The Effect of Principal Reduction on Household Distress: Evidence from Mortgage Cramdown
52 Pages Posted: 20 Oct 2020 Last revised: 1 Feb 2021
Date Written: January 24, 2021
Abstract
Mortgage cramdown 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 cramdown courts, we use a new dataset of district courts that allowed mortgage cramdown 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 cramdown courts reduces the five-year foreclosure rate by 29 percentage points and decreases the number of moves post-bankruptcy. Although cramdown is beneficial for all demographic groups, we observe that cramdown particularly helps female filers, who are also less likely to receive a debt discharge during bankruptcy. Our results support that principal write-down explain the vast majority of the reduction in foreclosure, and thus debt overhang considerations play an important role in explaining homeowners' default.
Keywords: Debt Relief, Principal Reduction, Debt Overhang, Foreclosures, Consumer Bankruptcy, Housing Policies
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