The Effect of Principal Reduction on Household Distress: Evidence from Mortgage Cramdown

52 Pages Posted: 20 Oct 2020 Last revised: 15 Mar 2021

See all articles by Jacelly Cespedes

Jacelly Cespedes

University of Minnesota - Carlson School of Management

Carlos Parra

Pontifical Catholic University of Chile - School of Business

Clemens Sialm

University of Texas at Austin - McCombs School of Business; National Bureau of Economic Research (NBER)

Date Written: February 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-downs 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

Suggested Citation

Cespedes, Jacelly and Parra, Carlos and Sialm, Clemens, The Effect of Principal Reduction on Household Distress: Evidence from Mortgage Cramdown (February 24, 2021). Available at SSRN: https://ssrn.com/abstract=3700190 or http://dx.doi.org/10.2139/ssrn.3700190

Jacelly Cespedes (Contact Author)

University of Minnesota - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

HOME PAGE: http://sites.google.com/site/jacellycespedes/

Carlos Parra

Pontifical Catholic University of Chile - School of Business ( email )

Vicuna Mackenna 4860
Santiago
Chile

HOME PAGE: http://www.carlosrparra.com/

Clemens Sialm

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

HOME PAGE: http://faculty.mccombs.utexas.edu/Clemens.Sialm/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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