Less Forgiven? Race and the Bankruptcy System

Abstract

For a consumer considering bankruptcy, Chapter 7 and Chapter 13 are options with vastly different consequences. In Chapter 7, a consumer earns a quick discharge after turning over all nonexempt or unencumbered assets to the bankruptcy trustee. In over 90% of Chapter 7 cases, the debtor has no such assets, and the case is a quick administrative affair that allows the debtor to emerge with the proverbial “fresh start.” In contrast, Chapter 13 requires a debtor to devote all of his or her disposable income to repayment to creditors over a 3- or 5-year plan. A Chapter 13 debtor can earn a discharge only after completing the repayment plan, yet only approximately one-third of Chapter 13 debtors complete their plan.

With a federal bankruptcy law, one would expect the ratio of Chapter 7 to Chapter 13 cases to be fairly uniform across the country. In fact, huge regional variation exists. In the upper Midwest, only one Chapter 13 is filed for about every ten Chapter 7 cases, while many Southern states about half of all bankruptcies are Chapter 13 cases. Previous scholarship has attributed these differences to local legal culture, concluding that historical norms and the preferences of bankruptcy professionals drive consumers’ chapter choices.

This chapter identifies a different variable that is associated with chapter choice: the debtor’s race. African American debtors file Chapter 13 at over twice the rate of debtors of other races. The effect remains after controlling for geographic location, financial variables, home ownership, and other factors that seem likely to affect chapter choice. To earn forgiveness for their debts, African Americans are more likely to have to make some restitution under a Chapter 13 plan, while persons of other races are more likely to be given full forgiveness under a Chapter 7 bankruptcy. Their over-representation in Chapter 13 means that African Americans are more likely to have to wait years for a discharge of their debts and pay higher attorneys fees for relief.

The data show association but cannot show causation. The data cannot tell us whether African Americans are being discriminated against by being guided into repayment plans when others are not, or whether African Americans are choosing Chapter 13 out of a moral obligation to repay.

Keywords: Bankruptcy, Race, Chapter 13

JEL Classification: K29