Seismic Effects of the Bankruptcy Reform

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in the paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors. Terms of use: Documents in EconStor may Seismic Effects of the Bankruptcy Reform AbstractWe argue that the 2005 bankruptcy abuse reform (BAR) contributed to the surge in subprime foreclosures that followed its passage. Before BAR, over-indebted mortgagors could free up income to pay the mortgage by filing bankruptcy and having their unsecured debts discharged. BAR blocks that maneuver for better-off filers by way of a means test. We identify the effects of BAR using state home equity bankruptcy exemptions; filers in low-exemption states were not very protected before BAR, so they would be less affected by the reform. Difference-in-difference regressions confirm four predictions implied by that identification strategy. Our findings add to research trying to explain the surge in subprime foreclosures and to a broader literature on household bankruptcy demand and credit supply. We buttress the identification by looking for differential effects of BAR across different classes of household credit. We expect BAR will reduce delinquency rates on unsecured loans in states with high exemptions because lenders in those states were most exposed to loss under bankruptcy before BAR. 3 We figure BAR will be unrelated to prime mortgage foreclosures because prime mortgagors are, by definition, unlikely to demand bankruptcy, regardless of exemptions.We test those predictions using difference-in-difference regressions of mortgage foreclosure and loan delinquency rates estimated with state level, quarterly data over 1998:Q1 to 2007:Q3. The results are largely consistent with our predictions. Given home price appreciation and economic conditions, we find that the increase in subprime foreclosures after BAR was significantly higher in states with higher exemption. Prime foreclosure rates, by contrast, were unrelated to BAR. In still starker contrast, delinquency rates on unsecured personal loans decreased more post-BAR in states with higher home equity exemptions.The estimated impact of BAR on subprime foreclosures is substantial. For a state with average home equity exemption, the av...

How Did the US Housing Slump Begin? Role of the 2005 Bankruptcy Reform

“…When Li, White and Zhu distinguish effects on subprime and prime mortgages they find significant effects on both categories: they estimate default rates rose by 14% and 23% respectively in these two categories as a result of the reform. This is in contrast to Morgan, Iverson and Botsch (2008) who do not find a significant effect on prime borrowers.…”

“…The first paper to investigate the effect of the BAPCPA reform in light of the financial crisis has been Morgan, Iverson and Botsch (2008). Applying a similar identification strategy as employed in this paper to state level data, they find convincing evidence that higher exposure to the BAPCPA reform caused an increase of home foreclosures for subprime borrowers but not for prime borrowers.…”

“…This would intensify the 'contagion', causing in turn more defaults on housing loans. Morgan et al (2008).…”

“…In a subsequent paper, Li, White and Zhu (2010) use a finer micro-level database to investigate similar hypotheses concerning foreclosure as Morgan, Iverson and Botsch (2008). Li, White and Zhu (2010) also find convincing evidence from a large sample of house mortgage data that BAPCPA raised default rates immediately (e.g., three or six months) following the reform compared with (three or six months) before.…”

“…Since Li, White and Zhu (2010) use mortgage-level data while Morgan, Iverson and Botsch (2008) use state level data, the former paper can address more detailed questions, in particular concerning personal exposure. Li, White and Zhu find that the evidence concerning personal exposure effects of the reform on subprime defaults is mixed, thus raising the question why the BAPCPA effect on subprime defaults was so pronounced.…”