Consumer durables and risky borrowing: The effects of bankruptcy protection

I estimate a dynamic model of durable and non-durable consumption choice and default behavior in an economy where risky borrowing is allowed and bankruptcy protection is regulated by law. I exploit the substantial difference in the generosity of bankruptcy exemptions across the U.S. states to assess the role of durable goods as both informal collateral for unsecured debt and self-insurance against bad shocks to earnings. The model accounts for the equilibrium effects of bankruptcy protection on both consumer saving behavior and the credit market. The individual-specific borrowing limits are endogenously derived from the equilibrium condition of the banking sector. The default risk premium charged on unsecured loans is decreasing in durable wealth and increasing in the exemption level. The generosity of bankruptcy protection does change both the incentives and the ability of households to accumulate durable wealth. The proposed Bankruptcy Reform H.R. 333 (2002) would increase default and interest rates, and would not improve welfare.