Essays of credit market behavior and bankruptcy

Since the 1980s, household debt has been increasing rapidly. The high level of household indebtedness has been accompanied by a high household bankruptcy rate. My research attempts to provide a better understanding of the theoretical mechanisms behind these credit market and bankruptcy statistics. One of the purposes of Chapter 7 bankruptcy law is to improve debtors' work incentives by giving them a ``fresh start''. Chapter 13 bankruptcy, on the other hand, prescribes a repayment plan that garnishes future wages from debtors to repay creditors, which acts like a wage tax in standard models. In the first chapter, I ask the question ``How much does a fresh start increase labor supply by improving work incentives?'' Because the bankruptcy decision is endogenous, Chapter 7 filers tend to have less earnings and more debt than average individuals. Estimation of the change in labor supply as a consequence of the bankruptcy treatment must therefore take into account selection effects which is complicated by the interdependence of labor and credit market decisions. To answer my question quantitatively, I construct a dynamic partial equilibrium job search model with both bankruptcy choices which allows direct assessment of counterfactual outcomes. Competitive financial intermediaries offer a menu of loan sizes and interest rates that make zero profits. The model predicts that in the short run, a fresh start on average increases the labor supply of Chapter 7 bankruptcy filers by 3.5% over repayment and 3.4% over Chapter 13 bankruptcy.the Fair Credit Reporting Act (FCRA) dictates that adverse eventssuch as a Chapter 7 bankruptcy must be removed from an individual'scredit record after ten years. The intent of the law is to providepartial consumption insurance by giving an individual a fresh start.However, the law obviously weakens incentives not to default, whichcan result in higher interest rates that in turn reduceintertemporal insurance. Because of this tradeoff, it is unclearwhat is the optimal length of time that an adverse event should beon an individual's credit record. In the second chapter, I assess thewelfare consequences of varying the length of time that adverseevents can be on one's credit record. We calibrate themodel to US data where the exclusion parameter is for ten years.Then I run a counterfactual to find the length that maximizesex-ante welfare. I find that the optimal length is much lower,specifically 2.5 years, than the current regulation and that the consumption equivalent welfare gain (slightly over 1%) of such a policy change is large.In the third chapter, I explore how such credit checks (information on observable credit market actions) might help with incentives in labor market when there is a monopolistic employer. According to a Survey by the Society for Human Resource Management (2010), 25% of human resource representatives interviewed in 1998 indicated that the companies they worked for ran credit checks on potential employees while the fraction increased to 43% in 2004 and 60% in 2009. Ever since Holmstrom (1979), we've known that wage contracts can be designed to improve incentives for workers. I show by means of example that if the employer can have wage contracts contingent upon the asset choice of employees, the profit may be increased. However, some employees may be worse off. We may then assess the welfare consequences of a law (the Equal Employment for All Act (H.R. 3149)) prohibiting the use of credit information in employment decisions which currently sits before Congress.