A Blighted Land: An Empirical Study of Residential Developer Bankruptcies in the United States (2007-2008)
194 Pages Posted: 5 Aug 2009 Last revised: 13 Aug 2009
Date Written: July 3, 2009
With falling home prices and home foreclosures currently acknowledged as a severe problem in the U.S., more attention needs to be paid to the contributing phenomenon of residential developers undergoing liquidation, which has left behind a trail of partially-completed or abandoned properties. In order to understand this phenomenon, we investigated the following questions: How have the Chapter 11 bankruptcy cases of residential developers and home builders during this downturn been resolved? How did the actions taken by secured lenders in the course of bankruptcy proceedings shape the resolution outcome? To what extent was bank behavior during these bankruptcies affected and constrained by the banking regulatory framework and culture?
We analyzed more than 200 residential developers that filed Chapter 11 bankruptcy petitions between November 2007 and December 2008. Our finding was that only a small minority of these developers confirmed a reorganization plan. The majority of the cases were dismissed or converted to Chapter 7, culminating in foreclosure or liquidation sales. In the sample, over 70% of the cases showed at least one instance where a secured lender sought lift-stay motions to pursue foreclosure. Among such cases, orders granting the lift-stay motions were granted most of the time.
Investigating this insistence on quick foreclosure, we explore more nuanced views of banks' lending functions, risk management and their regulatory environment. We find that during a recession, banks may have a preference for liquidation in bankruptcy because of capital shortfalls and procyclical regulatory pressure to reduce portfolio concentrations, particularly in real estate lending. This would be inconsistent with theories that secured lenders will choose economically optimal outcomes within a bankruptcy case, as they may choose outcomes that are sub-optimal within a bankruptcy to maximize an exogenous urgent need for capital.
Finally, a study of FDIC data and banks’ comment letters suggests that in the period prior to the current crisis, the riskiness of debtors was only weakly linked to increased pricing for riskier debtors, because of competitive markets, increased securitization, and inadequate risk management and risk-based pricing systems. We find evidence that a general weakening of secured creditor control does not necessarily lead to specific changes in the cost and availability of credit.
Keywords: Bankruptcy, corporate reorganization, Chapter 11, creditor control, DIP financing, foreclosure, liquidation, bank regulation, capital adequacy, risk management
JEL Classification: G21, G33, G34, G38, K29, L51, O16
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