Bankruptcy Law and The Cost of Credit: The Impact of Cramdown on Mortgage Interest Rates

Joshua Goodman () and Adam Jeremiah Levitin

Scholarly Articles from Harvard Kennedy School of Government

Abstract: The role of bankruptcy law in credit markets has received renewed attention in the aftermath of the housing bubble collapse. The fundamental challenge for research on this topic is to separate the impact of legal factors from other features of the credit environment. We do so by exploiting historical variation in federal judicial rulings regarding whether Chapter 13 bankruptcy filers could reduce the principal owed on a home loan to the home’s market value. The practice, known as cramdown, was definitively prohibited by the Supreme Court in 1993. We find evidence that home loans closed during the time when cramdown was allowed had interest rates 10-20 basis points higher than loans closed in the same state when cramdown was not allowed, which translates to a roughly 1-2 percent increase in monthly payments. Consistent with the theory that lenders are pricing in the risk of principal modification, interest rate increases are higher for the riskiest borrowers and zero for the least risky, as well as higher in states where Chapter 13 filing is more common. Though the price of credit rises slightly, we find no evidence of a change in the quantity of credit provided. The relatively small impacts of cramdown on the cost of credit suggests that the insurance benefits of bankruptcy may be relatively inexpensive.

Date: 2012
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Published in HKS Faculty Research Working Paper Series

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http://dash.harvard.edu/bitstream/handle/1/9403179/RWP12-037_Goodman.pdf (application/pdf)

Related works:
Journal Article: Bankruptcy Law and the Cost of Credit: The Impact of Cramdown on Mortgage Interest Rates (2014)
Working Paper: Bankruptcy Law and the Cost of Credit: The Impact of Cramdown on Mortgage Interest Rates (2012)
Working Paper: Bankruptcy Law and The Cost of Credit: The Impact of Cramdown on Mortgage Interest Rates
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