TY  - JOUR
AU  - Li,Wenli
AU  - White,Michelle J.
AU  - Zhu,Ning
TI  - Did Bankruptcy Reform Cause Mortgage Default to Rise?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 15968
PY  - 2010
Y2  - May 2010
UR  - http://www.nber.org/papers/w15968
L1  - http://www.nber.org/papers/w15968.pdf
N1  - Author contact info:
Wenli Li
Federal Reserve Bank of Philadelphia
E-Mail: wenli.li@phil.frb.org

Michelle J. White
Department of Economics
University of California, San Diego
La Jolla, CA  92093-0508
Tel: 858/534-2783
Fax: 858/534-7040
E-Mail: miwhite@ucsd.edu

Ning Zhu
Graduate School of Management
UC, Davis
One Shields Avenue
Davis, CA 95616-8609
Tel: 530/752-3871
Fax: 530/752-2924
E-Mail: nzhu@saif.sjtu.edu.cn
M2  - featured in NBER digest on 2010-08-01
AB  - 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.
ER  -