Here is a new academic paper (by Livshits, MacGee, and Tertilt, "Accounting for the Rise in Consumer Bankruptcies") that ties increasing consumer bankruptcies with credit market innovations that have come about since 1970. Here's the abstract:

Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households' earnings, age and current asset holdings to evaluate several commonly offered explanations. We find that increased uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, the rise in filings appears to mainly reflect changes in the credit market environment. We find that credit market innovations which cause a decrease in the transactions cost of lending and a decline in the cost of bankruptcy can largely accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes are unimportant.

Question: Why would decreased transaction costs in loan contracts result in increased consumer bankruptcies? There is an adverse selection argument here (we have not yet covered adverse selection in class), but it seems weak in this case. (Note that in the early 2000s, former Fed Chairman Alan Greenspan encouraged the use of the subprime market.) One point we will discuss later in class is the lag between technological innovations and regulatory adjustment. Regulations are created to fit a specific banking environment, and when the environment changes, the regulations are often not adjusted until after a crisis of some sort develops. Also, the argument here is that lowered transaction costs leave lenders with decreased incentives to maintain minimum lending standards. Do you agree? Can you think of other likely--perhaps more likely--candidates for he increase in bankruptcies?

We'll discuss this in more detail in class. Also, here are some links to the full paper.