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Mortgage Default, Foreclosure, and Bankruptcy


  • Wenli Li
  • Michelle J. White


In this paper we examine the relationship between homeowners' bankruptcy decisions and their mortgage default decisions and the relationship between homeowners' bankruptcy decisions and lenders' decisions to foreclose. In theory, both relationships could be either substitutes or complements. Bankruptcy and default tend to be substitutes because homeowners' budgets are limited and, if they spend less on payments to unsecured lenders, then they have more money to pay their mortgages. But bankruptcy and default may also be complements if homeowners use bankruptcy to reduce the cost of defaulting on their mortgages. Bankruptcy and foreclosure similarly may be either substitutes or complements. In fact we show that both relationships are complementary, although homeowners reacted to the 2005 bankruptcy reform by treating them as substitutes. We also show that bankruptcies, defaults and foreclosures all tend to spread, i.e., higher bankruptcy rates in the neighborhood raise homeowners' probability of filing, higher default rates raise homeowners' probability of defaulting, and higher foreclosure rates raise homeowners' probability of foreclosure. We provide estimates of the size of these effects. The paper argues that these relationships have important public policy implications. In particular, foreclosures have very high social costs, and some of these costs are external to both borrowers and lenders. As a result, there is a social gain from discouraging bankruptcies, since fewer bankruptcies mean fewer defaults and foreclosures. We show that these considerations shift optimal bankruptcy law in a pro-creditor direction, because pro-creditor bankruptcy policies reduce the number of filings and therefore reduce foreclosures. But the same considerations shift other policies that affect bankruptcy in a pro-debtor direction. This is because pro-debtor shifts in, for example, wage garnishment policy reduce the number of bankruptcy filings and therefore reduce foreclosures.

Suggested Citation

  • Wenli Li & Michelle J. White, 2009. "Mortgage Default, Foreclosure, and Bankruptcy," NBER Working Papers 15472, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:15472
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    References listed on IDEAS

    1. Hülya Eraslan & Wenli Li & Pierre-Daniel G. Sarte, 2007. "The anatomy of U.S. personal bankruptcy under Chapter 13," Working Papers 07-31, Federal Reserve Bank of Philadelphia.
    2. Reint Gropp & John Karl Scholz & Michelle J. White, 1997. "Personal Bankruptcy and Credit Supply and Demand," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 217-251.
    3. Igor Livshits & James MacGee & Michèle Tertilt, 2007. "Consumer Bankruptcy: A Fresh Start," American Economic Review, American Economic Association, vol. 97(1), pages 402-418, March.
    4. Adelino, Manuel & Gerardi, Kristopher & Willen, Paul S., 2013. "Why don't Lenders renegotiate more home mortgages? Redefaults, self-cures and securitization," Journal of Monetary Economics, Elsevier, vol. 60(7), pages 835-853.
    5. Michelle J. White & Ning Zhu, 2010. "Saving Your Home in Chapter 13 Bankruptcy," The Journal of Legal Studies, University of Chicago Press, vol. 39(1), pages 33-61, January.
    6. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 175-200, Fall.
    7. Scott Fay & Erik Hurst & Michelle J. White, 2002. "The Household Bankruptcy Decision," American Economic Review, American Economic Association, vol. 92(3), pages 706-718, June.
    8. Green, Richard K. & White, Michelle J., 1997. "Measuring the Benefits of Homeowning: Effects on Children," Journal of Urban Economics, Elsevier, vol. 41(3), pages 441-461, May.
    9. Piskorski, Tomasz & Seru, Amit & Vig, Vikrant, 2010. "Securitization and distressed loan renegotiation: Evidence from the subprime mortgage crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 369-397, September.
    10. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," NBER Working Papers 13265, National Bureau of Economic Research, Inc.
    11. Lawrence R. Cordell & Karen E. Dynan & Andreas Lehnert & J. Nellie Liang & Eileen Mauskopf, 2008. "The incentives of mortgage servicers: myths and realities," Finance and Economics Discussion Series 2008-46, Board of Governors of the Federal Reserve System (U.S.).
    12. John Y. Campbell & Stefano Giglio & Parag Pathak, 2011. "Forced Sales and House Prices," American Economic Review, American Economic Association, vol. 101(5), pages 2108-2131, August.
    13. 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.
    14. Donald P. Morgan & Benjamin Iverson & Matthew Botsch, 2008. "Seismic effects of the bankruptcy reform," Staff Reports 358, Federal Reserve Bank of New York.
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    Cited by:

    1. Kirkpatrick, A. Justin & Bennear, Lori S., 2014. "Promoting clean energy investment: An empirical analysis of property assessed clean energy," Journal of Environmental Economics and Management, Elsevier, vol. 68(2), pages 357-375.
    2. Corradin, Stefano & Gropp, Reint & Huizinga, Harry & Laeven, Luc, 2010. "Who Invests in Home Equity to Exempt Wealth from Bankruptcy?," CEPR Discussion Papers 8097, C.E.P.R. Discussion Papers.
    3. Gordon, Grey, 2017. "Optimal bankruptcy code: A fresh start for some," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 123-149.
    4. Chatterjee, Satyajit & Gordon, Grey, 2012. "Dealing with consumer default: Bankruptcy vs garnishment," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 1-16.
    5. Nakajima, Makoto, 2017. "Assessing bankruptcy reform in a model with temptation and equilibrium default," Journal of Public Economics, Elsevier, vol. 145(C), pages 42-64.
    6. repec:red:issued:15-201 is not listed on IDEAS
    7. Wenli Li & Michelle J. White & Ning Zhu, 2011. "Did Bankruptcy Reform Cause Mortgage Defaults to Rise?," American Economic Journal: Economic Policy, American Economic Association, vol. 3(4), pages 123-147, November.
    8. Steven Laufer, . "Equity Extraction and Mortgage Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    9. Loibl, Cäzilia & Kraybill, David S. & DeMay, Sara Wackler, 2011. "Accounting for the role of habit in regular saving," Journal of Economic Psychology, Elsevier, vol. 32(4), pages 581-592, August.
    10. Aivazian, Varouj & Gu, Xinhua & Qiu, Jiaping & Huang, Bihong, 2015. "Loan collateral, corporate investment, and business cycle," Journal of Banking & Finance, Elsevier, vol. 55(C), pages 380-392.
    11. Nurlan Turdaliev & Yahong Zhang, 2017. "Household Debt, Macroprudential Rules, and Monetary Policy," Working Papers 1704, University of Windsor, Department of Economics, revised May 2017.

    More about this item

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G2 - Financial Economics - - Financial Institutions and Services
    • K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • R28 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Government Policy
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets
    • R51 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Regional Government Analysis - - - Finance in Urban and Rural Economies

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