By: Donald L Swanson
BAPCPA harmed honest but unfortunate consumers in these United States. It did so by moving them out of Chapter 7 bankruptcy and into an unworkable Chapter 13 system that few consumers can use effectively in times of economic stress.
- That’s a given.
But the up-side tradeoff that’s being pitched to us is this: by keeping consumers out of Chapter 7 bankruptcy, interest rates on credit card debt are reduced.
- An illustration of such a pitch is this study: The Economic Consequences of Bankruptcy Reform.[Fn. 1]
Summary of the Study
Here’s a summary of the study and its findings.
“Our analysis consists of three main steps”:
- first, we develop a stylized model of consumer bankruptcy to study the relationship between the bankruptcy filing rate and the cost of borrowing;
- then, we show that decreases in bankruptcy filing risks are associated with interest rate declines; and
- the pass-through rate depends on the amount recovered from those deterred from filing at the margin.
“All else equal”:
- the higher the average repayment rate for these marginal filers, the greater the change in interest rates; and
- We calibrate the pass-through expression under perfect competition to produce a benchmark of expected interest rate pass-through of 87–112 basis points for a 1 percentage point change in the bankruptcy filing rate (i.e., a 1% interest rate drop for every 1% drop in the bankruptcy filing rate).
Editorial Comment
I’m not buying what the study is selling on interest rate declines. Here’s why.
–Unreliable Assumptions
There is, for starters, no such thing as “all else equal” or “perfect competition” in the credit card market. Such phrases are nothing more than short-hand for a bunch of assumptions that are implicitly-acknowledged to be outside the realm of actual reality.
Nor is there any such thing as “a stylized model of consumer bankruptcy” that’s reliable. All such models are based on a bunch of assumptions that may . . . or might not . . . have any relationship to reality.
And what the heck does “amount recovered from those deterred from filing at the margin” mean in actual-life realities? That phrase might be interesting in the abstract, but it means nothing concrete or reliable in the real world.
And adding to that uncertainty, how does this inquiry get quantified reliably: “the higher the average repayment rate for these marginal filers, the greater the change in interest rates”? The answer is this: it doesn’t.
–Better Assumptions
Here are some better assumptions to suggest that BAPCPA had, in reality, no impact whatsoever on credit card interest rates thereafter.
First assumption: credit card companies will adjust their lending practices based on the risks involved. If, for example, middle class families were eligible for Chapter 7 bankruptcy relief, credit card companies would adjust their credit card solicitation practices accordingly to account for that risk. They would do so by such things as:
- removing consumers with the worst credit risks from solicitation mailing lists; and
- factoring into the solicitation calculation any lessons they learned from the history of such bankruptcy-inducing factors as hospitalizations, divorce, and the possibility of pregnancies among young couples reliant upon two incomes.
Second assumption: credit card companies will work to achieve a certain level of acceptable credit risk within their entire system in all circumstances. This assumption implies that the interest rates would be about the same at any given time in either a BAPCPA context or a no-BAPCPA context.
Third assumption: it’s possible that credit solicitation calculations, in a no-BAPCPA world, would include an interest rate adjustment. But a reliable quantification of such possibility (in a comparison of BACPA interest rates with what no-BAPCPA interest rates would have been) is not possible:
- it’s an interesting academic exercise . . . but one that’s, simply, not reliable.
Conclusion
What we know with certainty is this: BAPCPA drastically reduced the value of bankruptcy as a tool for honest but unfortunate consumers to use in dealing with economic stress.
There may be a trade-off that justifies such a drastic reduction in the economic welfare of our consumers. But a quantified decrease in credit card interest rates cannot be legitimately or reliably included among those justifications.
20th Anniversary!
NOTE: The year 2025 is the twenty-years anniversary of the enactment of BAPCPA. This article is the fourth in a series of six articles looking back over what BAPCPA has wrought.
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Footnote 1. The study is, The Economic Consequences of Bankruptcy Reform, by Tal Gross, Raymond Kluender, Feng Liu, Matthew J. Notowidigdo & Jialan Wang, published in Vol. 111, No. 7, pp. 2309-41 (July 2021).
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