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The Effect of Principal Reduction on Household Distress: Evidence from Mortgage Cramdown

Jacelly Céspedes¹; Carlos Parra²; Clemens Sialm³

¹ University of Minnesota · ² Escuela de Administración, Pontificia Universidad Católica de Chile, · ³ University of Texas at Austin and NBER

Abstract Mortgage cramdown enabled bankruptcy judges to discharge the underwater portion of a mortgage in a chapter 13 bankruptcy until the Supreme Court disallowed this practice in 1993. We investigate the impact of mortgage cramdown on household distress exploiting the random assignment of cases to judges. The impact of bankruptcy protection on foreclosures is reduced by more than half after the Supreme Court disallowed cramdown. Our results suggest that large principal reductions considerably decrease homeowners’ distress by reducing debt overhang.

DOI

10.1093/rfs/hhaf104

Volume

39 (2)

Pages

518-561

Language

en

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BibTeX

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