Law professor Paige Marta Skiba finds that for some, lottery jackpots and fast cash may end up breaking the bank
by Amy Wolf
photo by Steve Green
Many of us have daydreamed how we would spend the big cash payout of a lottery win: eliminate existing debt, invest in a new home or car, put something in the bank – and maybe purchase a big-ticket item or two to celebrate our good fortune.
But research conducted by Assistant Professor of Law Paige Marta Skiba finds that many actual lottery winners fail to heed Ben Franklin’s sage advice that “a penny saved is a penny earned.”
Skiba found that lottery winners who earned between $50,000 and $150,000 not only failed to solve their debt problems, but in fact only postponed bankruptcy. And though these mid-level winners were less likely than small winners (those who won less than $10,000) to file for bankruptcy immediately after winning, they were 50 percent more likely to file for bankruptcy three to five years after collecting their prize.
“Winning the lottery seemed to do little to help these winners ease their debt,” Skiba said. “Our results are consistent with some winners using their prize to take additional risks or buy expensive luxury goods. Others seemed to simply lack the knowledge to handle large amounts of money wisely.”
Working with Scott Hankins of the University of Kentucky and Mark Hoekstra of the University of Pittsburgh, Skiba used data from Florida’s Fantasy 5 lottery game from April 1993 through November 2002. The researchers looked at all winners who collected more than $600. If someone won the lottery more than once, they only considered that person’s initial win. Of the nearly 35,000 individuals this totaled, almost 2,000 Fantasy 5 winners were linked to a bankruptcy in the five years following their payout.
According to Skiba, the act of filing for bankruptcy is significant for several reasons.
“Filing for bankruptcy is arguably the most extreme signal of financial distress,” she said. “Not only is it bad for creditors, but it also seriously harms a filer’s credit score, impacting the availability and price of future loans.”
Skiba is viewing the research in light of the possibility that U.S. lawmakers may consider giving citizens large sums of money to ease their financial burdens. Her research found that receiving sufficiently large cash transfers to pay off all of one’s unsecured debt only enabled individuals to postpone, rather than prevent, bankruptcy.
And lottery players are fairly representative of the population. Research conducted in 2005 showed that more than half of all American adults had played the lottery in the past year.
“While we cannot be sure that homeowners or other beneficiaries of government aid would respond in the same way lottery winners did, the results may warrant some skepticism about the long-term efficacy of bailouts,” Skiba said.
These findings follow similar research Skiba conducted on the quick-fix allure of payday loans for people short on cash – an option that may drag them even further into debt.
Payday loans – small, short-term loans intended to cover a borrower’s expenses until his or her next payday – are used by some 10 million American households each year. Skiba found that payday loan applicants who received the quick cash after their first application were almost twice as likely to file for bankruptcy within two years as those whose applications were denied the first time. The interest from payday and pawn loans amounted to about 11 percent of the total liquid debt interest burden at the time of the bankruptcy filing.
“Payday loans seem to be the straw that breaks the borrower’s back, because the loans are normally due every week or every other week,” Skiba said. “So other debts, like credit cards or mortgages, tend to be ignored.”
With co-author Jeremy Tobacman, Skiba looked at four years of data for the state of Texas from a prominent payday loan company. From 2000 to 2004, the company received more than a million applications, and the average loan request was around $300. The median annual income of the applicants was $20,000, with a median checking account balance of $66.
Part of the problem is that first-time borrowers tended to continue borrowing. The researchers found that first-time applicants who were approved applied for about five more loans within a year than rejected first-time applicants.
“Access to payday loan credit predicts roughly $2,300 of additional payday borrowing within two years,” Skiba said. “Our research found that payday loans and their interest payments may be sufficient to tip the balance into bankruptcy for a population that is already severely financially stressed.”
Skiba’s research falls into the area of behavioral law and economics, one of the most innovative movements of legal scholarship to develop over the past 25 years. She teaches in Vanderbilt’s Ph.D. Program in Law and Economics, which is based in the law school with courses taught by faculty in law, the Department of Economics and the Owen Graduate School of Management.
Skiba’s interest in the field is rooted in a longtime fascination with people and how they behave.
“In college I was an engineering major. I tried it because I liked math, but engineering didn’t suit me,” she said. “I took an economics class my sophomore year and fell in love with it. To me, economics was the perfect blend of math and analytical skills combined with understanding human behavior.
“I am really fascinated by people – how they make decisions about things, the psychology of it. Behavioral law and economics especially embodies these elements, which I find intriguing and are policy-relevant.”
Skiba’s research touches on what seems to be a truth of contemporary culture: By and large, we are a nation of spenders and not savers.
“Managing money is hard for everyone – whether you have a lot or a little, whether you earn it or are lucky enough to win it,” Skiba said. “My work, like other work in behavioral law and economics, has studied how people make systematic mistakes in spending and saving due to psychological biases and temptation.”
So where does federal intervention come in? For example, should the government impose regulations on payday lenders to prevent unwitting borrowers from cycling deeper into debt? Skiba says it’s a complicated issue.
“It’s not clear that banning payday lending is the right answer,” she said. “There really aren’t great alternatives out there. Banning payday loans may send people into worse alternatives, like loan sharking.
“But policy makers do need to take a step back and think about the real problem: Why don’t people have $300 for when their car breaks down or when their kid goes to the emergency room? A policy to help people avoid payday lending is a policy to help people start saving.”
additional reporting by Kara Furlong
Posted 08/01/09
