Source: VOX
There is a fascinating article by economists Wenli Li and Michelle J. White called Bankruptcy, mortgage default, and foreclosure which discusses how the change in US bankruptcy law (which occurred right in the middle of the period where banks were lowering their lending standards) caused more problems related to housing mortgage defaults.
>In 2005, major reform of US bankruptcy law sharply increased debtors’ cost of filing for bankruptcy. This caused a sharp reduction in the number of filings. Because credit card debts and other types of unsecured debt are discharged in bankruptcy, filing for bankruptcy loosens homeowners’ budget constraints and makes paying the mortgage easier. Thus the 2005 reform set the stage for an increase in mortgage defaults by making bankruptcy less readily available.
In other words, reducing the ability to file for bankruptcy increases the probability of mortgage default and as a result:
>We estimate that the reform caused about 800,000 additional mortgage defaults and 250,000 additional foreclosures to occur in each of the past several years – thus contributing to the severity of the financial crisis.
Wow.
This makes the effort to create fair loan modification programs and prod lenders to work with borrowers that much more important.
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I would be in no hurry to accept this article as revealed truth. The principal author, Prof. White, has been unremittingly opposed to the Bankruptcy Reform Act on the ground that it was too pro-lender. The reform act was designed to eliminate perverse incentives of consumers to run up large amounts of unsecured debt and then leave their lenders holding the bag. Among other things, the authors conveniently omit the notion that resources that might have been used to pay mortgage debt were instead applied to unsecured debt. There is absolutely no factual basis for the 250,000 “additional” foreclosure figure cited by the authors, and no causal relationship is demonstrated by their figures. Consider in a non-deficiency-judgment state like California what incentive an under-water homeowner has to refrain from walking away in an environment of collapsing prices. This is simply an anti-lender diatribe — the most recent in a line of many.