Labor Market Upheaval, Default Regulations, and Consumer Debt

Labor Market Upheaval, Default Regulations, and Consumer Debt Kartik Athreya Juan M. Sánchez Xuan S. Tam Eric R. Young FRB Richmond FRB St Louis City Univ of Hong Kong University of Virginia December 6, 2013 ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 1 / 39

Motivation Motivation Since 2009 Big changes in household leverage ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 2 / 39

Motivation Drop in leverage 105 100 Mean Debt/Mean Income Index 95 90 85 80 75 Data 70 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 3 / 39

Motivation Motivation Since 2009 Big changes in household leverage Big changes in the level and type of consumer default ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 4 / 39

Motivation How You Can Default US offers consumers formal route to repudiate debt: ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 5 / 39

Motivation How You Can Default US offers consumers formal route to repudiate debt: Chapter 7: in exchange for assets above threshold, debts are removed ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 5 / 39

Motivation How You Can Default US offers consumers formal route to repudiate debt: Chapter 7: in exchange for assets above threshold, debts are removed Also an informal method...just stop paying ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 5 / 39

Motivation Change in default 14 0.6 DQ Debt Rate 12 0.4 DQ Debt(%) BK Rate(%) 10 0.2 BK Rate 8 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 6 / 39

Motivation Why? Two relevant things happened just before, and during, this period... ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 7 / 39

Motivation Labor Market Upheaval 3.5 0.8 Average Unemployment Duration, Quaters 3 2.5 2 1.5 0.78 0.76 0.74 0.72 Employment Rate 1 0.7 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 8 / 39

Motivation Bankruptcy Reform In late 2005, BAPCPA roughly doubled bankruptcy filing cost Seems to have come as a surprise ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 9 / 39

Motivation Our Question What role did bankruptcy reform and labor market changes play in the paths of debt, delinquency, and bankruptcy over the Great Recession? ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 10 / 39

Motivation What we do ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 11 / 39

Motivation What we do Step 1: Feed in labor market upheaval, by setting ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 11 / 39

Motivation What we do Step 1: Feed in labor market upheaval, by setting job separation rates ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 11 / 39

Motivation What we do Step 1: Feed in labor market upheaval, by setting job separation rates job finding rates ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 11 / 39

Motivation What we do Step 1: Feed in labor market upheaval, by setting job separation rates job finding rates Step 2: Compare model predictions for paths of debt, delinquency, bankruptcy to data Step 3: Use counterfactuals to understand the roles of labor markets and bankruptcy law in outcomes Evaluate Step 2 with and without 2005 BK reform Evaluate Step 2 with and without changes in labor markets ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 11 / 39

Model Framework Model Framework Life cycle model with uninsurable idiosyncratic earnings risk: ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 12 / 39

Model Framework Model Framework Life cycle model with uninsurable idiosyncratic earnings risk: Deterministic education and lifecycle component Persistent component Transitory component Job offers and option to reject (I ll simplify the notation for income process in what follows) Riskless saving with exog. return, risky borrowing with default premium ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 12 / 39

Model Framework Model Framework Life cycle model with uninsurable idiosyncratic earnings risk: Deterministic education and lifecycle component Persistent component Transitory component Job offers and option to reject (I ll simplify the notation for income process in what follows) Riskless saving with exog. return, risky borrowing with default premium Two ways to default on debt: ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 12 / 39

Model Framework Model Framework Life cycle model with uninsurable idiosyncratic earnings risk: Deterministic education and lifecycle component Persistent component Transitory component Job offers and option to reject (I ll simplify the notation for income process in what follows) Riskless saving with exog. return, risky borrowing with default premium Two ways to default on debt: Bankruptcy: incur filing costs and high utility cost, debts are eliminated ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 12 / 39

Model Framework Model Framework Life cycle model with uninsurable idiosyncratic earnings risk: Deterministic education and lifecycle component Persistent component Transitory component Job offers and option to reject (I ll simplify the notation for income process in what follows) Riskless saving with exog. return, risky borrowing with default premium Two ways to default on debt: Bankruptcy: incur filing costs and high utility cost, debts are eliminated Delinquency: incur lower utility cost, debt is reset ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 12 / 39

Model Framework Value Function, Solvent vj,e d=0 (b 1, y) = max b {u(c) + β } y π (y y) v j+1,e (b, y ) subject to c + q j,e (b, y)b = b 1 + y ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 13 / 39

Model Framework Value Function, DQ v d=1 j,e (y) = u(c) ψ D + β y π (y y) v j+1,e (h j,e (y), y ) subject to c = y key object is h j,e ( ), as explained below ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 14 / 39

Model Framework Value Function, BK v d=2 j,e (y) = u(c) ψ B + β y π (y y) v j+1,e (0, y ) subject to c = y (y) (y) will differ by employment status b/c filing costs can be waived ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 15 / 39

Model Framework Optimal Behavior of an indebted household { v j,e (b 1, y) = max vj,e d=0 (b 1, y), v d=1 j,e (y), vj,e d=2 } (y) ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 16 / 39

Model Framework Delinquency and Debt If faced with a delinquent, optimizing lenders (who lack commitment) solve: h j,e (y) = arg max {bq j,e (b, y)} b Price of face value b of new debt: q j,e (b, y) = Q 1 + r + φ ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 17 / 39

Model Framework Pricing and Delinquency A law of motion Q = y π (y y) 1 (d j+1,e (b, y ) = 0) + [ y π (y y) 1 (d j+1,e (b, y ) = 1) q j+1,e(h j+1,e (y ),y )h j+1,e (y ) b ] ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 18 / 39

Quantitative Model Earnings Risk Quarterly model key for capturing delinquency Wage risk and employment risk UI, DI, Food stamps Follow Low, Meghir, Pistaferri (2010) Wages and employment both risky, depend on education Workers matched with firms, quality specific to current match m ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 19 / 39

Quantitative Model Earnings Risk, con t Wage Risk ln(w j (e, n, m)) = x j (e) + n j + m j n j = n j 1 + ζ j ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 20 / 39

Quantitative Model Earnings Risk, con t Employment Risk if employed, offers arrive with Pr. λ E e if unemployed, offers arrive with Pr. λ N e All matches break with exog. separation rate: δ e Disposable Earnings y j (n, m, p) = p(w j (e, n, m)h(1 τ) F e ) p {0, 1} Food Stamps T j (y) A Disability system in place too (like UI, but absorbing) ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 21 / 39

Quantitative Model Preferences u(c, p) = (c exp (ϕ ep)) 1 γ 1 γ ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 22 / 39

Quantitative Model Parameters Discount factor β 0.957 Non-pecuniary cost BK ψ B 1.786 Non-pecuniary cost DQ ψ D 0.104 Data Model Share of debt in 90+ DQ, % 8.9 7.8 Bankruptcy rate, % 0.26 0.26 Mean (assets/income) 4.07 3.09 ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 23 / 39

Results Repayment Decisions Persistent shocks 90 Solvency Bankruptcy Delinquency 80 70 Current Productivity, n 60 50 40 30 20 10 0.5 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 Current Stock of Debt, b ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 24 / 39

Results Repayment Decisions Persistent shocks good times for wages means repayment bad times for wages means delinquency get debt forgiveness! medium times for wages and a lot of debt means bankruptcy no forgiveness in DQ. Notice: conditional on shocks no switches in choice of default path Repayment branch value function is only one that depends on debt ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 25 / 39

Results On the determination of h(.) and the decision to enter DQ Market Value of h, h*q(h, ) A C h(n_h) B h(n_l) Amount to Repay Next Period, h ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 26 / 39

Results Debt and Default in The Great Recession Shocks to job finding and separation Each shock unanticipated, expected to be permanent (can be relaxed) ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 27 / 39

Results Model Approximation, shocks Permanent Shocks SS Anticipate BK Reform Shocks 1 Shock 2 Shock 4 New SS Shocks 3 Shocks 5 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 28 / 39

Results The Shocks 1 0.03 Job Finding Rate of UN, Left 0.028 0.8 0.026 Separation Rate 0.024 Job Finding Rate 0.6 0.4 0.022 Seperation Rate Job Finding Rate of EM, Left 0.2 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 29 / 39

Results Tracking Employment Rates 0.9 0.85 Employment Rate 0.8 0.75 0.7 Data Benchmark 0.65 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 30 / 39

Results Tracking Unemployment Duration 3.5 Data Average Unemployment Duration 3 2.5 2 1.5 Benchmark 1 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 31 / 39

Results Bk Reform Mattered for Observed Bankruptcy Model accounts well for path of bankruptcy during GR 0.7 0.6 0.5 BK Rate (%) 0.4 0.3 No Reform Benchmark 0.2 Data 0.1 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 32 / 39

Results Model Generates Rise in Delinquencies in seen in GR Model suggests that labor markets deterioration key for DQ, reform does not matter. 18 16 Benchmark 14 No Reform 12 DQ Debt (%) 10 8 Data 6 4 2 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 33 / 39

Results The distribution of renegotiated debt BK Reform would have made DQ a lot tougher but labor markets intervened 0.35 0.3 Original SS After Reform 0.25 Distribution of h 0.2 0.15 Great Recession 0.1 0.05 0 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 h ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 34 / 39

Results Bankruptcy in the GR decompositions Job finding is central, not separation 0.7 0.6 0.5 BK Rate (%) 0.4 0.3 Separation 0.2 Benchmark Data 0.1 Job Finding 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 35 / 39

Results Delinquency in the GR decompositions Again, movements in job finding rate are the key 18 16 Benchmark 14 Separation 12 Data DQ Debt (%) 10 8 Job Finding 6 4 2 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 36 / 39

Results Bankruptcy Reform and Deleveraging Debt more sensitive to income in model than data lenders here learn immediately 160 140 Mean Debt/Mean Income Index 120 100 80 Data Benchmark 60 No Reform 40 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 37 / 39

Results The Proximate Cause of Deleveraging 50 45 40 Interest Rate (%) 35 30 25 20 15 2006 2004 2009 10 5 0 1.4 1.2 1 0.8 0.6 0.4 0.2 b ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 38 / 39

Concluding Remarks What we ve done... Have taken a step towards understanding consumer credit use and default during Great Recession ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 39 / 39

Concluding Remarks What we ve done... Have taken a step towards understanding consumer credit use and default during Great Recession Model quantitatively consistent with both bk and dq paths in GR Model suggests that: bankruptcy reform did in fact lower filing rates, given the evolution of labor market risk delinquency not strongly affected by BK reform changes in job finding rates key for default and debt ASTY (FRB, FRB, CUHK, UVa) Bk Reform and the GR December 6, 2013 39 / 39