Did Bankruptcy Reform Cause Mortgage Default to Rise?

Wenli Li, Michelle White and Ning Zhu

No 15968, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: G21 K35 R21 (search for similar items in EconPapers)
Date: 2010-05
Note: LE
References: Add references at CitEc
Citations: View citations in EconPapers (14)

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.

Downloads: (external link)
http://www.nber.org/papers/w15968.pdf (application/pdf)

Related works:
Journal Article: Did Bankruptcy Reform Cause Mortgage Defaults to Rise? (2011)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:15968

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w15968

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().