On the Need for Financial Epidemiology

Introduction

Much has been made in the recent legal and financial literatures about the dramatic rise in U.S. consumer bankruptcies. Articles in the academic and popular medias suggest that this rise is attributable to two factors: a declining economy (which increases unemployment and un-insurance rates) and an increase in the prevalence of unexpected medical care which individuals (even those with reasonable health insurance coverage) are unable to pay (Agarwal & Liu, 2003; White, 2007a, 2007b; Agarwal, Skiba, & Tobacman, 2009; Hackney, McPherson, & Friesner, 2010a, 2010b). One or both conditions gradually reduce consumer assets and increase both expenses and liabilities until the household becomes insolvent and files for bankruptcy protection. The special case where outstanding medical bills drive the insolvency is known as “medical bankruptcy”.

Individuals who file for personal bankruptcy protection transfer a substantial legal, financial and ethical burden upon the remainder of society. The legal burden occurs because the bankruptcy process erodes property rights and the enforcement of contracts (Waller, 2001). Financial burdens are substantial because in many cases (especially if the case where a debtor files under Chapter 7 of the bankruptcy code) creditors are unable to collect more than a small fraction of outstanding debt (White, 2007a, 2007b). At least a portion of these costs are passed on to the remainder of society as higher prices. Sociological burdens are high because most individuals place a very negative stigma upon the bankruptcy process (Sullivan, Warren, & Westbrook, 1997, 2003). In many cases, debtors wait until the last possible moment to file for bankruptcy protection in order to avoid this stigma. This not only creates considerable stress and tension within the debtor’s family unit, but also disproportionally magnifies the amount of the debt being discharged in the bankruptcy process.

An obvious solution to this problem is to develop a viable policy intervention that can be implemented in advance of the need for bankruptcy protection. Indeed, this was the idea behind consumer credit counseling, although this policy option has failed for a myriad of reasons, many of which are similar to the detriments of bankruptcy (i.e., it is initiated by consumers and thus delayed until it is not a viable option, it has a very negative set of consequences, including social stigma, and it has been abused by for-profit companies who take advantage of an already distressed and vulnerable population) (Loonin & Plunkett, 2003; Vohwinkle, 2011). For any viable policy option to be pursued in a meaningful fashion, it must first implement a mechanism to identify individuals and/or households on a course for bankruptcy and offer (or possibly impose upon) them a viable alternative that does not carry negative social stigmas.¹ To do so, one must develop a way to systematically assess and track consumer behavior (in a manner that is resistant to distortion by creditors and lenders) and identify a “tipping point” at which the debtor begins an un-reversible path towards insolvency. Policies must be implemented prior to this “tipping point” to minimize the negative impacts of consumer insolvency upon the remainder of society. Moreover, a tipping point must be based as much on actual consumption patterns as it is a debtor’s potential for future consumption; that is, a credit score rating (Agarwal & Liu, 2003; Agarwal, Amromin, Ben-David, Chomsisengphet, & Evanoff, 2010). Indeed, the use of credit scores as a proxy is often what allows individuals with medium and high incomes to postpone debt reconciliation and creditor repayment.