Consumer Default After the 2005 Bankruptcy Reform

Abstract

The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act is the most important reform of personal bankruptcy in the United States in recent years. This law left benefits of filing for bankruptcy mostly unchanged, but increased the monetary costs of filing, both for Chapter 7 and Chapter 13 bankruptcy. Using administrative credit bureau data from a nationally representative panel, we quantify the effects of the rise in filing costs exploiting geographical variation in this increase. We show that the increase in filing costs reduced Chapter 7 bankruptcy rates by 15% for newly financially distressed borrowers, but had no statistically significant effect on Chapter 13. We argue that this differential is consistent with binding liquidity constraints driving the response to the reform. Additionally, we find that the missing Chapter 7 bankruptcies lead to an increase in long term financial distress but also a limited rise in the rate consumers return to being current, while there is no evidence of substitution from Chapter 7 bankruptcy to Chapter 13 filing or foreclosure.