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Did Bankruptcy Reform Cause Mortgage Default to Rise?

  • Wenli Li
  • Michelle J. White
  • Ning Zhu
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This paper argues that the U.S. bankruptcy reform of 2005 played an important role in the mortgage crisis and the current recession. When debtors file for bankruptcy, credit card debt and other types of debt are discharged--thus loosening debtors' budget constraints. Homeowners in financial distress can therefore use bankruptcy to avoid losing their homes, since filing allows them to shift funds from paying other debts to paying their mortgages. But a major reform of U.S. bankruptcy law in 2005 raised the cost of filing and reduced the amount of debt that is discharged. We argue that an unintended consequence of the reform was to cause mortgage default rates to rise. We estimate a hazard model to test whether the 2005 bankruptcy reform caused mortgage defaults to rise, using a large dataset of individual mortgages. Our major result is that prime and subprime mortgage default rates rose by 23% and 14%, respectively, after bankruptcy reform. We also use difference-in-difference to examine the effects of three provisions of bankruptcy reform that particularly harmed homeowners with high incomes and/or high assets and find that their default rates rose even more. Overall, we calculate that bankruptcy reform caused the mortgage default rate to rise by one percentage point even before the start of the financial crisis, suggesting that the reform increased the severity of the crisis when it came.

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File URL: http://www.nber.org/papers/w15968.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15968.

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Date of creation: May 2010
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Publication status: published as "Did Bankruptcy Reform Cause Mortgage Defaults to Rise?" with Wenli Li and Ning Zhu. NBER working paper 15968. Published in American Economic Journal: Economic Policy, 2011.
Handle: RePEc:nbr:nberwo:15968
Note: LE
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  1. 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, 01.
  2. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 175-200, Fall.
  3. Ronel Elul & Nicholas S. Souleles & Souphala Chomsisengphet & Dennis Glennon & Robert Hunt, 2010. "What "Triggers" Mortgage Default?," American Economic Review, American Economic Association, vol. 100(2), pages 490-94, May.
  4. Ai, Chunrong & Norton, Edward C., 2003. "Interaction terms in logit and probit models," Economics Letters, Elsevier, vol. 80(1), pages 123-129, July.
  5. Christopher J. Mayer & Karen Pence, 2008. "Subprime Mortgages: What, Where, and to Whom?," NBER Working Papers 14083, National Bureau of Economic Research, Inc.
  6. Wenli Li & Michelle J. White, 2009. "Mortgage Default, Foreclosure, and Bankruptcy," NBER Working Papers 15472, National Bureau of Economic Research, Inc.
  7. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  8. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," NBER Working Papers 13265, National Bureau of Economic Research, Inc.
  9. Manuel Adelino & Kristopher Gerardi & Paul S. Willen, 2009. "Why don't lenders renegotiate more home mortgages? redefaults, self-cures, and securitization," Working Paper 2009-17, Federal Reserve Bank of Atlanta.
  10. 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.
  11. Kiefer, Nicholas M, 1988. "Economic Duration Data and Hazard Functions," Journal of Economic Literature, American Economic Association, vol. 26(2), pages 646-79, June.
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