Bankruptcy Reform and Foreclosure Crisis in the Great Recession
Between 2007 and 2010, the average U.S. single-family house price fell by 27% and the foreclosure rate rose by 150%. This research investigates on the causes of this explosive rise in the foreclosure rate, taking as given the fall of housing prices. Specifically, the project seeks to determine the individual contributions of each of the following three factors: the concomitant rise in the average number of days of free renting induced by the foreclosure process, the drop in average earnings that started just before the housing bust, and the 2005 Bankruptcy Reform law.
The project investigates a lifecycle economy in which households access homeownership by entering into 30-year fixed interest rate mortgage contracts with a default option. Also, they partially insure against labor income risk through market arrangements that mimic key features of both Chapter 7 and Chapter 13 of the U.S. bankruptcy code. When the model is calibrated to the U.S. economy before 2004, one finds that the ability of households to deplete their home equity by taking on second mortgages played a central role in the explosion of the foreclosure rate once housing prices fell during the great recession. The foreclosure rate would have been 36% higher during the period 2007-2010, had the bankruptcy reform law not taken place prior to the fall of housing prices. The lengthening of the free renting period associated with the foreclosure process and the drop in average earnings respectively caused the foreclosure rate to be 10% and 18% higher.