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Informal unemployment insurance and labor market dynamics

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  • Kyle F. Herkenhoff

Abstract

How do job losers use default -- a phenomenon 6x more prevalent than bankruptcy --as a type of “informal" unemployment insurance, and more importantly, what are the social costs and benefits of this behavior? To this end, I establish several new facts: (i) job loss is the main reason for default, not negative equity (ii) people default because they are credit constrained and cannot borrow more, and (iii) the value of debt payments is a significant fraction of a defaulter's earnings. Using these facts, I calibrate a general equilibrium model with a frictional labor market similar to Burdett and Mortensen (1998) and Menzio and Shi (2009, 2011) and individually priced debt along the lines of Eaton and Gersovitz (1981) and Chatterjee et al. (2007). After proving the existence of a Block Recursive Equilibrium, I find that the extra self- insurance job losers obtain by defaulting outweighs the subsequent increase in the cost of credit, and as a result, protectionist policies such as the Mortgage Servicer Settlement of 2012 or the CARD Act of 2009 improve overall welfare by .1%. The side effect of the policies, however, is a .2-.5% higher unemployment rate during recessions that persists throughout the recovery.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2012-057.

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Date of creation: 2012
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Handle: RePEc:fip:fedlwp:2012-057

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Keywords: Unemployment ; Insurance ; Labor market;

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References

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  1. Xavier Mateos-Planas & David Benjamin, 2012. "Formal vs. Informal Default in Consumer Credit," 2012 Meeting Papers 144, Society for Economic Dynamics.
  2. Kyle F. Herkenhoff & Lee E. Ohanian, 2011. "Labor Market Dysfunction During the Great Recession," NBER Working Papers 17313, National Bureau of Economic Research, Inc.
  3. Jesse Rothstein, 2011. "Unemployment Insurance and Job Search in the Great Recession," NBER Working Papers 17534, National Bureau of Economic Research, Inc.
  4. Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sánchez, 2011. "Mortgage defaults," Working Papers 2011-019, Federal Reserve Bank of St. Louis.
  5. Lars Ljungqvist & Thomas J. Sargent, 1995. "The European unemployment dilemma," Working Paper Series, Macroeconomic Issues 95-17, Federal Reserve Bank of Chicago.
  6. Victor Rios-Rull & Dean Corbae: & Satyajit Chatterjee, 2011. "A Theory of Credit Scoring and the Competitive Pricing of Default Risk," 2011 Meeting Papers 1115, Society for Economic Dynamics.
  7. Krueger, Alan B. & Mueller, Andreas I., 2011. "Job Search and Job Finding in a Period of Mass Unemployment: Evidence from High-Frequency Longitudinal Data," IZA Discussion Papers 5450, Institute for the Study of Labor (IZA).
  8. Guido Menzio & Shouyong Shi, 2008. "Efficient Search on the Job and the Business Cycle," Working Papers tecipa-327, University of Toronto, Department of Economics.
  9. Igor Livshits & James MacGee & Michele Tertilt, 2003. "Consumer bankruptcy: a fresh start," Working Papers 617, Federal Reserve Bank of Minneapolis.
  10. Guido Menzio & Shouyong Shi, 2009. "Block Recursive Equilibria for Stochastic Models of Search on the Job," PIER Working Paper Archive 09-005, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  11. Chatterjee, Satyajit & Corbae, Dean & Ríos-Rull, José-Víctor, 2008. "A finite-life private-information theory of unsecured consumer debt," Journal of Economic Theory, Elsevier, vol. 142(1), pages 149-177, September.
  12. Satyajit Chatterjee, 2010. "An Equilibrium Model of the Timing of Bankruptcy Filings," 2010 Meeting Papers 1282, Society for Economic Dynamics.
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  14. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304, Cowles Foundation for Research in Economics, Yale University.
  15. Mark Furletti, 2003. "Consumer bankruptcy: how unsecured lenders fare," Payment Cards Center Discussion Paper 03-17, Federal Reserve Bank of Philadelphia.
  16. Marcus Hagedorn & Iourii Manovskii, 2008. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," American Economic Review, American Economic Association, vol. 98(4), pages 1692-1706, September.
  17. Xavier Mateos-Planas, 2011. "Consumer default with complete markets," 2011 Meeting Papers 954, Society for Economic Dynamics.
  18. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  19. Kartik Athreya & Nicole B. Simpson, 2004. "Unsecured debt with public insurance : from bad to worse," Working Paper 03-14, Federal Reserve Bank of Richmond.
  20. David Benjamin & Mark L. J. Wright, 2009. "Recovery Before Redemption: A Theory Of Delays In Sovereign Debt Renegotiations," CAMA Working Papers 2009-15, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  21. Guido Menzio & Shouyong Shi, 2008. "Efficient Search on the Job and the Business Cycle, Second Version," PIER Working Paper Archive 09-010, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 28 Feb 2009.
  22. Aloisio Araujo & Paulo K. Monteiro & M�rio Rui P�ascoa, 1996. "Infinite Horizon Incomplete Markets With A Continuum Of States," Mathematical Finance, Wiley Blackwell, vol. 6(2), pages 119-132.
  23. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
  24. Donghoon Lee & Wilbert van der Klaauw, 2010. "An introduction to the FRBNY Consumer Credit Panel," Staff Reports 479, Federal Reserve Bank of New York.
  25. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  26. Araújo, Aloísio Pessoa de & Funchal, Bruno, 2006. "How much debtors' punishment?," Economics Working Papers (Ensaios Economicos da EPGE) 615, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  27. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2004. "Cyclical Dynamics in Idiosyncratic Labor Market Risk," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 695-717, June.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Why so many debt defaults?
    by Economic Logician in Economic Logic on 2013-01-04 15:32:00
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Cited by:
  1. Xavier Mateos-Planas & Giulio Seccia, 2013. "Consumer Default with Complete Markets: Default-based Pricing and Finite Punishment," Working Papers 711, Queen Mary, University of London, School of Economics and Finance.
  2. Lukasz A. Drozd & Ricardo Serrano-Padial, 2013. "Modeling the credit card revolution: the role of debt collection and informal bankruptcy," Working Papers 13-12, Federal Reserve Bank of Philadelphia.

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