The Effect of Principal Reduction on Household Distress: Evidence from Mortgage Cramdown
48 Pages Posted: 20 Oct 2020
Date Written: September 26, 2020
Mortgage cram-down has been proposed as a mechanism to avoid mortgage foreclosures in times of crisis. In this restructuring, the underwater portion of the mortgage is treated as unsecured debt and can be discharged during Chapter 13 bankruptcy. To quantify the ex-post effects of bankruptcy discharge in cram-down courts, we use a new data set of district courts that allowed mortgage cram-down over the period from 1989 to 1993. We take advantage of the random assignment of cases to judges who exhibit significant differences in leniency. We find that a successful bankruptcy filing in cram-down courts reduces the five-year foreclosure rate by 29 percentage points and reduces the number of moves post-bankruptcy. Principal write-downs explain the vast majority of the reduction in foreclosure rates.
Keywords: Debt Relief, Principal Reduction, Debt Overhang, Foreclosures, Consumer Bankruptcy, Housing Policies
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