Borrower Protection and the Supply of Credit: Evidence from Foreclosure Laws

IMF Working Papers, November 26, 2014

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Laws governing the foreclosure process can have direct consequences on the costs of foreclosure and could therefore affect lending decisions.
Exploiting heterogeneity in the judicial requirements across U.S. states and a sample of urban areas straddling state borders, the study examines the impact of foreclosure laws on banks’ lending decisions.
A key identification feature exploits an exogenous cutoff in loan eligibility to GSE guarantees which shift the burden of foreclosure costs onto the GSEs.
Main empirical findings:
- Judicial requirements reduce the supply of credit only for jumbo loans that are ineligible for GSE guarantees.
- These laws do not affect the relative demand of jumbo loans.
- Findings hold using novel nonbinary measures of judicial requirements.
Policy-relevant implication:
- Results illustrate the consequences of foreclosure laws on the supply of mortgage credit and highlight a significant indirect cross-subsidy by the GSEs to borrower-friendly states that has been overlooked thus far.

Research design exploits:
- Heterogeneity in judicial foreclosure requirements across U.S. states.
- Sample focused on urban areas straddling state borders to control for local demand and economic conditions.
- An exogenous cutoff in loan eligibility to GSE guarantees to isolate supply-side effects, since GSE guarantees shift foreclosure cost burdens onto the GSEs.

Subject: Bank credit, Banking, Credit, Financial institutions, Loans, Money, Mortgages, National accounts, Personal income
Keywords: bank characteristic, Bank credit, Borrower protection, Credit, credit supply, foreclosure crisis, foreclosure law, foreclosure laws, foreclosure process, foreclosure timeline, GSE guarantee, GSEs, judicial foreclosure dummy, Loans, mortgage market, Mortgages, Personal income, regulation, WP