Tuesday, May 15, 2012

Wealth exemptions do not matter in bankruptcy

The major aspect in bankruptcy law variation across states in the US is the wealth exemption. Some states protect substantial wealth from the creditors, the prime example being Texas where housing is exempted without limits, plus $30,000 per spouse. Maryland, however, exempts only $11,000 total personal property plus about $20,000 in owner-occupied housing. This considerable source of variation ought to lead to cross-state variation in bankruptcy rates, as several models would predict, yet the data does not show it.

Jochen Mankart explains why. He uses a life-cycle model where households borrow and save, and they are subject to a variety of shocks, the most relevant being health expense shocks, the most common trigger of bankruptcy in the United States. Varying bankruptcy exemptions, he finds no significant change in bankruptcy rates. The reason is quite simple: those who file for bankruptcy are so poor they have nothing left anyway, thus exemptions do not matter to them. Where it matters though is in the savings rate. Higher exemptions encourages especially the poor to save more. To boot, the model solves the credit card puzzle (see posts 1 and 2).

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