Life after Debt: Understanding the Credit Restraint of Bankruptcy Debtors

Abstract

Bankruptcy gives individuals a fresh start by allowing them to discharge much of their unsecured debt. But the consequences of bankruptcy do not end when the legal process is complete. After bankruptcy, families still must figure out how to make ends meet and how to interact with the credit economy. This paper presents data showing that bankruptcy transforms how people borrow. Despite very difficult financial circumstances after bankruptcy, most families initially refuse new credit. As years elapse, more families begin to borrow. The overall pattern of credit use is restrained, however, compared both with Americans generally and with these families' pre-bankruptcy borrowing. While the modest use of credit could reflect an inability to access credit markets, this paper argues that the limited use of credit is consistent with an alternate hypothesis: that bankruptcy debtors discipline themselves in their future credit use, even in the face of temptation by lenders and their households' ongoing financial struggles. This interpretation of the data suggests that people who have endured financial failure may curtail their future economic activity. Such actions are evidence of the pain of declaring oneself broke and of the way in which bankruptcy may shape debtors' decisions for years to follow.