Using Bankruptcy to Reduce Foreclosures: Does Strip-Down of Mortgages Affect the Supply of Mortgage Credit?

38 Pages Posted: 10 Mar 2014 Last revised: 19 Aug 2014

See all articles by Wenli Li

Wenli Li

Federal Reserve Bank of Philadelphia

Ishani Tewari

Yale School of Management

Michelle J. White

University of California, San Diego (UCSD) - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: March 2014

Abstract

We assess the credit market impact of allowing mortgage "strip-down"--that is, reducing the principal of underwater residential mortgages to the current market value of the property for homeowners in Chapter 13 bankruptcy. Our identification is provided by a series of U.S. Circuit Court of Appeals decisions in the early 1990's that introduced mortgage strip-down in parts of the U.S., followed by a 1993 Supreme Court ruling that abolished it all over the U.S. We find that the Supreme Court decision led to a short-term reduction of 3% in mortgage interest rates and a short-term increase of 1% in mortgage approval rates, but only the approval rate effect persists in longer sample periods. In contrast, the circuit court decisions to allow strip-down did not have consistent effects on mortgage terms. We also show that strip-down had little effect on default rates by homeowners with existing mortgages. Taken together, these results suggest that mortgage lenders responded weakly to both the adoption and abolition of strip-down because strip-down had little effect on their profits from mortgage lending. According to these findings, re-introducing strip-down of mortgages in bankruptcy as a foreclosure-prevention program would have only small and transient effects on the supply of mortgage loans.

Suggested Citation

Li, Wenli and Tewari, Ishani and White, Michelle J., Using Bankruptcy to Reduce Foreclosures: Does Strip-Down of Mortgages Affect the Supply of Mortgage Credit? (March 2014). NBER Working Paper No. w19952. Available at SSRN: https://ssrn.com/abstract=2406754

Wenli Li (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Ishani Tewari

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Michelle J. White

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
La Jolla, CA 92093-0508
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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