Department of “No DOY”: NY Fed Report on Bankruptcy Reform
The New York Federal Reserve confirms what I’ve been saying for years (WARNING, PDF):
Is it just coincidence that the surge in subprime foreclosures that has rocked financial
markets came right after the bankruptcy reform in 2005 (Chart 1)? Is that surge just about falling
home prices, bad mortgage decisions, and weak economic conditions? No and no. Indeed, we
would be surprised if the answers were otherwise. Bankruptcy is about protection, after all, and
foreclosure is what mortgagors most want to protect against. The Bankruptcy Abuse Prevention
and Consumer Protection Act of 2005, the first overhaul of U.S. personal bankruptcy law in over
a quarter century, made filing bankruptcy much less protective and much more expensive. How
could that not matter?Our specific argument is that the bankruptcy abuse reform (BAR) contributed to the
surge in subprime foreclosures by shifting risk from credit card lenders to mortgage lenders.
Before BAR, any household could file Ch. 7 bankruptcy and have credit cards and other
unsecured debts discharged. Sidestepping unsecured debts left more income to pay the
mortgage. BAR blocked that maneuver by way of a means test that forces better-off households
who demand bankruptcy to file Ch. 13, where they must continue paying unsecured lenders.
When the means test binds, cash constrained mortgagors who might have saved their home by
filing Ch. 7 are more likely to face foreclosure.
WHO COULD HAVE PREDICTED???
The estimated impact of BAR on subprime foreclosures is substantial. For a state with
average home equity exemption, the average subprime foreclosure rate over the seven quarters
after BAR was 12.6 percent higher than the average subprime foreclosure rate over all states over the period before BAR. This translates to just over 32,000 more subprime foreclosures
nationwide per quarter due to BAR.
Alexander (R-TN)
Allard (R-CO)
Allen (R-VA)
Baucus (D-MT)
Bayh (D-IN)
Bennett (R-UT)
Biden (D-DE)(thank you mr. Vice-President)
Bingaman (D-NM)
Bond (R-MO)
Brownback (R-KS)
Bunning (R-KY)
Burns (R-MT)
Burr (R-NC)
Byrd (D-WV)
Carper (D-DE)
Chafee (R-RI)
Chambliss (R-GA)
Coburn (R-OK)
Cochran (R-MS)
Coleman (R-MN)
Collins (R-ME)
Conrad (D-ND)
Cornyn (R-TX)
Craig (R-ID)
Crapo (R-ID)
DeMint (R-SC)
DeWine (R-OH)
Dole (R-NC)
Domenici (R-NM)
Ensign (R-NV)
Enzi (R-WY)
Frist (R-TN)
Graham (R-SC)
Grassley (R-IA)
Gregg (R-NH)
Hagel (R-NE)
Hatch (R-UT)
Hutchison (R-TX)
Inhofe (R-OK)
Inouye (D-HI)
Isakson (R-GA)
Jeffords (I-VT)
Johnson (D-SD)
Kohl (D-WI)
Kyl (R-AZ)
Landrieu (D-LA)
Lincoln (D-AR)
Lott (R-MS)
Lugar (R-IN)
Martinez (R-FL)
McCain (R-AZ)
McConnell (R-KY)
Murkowski (R-AK)
Nelson (D-FL)
Nelson (D-NE)
Pryor (D-AR)
Reid (D-NV)
Roberts (R-KS)
Salazar (D-CO)
Santorum (R-PA)
Sessions (R-AL)
Shelby (R-AL)
Smith (R-OR)
Snowe (R-ME)
Specter (R-PA) (thank you for looking out for Pennsylvanians, senator)
Stabenow (D-MI)
Stevens (R-AK)
Sununu (R-NH)
Talent (R-MO)
Thomas (R-WY)
Thune (R-SD)
Vitter (R-LA)
Voinovich (R-OH)
Warner (R-VA)
meanwhile, the NY Fed has more. A LOT more. As you read, ask yourself how a dope like me with a diploma from a public high school and a BA in English from UMass, and with no background at all in finance or economics could tell that this bill was going to be a catastrophe, and our leaders could not:
Legal scholars and practitioners have clearly recognized how filing Ch. 7 and discharging
unsecured debt can help avert foreclosure:“…many debtors file bankruptcy precisely so that they can pay their mortgage… by
discharging other debts.” Berkowitz and Hynes (1998), p. 3, original emphasis.“some mortgage lenders are eager to see a troubled borrower file for Chapter 7
bankruptcy, since the other debts can be discharged.” Sullivan, Warren, and Westbrook.9“If … the value of your home is covered by your state’s homestead exemption, Chapter 7
may be the way to go…” Bankruptcy for Dummies, Caher and Caher (2006), p. 190.
The answer of course is that any idiot with a drop of common sense who hasn’t been utterly corrupted by suitcases full of campaign donations could see that this would be a disaster. ANY COMMON IDIOT.
Conclusion:
We conclude that the bankruptcy abuse reform of 2005 (BAR) contributed to the rise in subprime foreclosures because it shifted risk from credit card and auto lenders to mortgage
lenders. The means test under BAR gives credit card and other unsecured creditors a stronger
claim on borrowers’ cash flow, and that weakens secured lenders’ (implicit) claim on that cash
flow. Limiting cram-down on auto loans eliminates another maneuver over-indebted borrowers
could use to free up income for their mortgage. By making it harder for borrowers to avoid paying credit card debt and auto loans, BAR made it harder to pay the mortgage, hence higher
foreclosure rates.
And because average mortgage debt is typical hundreds of times more than the average credit card debt, the predictable result is an impact on the economy on an order of hundreds of times what the unpaid credit card debt could have. And that’s not getting paid either, by the way.
Oh if only someone had predicted…
December 15th, 2008 at 1:31 pm
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