The Effect of Principal Reduction on Household Distress: Evidence from Mortgage Cramdown
Mortgage cramdown enabled bankruptcy judges to discharge the underwater portion of a mortgage during Chapter 13 bankruptcy before the Supreme Court disallowed this practice in 1993. We exploit the random assignment of cases to judges to quantify the ex-post effects of Chapter 13 bankruptcy over the period from 1989 to 1993. We find that a successful Chapter 13 filing in a cramdown court substantially decreases the five-year foreclosure rate, the propensity to move, and the crime rate. Our results suggest that principal write-down considerably reduces homeowner’s distress.
We are grateful to Hengjie Ai, Vimal Balasubramaniam, Ed Boltz, Peter Ganong, Borja Larrain, Feng Liu, Gonzalo Maturana, Felipe Severino, Jose Tessada, Tracy Wang, and seminar participants at the 2020 Virtual Real Estate Seminar, the 2021 CEPR European Workshop on Household Finance, the 2021 Consumer Financial Protection Bureau Research Conference, the 2021 University of Connecticut Finance Conference, the Pontificia Universitad Catolica de Chile, the Universidad Adolfo Ibanez, the University of Minnesota, and the University of Texas at Austin. In addition, we thank Tal Gross, Matthew Notowidigdo, and Jialan Wang for sharing their PACER dockets data and Joshua Goodman and Adam Levitin for sharing their data on the cramdown court rulings. Clemens Sialm is an independent contractor with AQR Capital Management. This research received generous financial support from the Alfred P. Sloan Foundation NBER Household Finance small grant program. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Clemens Sialm has received compensation for consulting services from AQR Capital Management over the last five years.