This paper looks at the extent that differences in foreclosure and bankruptcy laws can jointly explain variation in default rates across states. The author finds that more generous homestead exemptions raise the cost of unsecured borrowing. Households in states with high exemptions therefore hold less unsecured and more mortgage debt compared to low exemption states, which leads to lower bankruptcy rates but higher foreclosure rates. The paper predicts higher bankruptcy rates and a higher coincidence of foreclosure and bankruptcy in states that allow recourse mortgages, where the lender can sue the borrower for any deficiency following a foreclosure. The author also finds that the reforms of BAPCPA pushed borrowers, particularly in states with low homestead exemptions, to take on more secured, rather than unsecured debts, ultimately increasing the number of bankruptcies and foreclosures. The author conclusion is that to maximize consumer welfare, recourse mortgage loans should be eliminated and state homestead exemptions should be set at 25% of median income.
The elimination of recourse mortgages to maximize consumer welfare would seem to both view bankruptcy as a harm to consumers and would in effect grant a blanket amnesty to all borrowers. This ignores that bankruptcy courts are very adept at winnowing out the borrowers that have some ability to repay, so the benefit would seem to accrue mostly to borrowers with large mortgages, who are more likely to have higher incomes. These borrowers are also more likely to engage in "strategic defaults" and if there is no recourse following such default, the moral hazard (of which bankruptcy represents a large portion) is decreased.
For a copy of the paper:http://ssrn.com/abstract=1857517