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Abstract:
An estimated ten million American households borrow on payday loans each year. Despite the prevalence of these loans, little is known about the effects of access to this form of short-term, high-cost credit. We match individual-level administrative records on payday borrowing to public records on personal bankruptcy, and we exploit a regression discontinuity to estimate the causal impact of access to payday loans on bankruptcy filings. Though the size of the typical payday loan is only $300, we find that loan approval for first-time applicants increases the two-year Chapter 13 bankruptcy filing rate by 2.48 percentage points. There appear to be two components driving this large effect. First, consumers are already financially stressed when they begin borrowing on payday loans. Second, approved applicants borrow repeatedly on payday loans and pawn loans, which carry very high interest rates. For the subsample that identifies our estimates, the cumulative interest burden from payday and pawn loans amounts to roughly 11% of the total liquid debt interest burden at the time of bankruptcy filing.

payday loans, bankruptcy, regression discontinuity

Abstract:
Using a unique dataset matched at the individual level from two administrative sources, we examine household choices between liabilities and assess the informational content of prime and subprime credit scores in the consumer credit market. First, more specifically, we assess consumers' effectiveness at prioritizing use of their lowest-cost credit option. We find that most borrowers from one payday lender who also have a credit card from a major credit card issuer have substantial credit card liquidity on the days they take out their payday loans. This is costly because payday loans have annualized interest rates of at least several hundred percent, though perhaps partly explained by the fact that borrowers have experienced substantial declines in credit card liquidity in the year leading up to the payday loan. Second, we show that FICO scores and Teletrack scores have independent information and are specialized for the types of lending where they are used. Teletrack scores have eight times the predictive power for payday loan default as FICO scores. We also show that prime lenders should value information about their borrowers' subprime activity. Taking out a payday loan predicts nearly a doubling in the probability of serious credit card delinquency over the next year.

Abstract:
Using a unique dataset matched at the individual level from two administrative sources, we examine household choices between liabilities and assess the informational content of prime and subprime credit scores in the consumer credit market. First, more specifically, we assess consumers' effectiveness at prioritizing use of their lowest-cost credit option. We find that most borrowers from one payday lender who also have a credit card from a major credit card issuer have substantial credit card liquidity on the days they take out their payday loans. This is costly because payday loans have annualized interest rates of at least several hundred percent, though perhaps partly explained by the fact that borrowers have experienced substantial declines in credit card liquidity in the year leading up to the payday loan. Second, we show that FICO scores and Teletrack scores have independent information and are specialized for the types of lending where they are used. Teletrack scores have eight times the predictive power for payday loan default as FICO scores. We also show that prime lenders should value information about their borrowers' subprime activity. Taking out a payday loan predicts nearly a doubling in the probability of serious credit card delinquency over the next year.

payday loans, credit cards, liquidity puzzles, household finance, banking, credit scores, personal finance

Abstract:
Ten million American households borrowed on payday loans in 2002. Typically, to receive two weeks of liquidity from these loans households paid annualized (compounded) interest rates over 7000%. Using an administrative dataset from a payday lender, we seek to explain demand-side behavior in the payday loan market. We estimate a structural dynamic programming model that includes standard features like liquidity constraints and stochastic income, and we also incorporate institutionally realistic payday loans, default opportunities, and generalizations of the discount function. Method of Simulated Moments estimates of the key parameters are identified by two novel pieces of evidence. First, over half of payday borrowers default on a payday loan within one year of their first loans. Second, defaulting borrowers have on average already repaid or serviced five payday loans, making interest payments of 90% of their original loan's principal. Such costly delay of default, we find, is most consistent with partially naive quasi-hyperbolic discounting, and we statistically reject nested benchmark alternatives.

payday lending, payday loan, hyperbolic discounting, default

Abstract:
This paper addresses whether receiving large cash prizes of up to $150,000 reduces bankruptcy. While one might hope that additional resources help individuals avert bankruptcy, there are reasons why this may not be the case. For example, if recipients have high discount rates, engage in mental accounting, become accustomed to a more expensive lifestyle, or consciously consume the winnings in the expectation that they will later file for bankruptcy anyway, then receipt of large lump sums may not reduce future bankruptcy filings. To address this question, we exploit a unique dataset of Florida lottery winners from 1993-2002 linked to bankruptcy records. Under the identifying assumption that the magnitude of the cash prize is random conditional on winning one time, we isolate the effect of large lump-sum payments from the effects of potential confounding factors by comparing the bankruptcy rates of large winners to those of small winners. Results show that although recipients of $50,000 to $150,000 are 50 percent less likely to file for bankruptcy in the two years after winning than are recipients of less than $10,000, they experience a statistically significant increase in bankruptcy rates of similar magnitude three to five years after winning. This suggests that winning the lottery only postpones bankruptcy rather than reducing it despite the fact that the median large winner received enough money to pay off all of her unsecured debts. Furthermore, among those who filed for bankruptcy in the five years after winning we find that there is no difference in either net assets or unsecured debt between large and small winners. This suggests that policymakers ought to use considerable caution in giving additional resources to heavily indebted individuals with the hope of increasing their longer-term financial well-being.

lottery, bankruptcy, winnings

Abstract:
A fundamental question faced by policymakers is how best to help individuals who are in financial trouble. This paper examines the consequences of the most basic approach: giving people large cash transfers. To determine whether this prevents or merely postpones bankruptcy, we exploit a unique dataset of Florida Lottery winners linked to bankruptcy records. Results show that although recipients of $50,000 to $150,000 are 50 percent less likely to file for bankruptcy in the two years after winning relative to small winners, they are equally more likely to file three to five years afterward. Furthermore, bankruptcy records indicate that even though the median winner of a large cash prize could have paid off all of his unsecured debt or increased equity in new or existing assets, he chose not to do either. Consequently, although we cannot be sure other recipients of financial assistance would react in the same way lottery players did, our results do suggest that some skepticism regarding the long-term effect of cash transfers may be warranted.

bankruptcy, tort reform