The Volokh Conspiracy

This from the the Manhattan Jaspers basketball website:

Manhattan gets back in action on Saturday, February 19, when the Jaspers travel to Fairfax, VA to take on George Washington in the team's final non-conference game. Tip-off is slated for 4:00 p.m.

GMU beat 23-3 Old Dominion, earns an ESPN Bracket Buster game this weekend, and the team they are playing still can't get the name right. It is George Mason, not George Washington, and not Georgetown! Its bad enough being the other "George" school around here, but sometimes it gets old being the other, other "George" school in these parts.

I have a very busy day, so I don't have time for another long post on bankruptcy reform (I'll get back to it tomorrow I hope if I have time), so I'll just leave you with a self-explanatory chart on trends on attorney advertising and bankruptcy filings that is contained in my latest article:

Numerous caveats apply--this is just tv, it is all advertising and not just for bankruptcy, etc. So I'll just let you make of this what you wish and leave it at that.

Update:

2 points. First, I made no claim about causation in my original posting--there could be no causal link at all here and if there is correlation, it could be spurious. If there is a causal link, it could run in either direction (e.g., public demand for bankruptcy lawyers could lead to more advertising). Second, there is a very well established empirical literature that advertising for legal services increases demand for legal services, so that the relationship is theoretically possible, unlike, for instance, other random correlations that some have drummed up. I thought the underlying model was obvious, but apparently some who criticized me weren't aware of this vast body of academic literature. And, of course, there is other empirical evidence that finds some sort of relationship between lawyer advertising and bankruptcy filings, although again, existence and direction of causation remain open. Whether this particular chart provides any additional empirical evidence or intuition to support the theory, as I said once already, I leave to you. But that doesn't mean the theory doesn't make any sense.

Important new study of competition and consumer protection issues involving on-line sales of replacement contact lenses can be found here.

Great example of how the FTC can use its research tools to advance understanding of market competition furthers consumer welfare and how wrongheaded professional licensing requirements can harm consumers.

Apparently there are two of us now who blog on bankruptcy issues. For those who prefer a "front lines" analysis (and a bit more "colorful" take) rather than my academic analysis of bankruptcy reform, see the State 29 blog.

With 2 of us, I think that pretty much satiates the public's appetite for bankruptcy-related blogs.

Update:

Whoops, Kemplog points out that I missed one--Automatic Say. So there are three of us--soon we will overtake all those Constitutional Law blogs out there!

In Senate testimony last week, one of those testifying offered the observation, "One million men and women each year are turning to bankruptcy in the aftermath of a serious medical problem—and three-quarters of them have health insurance." In a column in the Washington Post last week, Professor Elizabeth Warren (who also gave the just quoted testimony) stated, "[H]alf [of bankruptcy filers] said that illness or medical bills drove them to bankruptcy," an assertion that was repeated at the Hearings last week on the bankruptcy reform legislation. Most of the Democratic Senators in attendance accepted the assertion that 50% of bankruptcies are caused by health problems without question (even going so far as to silence me when I raised doubts about the credibility of that figure). It has also been widely reported in the media.

Professor Warren writes, "With the dramatic rise in medical bankruptcies now documented, this tired approach would be no different than a congressional demand to close hospitals in response to a flu epidemic." This figure was used to throw cold water on the bankruptcy reform legislation, and it is expected that Sen. Feinstein at least will propose an amendment.

But is it true that it is "now documented" that 50% of bankruptcies are caused by health problems?

The conclusion is based on a study in Health Affairs. Reviewing the study, it appears that the estimate that 50% of bankruptcy filings are precipitated by a "serious medical problem" cannot be supported based on what that study actually examined.

First, the study comes on the heels of many studies over many decades that find mixed evidence for the belief that a substantial number of consumer bankruptcies are caused by health problems. Those that did find some relationship often found a very small relationship, which explains why Professor Warren has described it as "a dramatic rise" in medical bankruptcies. For instance, in an earlier book, Professor Warren and co-authors wrote, "The central finding is that medical debt is not an especiallly important burden for most debtors." In a more recent article, it was observed that "until the 1990s . . . most empirical studies of bankruptcy did not find illness, injury, or medical debt to be a major cause of bankruptcy." Indeed, in the Health Affairs article, it is stated that medical bankruptcies increased 23-fold over the past two decades. No previous credible study has ever found anything approximating the conclusion that 50% of bankruptcies are caused by medical problems. The appearance of such a huge anomaly usually augurs caution in interpreting the results in light of the massive contrary results on the other side. Such caution is warranted here.

In fact, the "finding" in this article of a massive rise in medical bankruptcies appears to actually be a result in the way in which medical bankruptcies are counted, rather than an actual change in the numbers. They draw their data from two sources. First, self-identified bankruptcy filers who say that some medical event "caused" their bankruptcy. Second, analysis of "objective" facts on filers bankruptcy papers that find either (1) debtor or spouse lost at least 2 weeks of work-related income because of illness or injury or (2) uncovered medical bills exceeding $1,000 in 2 years before bankruptcy, or (3) debtors who say they had to mortgage their home to pay medical bills (which for some reason they list as an "objective" factor rather than a self-identified factor.

Do these findings support the claim that 50% of bankruptcy filings were caused by a "serious medical problem"?

First, consider the self-identified filers. Among the self-identified factors that are listed as "medical" causes of bankruptcy in Exhibit 2 of the article are the following: illness or injury, birth/addition of new family member, death in family, alcohol or drug addiction, uncontrolled gambling. First, it is surely open to question whether uncontrolled gambling or a death in the family really should count as a "medical" problem. More generally, the category "illness or injury" is very broadly defined in the study, and there is no apparent limit on the time frame over which the illness or injury occurred, or the severity. So classifying all of these factors as medical problems that have "caused" bankruptcy certainly seems open to question.

Second, the "objective" measures from the debtors bankruptcy petitions are, if anything, even more questionable. First, the authors count anything above 2 weeks of lost work income as a "serious medical problem." There appears to be no time frame over which this is measured, nor does it apparently even need to be consecutive lost work. So, for instance, if a restaurant waiter called in sick for 2 weeks or more in some indeterminate period of time prior to filing bankruptcy, this would presumably count as a serious medical problem.

Nor does the requirement of $1,000 in unpaid medical bills within 2 years of bankruptcy seem like a very plausible measure of serious financial problems. Again, it is pretty easy to rack up $1,000 in unpaid medical bills over a 2 year period, especially if elective procedures not covered by insurance are added in. Moreover, it is well-understood that debtors who are falling into bankruptcy pick and choose which debts they pay, paying down their mortgage or nondichargeable debts for instance, while not paying their unsecured debts, such as medical and credit card debt. So the fact that the medical debts were unpaid says little, because it may reflect strategic payment of debts prior to bankruptcy.

So the categorization of what counts as a "serious medical problem" is quite questionable in this study. But there is a more fundamental problem that this concern hints at--there is no control group in this study. It is usually Statistics 101 that in order to infer causation from a data observation, it is necessary to have a control group. Absent a control group, it is not clear how the authors can make their claims.

So, for instance, one would want to know how many Americans missed 2 weeks of work or had a $1,000 in medical bills and didn't file bankruptcy. This is precisely why other previous studies have failed to find much of a correlation between health problems and bankruptcy--almost every family in America has a health problem, death in the family, or gives birth every year. Most of them do not file bankruptcy. In short, I suspect a lot of people had medical problems comparable to those who filed bankruptcy, but did not file bankruptcy. Of course, we will never know, because the authors have no control group to determine whether those in bankruptcy were more prone to illness or injury than the population at large.

Moreover, the authors do not compare the amount of medical debt they found to other debt or obligations that bankrupt debtors had. So, for instance, they would count as a medical bankruptcy a debtor who had $1,001 in medical bills, even if that debtor had say $50,000 in student loans, car loans, and other debt. It would be absurd, it seems to me, to say that the $1,001 in medical expenses "caused" that bankruptcy. Nonetheless, it would counted in this study, because the authors do not control for medical debt as a percentage or in relation to the debtors overall debt.

But the problems do not end there. For instance, the authors claim (page W5-71) that from 1981-2001, medical bankruptcies increased 23-fold, citing a study from 1981 published in "As We Forgive Our Debtors." I have read and reread the relevant chapter of that book, and have been unable to determine exactly what criteria were used to classify medical bankruptcies there, and how they compare to here. It appears that the measure used in the earlier work was the pure narrowest form of self-identified filers, those who stated that they filed bankruptcy because of a health problem. In the current study, it appears the authors ask the self-identified filers if health problems were "a reason" for bankruptcy. I can find no evidence that the authors there counted as medical bankruptcies any bankruptcy where the debtor had above a specified amount of medical expenses. Even if it were the case, there is no evidence that the $1,000 figure chosen in the current study was adjusted for inflation over the prior study. Nor is there any indication that the authors attempted to adjust the medical expenses that are found in the current study for increases in debtor's income. So again, it seems like they have just changed their method of counting, not the actual substance.

The authors also do not provide any causal explanation for what could have changed in the medical system to produce a 23-fold increase in health=related bankruptcies in 20 years, and specifically note that the percentage of those in bankruptcy who have health insurance has changed little over that time.

In fact consider the following passage from "As We Forgive Our Debtors":

Our central finding is that crushing medical debt is not the widespread bankruptcy phenomenon that many have supposed. To the extent that the typical debtors in bankrutpcy are painted as sympathetic characters because they are struggling with insurmountable medical debts, these data show that 'typical' is the wrong adjective. Only a few debtors find thmselves in such extreme circumstances.... About half of all debtors carry some medical debt, and many carry substantial medical debt. Althought these medical debts are not the obvious cause of the debtors' bankruptcies they are part of their financial troubles." (p. 173).

Again, what seems to have changed is not the frequency of the underlying problem, but simply the way the data is counted and classified. In the earlier study, the authors noted that half of filers had some amount of medical debt, but recognized that relatively small amounts of unpaid unsecured medical debt or minor injuries were likely not the cause of bankruptcy, because this is a part of the financial life for almost every American family. For the debtors in the earlier study, the medical debt that was found was relatively small in comparison to the bankrupts' other debts. In the more recent study, the authors have simultaneously increased what counts as a "medical problem" and classified even relatively small and trivial medical expenses and problems as bankruptcies "caused" by medical problems. Changing the way you count and classify the same data is not the same thing as finding a 23-fold increase in the underlying problem itself.

I close with an illustration that tries to put the major flaws of this study in perspective and the policy recommendations that have been drawn from it. Suppose that I wanted to find out how many Americans filed bankruptcy because of tax problems. I then interviewed bankruptcy filers and checked their financial records, and counted as a "tax-caused bankruptcy" anyone who either (1) paid $1,000 or more in taxes during the past two years, or (2) anyone who said that if he didn't have to pay taxes he wouldn't have had to file bankruptcy because he would have had more money for his other bills. I suspect that under that criteria I would find a pretty substantial number of "tax-caused bankruptcies." I then conclude that, as a result, we shouldn't make people pay taxes if they believe it might make them file bankruptcy, and that any unpaid tax obligations should get a blanket discharge in bankruptcy (unlike current law, which makes them largely nondischargeable).

Obviously, my hypothetical study of "tax-caused bankruptcies" would be sheer nonsense. I would have no control group (how many other people paid taxes and didn't file bankruptcy), I would have no information about how large my tax payments were relative to other obligations (mortgage, student loans, etc.), and my data would be subject to high rates of self-reporting bias. You would object--"almost everyone pays taxes, what is so unique about this group?" My policy proposal would be ridiculous. In short, my hypothetical study would be properly dismissed as junk science because it fails to use even the most basic statistical controls and techniques.

Let me emphasize--I do not deny that many bankruptcies are caused by health problems. This is why the bankrutpcy reform bill carves out several specific exceptions for treatment of health expenses and health insurance. In theory, the number may be as high as some now say, although as noted, the overwhelming number of studies fail to find anything approximating such a high number. But if it is true, that conclusion cannot be based on this article that is published in Health Affairs that got so much press last week and so much interest in the United States Senate. The statistical classification and methods are just too questionable to support that conclusion.

Naturally, the first question everyone wants to know is isn't the need for bankruptcy reform just a response to "too much" credit card credit. In fact, this argument not only lacks empirical foundation, it lacks sould economic theory to support it.

First, the argument doesn't make much sense from an economic perspective. Unless credit cards have somehow removed the borrowing constraint on individual credit (and no one has provided any evidence that it has), there would be no reason to believe that credit cards would increase overall household indebtedness.

Instead, economic theory would predict that the primary effect of the introduction of credit cars would be to shift around patterns of consumer credit use, by substituting credit card debt for other less-attractive forms of credit, such as pawn shops, personal finance companies, and retail store credit (such as from appliance and furniture stores). In fact, this is what the evidence indicates has actually happened.

Credit cards have not worsened household financial condition, because although consumers have increased their use of credit cards as a borrowing medium, this increase represents primarily a substitution of credit card debt for other high-interest consumer debt. Although this may seem irrational at first glance given the "high" interest rates charged on credit cards, consider that for consumers the alternatives may include pawn shops, personal finance companies, retail store credit, and layaway plans, all of which are either more costly or otherwise less attractive than credit cards.

Thus, while credit cards may not be ideal in some absolute terms, their growing popularity reflects the relative attractiveness of credit cards versus these other forms of credit. Credit cards are also generally less expensive for lenders to issue, which is reflected in the overall price of credit cards relative to these other forms of credit. The result, therefore, has not been to increase household indebtedness, but primarily to change the composition of debt within the household credit portfolio. Figure 7, from my article "An Economic Analysis of the Consumer Bankruptcy Crisis" (Forthcoming this year in the Northwestern Law Review) illustrates the nature of this substitution:

Source: Federal Reserve Board and Bureau of Economic Analysis

As this chart indicates, the growth in revolving (credit card) debt has clearly been a substitution from nonrevolving consumer debt to revolving debt, thus leaving overall consumer indebtedness (as a percentage of income) largely unaffected. Revolving debt outstanding has risen during this period from zero to roughly 9% of outstanding debt. Nonrevolving installment debt, by contrast, has fallen from its level of 19% of disposable income in the 1960s, to roughly 12% today. Thus, the increase in revolving debt has been almost exactly offset by a decrease in the installment debt burden. In fact the recent bump in total indebtedness in recent years was not caused by an increase in revolving debt, which has remained largely constant for several years, but by an increase in installment debt, primarily as a result of a recent increase in car loans for the purchase of new automobiles. Thus, there is little indication that increased use of credit cards has precipitated greater financial stress among American households. Because the increase in credit card usage has resulted primarily from a substitution of credit cards for other types of consumer credit, rather than an overall increase in indebtedness.

To the extent that there is some correlation between "high" credit card indebtedness and bankruptcy, but it is questionable whether this supports the causal inference that the credit card debt caused the bankruptcy, rather than the other way around.

First, the correlation between credit cards and bankruptcy may reflect the unique role of credit card borrowing in the downward spiral of a defaulting borrower. Credit cards provide an open line of unsecured credit to be tapped at the discretion of the borrower. Thus, for many debtors credit cards are a "credit line of last resort" to stay afloat to avoid defaulting on other bills. Thus, there may be nothing more than a simple correlation—a debtor confronting a downward spiral may increase his credit card borrowing in the period preceding bankruptcy simply because it is his most easily accessible line of credit. It may appear that because credit card borrowing preceded bankruptcy it also precipitated bankruptcy filing, but if the credit card was being used as a source of credit of last resort, this correlation would not support a causal inference.

Second, a debtor's increased use of credit cards preceding bankruptcy also may reflect strategic behavior taken in anticipation of filing bankruptcy. Credit card debt is unsecured debt that can be discharged in bankruptcy. By contrast, some unsecured debts are not dischargeable in bankruptcy, and secured debts, such as home and auto loans are minimally affected. For unsecured credit card debt, by contrast, generally the debtor can retain the property purchased with the credit card and discharge the obligation. Given the choice between defaulting on secured or nondischargeable obligations on one hand versus dischargeable credit card debt on the other, the incentive is to use credit cards to finance payment of nondischargeable and secured debt. In fact, empirical evidence shows that although credit card defaults have risen in tandem with bankruptcy filings, defaults on secured home and auto loans have remained steady during this period. Debtors also will have an incentive to "load up" their credit card on the eve of bankruptcy, especially by purchasing goods that will not be classified as "luxury goods and services" but might still be quite expensive and the timing of which might be discretionary. Still others simply spend the money or save in exempt assets rather than pay outstanding bills.

One article by Gross and Souleles (cited in my article), for instance find that in the year before bankruptcy, borrowers significantly increase the use of their credit cards, running up their balances rapidly in the period leading up to bankruptcy. This finding is inconsistent with the predictions of the traditional model, which identify credit cards as a special problem because of the gradual, subconscious, and "insidious" manner in which they accumulate over time. If this is true, then the accumulation of credit card debt should be gradual and spread out evenly over time. The rise in credit card debt rises rapidly and is concentrated in the period immediately preceding bankruptcy suggests that credit card indebtedness does not cause bankruptcy in many cases, but that the debtor is already on the way toward bankruptcy when the credit card borrowing begins, and is either acting strategically or is tapping his credit line of last resort.

It also has been argued that credit cards have contributed to increased bankruptcies through a profligate expansion of credit card credit to high-risk borrowers, especially low-income borrowers. Although often-repeated, empirical studies have failed to support this theory. First, the growth in credit card debt by low-income households primarily reflects a substitution for other types of debt, not an overall increase in indebtedness. In addition, two studies have examined the hypothesis empirically and have found little support. The first study, by economists Donald P. Morgan and Ian Toll concludes, "If lenders have become more willing to gamble on credit card loans than on other consumer loans credit card charge-offs should be rising at a faster rate [than non-credit card consumer loans] . . . . Contrary to the supply-side story, charge-offs on other consumer loans have risen at virtually the same rate as credit card charge-offs." Thus "suggest[s] that some other force [other than extension of credit cards to high-risk borrowers] is driving up bad debt."

A second study, by David B. Gross and Nicholas S. Souleles, concludes that changes in the risk-composition of credit card loan portfolios "explain only a small part of the change in default rates [on credit card loans] between 1995 and 1997." Moreover, if it were true that lower-income households were dramatically increasing their indebtedness through credit card increase then this should be reflected in the debt service ratio for lower-income households. As previously noted, however, this ratio has remained largely constant for lower-income households as with all others.

Increasing use of credit cards may be causing higher bankruptcies, but not in the way suggested by critics of reform. Because credit card credit is unsecured, it easily dischargeable in bankruptcy, which may make people more willing to file bankruptcy. Many older forms of credit were secured, such as furniture and appliance credit. Moreover, it may be that people fell less of a personal obligation to repay credit card debt, as opposed credit from a local merchant. But if these explanations explain what is happening, then it seems like this is an argument for bankruptcy reform, rather than against it.

The bottom line is that the standard argument about the relationship between credit cards and bankruptcy does not appear to be consistent with either economic theory or available evidence.