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

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  • Joshua Goodman
  • Adam Levitin

Abstract

Recent proposals to address housing market troubles through principal modification could increase the cost of credit in the mortgage market. We explore this possibility 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 that home loans closed during the time when cramdown was allowed had interest rates 12-16 basis points higher than loans closed in the same state when cramdown was not allowed, which translates to a roughly 1 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 and higher in states where Chapter 13 filing is more common.

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  • Joshua Goodman & Adam Levitin, 2014. "Bankruptcy Law and the Cost of Credit: The Impact of Cramdown on Mortgage Interest Rates," Journal of Law and Economics, University of Chicago Press, vol. 57(1), pages 139-158.
    • Handle: RePEc:ucp:jlawec:doi:10.1086/674573
    DOI: 10.1086/674573
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    1. Reint Gropp & John Karl Scholz & Michelle J. White, 1997. "Personal Bankruptcy and Credit Supply and Demand," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(1), pages 217-251.
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    6. Jeremy Berkowitz & Michelle J. White, 2004. "Bankruptcy and Small Firms' Access to Credit," RAND Journal of Economics, The RAND Corporation, vol. 35(1), pages 69-84, Spring.
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    9. Karl E. Case & John M. Quigley & Robert J. Shiller, 2011. "Wealth Effects Revisited 1978-2009," Cowles Foundation Discussion Papers 1784, Cowles Foundation for Research in Economics, Yale University.
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    12. Michelle J. White, 2011. "Corporate and Personal Bankruptcy Law," NBER Working Papers 17237, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Reed, Robert R. & LaRue, Amanda & Ume, Ejindu S., 2018. "Mortgage recourse provisions and housing prices," Regional Science and Urban Economics, Elsevier, vol. 73(C), pages 99-111.
    2. You Suk Kim & Steven M. Laufer & Karen Pence & Richard Stanton & Nancy Wallace, 2018. "Liquidity Crises in the Mortgage Market," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 49(1 (Spring), pages 347-428.
    3. Wenli Li & Ishani Tewari & Michelle J. White, 2014. "Using bankruptcy to reduce foreclosures: does strip-down of mortgages affect the supply of mortgage credit?," Working Papers 14-35, Federal Reserve Bank of Philadelphia.
    4. repec:ces:ifodic:v:12:y:2014:i:3:p:19126471 is not listed on IDEAS
    5. Mandai, Yu & Nakabayashi, Masaki, 2018. "Stabilize the peasant economy: Governance of foreclosure by the shogunate," Journal of Policy Modeling, Elsevier, vol. 40(2), pages 305-327.
    6. Jihad Dagher & Yangfan Sun, 2014. "Borrower Protection and the Supply of Credit: Evidence from Foreclosure Laws," IMF Working Papers 2014/212, International Monetary Fund.
    7. Wenli Li & Ishani Tewari & Michelle J. White, 2019. "Using Bankruptcy to Reduce Foreclosures: Does Strip-Down of Mortgages Affect the Mortgage Market?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 55(1), pages 59-87, February.
    8. Rajashri Chakrabarti & Nathaniel Pattison, 2019. "Auto Credit and the 2005 Bankruptcy Reform: The Impact of Eliminating Cramdowns," The Review of Financial Studies, Society for Financial Studies, vol. 32(12), pages 4734-4766.
    9. Wenli Li & Ishani Tewari & Michelle White, 2014. "Using Bankruptcy to Reduce Foreclosures," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(03), pages 31-38, October.
    10. Saad Azmat & Hira Ghaffar, 2021. "Ethical Commitments and Credit Market Regulations," Journal of Business Ethics, Springer, vol. 171(3), pages 421-433, July.
    11. Montebruno, Piero & Silva, Olmo & Szumilo, Nikodem, 2021. "Judge Dread: court severity, repossession risk and demand in mortgage and housing markets," LSE Research Online Documents on Economics 110474, London School of Economics and Political Science, LSE Library.
    12. Dagher, Jihad & Sun, Yangfan, 2016. "Borrower protection and the supply of credit: Evidence from foreclosure laws," Journal of Financial Economics, Elsevier, vol. 121(1), pages 195-209.
    13. Wenli Li & Ishani Tewari & Michelle White, 2014. "Using Bankruptcy to Reduce Foreclosures," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(3), pages 31-38, October.
    14. repec:bin:bpeajo:v:49:y:2019:i:2018-01:p:347-428 is not listed on IDEAS

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