The economic stimulus payments of $1,200 for each individual and higher unemployment insurance payments has cushioned the impact of the pandemic, and may play a role in pushing struggling households to hold off on declaring bankruptcy. Households filing for bankruptcy tend not to take undue advantage of the debt relief it brings; a bigger attraction is the increase in cash in their hands, according to a recent paper by Wharton finance professor Sasha Indarte.
Her paper, “Moral Hazard versus Liquidity in Household Bankruptcy,” argues that “increases in potential debt forgiveness have a positive, but small, effect on filing [and that] filing is five times more responsive to cash-on-hand than relief generosity.” She concludes that 83% of the effect of the debt burden (that bankruptcy alleviates) on filing is due to liquidity rather than moral hazard. “In other words, people file for bankruptcy not because of what they can get, but because of what they don’t have,” she says.
“If you give people more cash, that alleviates their financial distress and can give them a strong incentive to not file,” she notes. “Making the debt relief that they’re able to get in bankruptcy much more generous has a much smaller impact on that decision.”
“With the current public health and economic crises, we’re seeing some very unusual patterns in bankruptcy,” says Indarte. She pointed to a recent working paper that found a 27% year-over-year drop in bankruptcy filings by consumers and small businesses between January and August this year, despite the effects of the pandemic.
The takeaways from the research for policymakers are twofold. One is “we shouldn’t be as concerned about the cost associated with providing households generous debt relief and bankruptcy,” says Indarte. But her study also suggests that strengthening the social safety net in the U.S. could be valuable by eliminating some of the reasons households have for using bankruptcy.
Read more at Knowledge@Wharton.
