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«DiscoVeriNg HomelessNess Volume 13, Number 1 • 2011 U.S. Department of Housing and Urban Development | Office of Policy Development and Research ...»

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The results appear similar with and without the Heckman selection bias adjustment (Heckman,

1979) for significant explanatory variables. As expected, lenders incur larger losses with houses that have higher mortgage LTV ratios, although the increase in loss rate declines with LTV ratios.

Local lenders are able to fetch a higher relative price, likely because of their familiarity with local market conditions. In terms of local market conditions, foreclosure sales also cause large losses in areas with more households living below the poverty line.

Policy Implications In response to the housing crisis, many suggested repealing the antimodification provision of the Bankruptcy Code to improve bankruptcy relief and thus help families struggling with unaffordable home loans. For example, one proposal would allow federal judges to lengthen terms, cut interest 130 Refereed Papers The Homeownership Experience of Households in Bankruptcy rates, and reduce mortgage balances of homeowners in bankruptcy.22 A complete analysis of the effect of such a reform bill would require a structural model that deals explicitly with the feedback effect. In other words, the analysis must consider that households will respond to such a bill by changing their portfolios, by altering their bankruptcy filing decisions, and even by adjusting their labor supply.

Without such a structural model and the appropriate data that would allow us to control for these effects, we used our data and our analysis to make some inferences. Remember that the analysis we undertook has limitations. First, our data came only from Delaware. As we have noted in the introduction and the section on institutional background, Delaware is not representative of the nation, either in terms of its bankruptcy law or its economic characteristics, such as demographics and industry distribution. Second, our analysis assumed that the change in the law does not alter the characteristics of those who file for bankruptcy under chapter 13. This assumption certainly does not apply in the current economic environment. For example, in our sample, at the time of filing, 43 percent of the homeowners had a mortgage LTV ratio that exceeded 1 (that is, these households owed more than the value of their house); 10 percent of the filers had mortgage LTV ratios of more than 1.20. In the current environment, these numbers are much higher. That said, today’s real estate market is likely to be unusual even from a historical perspective. We are unlikely to see such an extreme boom-bust in the near future. In a way, our analysis can be viewed as the effect of cramdown in a stable real estate market.

Keeping the two limitations of our analysis in mind, we now turn to our empirical model to estimate the short-run effect of several reforms. About 28 percent of homeowners eventually lost their houses to foreclosure sales. About 20 percent of the homeowners in our data have unaffordable mortgages (that is, the monthly mortgage payment, plus tax and utility costs, exceeds 50 percent of their monthly income). If we reduced these households’ mortgage burdens so that the monthly payment-to-income ratio fell below 50 percent without changing all the other variables, the foreclosure rate fell by 2 percentage points (0.20* 0.10 [the marginal effect of the dummy variable that indicates that the mortgage payment-to-income ratio is below 50 percent from exhibit 5]=0.02), from 28 to 26 percent. By comparison, dealing with borrowers early in their delinquency proves more effective at reducing foreclosures. For example, in a sample of homeowners who resemble our data sample except that no homeowner has been more than 1 year delinquent on his or her mortgage payment, the total foreclosure rate will be reduced by 6 percentage points. 34 percent of the filers are more than 1 year late on their mortgage, and the marginal effect of being more than 1 year delinquent on a mortgage in foreclosure is 0.172 (exhibit 5), so the default rate will be reduced by 0.34*0.172=0.06. The proposed reform is likely to have little direct effect on foreclosure sale time because it depends heavily on the conditions of local housing markets. The mortgage LTV ratio alters the effect on lenders’ loss rates significantly. The more important question here is, “Who will bear the cost of the lower mortgage payment or lower mortgage obligation—the taxpayer or lenders themselves?” H.R. 200, Helping Families Save Their Homes in Bankruptcy Act of 2009. Available at http://thomas.loc.gov/.

–  –  –

As we stressed previously, our policy analysis is conducted under strong assumptions (for example, we assume that after policy changes, filers’ profiles remain unchanged). A complete assessment of the reform bill obviously requires a structural model that takes into account not only borrowers’ response to the new incentives but also lenders’ ability—or lack thereof—to pass all or some of the potential costs back to the borrowers in the form of higher interest rates or smaller loans, or both.

Conclusions In this article, we constructed a unique data set that tracks the homeownership experience of chapter 13 bankruptcy filers for 5 to 6 years after their initial filings. We found that about 28 percent of filers lost their houses to foreclosure. Confirming the conventional belief, filing for bankruptcy adds a little more than a year to a normal foreclosure process. Although foreclosure sale price, in nominal terms, exceeds a filer’s own estimates at filing, about 65 percent of lenders still lost money, and the average loss amounted to 28 percent of what was owed to the mortgage lender.





Our results, therefore, suggest that personal bankruptcy appears to provide homeowners with additional breathing room to try to cure their delinquent mortgages and, thus, to keep their houses.

Preliminary policy analysis indicates that, assuming that bankruptcy homeowners’ characteristics remain unchanged, policy reforms that cram down mortgage loan obligations by making mortgage payments more affordable or reducing total mortgage obligations will reduce foreclosure rates. The effects, however, are likely to be modest. Helping homeowners before they are too far behind on their mortgage payments, on the other hand, has the most effect.

Obviously, a complete assessment of the proposed policy changes would require more detailed national data and further structural analysis. We leave that to future research.

Acknowledgments The authors thank Mitchell Berlin, Ronel Elul, Hulya Eraslan, Bob Hunt, Melissa Jacoby, Geng Li, Katie Porter, Tara Twomey, Michelle White, Luke Willard, and seminar participants at the Organization for Economic Cooperation and Development, the Federal Reserve Bank of Philadelphia, the 2008 American Law and Economics Association Annual Meeting, and the 2008 Federal Reserve System Applied Micro Meeting for their comments and suggestions. We also thank the New Castle County Sherriff’s Office (Chris McBride, in particular) and the Reinvestment Fund of Delaware for providing us with their data and assistance. Finally, we thank two anonymous referees and Cityscape Managing Editor Mark Shroder for their reports, which greatly improved the article.

Authors Sarah W. Carroll is a J.D. candidate at the University of Pennsylvania Law School.

Wenli Li is an economic advisor and economist at the Federal Reserve Bank of Philadelphia.

–  –  –

References Ambrose, Brent W., Richard J. Buttimer, Jr., and Charles A. Capone, Jr. 1997. “Pricing Mortgage Default and Foreclosure Delay,” Journal of Money, Credit, and Banking 29 (3): 314–325.

Bahchieva, Raisa, Susan Wachter, and Elizabeth Warren. 2005. “Mortgage Debt, Bankruptcy, and the Sustainability of Homeownership.” In Credit Markets for the Poor, edited by Patrick Bolton and Howard Rosenthal. New York: Russell Sage Foundation.

Berkowitz, Jeremy, and Richard Hynes. 1999. “Bankruptcy Exemptions and the Market for Mortgage Loans,” Journal of Law and Economics 42: 809–830.

Capozza, Dennis, and Thomas Thomson. 2006. “Subprime Transitions: Lingering or Malingering in Default,” Journal of Real Estate Finance and Economics 33 (3): 241–258.

Chomsisengphet, Souphala, and Ronel Elul. 2006. “Bankruptcy Exemptions, Credit History, and the Mortgage Market,” Journal of Urban Economics 5: 171–188.

Eggum, John P., Katie Porter, and Tara Twomey. 2008. “Saving Homes in Bankruptcy: Housing Affordability and Loan Modification,” Utah Law Review: 1123.

Eraslan, Hulya, Wenli Li, and Pierre-Daniel Sarte. 2007. The Anatomy of U.S. Personal Bankruptcy Under Chapter 13. Working paper 07-31. Philadelphia, PA: Federal Reserve Bank of Philadelphia.

Gerardi, Kristopher, Adam Hale Shapiro, and Paul S. Willen. 2007. Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures. Working paper 07-15. Federal Reserve Bank of Boston.

Grover, Michael, Laura Smith, and Richard M. Todd. 2006. Targeting Foreclosure Interventions:

An Analysis of Neighborhood Characteristics Associated With High Foreclosure Rates in Two Minnesota Counties. Report prepared for Federal Reserve Bank of Minneapolis Community Affairs.

Heckman, James J. 1979. “Sample Selection Bias as a Specification Error,” Econometrica 47 (1): 153–161.

Jacoby, Melissa. 2007. “Bankruptcy Reform and Homeownership Risk,” University of Illinois Law Review 323 (1): 323–346.

Lambrecht, Bart M., William R.M. Perraudin, and Steven Satchell. 2003. “Mortgage Default and Possession Under Recourse: A Competing Hazards Approach,” Journal of Money, Credit, and Banking 35 (3): 425–442.

Lawless, Robert M., Angela K. Littwin, Katherine M. Porter, John A.E. Pottow, Deborah K. Thorne, and Elizabeth Warren. 2008. “Did Bankruptcy Reform Fail? An Empirical Study of Consumer Debtors,” American Bankruptcy Law Journal 82: 349–405.

Levitin, Adam. 2009. “Resolving the Foreclosure Crisis: Modification of Mortgages in Bankruptcy,” Wisconsin Law Review: 565–655.

–  –  –

Levitin, Adam, and Joshua Goodman. 2008. The Effect of Bankruptcy Strip-Down on Mortgage Markets. Georgetown University Law Center Business, Economics and Regulatory Policy working paper series 1087816. Washington, DC: Georgetown University Law Center.

Li, Wenli. 2009. “Residential Housing and Personal Bankruptcy,” Economic Quarterly, Federal Reserve Bank of Philadelphia: 19–29.

Li, Wenli, and Michelle White. 2009. Mortgage Default, Foreclosure, and Bankruptcy. National Bureau of Economic Research (NBER) working paper 15472.

Li, Wenli, Michelle White, and Ning Zhu. 2010. Did Bankruptcy Reform Cause Mortgage Default Rates to Rise? The Federal Reserve Bank of Philadelphia working paper 10-5.

Lin, Emily Y., and Michelle J. White. 2001. “Bankruptcy and the Market for Mortgage and Home Improvement Loans,” Journal of Urban Economics 50: 138–162.

Long, Cheryl. 2005. Negative Effects of Bankruptcy for Home Owners: Reduced Access to Credit and Lost Option Value. Unpublished.

Morgan, Donald, Benjamin Iverson, and Matthew Botsch. 2008. Seismic Effects of the Bankruptcy Reform. Staff report 358. New York: Federal Reserve Bank of New York.

Norberg, Scott, and Andrew Velkey. 2007. “Debtor Discharge and Creditor Repayment in Chapter 13,” Creighton Law Review 39 (3): 473–560.

Pence, Karen. 2006. “Foreclosing on Opportunity: State Laws and Mortgage Credit,” Review of Economics and Statistics 88: 177–182.

Pennington-Cross, Anthony. 2006. The Duration of Foreclosures in the Subprime Mortgage Market:

A Competing Risks Model With Mixing. Working paper 2006-027. St. Louis: Federal Reserve Bank of St. Louis.

Porter, Katherine. 2008. “Misbehavior and Mistake in Bankruptcy Mortgage Claims,” Texas Law Review: 121.

Stark, Debra P. 1997. “Facing the Facts: An Empirical Study of the Fairness and Efficiency of Foreclosures and a Proposal for Reform,” University of Michigan Journal of Law Reform 30: 639–688.

White, Michelle J. 1998. “Why Don’t More Households File for Bankruptcy?” Journal of Law, Economics and Organization 14: 205–231.

White, Michelle J., and Ning Zhu. 2010. “Saving Your Home in Chapter 13 Bankruptcy,” Journal of Legal Studies: 33–62.

134 Refereed Papers Policy Briefs The Policy Briefs department summarizes a change or trend in national policy that may have escaped the attention of researchers. The purpose is to stimulate the analysis of policy in the field while the policy is being implemented and thereafter.

Neighborhood Stabilization Program Paul A. Joice U.S. Department of Housing and Urban Development Abstract In July 2008, Congress established the Neighborhood Stabilization Program (NSP) to help local governments address the neighborhood effects of concentrated foreclosures.

As of the writing of this article, a total of $7 billion has been allocated to the program.

This policy brief presents a theoretical justification for NSP and discusses how the U.S.

Department of Housing and Urban Development implemented the program.

Introduction From the first quarter of 2006 to the first quarter of 2009, U.S. home values deflated by 31 percent.1 During the same period, the percentage of mortgages more than 90 days delinquent increased from 1.0 to 3.5 percent and the percentage of mortgages starting the foreclosure process increased from 0.5 to 1.4 percent (both three times the previous record highs) (Apgar and Herbert, 2009). The consequences of this foreclosure crisis have been wide ranging, from the devastating impact on individual households to the contribution to the broader economic malaise sweeping the nation. These consequences have been covered extensively by researchers and the press and have been the target of a number of high-profile government initiatives. But in between the personal effects and the national effects is a less discussed level of analysis: the neighborhood.

The S&P/Case-Shiller® Seasonally Adjusted Composite U.S. Index declined from 190.44 to 131.39 (http://www.

standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff--p-us----). The less volatile Federal Housing Finance Agency (FHFA) Index peaked in the second quarter of 2007 and, since then, has declined 13 percent, as of the first quarter of 2010 (http://www.fhfa.gov/Default.aspx?Page=87).



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