Forgive and Forget: Who Gets Credit after Bankruptcy and Why?
Conventional wisdom holds that individuals who have gone bankrupt face difficulties getting credit for at least some time. However, there is very little non-survey based empirical evidence on the availability of credit post-bankruptcy and its dependence on the credit cycle. Using data from one of the largest credit bureaus in the US, this paper makes three contributions. First, we show that individuals who file for bankruptcy are indeed penalized with limited credit access post-bankruptcy, but we find that this consequence is very short lived. Ninety percent of individuals have access to some sort of credit within the 18 months after filing for bankruptcy, and 75% are given unsecured credit. Second, we show that those individuals who have the easiest access to credit after bankruptcy tend to be the ones who have shown previously the least ability and least propensity to repay their debt. In fact, a significant fraction of individuals at the bottom of the credit quality spectrum seem to receive more credit after filing. We interpret the widespread post-bankruptcy credit access and the differential credit provision across borrower types as evidence that lenders target riskier borrowers. Employing a simple theoretical framework we show that this interpretation is consistent with a profit maximizing lender whose optimal strategy involves segmenting borrowers by observable credit quality and bankruptcy status. This interpretation is also in line with survey evidence that shows lenders repeatedly solicit debtors to borrow after bankruptcy, especially with offers of revolving credit. Finally, we show that our findings depend heavily on the aggregate credit environment: the ease of credit and limited bankruptcy credit cost observed in the initial period of our data (2003-2004) become much less significant when we repeat the analyses in 2007, as the recent credit downturn began.