How much can government-driven mortgage modification programs reduce the mortgage default rate? I compare an economy without a modification option to one with easy modifications, and evaluate the impact of these loan modifications on the foreclosure rate. Through loan modification, mortgage servicers can mitigate their losses and households can improve their financial positions without having to walk away from their homes. When modifying loan contracts is prohibitively costly, the default rate increases 1.5 percentage points in response to a 2007-style unexpected drop in housing prices of 30%. I calibrate the cost of modification after the financial crisis to match the Home Affordable Modification Program (HAMP) modification rate of 0.68%. My quantitative exercises show that current government efforts to promote mortgage modifications reduce the mortgage default rate by 0.63 percentage points.
"In this dissertation, I study the fallout from the 2007 US housing market crisis and analyze how effective government mortgage-related policies can be in mitigating mortgage defaults. In my introductory chapter, I analyze the heterogeneity in the financial characteristics of households that filed for bankruptcy or defaulted on their mortgage, using the 2007-09 Panel Survey of Consumer Finances. Since different households hold different amounts and varieties of debts, households considering default choose to default on different debts depending on their financial conditions. In chapter 2, I analyze the effectiveness of government-driven mortgage modification programs in reducing mortgage defaults. I compare an economy without the possibility of modification to one with fairly cheap modifications, and evaluate the impact of these loan modifications on the mortgage default rate. Through loan modification, mortgage servicers can mitigate their losses and households can improve their financial positions without having to walk away from their homes. I calibrate the cost of modifying loan contracts based on government spending on modification programs in 2011. My quantitative exercises show that current government efforts to promote mortgage modification are not very successful in reducing mortgage defaults. However, the US government can potentially decrease mortgage defaults by increasing subsidies for such programs. In chapter 3, I analyze households optimal mortgage and unsecured loan borrowing and default decisions in the recent recession. I model households as able to default on mortgage debt to walk away from negative home equity, at the price of foreclosure. A household can also default on unsecured debt (file for bankruptcy) to maintain its home, in exchange for a longer exclusion from credit markets following default. Depending on the costs of each alternative, financially constrained households exhibit heterogeneity in optimal default decisions within the model that parallels the data. Next, I analyze how mortgage loan modification policy affects household choices in the mortgage and unsecured loan markets. My quantitative exercise shows that while mortgage modification policy can be an effective way of reducing mortgage defaults, it can potentially increase the unsecured loan default rate, especially unsecured loan charge-off rates"--Pages v-vi.
Some homeowners might intentionally skip mortgage payments that they can afford to be eligible for mortgage modification programs, such as Home Affordable Mortgage Program (HAMP). We use a natural experiment to investigate such strategic behavior. We find that the modification program not only substantially increases the default rates among borrowers who were current in their loan payments, but also dramatically decreases the cure rate of those already in payment delinquency before the settlement, and the latter venue has been largely overlooked in the literature. Evidence from our base sample indicates that, four months after the modification announcement, modification-induced strategic default is about nine percentage points, on a base default rate of thirty percent. Further, modification-induced strategic defaults appear to be quite widespread and more severe among more risky loans.
During the recent housing recession and financial crisis, mortgage modification has been heavily promoted by government as a way to stabilize the housing and the national banking systems. Numerous programs, such as the Home Owners Preserving Equity (HOPE), Home Affordability Modification Program (HAMP), and Home Affordability Refinance Program (HARP), were introduced or enhanced to allow more aggressive modifications than traditionally observed prior to the crisis. Loan modification is believed to be a way to avoid foreclosure and help borrowers to keep their homes. However, the effectiveness of modification in preventing eventual foreclosure has not been quantified.In this paper, we use FHA modified loans to analyze their re-default risk. We use loan-level data to trace the performance of loans with heavy modifications. We have three major empirical findings. First, the empirical model shows that modified loans tend to have much higher re-default risk than otherwise identical never-defaulted loans. Second, the re-default model shows that re-default hazard is less sensitive to traditional risk drivers, compared with non-modified loans. Third, the re-default risk declines initially with the magnitude of the payment reduction associated with the modification received. However, as the payment reduction becomes substantial, the re-default probability increases. Our empirical results suggest payment reduction is most effective around 10% to 30% level, in order to reduce the re-default risk. The effect is relatively flat between 30% to 40% level. Payment reduction beyond 40% level turned to increase re-default risk, controlling for all observable variables. These findings have profound implications in how lenders may design optimal modification policies.
Takes a skeptical look at a leading argument about what is causing the foreclosure crisis and what should be done to stop it. The authors focus on two key decisions: the borrower's choice to default on a mortgage and the lender's subsequent choice whether to renegotiate or modify the loan. Unaffordable loans, defined as those with high mortgage payments relative to income at origination, are unlikely to be the main reason that borrowers decide to default. The efficiency of foreclosure for investors is a more plausible explanation for the low number of modifications to date. Policies designed to reduce foreclosures should focus on ameliorating the effects of job loss rather than modifying loans to make them more affordable on a long-term basis. Illustrations.
In housing crises, high mortgage debt can feed a vicious circle of falling housing prices and declining consumption and incomes, leading to higher mortgage defaults and deeper recessions. In such situations, resolution policies may need to be adapted to help contain negative feedback loops while minimizing overall loan losses and moral hazard. Drawing on recent experiences from Iceland, Ireland, Spain, and the United States, this paper discusses how economic trade-offs affecting mortgage resolution differ in crises. Depending on country circumstances, the economic benefits of temporary forbearance and loan modifications for struggling households could outweigh their costs.
This is a print on demand edition of a hard to find publication. Servicers have been reluctant to renegotiate mortgages since the foreclosure crisis started in 2007, having performed payment-reducing modifications on only 3% of seriously delinquent loans. This reluctance does not result from securitization: Servicers renegotiate similarly small fractions of loans that they hold in their portfolios. The paper¿s results are robust to different definitions of renegotiation, including the one most likely to be affected by securitization, and to different definitions of delinquency. Redefault risk, the possibility that a borrower will still default despite costly renegotiation, and self-cure risk, the possibility that a seriously delinquent borrower will become current without renegotiation, make renegotiation unattractive to investors. Illus.
