Household debt restructuring: the effect of debt suspensions

Household debt and the number of households facing personal bankruptcy reached record levels during the recent financial crisis in many countries. In the context of high debt levels, the debate about economic policies to deal with overindebtedness moved from the search for the best bankruptcy regime to prevent overindebtedness (see the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act in the United States) to the introduction of concrete measures to restructure the debt of already overindebted households (the US Home Affordable Modification Program brought in in 2009). One unexplored empirical issue is the extent to which debt restructuring enables households to escape the debt trap. 

A recent academic topic

Henri Fraisse is studying this issue in the case of France, and in particular the impact of the two-year debt suspension, as opposed to the requirement for immediate repayment, on re-default rates. He draws on a database that makes it possible to observe what happened to the overindebted households assisted in 2008 over the 2009-2015 period.

Benefiting from a debt suspension and refiling for overindebtedness may be linked to poor job prospects or substantial financial constraints that are imperfectly measured by the available statistical data. It is therefore difficult to establish a causal link between debt suspensions and re-defaults.

To get round this problem, Henri Fraisse makes use of the random allocation of applications among the household debt commission case managers. It is verified that within the same commission managers deal with cases of household debt that have statistically similar characteristics. A causal approach is then applied using instrumental regression, where the instrument is a manager's propensity to propose debt suspensions relative to his/her peers.

A substantial protective effect of debt suspensions in preventing refiling

The empirical results show that debt suspensions reduce by 37% the probability of re-defaulting during the seven years following the decision. The effect of the debt suspension reaches its peak after two years and disappears after four. For the population that have benefited from a debt suspension and have not re-defaulted within four years, this debt suspension does not change their repayment behaviour relative to households that have not benefited from one.

Heterogeneity of effects caused by the living expenses-to-income ratio and the identity of creditors 

In addition, according to Henri Fraisse, the identification strategy makes it possible to measure the effects of tightening the conditions for granting a debt suspension. These effects depend little on the number of creditors or on the share of bank debt in total debt, but stem significantly from the living expenses-to-income ratio. Moreover, some customers of some banks appear to be more sensitive to this tightening, suggesting indirectly that these banks' lending policies target the most vulnerable customers. From a general equilibrium point of view, stricter commissions could change the local credit market by reducing borrowers' moral hazard. However, these effects are not visible in a preliminary analysis.

Indirect proof of the utility of financial education and consumer protection programmes

All in all, the results highlight the utility of debt restructuring programmes in helping households escape the poverty trap. They also argue for the introduction of policies for financial education and the regulation of standards governing consumer credit. These policies have indeed been given prominence in France over the past few years. Thus, the 2010 Lagarde Act further regulates the granting of consumer credit, while a national strategy for financial education was drawn up in 2015.

Henri Fraisse (2017) Households Debt Restructuring: The Re-default Effects of a Debt Suspension, The Journal of Law, Economics, and Organization, Volume 33, Issue 4, 1 November, Pages 686–717, https://doi.org/10.1093/jleo/ewx011