with David Benjamin (SUNY Buffalo)

Abstract: This paper studies informal default (or delinquency) in consumer credit as a process involving negotiations over unpaid debts. We consider an economy with uninsurable individual risk where, as an alternative to informal default, households can also declare formal bankruptcy. Negotiated settlements, which may be reached with some delay, involve limited recovery, are often followed by further defaults, and may end in bankruptcy as households reduce their assets in the process. When calibrated to aggregate measures of default, debt and wealth, the model yields differences in the financial positions of formal and informal defaulters which are quantitatively consistent with observed data. Informal defaulters have higher debts, assets, and net worth, but lower incomes. The opportunity to bargain in informal default - in contrast with informal default via prescriptive collection procedures - provides substantial insurance opportunities and welfare gains. It considerably mitigates the known adverse welfare consequences of formal bankruptcy. Bargaining also enhances the welfare gains following from a tighter asset exemption. Attempts at limiting debt collection outside bankruptcy lower generally, but not uniformly, welfare.

Under revision as of December 2018. Old version February 2014 - download.