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American Economic Journal: Economic Policy: Vol. 3 No. 4 (November 2011)

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Did Bankruptcy Reform Cause Mortgage Defaults to Rise?

Article Citation

Li, Wenli, Michelle J. White, and Ning Zhu. 2011. "Did Bankruptcy Reform Cause Mortgage Defaults to Rise?" American Economic Journal: Economic Policy, 3(4): 123-47.

DOI: 10.1257/pol.3.4.123

Abstract

Homeowners in financial distress can use bankruptcy to avoid defaulting on their mortgages, since filing loosens their budget constraints. But the 2005 bankruptcy reform made bankruptcy less favorable to homeowners and therefore caused mortgage defaults to rise. We test this relationship and find that the reform caused prime and subprime mortgage default rates to rise by 23% and 14%, respectively. Default rates rose even more for homeowners who were particularly negatively affected by the reform. We calculate that bankruptcy reform caused mortgage default rates to rise by one percentage point even before the start of the financial crisis. (JEL D14, G01, G21, K35)

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Authors

Li, Wenli (Federal Reserve Bank and Philadelphia)
White, Michelle J. (U CA, San Diego)
Zhu, Ning (Shanghai Advanced Institute of Finance, Shanghai Jiao Tong U)

JEL Classifications

D14: Personal Finance
G01: Financial Crises
G21: Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
K35: Personal Bankruptcy Law

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