Law Review: Nagel, Fabian, Consumer Bankruptcy Audits (October 12, 2024).

Available at:    https://ssrn.com/abstract=4991384 or http://dx.doi.org/10.2139/ssrn.4991384

Abstract:

Bankruptcy insures consumers against large and unexpected wealth shocks. However, debtors may abuse this insurance. Indeed, close to 20% of consumer bankruptcy filings contain at least one material misstatement. I exploit the conditionally random assignment of audits to estimate the effect of mandatory audits on debt forgiveness in consumer bankruptcy. I find that audits reduce debt forgiveness, but only when alternative oversight is low (Chapter 7). Audits come at the cost of increased case complexity for filers, deteriorating the long-run financial health of unsophisticated filers. Generally, audits drive a reallocation of debt relief from non-compliers and misreporters to truthful filers. Aggregate calculations show that the reduction in debt forgiveness due to misstatements and deterrence exceeds the direct cost of increasing the audit rate when oversight is low. Reductions in debt relief due to deterrence exceed reductions due to identified misstatements two-fold.

Commentary:

While the conclusions of this research and analysis about the costs and benefits of random consumer audits is not a clear as studies have been regarding the requirement of pre-filing credit counseling (basically a pointless  filing fee paid to private entities),  this does lead to questioning whether audits in highly scrutinized Chapter 13 cases is warranted.

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