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The (Un-) importance of Chapter 7 wealth exemption levels

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  • Mankart, Jochen
Abstract
This paper examines the effects of the Chapter 7 wealth exemption level on welfare, bankruptcy filings, debt, and on asset holdings. I build a heterogeneous agent life cycle model which features uninsurable income and expense shocks. Moreover, households can borrow and save simultaneously. When a borrower defaults on her debt by filing for Chapter 7 bankruptcy, she can keep her assets up to the wealth exemption level. Wealth exemption levels are important for two reasons. First, they explain the extensive and intensive margin of the credit card debt puzzle. Around thirty percent of borrowers, both in the model and in the data, who borrow at high interest rates simultaneously save at low interest rates. However, these borrowers borrow and save only relatively small amounts, a few thousand U.S. Dollars. Second, ignoring the exemption level biases results because it overstates the costs of defaulting. The welfare gains from Chapter 7 compared to the European system, where debt is not discharged, are twice as high when exemption levels are positive compared to when they are ignored. At the same time, wealth exemption levels are unimportant in the sense that they have an impact only at low exemption levels. The effects of increases in the exemption level fade out very quickly. There is no strong positive relationship between exemption levels, which vary across U.S. states, and default rates in the model. This is in contrast to the previous literature, but consistent with the data. The reason is that those borrowers who might default do not own much wealth. Therefore, only very few households are affected by increases in the exemption level.

Suggested Citation

  • Mankart, Jochen, 2014. "The (Un-) importance of Chapter 7 wealth exemption levels," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 1-16.
    • Handle: RePEc:eee:dyncon:v:38:y:2014:i:c:p:1-16
    DOI: 10.1016/j.jedc.2013.10.007
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Wealth exemptions do not matter in bankruptcy
      by Economic Logician in Economic Logic on 2012-05-15 19:32:00

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    2. Igor Livshits, 2015. "Recent Developments In Consumer Credit And Default Literature," Journal of Economic Surveys, Wiley Blackwell, vol. 29(4), pages 594-613, September.
    3. Dal Borgo Mariela, 2021. "Do Bankruptcy Protection Levels Affect Households' Demand for Stocks?," Working Papers 2021-03, Banco de México.
    4. Olga Gorbachev & María José Luengo-Prado, 2019. "The Credit Card Debt Puzzle: The Role of Preferences, Credit Access Risk, and Financial Literacy," The Review of Economics and Statistics, MIT Press, vol. 101(2), pages 294-309, May.
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    6. Pattison, Nathaniel, 2020. "Consumption smoothing and debtor protections," Journal of Public Economics, Elsevier, vol. 192(C).

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    More about this item

    Keywords

    Personal bankruptcy law; Wealth exemption level; Asset portfolios; Credit card debt puzzle;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law

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