Informal Bankruptcy

  • Amanda E. Dawsey
  • Published 2001


In the economic literature on bankruptcy, the standard methodology is to model the individual’s bankruptcy decision as a binary choice between “bankruptcy” and “no bankruptcy.” We define an additional choice—non-repayment without seeking the formal protection of the bankruptcy system—as informal bankruptcy. Using data from a large credit card issuer, we find evidence that while both lenient exemption laws and garnishment laws increase bankruptcies in the standard model, loose garnishment discourages default in our expanded model, while at the same time more pronouncedly shifting individuals from informal to formal bankruptcy. This result suggests that previous research may substantially understate the degree to which garnishment laws drive defaulting individuals to choose bankruptcy. Moreover, lenient exemption laws increase both formal and informal bankruptcy. We also find that borrowers living in majority black neighborhoods are more likely to choose informal bankruptcy, and less likely to choose bankruptcy, than other borrowers. We also test whether creditors’ strategic interactions increase bankruptcies. We develop a two-period model of the “creditor’s dilemma,” a popular hypothesis in the legal literature. We examine a testable implication of this model, namely, that increasing the number of creditors (while holding the amount and availability of credit constant) should increase the probability that a defaulting borrower enters bankruptcy rather than a workout, and either decrease or not affect the probability of informal bankruptcy. We find that the number of creditors indeed has a positive and statistically significant effect on the probability of bankruptcy, and, depending on the specification, a significant negative or insignificant effect on informal bankruptcy.

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Cite this paper

@inproceedings{Dawsey2001InformalB, title={Informal Bankruptcy}, author={Amanda E. Dawsey}, year={2001} }