Did Changing Bankruptcy Laws Cause the Mortgage Mess?

By Mark Lieberman, Senior Economist

Source: FOXBusiness

During the debate over changes in personal bankruptcy laws, bankers were tripping over themselves to get Congress to agree to changes to make filing personal bankruptcy more difficult. The changes, they argued, would make borrowers more responsible – and by the way reduce bank losses as debts could no longer as easily be discharged in bankruptcy.

Now, in a classic case of be-careful-what-you-wish, a team of three economists argue “the U.S. bankruptcy reform of 2005 played an important role in the mortgage crisis and the current recession” – by increasing mortgage delinquencies and defaults by almost 200,000 a year.

“The 2005 bankruptcy reform caused mortgage default rates to rise,” the economists — Wenli Li of the Federal Reserve Bank of Philadelphia, Michelle J. White of the University of California at San Diego and Ning Zhu of the Graduate School of Management at the University of California, Davis– concluded. “Bankruptcy reform squeezed homeowners’ budgets by raising the cost of filing for bankruptcy and reducing the amount of debt discharged in bankruptcy. It therefore increased mortgage default by closing off a popular procedure that previously helped financially distressed homeowners save their homes.”