if their competitors do not suffer similarly large

losses. In those circumstances, they and taxpayers will bear the brunt of such losses.

Changes in bankruptcy law can also affect lenders’ profits in the short run.

Switching to a stricter law can temporarily raise creditors’ profits from their existing

loans, which were made under the previous bankruptcy law that implied greater

expected losses. If existing borrowers default under the new, stricter law, however,

they will have to repay more than if they had filed under the old law. Only creditors

benefit from those extra repayments; any such “windfall” is unlikely to affect the

terms of new lending.45

As is the case for many other aspects of personal bankruptcy, little is known

about the ways bankruptcy affects credit markets. One study found that the level of

asset exemptions affected consumers’ access to and cost of credit. Bankruptcy losses

are likely to affect the cost and availability of bank credit card lending because they

are a significant, though not the largest, component of losses on such loans. Other

evidence suggests that bankruptcy losses during the mid-1990s may have spurred

tighter conditions in the market for consumer lending, which contributed to the

decline in filings by the end of the 1990s. What is missing is evidence on creditors’

responses to changes in bankruptcy law. Without that evidence, it is unclear exactly

how any reduction in losses stemming from a means-testing bankruptcy requirement

would affect the cost and availability of unsecured credit for consumers.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 33

Creditors’ Responses to Personal Bankruptcy Provisions

Two recent studies have found that the effect of asset exemptions on lending

practices varies by the type of loan:

o Gropp, Scholz, and White (1997) found that the likelihood that a person

seeking credit (of any kind) would be denied or discouraged from applying

was greater for people living in high-exemption states than for those living

in low-exemption states. They also found that households with few assets

in high-exemption states had less debt and faced higher interest rates for

auto loans than did households in low-exemption states. In contrast, they

found that households with many assets had more credit in high-exemption

states than in states with low exemptions. The authors interpret their

findings to mean that asset exemptions may redistribute credit to

households with many assets.

o Hynes and Berkowitz (1998) found different results in the mortgage

market. Their research showed that the probability of being turned down

for a mortgage loan was marginally lower for residents of states with large

homestead exemptions. They also found that mortgage rates appeared to

be slightly lower in those states. They reasoned that homestead exemptions

affect mortgage lending to only a small degree because mortgage loans are

backed by collateral and the interests of the lenders are protected by

bankruptcy law.

Unfortunately, researchers have not specifically examined credit card lending,

which theoretically ought to be the part of the credit market most affected by changes

in bankruptcy provisions. Those lenders’ responses ought to be quite noticeable

(because virtually all credit card lending is unsecured), and a good place to look for

them should have been in the wake of BRA-78. Lenders should have tightened the

supply of credit card debt after the law was passed because many of the law’s

changes made bankruptcy a more attractive option for consumers. But those effects

are not evident because, as noted earlier, the supply of credit card debt has ballooned

since then as a result of the deregulation of interest rates and technological

innovations. Evidently, the factors that raised the supply of credit card lending more

than offset the provisions of BRA-78 that should have lowered it.

The Impact of Personal Bankruptcy on Creditors’ Losses

One clue to the importance of bankruptcy losses in creditors’ decision making would

be the magnitude of those losses relative to other loan losses. Yet as noted earlier,

there are no comprehensive data on losses resulting from personal bankruptcy.

Neither the Administrative Office of the U.S. Courts nor the Executive Office for
34 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

U.S. Trustees compiles data on debt discharged in bankruptcy. And few creditors’

groups consistently report loan losses from bankruptcy.

Nevertheless, several measures suggest that bank credit card lenders have

suffered greater losses from bankruptcy in recent years than in earlier periods. Data

collected by the American Bankers Association (ABA) show an increase in

bankruptcy-related gross losses on credit cards as a percentage of outstanding debt

(see Table 3). In 1994, for example, average gross losses related to bankruptcy were

about 1.7 percent of the outstanding credit card balances at large issuing banks, or

about 37 percent of their total gross losses. Although not strictly comparable, the

bankruptcy loss rate in 1997 was 2.9 percent, or about 44 percent of total gross losses

for those banks.

Three other features of the ABA’s data are noteworthy. First, gross bankruptcy

losses were smaller than combined gross losses from all other sources excluding

fraud. Second, for most banks, the percentages of gross losses excluding bankruptcy

and gross bankruptcy losses increased over the 1994-1997 period. Third, gross losses

and bankruptcy-related losses increased with the size of a bank’s credit card

portfolio, suggesting that the banks with the largest portfolios were the most

aggressive credit card lenders.

Another estimate of bankruptcy-related losses on bank credit cards comes from

a report by Visa U.S.A. Inc. (1996). The report noted that the fraction of bankruptcyrelated net losses on bank credit cards (Visa and MasterCard) grew from 39.8 percent

in 1987 to 45.0 percent in 1995, which is similar to what the ABA reports. But the

dollar value of nonbankruptcy losses also rose over that period, indicating that the

increased losses suffered by credit card lenders were not all due to bankruptcy filings.

In addition, it is not clear whether the figures reported by Visa are representative of

the whole industry or only of a sample of card issuers.

As the ABA and Visa data indicate, personal bankruptcy does not explain all of

the rise in losses by credit card lenders in recent years. Indeed, analysts believe that

the losses reflect the effects of intense competition within the credit card industry.

According to the Board of Governors of the Federal Reserve System (August 1997),

such competition drove down profitability as the banks’ focus shifted in the 1990s

from annual fees and program enhancements to interest rates. By the mid-1990s,

unpublished data from the Federal Deposit Insurance Corporation (FDIC) show that

the return on assets (a measure of profitability) for banks specializing in credit card

lending had begun to fall (see Figure 4). Net losses rose from a little more than 3

percent of outstanding balances, on average, in 1994 to nearly 5.5 percent in 1998.

More recently, the return on assets at banks with extensive credit card lending has

improved. In addition, net losses appear to be dropping.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 35

TABLE 3. AVERAGE LOSSES AND RECOVERIES PER BANK ON BANK CREDIT

CARDS (As a percentage of outstanding balances)

Banks 1994 1995 1996 1997

Small Issuersa

Losses excluding bankruptcy 1.84 1.67 1.84 2.15

Bankruptcy losses 0.70 0.89b 1.09 1.16

Total gross losses 2.54 2.56 2.93 3.31

Total recoveries -0.69 -0.55 -0.37 -0.38

Total Net Losses 1.85 2.01 2.56 2.93

Medium-Size Issuersc

Losses excluding bankruptcy 2.04 2.43 2.96 2.82

Bankruptcy losses 0.94 1.43 1.32 1.66

Total gross losses 2.98 3.86 4.28 4.48

Total recoveries -0.63 -0.62 -0.37 -0.53

Total Net Losses 2.35 3.24 3.91 3.95

Large Issuersd

Losses excluding bankruptcy 2.97 3.50 3.59 3.65

Bankruptcy losses 1.74 2.14 2.40 2.91

Total gross losses 4.71 5.64 5.99 6.56

Total recoveries -0.72 -0.82 -0.64 -0.62

Total Net Losses 3.99 4.72e 5.35 5.94

SOURCES: Congressional Budget Office; American Bankers Association, Bank Card Industry Survey Report (Washington,

D.C.: American Bankers Association, various years).

NOTES: Losses exclude losses from fraud.

The data for 1994 and 1995 cover standard and classic cards; data after 1995 also include gold cards. As a result,

losses in 1994 and 1995 are not strictly comparable with those in 1996 and 1997.

a. For 1994 and 1995, small issuers include banks with under $50 million in outstanding balances. For 1996 and 1997, they

include banks with under $50 million in outstanding balances and fewer than 50,000 active accounts.

b. Estimated.

c. For 1994 and 1995, medium-size issuers include banks with between $50 million and $749 million in outstanding

balances. For 1996 and 1997, they include banks with between $50 million and $749 million in outstanding balances or

between 50,000 and 749,999 active accounts, whichever implies the larger size for the bank.

d. For 1994 and 1995, large issuers include banks with at least $750 million in outstanding balances. For 1996 and 1997,

they include banks with at least $750 million in outstanding balances or more than 750,000 active accounts, whichever

implies the larger size for the bank.

e. As reported by the American Bankers Association.
36 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

FIGURE 4. PROFITABILITY MEASURED AS THE RETURN ON ASSETS AND NET 

LOSSES FOR COMMERCIAL BANKS SPECIALIZING IN CREDIT CARD 

LENDING (In percent)

SOURCES: Congressional Budget Office; Federal Deposit Insurance Corporation.

NOTES: Net losses are net charge-offs of credit card loans.

Many commercial banks specializing in credit card lending securitize (essentially, sell to others) a significant share

of their credit card loans. After doing so, they do not count the securitized loans as assets, even though they

continue to earn income from them. Consequently, the return on assets shown in the figure may be considered

inflated because the denominator does not include the securitized loans. If those loans are added to the banks'

assets, the return on assets in recent years falls by about half.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 37

46. See General Accounting Office (April 22, 1998).

47. Various reports between 1994 and 1996 also noted a drop in the demand for consumer loans at commercial

banks.

Data collected by the FDIC also indicate that delinquencies on credit card loans

have recently leveled off. Delinquencies refer to loans that are 30 or more days past

due; the delinquency rate is the average percentage of delinquent credit card loans at

all insured commercial banks. That figure for all commercial banks rose from 3.4

percent in 1994 to 4.7 percent in 1998 and then fell slightly in 1999 (see Figure 5).

The delinquency rate for specialized credit card lenders was higher than that for all

insured commercial banks from 1991 to 1999, suggesting that the former have riskier

loan portfolios.

The WEFA Group (1998) has estimated the costs of bankruptcy for consumer

lenders in 1997 and in the 1997-2000 period. The group estimated that loan losses

stemming from personal bankruptcy totaled more than $40 billion in 1997, or about

$400 per U.S. household. However, the estimate relies on a variety of assumptions

and bits of information from a broad range of sources, most of which are difficult to

evaluate.46 In addition, WEFA’s report does not examine the sensitivity of its results

to changes in assumptions. As a result, judging the reliability of the estimate is quite

difficult.

WEFA’s projected losses for the 1997-2000 period undoubtedly overstate actual

losses. The projections assumed an annual rate of growth of 15 percent in personal

bankruptcies between 1998 and 2000. But the growth in personal filings has slowed

considerably since that projection was made: filings grew by only 3.6 percent in

1998, and they fell by 8.3 percent in 1999.

Explaining the Recent Decline in Personal Filings

The personal filing rate measured on a quarterly basis began falling after the second

quarter of 1998; by the end of 1999, it had dropped to its level at the end of 1996.

At the same time, delinquency rates on credit cards and other consumer loans

stabilized or fell. Why personal filings have slowed is not known, but one possible

explanation may be the efforts of consumer lenders to tighten their lending standards

and better determine the creditworthiness of their borrowers. According to the

Federal Reserve’s periodic Senior Loan Officer Opinion Survey on Bank Lending

Practices, the net percentage of banks willing to make consumer loans plummeted

between 1994 and 1996 and increased at a moderate pace through the end of 1999.47

The Board of Governors of the Federal Reserve System (August 1997) also reported

that some credit card issuers were attempting to gauge the default risk their
38 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

FIGURE 5. THE DELINQUENCY RATE ON CREDIT CARD LOANS AT COMMERCIAL

BANKS (As a percentage of the dollar amounts of loans)

SOURCES: Congressional Budget Office; Federal Deposit Insurance Corporation.
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 39

borrowers posed and to offer card plans with different terms to borrowers in different

risk categories. The American Bankers Association (1997) credited tighter

underwriting standards of card issuers for at least part of the improvement in their

measure of the delinquency rate on credit cards. And Standard & Poor’s (1998)

reported that financial services companies appeared to be handling bigger loan losses

not by raising interest rates generally but by “tightening underwriting standards to

preserve credit quality, limiting credit line increases to existing customers, stepping

up credit collection efforts, and creating better credit scoring methods to weed out

customers with potential credit problems” (p. 4).

Another possible reason for the slowdown in personal bankruptcy filings is the

large amount of mortgage refinancing from 1997 to 1999. Lower interest rates for

mortgages have allowed homeowners to reduce their monthly mortgage payments

and their potential for financial trouble. Some homeowners may also have

strengthened their financial position by consolidating their higher-interest debts into

their lower-interest mortgages. (Note the reduction in the debt-service burden shown

in Figure 3.) That apparently explains much of the recent interest among

homeowners in high loan-to-value mortgages (see Ellis 1999). However, it remains

to be seen whether such loans will actually solve those homeowners’ financial

problems.

48. Sullivan, Warren, and Westbrook’s finding, however, might overestimate the number of personal filings

spurred by a business failure in an average year because their sample was drawn from 1981, a recessionary

year. Using a sample drawn from 1997, Bermant and Flynn (1999) found business debt among only 5.8

percent of the Chapter 7 filers who had income above the medians set by H.R. 3150 and S. 1301.

APPENDIX A: 

PROBLEMS WITH THE DATA ON PERSONAL BANKRUPTCY FILINGS

The statistics on personal bankruptcy are widely quoted and used as indicators of

financial stress in the consumer sector and of losses by creditors. A number of

problems bedevil the personal bankruptcy data, however, making them less useful as

measures of creditors’ losses and as signs of financial pressure among consumers.

Those problems must be kept in mind when analyzing personal filings.

One serious difficulty with the data is that some bankruptcy filings that are

classified as personal may have originated as business failures. Proprietors of small

businesses may use personal lines of credit or pledge personal assets as collateral to

fund their commercial operations. When a small business fails, the owner may file

for personal bankruptcy rather than, or as well as, for business bankruptcy. Sullivan,

Warren, and Westbrook (1989, pp. 16 and 40-41) estimate that about 20 percent of

their sample of individual filers in 1981—who also account for more than half of

their sample’s debt—either were self-employed at the time of filing or had formerly

been self-employed.48

Another problem is that the filings data do not represent discharges of debts, just

petitions for discharge. As Table 2 noted, a significant number of Chapter 13 filings

are dismissed, with those people never receiving a discharge. The Chapter 13 filings

data also contain multiple, or “serial,” filings by consumers who repeatedly file and

carry out repayment plans. Moreover, the filings data include so-called face filings

by consumers who use the automatic-stay provision of bankruptcy law to temporarily

stop creditors’ collection efforts (Brown 1998). Apart from those problems, the

dollar amounts of debt discharged in bankruptcy are not necessarily correlated with

the number of filings. 

Other minor problems in the filings data add to the confusion for researchers.

The data on the annual number of personal filings, prepared by the Administrative

Office of the U.S. Courts, do not equal the sum of higher-frequency (monthly or

quarterly) filings data that the office also publishes because revised versions of the

higher-frequency data are not released. Users of the monthly or quarterly data must

also bear in mind that the filings data are not seasonally adjusted.

As noted earlier, the introduction of joint petitions by the Bankruptcy Reform

Act of 1978 has posed a serious problem for understanding how personal filings

reacted to the change in the federal bankruptcy law. Subject to court approval,

husbands and wives may now file a single joint petition instead of the two separate

petitions required under previous law. The rationale for joint petitions is to ease the

administrative burden posed by essentially duplicate bankruptcy cases. (Although
42 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

legally there are two debtors, in many cases only one set of assets exists to settle

creditors' claims.) But introducing joint filings creates a potentially large break in the

data series on the same date that the bankruptcy law was completely overhauled. At

the end of the first year under BRA-78, joint filings accounted for more than 44

percent of personal filings (see Figure A-1). Since then, joint filings have fallen to

about 32 percent of personal filings, possibly reflecting relatively greater financial

strains among single filers.

No consensus exists on the best way to adjust the personal filings data to account

for the introduction of joint filings. Some researchers have counted joint petitions

twice when comparing filing rates before and after BRA-78. Their rationalization is

that the joint filings would have been separate filings by a husband and wife under

the previous bankruptcy law. But counting joint filings twice may not correctly

approximate the number of filings that would have occurred in the absence of the

joint filing option because the costs of filing for a couple are little more than the costs

for an individual. Consequently, even if only one spouse has burdensome debts, a

husband and wife have an incentive to file a joint petition to protect the other spouse

from debt-collection actions by creditors at little additional cost to the couple.

Domowitz and Eovaldi (1993) argue that doubling joint filings is inappropriate

not only because of the low marginal cost of the joint filing but also because “spousal

propensities to become bankrupt have significantly changed under the Code.” (The

authors do not explain those changes.) Indeed, if many joint filings occurred simply

because more spouses hold credit in their own names, then the filings would

represent a shift only in the distribution of credit holdings within households and not

necessarily in the propensity to file for bankruptcy. Consequently, doubling the

number of joint filings would overrepresent them compared with filings under the old

law. Shuchman and Rhorer (1982) also argue that, on the basis of their findings from

a small sample of filers in Connecticut in 1980, doubling joint filings would overstate

the potential losses to creditors. Instead, they recommend increasing personal filings

by only one-half the number of joint filings. It is not clear that such an adjustment

would be appropriate today.

More research is required to determine how the incentives to file a joint petition

may have changed with BRA-78. For example, a husband and wife who filed in a

state that permitted the use of either the federal or the state asset exemptions

temporarily had an additional incentive to file jointly because one spouse could use

the state limits and the other the federal as a way to exempt more assets. (The 1984

amendments to BRA-78 revoked that incentive.) In the 15 states including the

District of Columbia that currently allow the use of the federal exemption limits,

joint filers may double the value of exemptions that a single filer can use. In

contrast, some of the other states that do not allow use of the federal limits prohibit

joint filers from taking double exemptions, which reduces the attractiveness of filing
PERSONAL BANKRUPTCY: A LITERATURE REVIEW 43

FIGURE A-1. JOINT PERSONAL BANKRUPTCY FILINGS (In percent)

SOURCES: Congressional Budget Office; Administrative Office of the U.S. Courts.

NOTE: The large drop in the series in 1991 appears to be an error in the reported data. 
44 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

jointly. It is not as yet known whether those states may have changed their doubling

provisions around the time of BRA-78's passage and whether spouses in the states

that do not permit doubling can effectively do so by filing two petitions.

Little information is available about husband-and-wife filings under the old

bankruptcy law. On the basis of estimates in the literature, Domowitz and Eovaldi

(1993) noted that between 14 percent and 24 percent of all filings were by a spouse.

The 14 percent figure is quite dated, however—it was taken from a 1964 survey

conducted by Stanley and Girth (1971). The 24 percent figure comes from a report

by the General Accounting Office (1983), which does not indicate how it was

calculated. If GAO calculated it by using data after the change in the law, as

Shuchman and Rhorer did, the adjustment factor may be overstated. Moreover, in

light of the drop in the percentage of joint filings as a share of total personal filings,

those adjustment factors might overstate filings more recently.

A further question concerns the reliability of the data. A sharp drop in the joint

filings data occurred in the third quarter of 1991 and was reversed in the following

quarter. Such a pattern usually suggests a data error, which would indicate reliability

problems.
49. An increase of 1,000 filings per million people is substantial. By comparison, the national filing rate in

1999 was 4,950 per million people.

APPENDIX B: 

THE STIGMA VARIABLES USED BY FAY, HURST, AND WHITE

Fay, Hurst, and White (1998) computed their proxy variables for the stigma

associated with filing for bankruptcy using state and national personal filing rates.

The variable they called stigma I is the difference between the filing rate in a state

and the national filing rate, summed over the previous three years. The other variable

(called stigma II) is the residual from a regression of state filing rates on state and

time dummy variables, which is also summed over the previous three years. The

stigma II variable attempts to isolate the effect of the spread of information, as well

as changes in attitudes resulting from high rates of bankruptcy in the past, from the

effect of differences in consumers across states. (The effect of differences in

consumers is also part of stigma I.) The researchers found that increasing a state’s

rate by 1,000 bankruptcy filings per million people (holding the national rate

constant) raised the state’s filing rate by 4.6 percent in the following year.49

In their paper, Fay, Hurst, and White argued that their proxy variables for the

stigma associated with bankruptcy were intended to measure changes in stigma, but

their argument seems to refer only to the spread of information about the bankruptcy

process. They argued that “[a]s the bankruptcy filing rate rises, people become more

knowledgeable about bankruptcy both because they are more likely to hear about it

from friends and relatives and because there is greater advertising of bankruptcy by

lawyers and more coverage of bankruptcy by the local media. . . . When they [filers]

tell their friends about bankruptcy, the friends are likely to be reassured about the

process and to become more likely to file” (pp. 8-9). By that reasoning, people are

more likely to file because they know more about the process rather than because

their attitudes about the stigma of bankruptcy have changed. Indeed, Fay, Hurst, and

White assumed that, for people to have the courage to tell their family and friends

about their bankruptcy, the stigma of filing for bankruptcy must have fallen.

A critical problem with the stigma variables is that they appear to incorporate

other effects besides stigma. That possibility is suggested by the different time

patterns of the proxy variables for different states. Over the 1984-1995 sample

period that the researchers used, filing rates for some states both rose and fell relative

to the national rate. In contrast, filing rates for other states always increased or

always decreased relative to the national rate. A shrinking difference between the

filing rate in a state and the national rate suggests that the stigma effect was lessening

in that state—a seemingly paradoxical result, given the researchers’ assumptions.

That such movements reflected only changes in stigma seems unlikely.
46 PERSONAL BANKRUPTCY: A LITERATURE REVIEW

50. Gross and Souleles (1998) also argue that factors affecting the chances of declaring bankruptcy in a state

might show up in the state’s filing rate and mistakenly be labeled a change in bankruptcy stigma.

51. Fay, Hurst, and White use the growth in nominal state income and the standard deviation of nominal state

income per capita in their models, but those variables may not control for the differences in relative

economic performance.

52. CBO computed the residual using the same technique as the authors—by regressing the state filing rates

on the same state and time dummy variables. However, CBO’s results differed slightly from the results

given in Fay, Hurst, and White’s paper. Details of CBO’s calculations are available on request.

One important factor that accounts for the variation among the states is

differences in their economic fortunes relative to the nation as a whole.50 If a state’s

economy worsens relative to that of the nation, its filing rate should rise relative to

the U.S. rate, provided everything else remains constant. For example, the 1990-

1991 recession hit the states in New England and the mid-Atlantic region particularly

hard. Not surprisingly, the filing rates for most of those states climbed at that time

in comparison with the national rate. Such economic effects appear in a simple

pooled regression of the difference between state filing rates and the national rate (the

term used to compute the stigma I variable) as a function of the ratio of state civilian

unemployment rates to the national civilian unemployment rate. The coefficient on

the ratio of unemployment rates is positive and statistically significant.51 Similar

economic effects also appear in a regression using the residual used to compute

stigma II as the dependent variable.52
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