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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 one 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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  • Joshua Goodman & Adam Levitin, "undated". "Bankruptcy Law and The Cost of Credit: The Impact of Cramdown on Mortgage Interest Rates," Working Paper 117016, Harvard University OpenScholar.
  • Handle: RePEc:qsh:wpaper:117016
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    File URL: http://scholar.harvard.edu/joshuagoodman/node/117016
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    References listed on IDEAS

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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, Oxford University Press, vol. 112(1), pages 217-251.
    2. Fitzpatrick, Thomas J. & Thomson, James B., 2010. "Stripdowns and bankruptcy: lessons from agricultural bankruptcy reform," Economic Commentary, Federal Reserve Bank of Cleveland, issue Aug.
    3. 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.
    4. 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.
    5. 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 809-830, October.
    6. Chomsisengphet, Souphala & Elul, Ronel, 2006. "Bankruptcy exemptions, credit history, and the mortgage market," Journal of Urban Economics, Elsevier, vol. 59(1), pages 171-188, January.
    7. Michelle J. White, 2011. "Corporate and Personal Bankruptcy Law," NBER Working Papers 17237, National Bureau of Economic Research, Inc.
    8. 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.
    9. 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.
    10. 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.
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    Cited by:

    1. 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.
    2. Wenli Li & Ishani Tewari & Michelle J. White, 2014. "Using Bankruptcy to Reduce Foreclosures: Does Strip-down of Mortgages Affect the Supply of Mortgage Credit?," NBER Working Papers 19952, National Bureau of Economic Research, Inc.
    3. Chakrabarti, Rajashri & Pattison, Nathaniel, 2016. "Auto credit and the 2005 bankruptcy reform: the impact of eliminating cramdowns," Staff Reports 797, Federal Reserve Bank of New York.
    4. 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.
    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.

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