Seismic Effects of the Bankruptcy Reform (Did BAPCPA Burst the House Bubble & Boost Foreclosures?) Donald Morgan* and Benjamin Iverson§ Bank Structure Conference, Federal Reserve Bank of Chicago May 8, 2009 *Research Officer (FRBNY), §Ph.D. Student (Harvard) Our views are not necessarily those of the Federal Reserve or Harvard.

Why Subprime Foreclosures Rose? Usual Suspects Home price deflation Excess credit supply/securitization Rising interest rates

New Suspect: BAPCPA (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005) Reduces “supply” of bankruptcy protection fees tripled limits cram-down on auto loans residency requirement limits access to exemptions means test limits access to Ch. 7

Why Suspect BAR? Pre-BAR, over-indebted mortgagors could free up cash-flow by filing bankruptcy and have credit card debt discharged and auto loan crammed down Reform blocks maneuver with means test etc., hence higher foreclosures or forced home sales

Prima facie evidence? Subprime Foreclosures Surged & Home Prices Peaked with BAPCPA.

Practitioner Testimony and Predictions “…many debtors file bankruptcy precisely so that they can pay their mortgage… by discharging other debts.” Berkowitz and Hynes (1998) original emphasis. “ If … covered by your state’s homestead exemption, Ch. 7 may be the way to go…by getting rid of most your other debts, keeping up the mortgage will be just that much easier” Bankruptcy for Dummies (2006) “[P]eople get in over their heads by further encumbering their homes with equity lines of credit…Then, when interest rates rise, and home values stop increasing, they can no longer refinance and file a Chapter 7 bankruptcy petition to wipe out their [unsecured] debts and hold off foreclosure by their lender…[Now] they must file under Chapter 13, and pay off their debt in 60 months or less. Middle income families in this position could face the loss of their homes” Ms. Alexis McGee, President Foreclosure.com, Business Wire, April 25, 2005.

Circumstantial Evidence: Before BAR, Past due mortgages/past due credit card loans improved when bankruptcy filings Increased

Identifying Impact of BAPCPA on Foreclosures, etc. Look across states and credit markets Bigger impact in states with high bankruptcy demand, i.e, high exemption (X) states X opposite of collateral; Smaller impact in low X states

Diff-in-Diff Predictions After BAPCPA, in high X (exemption) states subprime foreclosures surge more, prime foreclosures invariant unsecured personal loan delinquency improve. auto loans more secure & cheaper (due to reduced cramdown) home prices fall more

Data State level Multiple markets Windows: Sources: see paper Pre-BAPCPA: 1998:1 – 2005:4 Post-BAPCPA: 2006:1 – 2007:3 Sources: see paper

Diff-in-Diff Regression Yst = α + as + α t + βBAPCPA∙X + `BAPCPA∙UNLIM_X …+ εst. Yst = foreclosure rate (subprime or prime) delinquency (personal loan or auto) home prices Controls = unemployment, log(income), income growth, home prices Complete regression results in paper.

Subprime Foreclosures Rose More Since BAR in States with Higher, Finite, Exemptions.

Selected Regression Coefficients (Table 3) Dependent Variable: Mortgage Foreclosure Rate: Personal Loan Subprime Prime Delinquency Rate (2) BAPCPA ∙ X 2.85*** 2.04*** 0.07 -0.06 -0.78*** -0.84*** BAPCPA∙ UNLIM X 0.81 0.68 0.04 0.02 -0.12 -0.16 HOME APP. -0.11*** -0.01*** 0.01 UNEMP. 0.53* 0.12*** 0.14** - Impact: (2) → for median X state, foreclosure rate 12.6 % higher than average before → 32k more foreclosures per quarter - St. dev in HOME APP → 48k “ “

Auto Loan Interest Spreads Fell After BAR, Especially in Unlimited Exemption States.

House Price Appreciation Higher House Prices & Steeper Declines Post-BAR in Higher X States (new, tentative result) Dependent Variable: House Price Level House Price Appreciation BAPCPA*X 36.66** -3.30** BAPCPA*Unlim. X -3.04 -1.66 % of subprime loans in foreclosure -6.09*** -0.65*** Unemployment rate -5.95 -2.01*** Log(per capita income) 117.08 -1.48 Per capita income annual growth -0.36 0.07

Seismic Effects of BAPCPA: Summary Shifted risk unsecured (credit card) & under-secured (upside down auto loans) safer secured riskier Impact subprime foreclosures surged home prices peaked cheaper auto credit Was BAPCPA the needle that burst the buggle and boosted foreclosures?

Reference Slides

Ch. 7 v. Ch. 13 Ch. 7 Þ liquidate nonexempt home equity; remaining unsecured debts discharged; keep future income Ch. 13 Þ reschedule/keep all assets so long as maintain payments Sweet spot for over-indebted mortgagor with positive equity: Ch. 7 in high exemption state

Did BAR Make Auto Credit Cheaper and Safer? (selected diff-in-diff regression coefficients-Table 4) Delinquency Rate on Auto Loan Spread Direct Auto Loans Indirect Auto loans BAR ∙ X -0.09 -0.14 -0.25 -0.34 -0.17 BAR∙ UNLIM X -0.11 -0.15* -0.62** -0.67** -0.20 -0.13 Unscaled Exemptions BAR∙X -0.05* -0.06** -0.02 -0.04 0.01 BAR∙UNLIM X -0.12 -0.15* -0.57* -0.62** -0.18 -0.11

Home Prices Peaked with BAR

Housing Bust Coincides with BAPCPA

Higher Rush Before BAPCPA in Higher Exemption States Ashcraft, Dick, Morgan (2007)