24 Pages Posted: 25 Feb 2009 Last revised: 9 May 2015
Date Written: February 25, 2009
The housing crisis threatens to destroy hundreds of billions of dollars of value by causing homeowners with negative equity to walk away from their houses. A house in foreclosure is worth 30 to 50 percent less than a house that a homeowner either retains or sells on the market, and a foreclosed house damages neighboring property values as well. We advocate a reform of Chapter 13 that would allow homeowners to strip down the value of their mortgages in a prepackaged bankruptcy. Such a plan would give homeowners an incentive to keep or resell their homes, thus reducing the market value loss of homes while protecting the effective value of creditors' interests. Two further key elements of the plan are that it uses prices based on the average house price in a particular ZIP code, which reduces moral hazard; and it is automated, requiring only a rubber stamp by a bankruptcy judge or other official, thus preserving judicial resources. Other plans, including that of the Obama administration, are compared.
Keywords: Housing, banking, chapter 13
JEL Classification: K35, R28
Suggested Citation: Suggested Citation
Posner, Eric A. and Zingales, Luigi, The Housing Crisis and Bankruptcy Reform: The Prepackaged Chapter 13 Approach (February 25, 2009). Chicago Booth School of Business Research Paper No. 09-11; U of Chicago Law & Economics, Olin Working Paper No. 459. Available at SSRN: https://ssrn.com/abstract=1349364 or http://dx.doi.org/10.2139/ssrn.1349364