Wednesday, February 17, 2016

Housing: Part 118 - Bankruptcy Reform in 2005, Another in the Chain of Credit Shocks

I was looking at the latest graphs from the Quarterly Household Debt and Credit Report.  Looking at this one:

I realized that I had not looked into the effects of the 2005 Bankruptcy Reform Act (BAPCPA) on housing markets.  Note that it came into effect right at the top of the housing boom.

And, it turns out, there are at least a couple of papers on this topic.  One from Donald P. Morgan, Benjamin Iverson, and Matthew Botsch at the New York Fed, and one from Ulf von Lilienfeld-Toal and Dilip Mookherjee.

The effects of BAPCPA included making it more difficult for some households to use the homestead exemption in bankruptcy.  So, before BAPCPA, households would consolidate their wealth in their home equity and seek relief on their unsecured debts.  The passage of BAPCPA lowered some of the implicit value of homeownership, especially among highly leveraged or economically stressed households.

Both papers find significant correlations between home price movements before and after 2005 and the scale of the homestead exemption.  Here is one chart on the difference between states, from the L-T & M paper.  Home prices rose faster in 2004 and 2005 in states more affected by the law and then declined more sharply after the law was in force and mortgage defaults became more common in bankruptcies.

Among the states with high homeowner protections: Nevada, Arizona, and Florida (although some states that did not experience extreme price movements, like Texas and Oklahoma, also have strong protections).

It seems that this might have increased demand for homeownership in 2005, during the rush of bankruptcies and then decreased the demand for homeownership after 2005.  Also, it has made it more likely for households to default on their mortgages, as opposed to their unsecured debts.  Additionally, L-T & M find contagion effects in geographic areas with large numbers of bankruptcies.


  1. As an Arizona real estate agent at that time, the argument doesn't ring true.

    Nevertheless, my impression at the time was that the changes all favored the banks.

    Fascinating that bankruptcies during The Great Recession were lower than in the normal years of 2003, 2004, 2005. Yeah, I'd say all the changes favored the banks.

    1. I agree. It's a shame, because lenient bankruptcy is one of the underappreciated pieces of the American system, I think.

      Thanks for the input. You may be right. I do think the regressions they run in these studies are probably picking up other effects that happen to correlate with the states with high homestead protections.

      I might be a little biased. I was defrauded by a guy when I sold my business, sued him, and won with punitive damages. He piled all his money into his homestead and claimed poverty while he went out trolling for new victims. There is definitely some segment of the population that is making that calculation. It is probably true that it normally doesn't amount to much in the aggregate. But, when there is a one time spike of a 1/4 million households followed by a drop of 3/4 million households, it seems plausible to me that there could be a measurable one-time effect on related markets.

    2. And from an EMH perspective, if something about bankruptcy law makes it harder to protect the home equity, the value of the home would decline.