Economics Letters 124 (2014) 439–442

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Economics Letters

journal homepage: www.elsevier.com/locate/ecolet

Effects of the BAPCPA on the chapter composition of consumerbankruptciesChristopher Cornwell a, Bing Xu b,∗

a Department of Economics, University of Georgia, Athens, GA, 30602, USAb RIEM, Southwestern University of Finance and Economics, 55 Guanghuacun Street, Chengdu, Sichuan, 610074, China

h i g h l i g h t s

• We examine the impact of the BAPCPA’s homestead exemption restrictions and means test.• State-level panel data from 2000 to 2007 is used.• We form a treatment group from states that have greater exposure to these provisions.• Homestead exemption restrictions increased the Chapter 13 share by 3.6 percentage points in treated states.• Means test increased the Chapter 13 share by 3 percentage points in treated states.

a r t i c l e i n f o

Article history:Received 13 January 2014Received in revised form8 July 2014Accepted 8 July 2014Available online 15 July 2014

JEL classification:D14K35R21

Keywords:BankruptcyBAPCPAHomestead exemptionMeans test

a b s t r a c t

The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act limited homestead exemptions andimposed means test to discourage petitioners seeking financial benefits. We find that these restrictionswere effective in steering petitioners away from Chapter 7 filings and into Chapter 13.

© 2014 Published by Elsevier B.V.

1. Introduction

Individuals in theUS file for bankruptcy under Chapter 7 or 13 ofthe Bankruptcy Code. Under Chapter 7, only the petitioner’s assetsthat are not exempt under the homestead or the personal propertyrule are used to repay his outstanding debt. Therefore, petitionerswith few assets, or those holding significant assets in the formof their home and living in states with generous homesteadexemptions, can write off their debt at little cost. Moreover,individuals living in states with low homestead exemptions canshelter their assets by moving to a state with a higher exemptionlevel and buying a home before filing. For these reasons, creditors

∗ Corresponding author. Tel.: +86 (0)28 87352905.E-mail address: xubing@swufe.edu.cn (B. Xu).

http://dx.doi.org/10.1016/j.econlet.2014.07.0090165-1765/© 2014 Published by Elsevier B.V.

have long complained about Chapter 7’s friendliness to debtors. Incontrast, a petitioner’s assets are protected under Chapter 13, butthe petitioner is required to allocate a portion of his income overthe subsequent five years to debt repayment. Therefore, Chapter 13filings have always been fewer in number than Chapter 7 petitions.

The Bankruptcy Abuse Prevention and Consumer ProtectionAct (BAPCPA), enacted in 2005 with a strong push from banksand credit card companies, reshaped the bankruptcy law tobe significantly less debtor friendly. One of its key provisionsrestricted the homestead exemption. First, a petitioner whomovesto a new state within two years prior to filing Chapter 7 must usethe homestead exemption level of the state of origin. Second, if ahome is purchasedwithin 1,215 days prior to filing, the exemptionis capped at $125,000. Third, any additional equity convertedfrom a non-exempt asset within 1,215 days prior to filing cannotbe exempted. Another key provision created a means test to

440 C. Cornwell, B. Xu / Economics Letters 124 (2014) 439–442

Fig. 1. Total consumer bankruptcy filings.

determine Chapter 7 eligibility. A petitionerwhose income exceedshis state’s medianmust now have his disposable income examinedto determine ability to pay. If monthly income exceeds $166.67after deduction of necessary living expenses, the petitioner isrequired to file under Chapter 13.

Together, these provisions were intended to steer petitionersaway from Chapter 7 and into Chapter 13, and reduce filingsoverall. This paper examines the effect of the BAPCPA on thechapter composition of bankruptcy filings. Using state-level data,we employ a difference-in-differences (DD) strategy by creatingtreatment and control groups from states that are relatively moreand less affected by the reforms. We provide evidence that thechanges to the homestead exemption rules reduced opportunisticmoves to states with more favorable exemptions by individualsseeking bankruptcy protection. In addition, we find that themeanstest caused a significant drop in the share of Chapter 7 filingsin states that are identified as having greater exposure to thetest. This result is consistent with White and Zhu (2010), whosefindings suggest that the means test may be more binding thanpre-BAPCPA studies by Culhane and White (1999) and Flynn andBermant (2000) had predicted.

2. Analysis

Our analysis is based on state-level annual bankruptcy filingsfrom 2000 to 2007, obtained from the US Bankruptcy Institute.1Fig. 1 shows the total filings by chapter from 1998 to 2008. In eachof these years, Chapter 7 filings exceeded Chapter 13 filings. How-ever, a year after the passage of the BAPCPA, the difference betweenthe number of filings fell almost 85%. Although the gap started toincrease again after 2006, the size of the gap remainsmuch smallerthan before.

2.1. Estimation method and data

We estimate the effects of the BAPCPA’s homestead exemptionrestrictions and means test on chapter composition by classifyingstates into treatment and control groups based on their relative ex-posure to these provisions. This leads to difference-in-differencesregressions of the form

chap13it = δ1 treat i + δ2 after t + δ3 (treat i × after t)

+ xitβ + ci + dt + uit , (1)

where chap13it is the percentage of bankruptcy filings that areChapter 13, treat i indicates a treated state, after t indicates the

1 Our sample period begins in 2000, when the housing-variable data becamepublicly available. It ends in 2007 to avoid the effects of the Great Recession.

Fig. 2. Homestead exemption.

treatment (BAPCPA) period, xit contains state characteristics thatmay affect bankruptcy filings, and ci and dt are state and year fixedeffects. The primary coefficient of interest is δ3, which captures theeffect of the BAPCPA provision on chapter composition.

Following Domowitz and Sartain (1999) and Fay et al. (2002),we include a range of state-level economic and demographic vari-ables, drawn from the Current Population Survey, that capturechanges in economic prospects or correlate with the potential forfinancial gain: percentage of the state’s population that is withouthealth insurance, divorced,white, female, college educated and be-tween the ages of 25 and 45. We also control for the state’s unem-ployment rate and total population. Based on the findings ofWhiteand Zhu (2010), we use the American Community Survey’s PublicUse Microdata Samples to account for the percentage of owner oc-cupied housing, log of averagemonthly owner cost (which includesmortgage payments, taxes and insurance), state median housingvalue and percentage of households with a mortgage or trust.

2.2. Homestead exemption restrictions

The most critical aspect of a DD estimation is the assignment ofobservations into treatment and control groups. However, whenthe treatment is a federal law, identifying treatment and controlstates is difficult. Nevertheless, it is possible to distinguish stateswith high homestead exemption levels from those with low ex-emption levels, and form treatment and control groups accord-ingly. Because the BAPCPA’s restrictions discourage petitionersfrom moving to states with more generous homestead exemptionrules prior to filing Chapter 7, the law should have a larger effect onthe composition of filings in states that have high exemption levels.

We capture the intensity of exposure to the BAPCPA’shomestead exemption changes by the ratio of a state’s maximumhomestead exemption level to its median housing price.2 Stateswhere the homestead exemption covers the value of a medianpriced home are assigned to the treatment group. States withratios of at least one are Arkansas, District of Columbia, Florida,Iowa, Kansas, Kentucky, Massachusetts, Nevada and Texas. Overour sample period, the median and the mean of this ratio is 0.37and 1.21 respectively; the 75th percentile value is 0.95. Fig. 2 plotsthe Chapter 13 percentage by treatment and control groups.

Table 1 reports the estimated δs from OLS applied to Eq. (1)for the homestead exemption provision. Starting with the simpleDD results, our estimated coefficients of the post-legislation andtreatment indicators point to a sharp rise in the share of Chapter13 filings in the post-BAPCPA period and little difference between

2 For each year in the sample period, the exemption level that is in effect in thatyear is used.

C. Cornwell, B. Xu / Economics Letters 124 (2014) 439–442 441

Table 1Effects of the homestead restrictions on the share of Chapter 13 filings, 2000–2007.

Simple DD With covariates With state trends Without 2005/2006 Without exemption increasing states

After × treatment 0.036** 0.034* 0.061** 0.030* 0.031*

(0.017) (0.018) (0.030) (0.018) (0.018)After 0.129*** 0.111** 0.150*** 0.125*** 0.135***

(0.014) (0.032) (0.017) (0.014) (0.014)Treatment 0.020* 0.017 0.007 0.020 0.021

(0.012) (0.011) (0.019) (0.013) (0.014)

R2 0.595 0.608 0.504 0.460 0.592N 408 408 408 306 360

State and year fixed effects included.Standard errors clustered by state.

* p < 0.05.** p < 0.01.*** p < 0.001.

treatment and control-group states in their Chapter 13 shares,findings which are comforting from the perspective of the quasi-experiment. The estimated policy effect (δ̂3) is 3.6 percentagepoints and statistically significant, suggesting that the BAPCPAcaused the Chapter 13 share to rise more in the treated states.Adding the covariates does not change the basic picture. However,including state-specific trends increases the magnitude of thepolicy effect estimate to 6.1 percentage points.

Although the BAPCPA was enacted in April 20, 2005, most ofits provisions did not become effective until October 17, 2005.Fig. 1 shows a sharp increase in filings before the more onerousprovisions became effective in late 2005. To determinewhetherwehave estimated the long-run impact of the law and not the effectof an immediate rush to file, we also present simple DD resultsthat exclude 2005 and 2006 in Table 1. The estimated policy effectremains significant and 3 percentage points.

Finally, some states increased their homestead exemptionlevels during our sample period, as home prices rose duringthe housing boom of the early to mid-2000s.3 In these states,petitioners may have been induced to file in their own states notbecause theBAPCPAdiscouraged opportunisticmoves, but becausetheir state’s exemption level became more generous. However,excluding those states that changed their exemption levels fromthe sample has little impact on the estimated policy effect. Thesimple DD estimate of δ3 in this case, reported in the last columnTable 1, is 0.031 with a standard error of 0.018. So, while slightlyless precise, itsmagnitude is in linewith the policy effect estimatesin the first two columns.

2.3. Means test

As with the homestead exemption restrictions, states varyin intensity of exposure to the means test. States with incomedistributions that concentrate more potential filers on the means-test margin should have greater exposure. We measure exposureas the fraction of the population in the income region above themedian but below the mean. We assign a state to the treatmentgroup if the share of its population in this income region is greaterthan the median, 0.134, in both 2006 and 2007. States with ratiogreater than 0.134 are California, District of Columbia, Florida,Louisiana, Mississippi, NewMexico, New York, Oregon and Texas.4Fig. 3 plots the Chapter 13 share by treatment and control groups.

Table 2 presents the estimated δs from Eq. (1) for the meanstest. From the simple DD through the addition of state trends, wefind that the BAPCPA increased the Chapter 13 share by about

3 These states are Colorado,Michigan,Minnesota,Montana, NewYork, andRhodeIsland.4 Hurricane Katrina affected states are not dropped from the treatment group

because bankruptcy judges had the discretion to enforce the means test to disastervictims.

Fig. 3. Means test.

3 percentage points in states whose income distributions wouldhave more likely placed potential petitioners on the means-testmargin. The policy effect estimate remains significant, rising to0.04 when 2005 and 2006 are dropped. These results suggest thatthe means test may have directed those with the ability to repaytheir debts away from Chapter 7 and into Chapter 13.

As a robustness check,we consider treatment groupswithmoreintensive exposure using the simple DD specification. Columns 5and 6 report the results for treatment groups defined by the 75thand 90th percentile state values, 0.145 and 0.154, of the massbetween the statemedian andmean personal income. As expected,intensifying the exposure increases the estimated policy effects,which are 0.035 and 0.042 at the 75th and the 90th percentilethresholds.

2.4. Effects by chapter

Our empirical model produced estimates of the BAPCPA’s effecton the percentage of total filings in the chapter 13 category (orthe Chapter 13 share of total filings). It is of interest to examinewhether the positive BAPCPA effects estimated for the Chapter 13share of filings are the result of declining Chapter 7 filings or risingChapter 13 filings. Thus, we estimated a two-equation model forthe homestead exemption effect with Chapter 7 and 13 filings,respectively, as the dependent variables, allowing the equationerrors to be correlated. The estimated policy effects from thesimple DD setup (including state population as a control variable)are both positive, but small in magnitude, with t-ratios less than0.80.5 Not surprisingly, a test of their equivalence does not rejectthe null (the p-value is 0.67). We suspect that the reason we do

5 The point estimate for Chapter 7 filings is 1,518; however, the confidenceinterval is (−7, 823.54, 10, 860.71).

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Table 2Effects of the means test on the share of Chapter 13 filings, 2000–2007.

Simple DD With covariates With state trends Without 2005/2006 Criterion = 0.145 Criterion = 0.154

After × treatment 0.030** 0.030** 0.032* 0.040*** 0.035** 0.042**

(0.014) (0.012) (0.019) (0.015) (0.015) (0.017)After 0.115*** 0.098*** 0.165*** 0.105*** 0.116*** 0.122***

(0.015) (0.023) (0.016) (0.015) (0.015) (0.014)Treatment −0.016*

−0.009*−0.008*

−0.004 −0.009 −0.013*

(0.015) (0.006) (0.004) (0.005) (0.006) (0.017)

R2 0.590 0.606 0.503 0.463 0.589 0.588N 408 408 408 306 408 408

State and year fixed effects included.Standard errors clustered by state.

* p < 0.05.** p < 0.01.*** p < 0.001.

not pick up a significant treatment effect on the level of Chapter7 filings is that opportunistic moves to states with more generousexemptions are few relative to a state’s population. Onlywhen theyare captured in the chapter shares of total filings are their actionsevident.

We repeated this exercise for the means test. In this case, weexpect Chapter 7 filings to fall; Chapter 13 filings may or may notrise. The simple DD produces a statistically significant policy effectestimate for Chapter 7 filings of almost−8,000; the correspondingt-ratio is about 4.3. The estimated treatment effect for Chapter13 filings is also negative, but it is less than one-eighth of themagnitude of the Chapter 7 estimate and not significant at the 10%level. A test of the equivalence of the two policy effects rejects thenull at any reasonable test size.

3. Conclusion

The BAPCPA was a landmark legislation directed at stemmingthe abuse of the bankruptcy law. We find evidence that theBAPCPA shifted petitioners away from Chapter 7 and into Chapter

13 in states where the reforms would most likely have bite.The estimated homestead-exemption effects, which are on theorder of 3–6 percentage points, suggest that the BAPCPA curbedopportunistic moves to states with more liberal exemptionpolicies, where assets could potentially be sheltered by a homepurchase. The baseline means-test estimates imply that theBAPCPA increased the share of Chapter 13 petitioners by 3percentage points, a result that rises in magnitude with exposureintensity.

References

Culhane, M.B., White, M.M., 1999. Taking the new consumer bankruptcy model fora test drive: means-testing real Chapter 7 debtors. Am. Bankruptcy Inst. LawRev. 7, 27–38.

Domowitz, I., Sartain, R.L., 1999. Determinants of the consumer bankruptcydecision. J. Finance 54, 403–420.

Fay, S., Hurst, E., White, M.J., 2002. The household bankruptcy decision. Am. Econ.Rev. 92, 706–718.

Flynn, E., Bermant, G., 2000. Bankruptcy by the numbers: pre-bankruptcy planninglimits means-testing impact. Am. Bankruptcy Inst. J. 19, 22–28.

White, M.J., Zhu, N., 2010. Saving your home in Chapter 13 bankruptcy. J. Leg. Stud.39, 33–61.