Bankruptcy Reform Research Articles

Powerpoint Presentation of Credit Card Reform and Bankruptcy Reform: The Effect of BAPCPA on Credit Card Industry Profits and Prices

This is a powerpoint presentation based on The Effect of BAPCPA on Card Industry Profits and Prices and on Credit Card Reform and Bankruptcy Reform. Presented at Seton Hall in December 2009.

Did Bankruptcy Reform Cause Mortgage Defaults to Rise?

Homeowners in financial distress can use bankruptcy to avoid defaulting on their mortgages, since filing loosens their budget constraints. But the 2005 bankruptcy reform made bankruptcy less favorable to homeowners and therefore caused mortgage defaults to rise. We test this relationship and find that the reform caused prime and subprime mortgage default rates to rise by 23% and 14%, respectively. Default rates rose even more for homeowners who were particularly negatively affected by the reform. We calculate that bankruptcy reform caused mortgage default rates to rise by one percentage point even before the start of the financial crisis. (JEL D14, G01, G21, K35)

Bankruptcy Law and Corporate Investment Decisions

This paper contributes to the debate on optimal bankruptcy reform by providing a set of results that challenge the wisdom that soft bankruptcy codes have necessarily positive effects. The model hinges on the key idea that soft bankruptcy allows a poor performing entrepreneur to renegotiate the terms of the initial contract with a lender. In the presence of moral hazard, the optimal arrangement requires the hampering of project's continuation as punishment for poor performance. However, if the lender can increase recovery rates in bankruptcy such pun- ishment is not renegotiation-proof. Clearly, this exacerbates the agency problem and creates a tension between ex-post and ex-ante effciency that may impede the implementation of long- term projects.

Did Bankruptcy Reform Contribute to the Mortgage Crisis?

Before 2005 bankruptcy reform, debtors could file for bankruptcy and have their unsecured debt discharged in Chapter 7 without losing their homes, as long as their home equity was less than their state’s homestead exemption. Chapter 7 bankruptcy thus made it easier for financially distressed homeowners to meet their mortgage payments and keep their homes. But the 2005 bankruptcy reform made filing for bankruptcy less attractive. First, debtors’ cost of filing for bankruptcy increased sharply after the reform. Second, a new “means test” prevents some higher-income debtors from filing under Chapter 7. Third, the homestead exemption in Chapter 7 bankruptcy is capped at $125,000 for some debtors who live in high-exemption states. Because these changes reduce the debtors’ gain from filing for bankruptcy, they reduce debtors’ likelihood of defaulting on their unsecured debt. And because debtors’ ability-to-pay is fixed in the short-run, they increase debtors’ likelihood of defaulting on their mortgages. In the paper, we test whether adoption of the 2005 bankruptcy reform led to higher rates of mortgage default. We examine a three month period before versus after bankruptcy reform in order to separate the effect of bankruptcy reform from the effect of the financial crisis. We also plan to extend the analysis to examine how default rates changed in 2007-08 after the mortgage crisis began. We use the McDash mortgage dataset, which includes detailed information for a large sample of mortgages, including detailed characteristics of the mortgage at the time of origination and information on whether/when the debtor defaulted. Both prime and subprime mortgages are included. Our main results are, first, that bankruptcy reform caused mortgage default rates to rise, at least temporarily. The increase was 45% for prime mortgage-holders and 22% for subprime mortgage-holders. Second the new means test in bankruptcy caused mortgage default rates to rise by more for higher-income debtors: default rates of prime and subprime mortgage-holders who are subject to the means test increased by 26% and 22%, respectively, relative to the increase for lower-income debtors not subject to the means test. But we did not find a significant impact of the cap on homestead exemptions. We are currently expanding our tests to a longer period to see if the effect of bankruptcy reform on mortgage default rates continued into the financial crisis.

Bankruptcy Reform and Foreclosures from the Perspective of the Taxpayer

The debate over bankruptcy law is generally thought of as a conflict between the rights of debtors and creditors. However, the U.S. government is now providing direct financial aid to financial institutions and to homeowners. Several potential revisions to the bankruptcy code could help homeowners avoid foreclosure and substantially reduce potential financial bailout costs for the taxpayer. The U.S. taxpayer now has an important stake in policy discussions on the bankruptcy code.

Bankruptcy: Past Puzzles, Recent Reforms, and the Mortgage Crisis

This paper discusses four bankruptcy-related policy issues. First, what is the economic rationale for having a bankruptcy procedure at all and what defines an economically efficient bankruptcy procedure? Second, why did the number of U.S. bankruptcy filings increase so dramatically between 1980 and 2005? Third, a major bankruptcy reform went into effect in the United States in 2005�what did it do and how did it affect credit and mortgage markets? Finally, the paper discusses the mortgage crisis, the high social cost of foreclosures, and the difficulty of avoiding foreclosure by voluntarily renegotiation of mortgage contracts, even when such renegotiations are in the joint interest of debtors and creditors. I also discuss the pros and cons of government programs to refinance mortgages and the argument for giving bankruptcy judges new power to change the terms of residential mortgage contracts in bankruptcy.

Financial Markets in Bankruptcy Court: How Much Uncertainty Remains after BAPCPA?

In 2005, Congress continued a tradition that can be traced back to the passage of the original Bankruptcy Reform Act. Spurred by a near crisis in the financial markets in the late 1990s, Congress passed legislation extending coverage of the parties and contracts that would be exempted from certain provisions of the Bankruptcy Code (the “Code”). In doing so, much attention was given to the fear that were a major player in the financial industry to declare bankruptcy, the counterparties to its financial contracts would be unable to exercise their contractual rights immediately. This, in turn, would lead to massive uncertainty, exposing the inherently volatile exchanges to widespread risk that could not be controlled by the contractors themselves. The amendments addressed this fear, and did so quite comprehensively. But in a few key areas, recent developments suggest they may not have gone far enough. This Note argues that three important legislative omissions will continue to expose the financial markets to substantial uncertainty and operate contrary to Congress’s intent. Part I will explain the background and purpose of the amendments. Part II will address Congress’s failure to clearly manifest its intent to use industry custom as the primary interpretive tool for ambiguous contracts. This failure has left the door open for courts to undertake the very sort of analysis the amendments were designed to prevent. Part III will show that the inability to capture all relevant financial agreements within the definition of protected netting agreements has recently led to a substantial devaluing of assets during the mortgage crisis. Part IV will show that a new provision intended to clarify the timing of damages actually has injected the Code with more uncertainty. In all three cases, this Note will suggest legislative solutions where possible, and draw attention to existing law within bankruptcy and other areas of commercial law that can be used to craft judicial solutions.

Seismic Effects of the Bankruptcy Reform

We argue that the 2005 bankruptcy abuse reform (BAR) contributed to the surge in subprime foreclosures that followed its passage. Before BAR, distressed mortgagors could free up income by filing bankruptcy and having their unsecured debts discharged. BAR blocks that maneuver for better-off filers by way of a means test. We identify the effects of BAR using state home equity bankruptcy exemptions; filers in low-exemption states were not very protected before BAR, so they would be less affected by the reform. Difference-in-difference regressions confirm four predictions implied by that identification strategy. Our findings add to research trying to explain the surge in subprime foreclosures and to a broader literature on household bankruptcy demand and credit supply.

Bankruptcy Reform and Foreclosures

The Bankruptcy Abuse and Protection Act (BAPCPA) (2005) by making it more difficult and costly for marginal homeowners to utilize the bankruptcy code, restructure their debts, and maintain mortgage payments, increased foreclosures and the number of homes for sale. BAPCPA was intended to help creditors at the expense of debtors. However, the negative impact of BAPCPA on real estate markets appears to have damaged the balance sheets of both debtors and creditors.

The effects of the 2005 Bankruptcy Reform in Brazil

This paper studies the effect of the 2005 Bankruptcy Reform in Brazil. Using firm-level data we found that the increase in the level of creditors' protection reduced the cost of debt and increased the amount borrowed by the firms.

Soft vs. Tough Bankruptcy Law. Evidence from the US and Germany

We argue that stronger debt enforcement in bankruptcy can reduce indirect costs of financial distress: (i) by increasing the likelihood of restructuring outside bankruptcy and (ii) by improving the recovery rate of trade creditors through explicit legal provisions. Consistent with these predictions, we find that when debt enforcement is stronger, financially distressed firms are less exposed to indirect distress costs in the form of reduced access to trade credit and forgone sales. We document these effects in a panel of firms from 40 countries with heterogeneous debt enforcement characteristics and in differences-in-differences tests exploiting a 2005 U.S. bankruptcy reform.

A Comparison of the Effects of the 1978 and 2005 Bankruptcy Reform Legislation

Bankruptcy legislation in the United States has represented an amalgam of politics, economic pragmatism, and the prevailing attitude toward debt and debtors at the time of passage. The rationale offered to support bankruptcy laws has varied: early bankruptcy legislation was designed, among other things, to aid businesses; subsequent legislation was intended, largely, to assist consumers burdened with debt; and the latest incarnation of bankruptcy law was crafted to curtail alleged consumer abuses arising from the previous quarter century of bankruptcy reform. It is clear that bankruptcy itself has evolved in the U.S. from a means used mostly by creditors to collect debts owed them by businesses to an instrument used overwhelmingly by individual, non-commercial debtors. After briefly recapping the history of bankruptcy legislation, this paper describes and contrasts the outcomes of the two most recent and important pieces of bankruptcy reform, the Bankruptcy Reform Act of 19781 and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The course of bankruptcy filings since passage of the former is part of the historical record, while the nearly two years of monthly data since the effective date of BAPCPA provides a basis for making a preliminary assessment of this act, and for forecasting its future implications.

Bankruptcy Reform and Credit Cards

From 1980 to 2004, the number of personal bankruptcy filings in the United States increased more than five-fold, from 288,000 to 1.5 million per year. By 2004, more Americans were filing for bankruptcy each year than were graduating from college, getting divorced, or being diagnosed with cancer. In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) became law. It made bankruptcy law much less debtor-friendly. Personal bankruptcy filings fell to 600,000 in 2006. This paper explores why personal bankruptcy rates rose, and will argue that the main reason is the growth of “revolving debt”—mainly credit card debt. It explains how the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 altered the conditions of bankruptcy. Finally, this essay considers the balances that need to be struck in a bankruptcy system and how the U.S. bankruptcy system strikes these balances in comparison with other countries. I argue that a less debtor-friendly bankruptcy policy should be accompanied by changes in bank regulation and truth-in-lending rules, so that lenders have a greater chance of facing losses when they supply too much credit or charge excessively high interest rates and fees.

Abuse or Protection? Consumer Bankruptcy Reform under ‘BAPCPA’

Entre 1980 et 2004, le nombre de candidatures à la faillite personnelle aux États-Unis a plus que quintuplé, passant de 288 000 à 1,5 million par an. Les prêteurs ont réagi à cette augmentation par une campagne de lobbying qui conduisit à l’adoption en 2005 de la loi de prévention de l’abus de faillite et de protection du consommateur (BAPCPA), qui a eu pour effet de rendre la loi sur les faillites moins favorable au débiteur. Avant 2005, la loi américaine sur les faillites offrait aux débiteurs une voie de sortie assez facile de la dette, dans la mesure où celle-ci, liée aux cartes de crédit comme aux autres types de prêts pouvait être éliminée par la faillite ; même les débiteurs riches n’avaient aucune obligation à rembourser. La BAPCPA a rendu cette voie de sortie moins attractive en augmentant les coûts de la candidature et en forçant certains débiteurs à revenus élevés à rembourser à partir de leur revenus postérieurs à la faillite. L’article examine comment la BAPCPA a fait pencher la balance non plus dans le sens d’une assurance de la consommation pour les débiteurs, mais vers une protection des créanciers en pénalisant le défaut de paiement. Il brosse les grands traits d’une procédure optimale de faillite et contraste le fardeau supporté dans la procédure de faillite par les différentes parties dans les lois française et allemande, d’une part, et américaine, d’autre part.

Consumer Bankruptcy Filings: Trends and Indicators

This paper examines consumer bankruptcy filing rates. It attempts to identify some trends and some economic indicators that might predict those filing rates. While several studies examined these questions prior to the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), there remains considerable uncertainty and debate over what economic factors correlate to consumer bankruptcy. This is the first study that takes into account the impact of BAPCPA, both in anticipation of and in the aftermath of its effective date. 1. Part I lays out the historical filing rate data following the effective date of the Bankruptcy Reform Act of 1978. Part II examines the impact of BAPCPA on filing rates, and finds that the dramatic post-BAPCPA drop in filings may be almost over. Soon, consumer bankruptcy filing rates are likely to return to their pre-BAPCPA levels. Part III then analyzes the possible correlation of numerous plausible economic data sets to non-business bankruptcy filing rates. The paper finds several such data sets that correlate to non-business filings to a high level of statistical significance. These economic indicators point to a return to pre-BAPCPA filing levels. However, those indicators also suggest that it is unlikely that consumer filings will increase much over those old levels unless fundamental underlying economic changes occur. The findings in Part III further indicate that if Congress wants to curb consumer bankruptcy filings, it needs to focus on treating root causes - such as the explosion in revolving consumer credit - rather than on symptoms. Thus, BAPCPA may have been misguided

The Evolution of U.S. Insolvency Law for Financial Market Contracts

The enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was the most significant change to the United States' insolvency laws for the financial markets in more than fifteen years. Unlike all prior laws defining how financial market contracts would be treated in bankruptcy or a bank insolvency, the new comprehensively updated and harmonized all of the principal laws that could come into play in insolvencies of market participants, including banks, thrifts, credit unions, broker-dealers, investment banks, and other companies. The 2005 Bankruptcy Reform Act, however, was not a new direction in American law. The special protections provided to termination and close-out netting for capital markets contracts in the new amendments simply continued an evolutionary process in American insolvency law that started with the enactment of the new Bankruptcy Code in 1978. Once the foundation for protection of the liquidity of financial market contracts had been established by 1991, American law provided the basis for effective risk management by market participants. The task of the past fifteen years has been to secure those benefits, clarify the interrelationships between different insolvency laws, and define the scope of flexibility to accommodate market developments. It must be recognized, however, that these protections are a departure from the pari pasu principle inherent in equitable insolvency laws. Nonetheless, this principle has never meant that all creditors should receive the same proportional share. Insolvency law has always recognized that creditors should be able to benefit from some characteristics of the bargain they made with the debtor before its failure. As illustrated in the article, the fundamental goal of those special protections is the prevention of the risks to the stability of the financial system that could result from a cascade of interrelated defaults if normal insolvency processes prevented termination and settlement of pending trades. As a result, there are limits to the further expansion of those protections if they are to remain consistent with the underlying public policy that supports them. This article examines the evolution of the special protections for financial market contracts under U.S. insolvency law (including the Bankruptcy Code and the Federal Deposit Insurance Act's protection for qualified financial contracts) and the public policy goals underlying those protections, looks at the continuing course of that evolution in the Bankruptcy Reform Act, and provides an overview of what this evolution means for bank and non-bank insolvencies of financial market participants.

Bankruptcy reform and the effects on chapter 12 bankruptcy for farmers (and fishermen)

The United States Constitution assures debtors a right to relief from creditors seeking to satisfy claims against debtors unable to pay their debts. For well over a century, farmers as debtors have enjoyed a favored status by being exempt from involuntary bankruptcy. The landmark 2005 bankruptcy legislation continues that favored status even though the thrust of most of the rest of the 2005 law tightens the rules for non‐farm debtors in several significant respects. The 2005 bankruptcy amendments made Chapter 12 bankruptcy for family farmers a permanent part of the Bankruptcy Code, relaxed the rules on family farmers eligible to file for Chapter 12 bankruptcy relief, and created an innovative way to treat tax liability from liquidation of business assets. The contrast in Congressional treatment of farm debtors and non‐farm debtors in the 2005 statute is striking and appears to be attributable to strong and effective political support from farm state Members of Congress, the widespread belief that farmers in financial difficulty are deserving of assistance, and that abuse of the bankruptcy system has been less of a problem with the agricultural sector.

Bankruptcy Reform and the Law of Preferences

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 represents the most significant modification to the U.S. Bankruptcy Code since its enactment in 1978. This article outlines the amendments in the act that affect the law of preferences and evaluates both the scope and the significance of these changes. In the author9s view, the Reform Act9s amendments constitute a significant improvement over the prereform status quo. They more closely align the policy goals of the preference statute with its practical application and should empower creditors to resist abusive preference actions more effectively. <b>TOPICS:</b>Private equity, financial crises and financial market history

Forced to make mistakes: Reasons for complaining about Bebchuk's scheme and other market-oriented insolvency procedures

Bebchuk's proposal for bankruptcy reform is analysed, in particular his claim that using options is fair and prevents justified complains. However, the proposal has a systematic bias against junior creditors and former shareholders because they have to pay for unavoidable mistakes in estimating the company's value, may lack the financial resources to exercise their options and lose by a day of reckoning. A market solution will be specified that is simpler and at least as fair as Bebchuk's scheme according to his own standards. However, a complete solution to these problems may have to be a non-market one.

Adjusting the Rules: What Bankruptcy Reform Will Mean for Financial Market Contracts

Most of the commentary written on the recent Bankruptcy Reform Act (The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005) has focused on provisions that will make bankruptcy less appealing for individuals. However, the Bankruptcy Act also contains important provisions that determine how financial market contracts are handled when a market participant goes into bankruptcy. These provisions, designed to update, clarify and strengthen the existing laws pertaining to financial contracts, will have far reaching implications for a wide variety of financial market participants, including banks and the Federal Deposit Insurance Corporation (FDIC) itself. The 2005 Bankruptcy Act promises to significantly improve the efficiency of the business bankruptcy process by harmonizing the treatment of financial contracts across the spectrum of bank and non-bank market participants and instruments. It does so by revising and amending a number of previous statutes (including the Bankruptcy Code, FIRREA (1989) and FDICIA (1991)) that currently govern these matters. The most important result of these changes is an improved ability of creditors under certain financial contracts to quickly resolve claims against bankrupt debtors by employing what is known as close-out netting. This ability to terminate financial contracts, determine a net amount due, and liquidate any pledged collateral is a valuable tool in minimizing losses in receivership and reducing the disruptions that result from the bankruptcy process. An equally important feature of the changes is that it clarifies and strengthens the FDIC's ability to resolve a failing bank involved in the financial markets. The past twenty-five years have been marked by a proliferation of new institutional players and ever-increasing complexity in financial instruments. These changes have led to a growing recognition that legal structures governing the disposition of financial market contracts in bankruptcy also needed to be updated. In the past, changes in how such contracts were handled were made in different statutes at different times creating inconsistencies, as well as persistent uncertainties as to how a given instrument might be handled in bankruptcy. By bringing more consistency and certainty to this process, the Bankruptcy Reform Act promises to reduce the risk that a bankruptcy will create systemic instability, which could affect individuals as well as financial institutions. To the extent that these changes allow financial market participants to more effectively manage market risks, they will also help to promote greater efficiency in the operation of U.S. financial markets.