Dealing with consumer default: Bankruptcy vs garnishment

What are the positive and normative implications of eliminating bankruptcy protection for indebted individuals? 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. There is a large increase in consumer debt financed essentially by super-wealthy individuals, a modest drop in capital per worker, and a higher frequency of consumer default. Average welfare rises by 1% of consumption in perpetuity, with about 90% of households favoring the change.

► Individuals can default without declaring bankruptcy by ceasing to pay. ► Wage garnishment allows creditors to recover debt from these individuals. ► A calibrated GE model having both bankruptcy and garnishment is constructed. ► Individuals only choose garnishment over bankruptcy for small debts. ► Eliminating bankruptcy, not default, increases credit and welfare.