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Debtor Protection and Asset Exemptions

Introduction

Pattison (2020) studies a specific type of protection for debtors: asset exemptions. Asset exemptions protect certain types of property (e.g., home equity) from seizure by unsecured creditors. How much is protected varies from state to state, and can be as little as $10,000 and as much as $500,000. When facing higher asset exemption levels, lenders increase the cost of credit through higher interest rates. Using an event study approach and 57 in-state changes in asset exemption levels, the paper estimates both how these types of protections allow debtors to smooth their consumption and the impact on interest rates.

The paper calculates the MVPF of an additional dollar of consumption financed by an additional dollar of asset exemptions during default in the hypothetical world where the additional interest owed due to increased rates was paid by the government.

MVPF = 0.2

Net Cost

The net cost is composed of the mechanical cost and a fiscal externality. The direct cost of the government for paying an additional dollar of interest payments is $1.

The formula for the fiscal externality is derived in the paper and given below:

FE=-\big(\frac{\text{Prob. of not defaulting}}{\text{Prob. of defaulting}}\big)\big(\frac{\Delta \text{interest rate}}{\Delta\text{rate of debt recovery}}\big) - 1

The paper estimates the probability of defaulting as 0.0216 (and therefore the probability of not defaulting as 1 – 0.0216 = 0.9784). The estimated interest rate change is 0.448/100, and the estimated change on debt recovery is -3.568/100.

The fiscal externality is therefore:

FE=-\big(\frac{0.9784}{0.0216}\big)\big(\frac{0.448/100}{-3.568/100}\big) - 1 = 4.69

And net costs are 1 + 4.69 = 5.69.

$5.7 Net Cost

2.1 34.6

Willingness to Pay

The willingness-to-pay is calculated as the sum of a direct component and a component based on the change in consumption.

The direct component for a $1 increase in asset exemptions is assumed to be $1.

The change in consumption piece is calculated as the percent change in consumption multiplied by a risk aversion parameter. The paper estimates the change in consumption as 0.0556 and assumes a risk parameter of 3. Thus, the change in consumption component is equal to 0.0556 x 3 = 0.17.

The total willingness-to-pay is then 1 + 0.17 = 1.17.

$1.2 WTP

MVPF Summary

Dividing the willingness-to-pay by the net cost yields an MVPF = 1.17 / 5.69 = 0.21.

0.2 MVPF

0.0 0.6

References

Pattison, Nathaniel. (2020). Consumption Smoothing and Debtor Protections. Journal of Public Economics 192, 1-22. https://doi.org/10.1016/j.jpubeco.2020.104306.

Policy Features

Category: Social Insurance
Sub-Category: Cash Transfers
Beneficiary Type(s): Adults
Country of Implementation: United States
Empirical Method: Difference in Differences
Research Type: Primary
Peer Reviewed: Yes
MVPF Publication Link: doi.org/10.1016/j.jpubeco.2020.104306