Abstract:
Mortgage cramdown has been proposed as a mechanism to avoid mortgage foreclosures in times of crisis. In this restructuring, the underwater portion of the mortgage is treated as unsecured debt and can be discharged during Chapter 13 bankruptcy. To quantify the ex-post effects of bankruptcy discharge in cramdown courts, we use a new dataset of district courts that allowed mortgage cramdown over the period from 1989 to 1993. We take advantage of the random assignment of cases to judges who exhibit significant differences in leniency. We find that a successful bankruptcy filing in cramdown courts reduces the five-year foreclosure rate by 29 percentage points and decreases the number of moves post-bankruptcy. Although cramdown is beneficial for all demographic groups, we observe that cramdown particularly helps female filers, who are also less likely to receive a debt discharge during bankruptcy. Our results support that principal write-downs explain the vast majority of the reduction in foreclosure, and thus debt overhang considerations play an important role in explaining homeowners' default.
Commentary:
By looking at bankruptcy cases filed before Nobelman v. American Savings Bank (508 U.S. 324 1993) banned most mortgage cramdown in Chapter 13 cases, this paper shows how effective cramdown is in preventing foreclosure and also increasing success of of those cases. From this, the authors "provide a partial-equilibrium back-of-the-envelope calculation" that more than 500,000 foreclosures would have been avoided during the Housing Crisis between 2008 and 2013. This may be particularly timely when Congress again considers proposed changes to the Bankruptcy Code, including Sen. Elizabeth Warren's Consumer Bankruptcy Reform Act.
In addition to findings regarding the effectiveness of mortgage cramdown, this paper includes fascinating and frustrating statistics regarding the varying Chapter 13 outcomes based on the judge assigned to the case, with the discharge rate for the most lenient judges being 60% higher than the other judges in the same district but at the same time being 30% lower for the strictest judges than their peers. This will not surprise any consumer bankruptcy attorney or Trustee, but perhaps this will give judges themselves a cause to reflect on their own results.
This article does make many of the overly broad statements too common in law reviews, including that:
- "Chapter 13 debtors receive protection of their assets in exchange for partial repayment of debt", when in fact not only does the Bankruptcy Code not require more be paid to creditors than would be paid in Chapter 7 but also in practice the vast majority of Chapter 13 cases pay little or nothing to unsecured creditors.
- "[M]ortgage modification is prohibited in Chapter 13 bankruptcy", ignoring that mortgage modification is permitted when the note is secured by more than real property, see e.g., Ennis v. Green Tree, when the property is the residence of more than just the debtor, see, e.g. A Troublesome Prospect: Section 1322(b)(2) and a New Generation of Mixed-Use Developments, or when the mortgage note has or will shortly come due, see e.g., Hurlburt v. Black.
For a copy of this article, please click here:
The Effect of Principal Reduction on Household Distress: Evidence from Mortgage Cramdown
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