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Informal unemployment insurance and labor market dynamics

  • Kyle F. Herkenhoff

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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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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  1. Ljungqvist, Lars & Sargent, Thomas J., 1997. "The European Unemployment Dilemma," Working Paper Series 481, Research Institute of Industrial Economics.
  2. Satyajit Chatterjee & Dean Corbae & José-Víctor Ríos-Rull, 2007. "A finite-life private-information theory of unsecured consumer debt," Working Papers 07-14, Federal Reserve Bank of Philadelphia.
  3. 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).
  4. 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.
  5. Menzio, Guido & Shi, Shouyong, 2010. "Block recursive equilibria for stochastic models of search on the job," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1453-1494, July.
  6. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304R5, Cowles Foundation for Research in Economics, Yale University, revised Mar 2004.
  7. Igor Livshits & James MacGee & Mich�le Tertilt, 2007. "Consumer Bankruptcy: A Fresh Start," American Economic Review, American Economic Association, vol. 97(1), pages 402-418, March.
  8. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  9. Xavier Mateos-Planas & David Benjamin, 2012. "Formal vs. Informal Default in Consumer Credit," 2012 Meeting Papers 144, Society for Economic Dynamics.
  10. Xavier Mateos-Planas, 2011. "Consumer default with complete markets," 2011 Meeting Papers 954, Society for Economic Dynamics.
  11. Donghoon Lee & Wilbert van der Klaauw, 2010. "An introduction to the FRBNY Consumer Credit Panel," Staff Reports 479, Federal Reserve Bank of New York.
  12. 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.
  13. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  14. Mark Furletti, 2003. "Consumer bankruptcy: how unsecured lenders fare," Payment Cards Center Discussion Paper 03-17, Federal Reserve Bank of Philadelphia.
  15. 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.
  16. Kartik Athreya & Nicole B. Simpson, 2004. "Unsecured debt with public insurance : from bad to worse," Working Paper 03-14, Federal Reserve Bank of Richmond.
  17. 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.
  18. Athreya, Kartik B., 2002. "Welfare implications of the Bankruptcy Reform Act of 1999," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1567-1595, November.
  19. Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2011. "Mortgage defaults," Working Paper 11-05, Federal Reserve Bank of Richmond.
    • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2015. "Mortgage Defaults," Caepr Working Papers 2015-011 Classification-D, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    • Leonardo Martinez & Juan Carlos Hatchondo & Juan M. Sanchez, 2012. "Mortgage Defaults," IMF Working Papers 12/26, International Monetary Fund.
    • Hatchondo, Juan Carlos & Martinez, Leonardo & Sánchez, Juan M., 2011. "Mortgage defaults," Working Papers 2011-019, Federal Reserve Bank of St. Louis, revised 31 Jul 2015.
  20. 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.
  21. Jesse Rothstein, 2011. "Unemployment Insurance and Job Search in the Great Recession," NBER Working Papers 17534, National Bureau of Economic Research, Inc.
  22. 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).
  23. Guido Menzio & Shouyong Shi, 2009. "Efficient Search on the Job and the Business Cycle," NBER Working Papers 14905, National Bureau of Economic Research, Inc.
  24. Kyle F. Herkenhoff & Lee E. Ohanian, 2011. "Labor Market Dysfunction During the Great Recession," NBER Working Papers 17313, National Bureau of Economic Research, Inc.
  25. 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.
  26. Satyajit Chatterjee, 2010. "An Equilibrium Model of the Timing of Bankruptcy Filings," 2010 Meeting Papers 1282, Society for Economic Dynamics.
  27. David K. Musto, 2004. "What Happens When Information Leaves a Market? Evidence from Postbankruptcy Consumers," The Journal of Business, University of Chicago Press, vol. 77(4), pages 725-748, October.
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