Gordon, Richard Grey

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  • Publication
    Essays on Consumer Default
    (2012-01-01) Gordon, Richard Grey
    Legislation dealing with consumer default has consistently struggled with an important trade-off: more debt forgiveness directly benefits households but indirectly makes credit more expensive. This dissertation assesses this trade-off in two ways and provides a tool for future research into this and other topics. Specifically, the first chapter analyzes how business cycles affect the positive and normative consequences of eliminating or restricting default, including the default restrictions put in place by the recent Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The second chapter examines the implications of eliminating bankruptcy protection while still allowing households access to informal default. Lastly, the third chapter provides a novel tool for computing equilibrium in dynamic heterogeneous-agent economies, such as the economy in the first chapter. There are four main findings. First, accounting for business cycles substantially reduces the welfare benefit of eliminating default. With or without business cycles, eliminating default greatly expands credit availability; however, when a protracted recession is possible, households use less credit unless they have a default option. Second, while business cycles reduce the welfare gain of eliminating default, this is not necessarily true for restricting default: BAPCPA significantly improves welfare whether or not aggregate risk is taken into account. Because the policy makes default more costly only for earnings-rich households, the reform improves credit markets while still preserving most of the insurance value of default. Third, eliminating bankruptcy protection leads to an increase in total defaults, debt, and welfare. Without bankruptcy protection, creditors can collect on defaulted debt to the extent permitted by wage garnishment laws. The elimination lowers the default premium on unsecured debt and permits low-net-worth individuals suffering bad earnings shocks to smooth consumption by borrowing. Last, the proposed computational method is capable of delivering a more accurate solution than the most widely used method and can be as efficient.