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Bankruptcy Law and the Cost of Credit: The Impact of Cramdown on Mortgage Interest Rates

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  • Goodman, Joshua

    (Harvard University)

  • Levitin, Adam

    (Harvard University)

Abstract

Recent proposals to address housing market troubles through principal modification raise the possibility that such policies could increase the cost of credit in the mortgage market. We explore this using historical variation in federal judicial rulings regarding whether Chapter 13 bankruptcy filers could reduce the principal owed on a home loan to the home's market value. The practice, known as cramdown, was definitively prohibited by the Supreme Court in 1993. We find evidence that home loans closed during the time when cramdown was allowed had interest rates 10-20 basis points higher than loans closed in the same state when cramdown was not allowed, which translates to a roughly 1-2 percent increase in monthly payments. Consistent with the theory that lenders are pricing in the risk of principal modification, interest rate increases are higher for the riskiest borrowers and zero for the least risky, as well as higher in states where Chapter 13 filing is more common.

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Bibliographic Info

Paper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number rwp12-037.

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Date of creation: Aug 2012
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Handle: RePEc:ecl:harjfk:rwp12-037

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  1. Michelle J. White, 2011. "Corporate and Personal Bankruptcy Law," NBER Working Papers 17237, National Bureau of Economic Research, Inc.
  2. Reint Gropp & John Karl Scholz & Michelle White, 1996. "Personal Bankruptcy and Credit Supply and Demand," NBER Working Papers 5653, National Bureau of Economic Research, Inc.
  3. Berkowitz, Jeremy & Hynes, Richard, 1999. "Bankruptcy Exemptions and the Market for Mortgage Loans," Journal of Law and Economics, University of Chicago Press, vol. 42(2), pages 809-30, October.
  4. Karen M. Pence, 2006. "Foreclosing on Opportunity: State Laws and Mortgage Credit," The Review of Economics and Statistics, MIT Press, vol. 88(1), pages 177-182, February.
  5. Lin, Emily Y. & White, Michelle J., 2001. "Bankruptcy and the Market for Mortgage and Home Improvement Loans," Journal of Urban Economics, Elsevier, vol. 50(1), pages 138-162, July.
  6. Christopher Mayer & Karen Pence & Shane M. Sherlund, 2009. "The Rise in Mortgage Defaults," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 27-50, Winter.
  7. Thomas J. Fitzpatrick & James B. Thomson, 2010. "Stripdowns and bankruptcy: lessons from agricultural bankruptcy reform," Economic Commentary, Federal Reserve Bank of Cleveland, issue Aug.
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