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Cramdown and the Cost of Mortgage Credit

posted by Adam Levitin

Joshua Goodman at the Harvard Kennedy School and I have a new paper out examining the impact of Chapter 13 cramdown on the cost and availability of mortgage credit.  Historically, when cramdown was permitted in some judicial districts prior to 1993 it was associated with a statistically significant, if small, increase in the cost of credit. Here's the abstract:

Recent proposals to address housing market troubles through principal modification raise the possibility that such policies could increase the cost of credit in the mortgage market. We explore this using historical variation in federal judicial rulings regarding whether Chapter 13 bankruptcy filers could reduce the principal owed on a home loan to the home’s market value. The practice, known as cramdown, was definitively prohibited by the Supreme Court in 1993. We find evidence that home loans closed during the time when cramdown was allowed had interest rates 10-20 basis points higher than loans closed in the same state when cramdown was not allowed, which translates to a roughly 1-2 percent increase in monthly payments. Consistent with the theory that lenders are pricing in the risk of principal modification, interest rate increases are higher for the riskiest borrowers and zero for the least risky, as well as higher in states where Chapter 13 filing is more common.


I think the headline should be, "Cramdown vindicated; study shows under 20 basis points effect on rates." Seriously, even if this were definitive, I think the tradeoff would be excellent for society.

Does the paper address the argument that interest rates for second homes, sailboats, etc. are higher because of the risk of cramdown? If it's not this risk, what accounts for the alleged difference in interest rates--actual risk or just venal rent seeking?

Matthew--it doesn't, but there's a much simpler answer. 2d homes, sailboats, etc. have higher interest rates because default rates are higher, as consumers are more willing to walk away from these properties.

Of course, the figures cited were for situations in the pre-1993 jurisdictions where the ability to cram down was PROSPECTIVE. New mortgage loans were being made with the knowledge that they could be crammed down at any time.

The cram down legislation that was introduced to battle the foreclosure crisis was limited to existing mortgages. It didn't apply to mortgages issued after the passage of the legislation.

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