Research

Publications

The two channels of default on unsecured consumer debt are (i) bankruptcy, which legally grants partial or complete removal of unsecured debt under certain circumstances, and (ii) delinquency, informal default via nonpayment. In the United States, both channels are used routinely. This paper introduces a model of unsecured consumer credit in the presence of both bankruptcy and delinquency and presents three new findings: First, with respect to the choice between bankruptcy and delinquency, labor income shocks matter. Specifically, we find delinquency is readily used by borrowers with the worst labor market outcomes, even those with relatively minor levels of debt. In contrast, bankruptcy is used by households with relatively high debts, but whose long-run earnings prospects are high enough to make interest rate penalties from delinquency too large. Second, financial distress is persistent, in the sense that households in poor financial conditions stay in that state for several quarters. Third, in broad terms, bankruptcy and delinquency are “substitutes,” with bankruptcy increasing as delinquency costs rise.

In 2005, reforms made formal personal bankruptcy much more costly. Shortly after, the US began to experience its most severe recession in seventy years, and while personal bankruptcy rates rose, they rose only modestly given the severity of the rise in unemployment. By contrast, informal default through delinquency rose sharply. In the subsequent recovery, households have been widely viewed as deleveraging" (Mian and Su 2011, Krugman and Eggertson 2012) via the largest reduction of unsecured debt seen in the past three decades. We measure the relative roles of recent bankruptcy reform and labor market risk in accounting for consumer debt and default over the Great Recession. Our results suggest that bankruptcy reform likely prevented a substantial increase in formal bankruptcy filings, but had only limited effect on informal default from delinquencies, and that changes in job-finding rates were central to both.

Loan guarantees are arguably the most widely used policy intervention in credit markets, especially for consumers. This may be natural, as they have several features that, a priori, suggest that they might be particularly effective in improving allocations. However, despite this, little is actually known about the size of their effects on prices, allocations, and welfare.

In this paper, we provide a quantitative assessment of loan guarantees, in the context of unsecured consumption loans. Our work is novel as it studies loan guarantees in a rich dynamic model where credit allocation is allowed to be affected by both limited commitment frictions and private information.

Our findings suggest that consumer loan guarantees may be a powerful tool to alter allocations that, if carefully arranged, can improve welfare, sometimes significantly. Specifically, our key findings are that (i) under both symmetric and asymmetric information, guaranteeing small consumer loans nontrivially alters allocations, and strikingly, yields welfare improvements even after a key form of uncertainty–one’s human capital level–has been realized, (ii) larger guarantees change allocations very significantly, but lower welfare, sometimes for all household-types, and (iii) substantial further gains are available when guarantees are restricted to households hit by large expenditure shocks.

Important changes have occurred in unsecured credit markets over the past three decades. Most prominently, there have been large increases in aggregate consumer debt, the personal bankruptcy rate, the size of bankruptcies, the dispersion of interest rates paid by borrowers, and the relative discount received by those with good credit ratings. We find that improvements in information available to lenders on household-level costs of bankruptcy can account for a significant fraction of what has been observed. The ex ante welfare gains from better information are positive but small.

In this article, we evaluate in detail the role of debt forgiveness in altering the transmission of labor income risk in the absence of catastrophic out-of- pocket "expense shocks" used in the literature on consumer default. The experiments we present can be thought of as: "If we insure the out-of-pocket expenses that constitute expenditure shocks, is there still a role of debt relief as a form of insurance against 'pure labor income risk'?" We address this question by studying a range of specifications for households' attitudes toward the intra- and intertemporal properties of income risk alone. Our main finding is that, absent expense shocks, the ability to default very generally hinders the ability of households to protect themselves against labor income risk. Our findings suggest the scope of shocks that debt forgiveness is providing insurance against may be limited, perhaps principally to relatively catastrophic outcomes.

We study the extent to which unsecured credit markets have alters the transmission of increased income risk to consumption variability over the past several decades. We find that unsecured credit markets pass through increased income risk to consumption, irrespective of bankruptcy policy and the information possessed by lenders. If risk sharing has indeed improved over this period, the reasons do not therefore lie in the unsecured credit market.

Papers Under Review

  • "The Real Effect of Financial Reporting: A Quantitative Assessment," Joint with Pierre Liang and Bo Sun). R&R.

To quantify the role of financial reporting in improving investment efficiency, we embed a real-effect model of financial reporting into the neoclassical dynamic investment theory. We calibrate the model to assess the degree of reporting quality in the data and evaluate its economic consequences through an investment channel. Our result suggests that a near doubling in reporting quality would lead to a 5.5% increase in firm output, representing a sizable benefit to the real economy. In addition, our analysis indicates that key aspects of recent economic developments collectively point to an increasingly prominent role of reporting quality in promoting investment efficiency.

Developing countries have substantially lower tax revenue to GDP ratios than richer economies.Paradoxically, developing countries are also the ones with the largest infrastructure development needs, and require larger fiscal buffers to smooth external and domestic shocks. Substantial efforts have been made during the last two decades to strengthen revenue collections in developing countries. Many of these reforms have had increases in effective VAT rates as a key component. In this paper, we investigate the impact on output and on the income distribution of raising revenue through VAT. Our tool of analysis is a heterogeneous multi-sector model carefully calibrated to capture key features of developing countries. We find that in low income countries (LICs) the cost of raising government revenue is higher in terms of both output and poverty than in middle income countries. This also means compensatory measures to alleviate the regressive aspects of VAT in LICS are costlier to implement than in more developed countries.

Regulatory investigations affect information in financial markets through two channels: (i) investigations detect financial manipulation and reveal hidden negative information;(ii) regulatory investigations impose adverse consequences for executives involved in manipulation and deter managerial incentives to manipulate ex ante. More- over, regulatory intensity varies over time, depending on the aggregate state of the economy. We propose a model to study the implications of cyclical regulatory intensity for stock market dynamics, and show that countercyclicality in financial regulation can lead to countercyclicality in crash risk in the stock markets. We also provide evidence that a strong relation between stock crash risk and the business cycle exists in the data. In addition, our model illustrates a unifying mechanism that contributes to a number of stylized facts including gradual booms and sudden crashes in the financial markets, increased crash risk, and countercyclical stock volatility.

Working Papers

This paper studies the effectiveness of longer-term unsecured credit contracts in improving credit access, consumption smoothing, and welfare. I find that longer-term contracts result in higher average borrowing interest rates and hence lower levels of borrowing and fewer borrowers in the equilibrium. In addition, I show that longer-term contracts reduce consumer welfare. I also investigate the welfare implications of interest rate ceilings and show that imposing a modest interest rate cap under long-term contracts improves welfare.

Work in Progress