Do Credit Markets Watch the Waving Flag of Bankruptcy?   Liberty Street Economics

Personal bankruptcy is surprisingly common in the United States. Almost 15 percent of the U.S. population has filed for bankruptcy sometime over the past twenty-five years, based on my calculations using the New York Fed Consumer Credit Panel/Equifax (CCP). In 2015, roughly 800,000 debtors filed for bankruptcy, according to court records, representing 0.64 percent of U.S. households. One of the consequences for filers is a mark on their credit report—a bankruptcy “flag”—which indicates that the consumer has filed for bankruptcy.

This bankruptcy flag is visible to creditors and, according to the credit bureaus, hurts filers’ credit scores. To limit these effects, the Fair Credit Reporting Act restricts the length of time that credit bureaus can fly these flags on reports for each (personal) bankruptcy chapter: the flag for Chapter 7—in which debtors get a full discharge of (unsecured) debts after unprotected (non-exempt) assets are liquidated—must be removed after ten years, while the flag for Chapter 13—a partial debt repayment bankruptcy designed to help people keep their homes—is typically removed after seven years. For economists, the fixed timing of the flag removal (and the difference across bankruptcy chapters) gives us a laboratory to explore how the lifting of bankruptcy flags affects borrowers’ credit scores and credit outcomes, by comparing these outcomes directly before and after flag removal…

Source: Do Credit Markets Watch the Waving Flag of Bankruptcy?   Liberty Street Economics

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