Working Paper: NBER ID: w19952
Authors: Wenli Li; Ishani Tewari; Michelle J. White
Abstract: We assess the credit market impact of allowing mortgage "strip-down"--that is, reducing the principal of underwater residential mortgages to the current market value of the property for homeowners in Chapter 13 bankruptcy. Our identification is provided by a series of U.S. Circuit Court of Appeals decisions in the early 1990's that introduced mortgage strip-down in parts of the U.S., followed by a 1993 Supreme Court ruling that abolished it all over the U.S. We find that the Supreme Court decision led to a short-term reduction of 3% in mortgage interest rates and a short-term increase of 1% in mortgage approval rates, but only the approval rate effect persists in longer sample periods. In contrast, the circuit court decisions to allow strip-down did not have consistent effects on mortgage terms. We also show that strip-down had little effect on default rates by homeowners with existing mortgages. Taken together, these results suggest that mortgage lenders responded weakly to both the adoption and abolition of strip-down because strip-down had little effect on their profits from mortgage lending. According to these findings, re-introducing strip-down of mortgages in bankruptcy as a foreclosure-prevention program would have only small and transient effects on the supply of mortgage loans.
Keywords: mortgage stripdown; bankruptcy; foreclosure; mortgage credit
JEL Codes: G21; K22; K35
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stripdown reintroduced nationally (Y60) | lender response (G21) |
| Supreme Court's decision to abolish stripdown (K40) | short-term reduction in mortgage interest rates (E43) |
| Supreme Court's decision to abolish stripdown (K40) | increase in mortgage approval rates (G21) |
| circuit court decisions allowing stripdown (K40) | mortgage terms (G21) |
| stripdown (Y60) | default rates among homeowners with existing mortgages (G21) |