Wednesday, January 28, 2009

BAPCPA Significantly Contributed to the Mortgage Crisis, According to Federal Reserve Bank of New York Staff Report

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

BAPCPA (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005) substantially "contributed to the surge in subprime foreclosures by shifting risk from credit card lenders to mortgage lenders." That is the conclusion of a Federal Reserve Bank of New York Staff Report called Seismic Effects of the Bankruptcy Reform presented in November (and revised in early March 2009).

BAPCPA significantly increased foreclosures in two ways. First, the means test shifted some bankruptcy filers from Chapter 7 to Chapter 13, overall shifting debtors' post-petition cash flow from mortgage payments to unsecured creditors. Second, the prohibition against cramdowns on vehicles financed less than 910 days before bankruptcy filing made vehicle loans more secure and thus limited funds available for mortgage payments.

Plausibility of the Hypothesis
The authors start with the observation that "the surge in subprime foreclosures that has rocked financial markets came right after the bankruptcy reform in 2005." While acknowledging many other factors in the foreclosure fiasco, they argue that it made perfect sense that "the first overhaul of U.S. personal bankruptcy law in over a quarter century, [one which] made filing bankruptcy much less protective and much more expensive" would have the effect of protecting some classes of creditors while harming others.

The Circumstantial Statistics
The Report presents statistics showing that BAPCPA reduced overall bankruptcy rates, which "under either Chapter [7 or 13] remain lower than one would predict given economic and housing market conditions," and that the ratio of Chapter 7's to 13's has fallen, reflecting a lower relative demand for filing Chapter 7.

Very importantly, BAPCPA "appears to have reversed the historical relationship between
bankruptcy filings, on the one hand, and the relative performance of mortgages and credit loans, on the other." "Relative mortgage performance used to improve when filings increased, consistent with the argument that filers were better positioned to make the mortgage once their credit card and other unsecured debt was discharged, but not so since [BAPCPA]." Indeed, in the years since the amendment, large credit card lenders have had substantial profits while mortgage lenders and those holding mortgage-backed securities have had huge losses and many business failure. (See Harvard Law School Fellow Michael Simkovic's paper, The Effect of 2005 Bankruptcy Reforms on Credit Card Industry Profits and Prices.) Indeed, the former have been buying up the latter, such as Bank of America's purchase of Countrywide and JP Morgan Chase's takeover of Washington Mutual.

From Circumstantial Evidence to Proof of BAPCPA's Effect
Acknowledging that the above statistics could be just coincidental, not necessarily reflecting changes caused by BAPCPA's amendments, the Report creatively found a way to determine causation and even to begin quantifying BAPCPA's adverse effect. The authors used differences in states' property exemption statutes as a means to show that BAPCPA was more likely to induce bankruptcy filers to file Chapter 7 in high home exemption states than in low exemption states. "Intuitively, home owners in low exemption states were less likely to demand Ch. 7, so limiting access is less likely to matter there."

Using mathematical modeling and statistical analysis the Report found the impact of BAPCPA to be significant: "smaller, but of the same order" as that of changes in house value. It roughly predicted an additional 32,000 more subprime foreclosures per quarter nationally as a result of BAPCPA.

The Report contained this disclaimer, noteworthy because the involvement of the Federal Reserve:
"This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in the paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors."

Another Finger Pointing at BAPCPA
As a pertinent aside, in early November I reported on this website about another totally different adverse effect of BAPCPA in my Bulletin titled: At the Extreme of BAPCPA's Unintended Consequences: Did Arcane Provisions of BAPCPA Contribute to the Bear Stearns, Lehman Bros. & AIG Collapses? This Bulletin was based on an article reported in The Financial Times of London, and its primary thesis is summarized in this excerpt from the Bulletin:
By newly exempting credit default swaps and mortgage repurchase agreements from the automatic stay, instruments which Bear Sterns and Lehman Brothers used extensively, creditors of these institutions--such as hedge funds and other financial institutions--no longer had the disincentive that the institutions could file bankruptcy and freeze their transactions and their collateral if they were pushed too hard. These creditors, instead of being normally cautious about settling trades and about forcing these institutions to put up more collateral, became aggressive along these very same lines, which greatly accelerated the credit and liquidity squeeze that led to these institutions' demise.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys