Economic Problems Hinged on 2005 Reform

The Federal Reserve Bank of New York has published a study that states the housing mess can be directly linked to the passage of the 2005 Bankruptcy Abuse Reform, which made it harder for individuals to escape their creditors.

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.

Download the full paper here. It explains in detail how foreclosures increased as a result of that legislation.