Association for Public Policy Analysis & Management

Credit markets depend on the fair and speedy enforcement of the contracts between borrowers and lenders.  If lending contracts can be breached without swift remediation, then both borrowers and lenders may refuse to participate in credit markets, leading to underfunding of small businesses and other important restrictions on economic growth (La Porta et al. 1997, 1998).  Banks in areas where courts are quick to resolve mortgage issues may be more likely to lend to prospective homeowners.  In the U.S., civil trials at both the state and federal level are an important though costly mechanism for contract enforcement, and even the credible threat of suing over a breach of contract may improve credit market efficiency.  The credibility of using a lawsuit to redress contract breaches, however, is a function of the efficiency of the judicial system.  In this paper, I examine the causal relationship between bank lending behavior and the speed of judicial resolution of civil disputes.

Recent research on the economic impact of the functioning of the judiciary has focused on developing countries (Dam 2006; Chemin 2009a, 2009b, 2012), long judicial backlogs (Jappelli et al. 2005), or criminal sanctions (Yang 2015).  A common problem across this literature is the difficulty is finding exogenous changes in the supply of judicial services.  I use a fuzzy regression discontinuity strategy based on historical rules used by the Judicial Conference of the United States for recommending the creation of new federal judgeships to compare lending behavior in districts that narrowly received a new judgeship to lending behavior in those that narrowly did not.  I leverage expansions in number of federal district court judgeships in 1999, 2001, and 2002 that relied on these rules to create quasi-random assignment of judgeships to federal districts.  This strategy is designed to avoid potential bias that may arise from using the timing of judicial retirements or appointments made with credit market considerations in mind.  It also permits an additional falsification test of the effectiveness of courts, as lending from out-of-state banks is more likely to be impacted by changes in federal court efficiency than lending from in-state banks.

I obtain data on mortgage lending from Home Mortgage Disclosure Act lender reports and data on small business lending from Community Reinvestment Act lender reports from 1999-2012.  I match individual federal case filing data from the Federal Judicial Center to federal court districts and counties to measure the average time for civil case resolution for every county in the U.S. over the same period.  Preliminary results show that average time for resolution of a federal civil case falls by nearly one-third and that out-of-state lenders increase mortgage originations and small business loans per person and when a new federal judge is appointed.  These results suggest that even within relatively well-functioning judicial systems, increasing the efficiency of contract enforcement mechanisms can increase the willingness of banks to supply credit to home buyers and entrepreneurs.  Future results will explore the impact on the distribution of credit within the housing markets.