Paper looks at the Causes of Household Bankruptcy in Canada and the interaction of Income Shocks and Balance Sheets The Causes of Household Bankruptcy: The Interaction of Income Shocks and Balance Sheets, Vyacheslav Mikhed and Barry Scholnick, Philadelphia Fed Working Papers July 2016 Abstract We examine how household balance sheets and income statements interact to affect bankruptcy decisions following an exogenous income shock. For identification, we exploit government payments in one but not any other Canadian province that varied exogenously based on family size. Receiving a larger income shock from the payment (relative to household income) reduces the count of bankruptcies, with fewer remaining filers having higher net balance sheet benefits of bankruptcy (unsecured debt discharged minus liquidated assets forgone). Receiving an income shock thus causes households that would receive lower net balance sheet benefits under bankruptcy law to select out of bankruptcy. Conclusion There is little agreement in the recent literature on the causes of consumer defaults. Various papers emphasize how balance sheet or income statements may affect this consumer decision. We follow the idea of Elul et al. (2010) and empirically test if both of these channels can interact to cause household bankruptcy. Our paper contributes to the literature by providing causal evidence on this question using a plausibly exogenous income shock and rich data on balance sheets and income statements of bankruptcy filers in Canada. Our methodology exploits an exogenous, politically driven government cash payment provided in one but not any other Canadian provinces. Because the payment was made to each individual across households, we can observe exogenous variation in the magnitude of the payment received across households. We use a unique database that allows us to observe the complete balance sheet of every Canadian bankruptcy e-filer, thus allowing us to calculate the net BSBs received by each bankruptcy filer, as defined by bankruptcy law. Our main empirical conclusion is that the exogenous income shocks cause potential bankruptcy filers with lower BSBs from bankruptcy to select out of bankruptcy following the exogenous income shock. Our main contribution, therefore, is to provide causal empirical evidence that both balance sheets and income statements matter in the household decision to file for bankruptcy following exogenous income shocks. We show that the positive income shock from the Ralph bucks payment can work through the income statements of households to reduce liquidity constraints and motivate them to select out of bankruptcy. In addition, we observe that those selecting out of bankruptcy have lower BSBs of filing. These two findings together imply that both income statements and balance sheets are important in the bankruptcy decision. ID: 49054 Publication date: 30/08/16     URL(s): The Causes of Household Bankruptcy: The Interaction of Income Shocks and Balance Sheets, Philadelphia Fed Working Papers (19.07.2016)

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Created: 30/08/16. Last changed: 30/08/16.
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