Welfare implications of the Bankruptcy Reform Act of 1999

In recent years personal bankruptcy has become an important issue to consumers, creditors, and legislators alike. Over 40 billion dollars of unsecured debt were discharged in 1998 by 1.44 million households. These losses have led legislators to propose a variety of changes in bankruptcy law, the most important and recent of which is the Bankruptcy Reform Act of 1999 (BA99). I develop a dynamic, stochastic, general equilibrium model of personal bankruptcy to investigate the trade-off between the consumption smoothing role of bankruptcy and the interest rate and deadweight costs it imposes. I find that stringent means-tests would reduce filing rates only slightly, and would have only modest welfare consequences. On the other hand, the elimination of bankruptcy altogether is found to have substantial benefits. This result is robust to income shock persistence, and to stringency in the application of means-tests. (C) 2002 Elsevier Science B.V. All rights reserved.