Less Foreclosures, More Homeowners? Collateral Regimes, Non-Performing Loans and Credit Conditions Less Foreclosures, More Homeowners? Collateral Regimes, Non-Performing Loans and Credit Conditions

By Claire Labonne and Fergal McCann

We show that legal shocks to the collateral value of debt contracts can spill over to other debt portfolios and constrain new debt origination. Using a natural experiment in the Irish mortgage market, we find that lenders responded to an unexpected repossession ruling reducing the value of the collateral on their outstanding mortgages by restricting riskier credit originations. The effect was even stronger when the decision was reversed: when contract enforcement is improved, banks expand their credit risk appetite, and issue loans with substantially weaker credit risk scores, higher loan to value ratios, and higher probabilities of subsequent default or modification. Such cross-portfolio spillovers highlight a trade-off between protecting existing homeowners and allowing new entrants on the mortgage market.