Mortgage Modification and Strategic Behavior: Evidence from a Legal Settlement with Countrywide
TL;DR: This paper investigated whether homeowners respond strategically to news of mortgage modification programs by defaulting on their mortgages by exploiting plausibly exogenous variation in modification policy induced by U.S. state government lawsuits against Countrywide Financial Corporation, which agreed to offer modifications to seriously delinquent borrowers with mortgages throughout the country.
Abstract: We investigate whether homeowners respond strategically to news of mortgage modification programs by defaulting on their mortgages. We exploit plausibly exogenous variation in modification policy induced by U.S. state government lawsuits against Countrywide Financial Corporation, which agreed to offer modifications to seriously delinquent borrowers with mortgages throughout the country. Using a difference-in-difference framework, we find that Countrywide's relative delinquency rate increased more than ten percent per month immediately after the program's announcement. The borrowers whose estimated default rates increased the most in response to the program were those who appear to have been the least likely to default otherwise, including those with substantial liquidity available through credit cards and relatively low combined loan-to-value ratios. These results suggest that strategic behavior of borrowers should be an important consideration in designing mortgage modification programs.
Figures (5)
Figure 1: Index of Web Searches for the Term “Countrywide Modification,” as Reported by Google Trends 
Figure 2: Probability of Rolling from Current to 60 Days Past Due 
Figure 5: 2/28 ARMs: Current CLTV by Origination Quarter 
Figure 4: 2/28 ARMs: Current Vantage Score by Origination Quarter 
Figure 3: 2/28 ARMs: Current Interest Rate by Origination Quarter
Citations
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TL;DR: This article showed that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the rise in U.S. household leverage from 2002 to 2006 and increase in defaults from 2006 to 2008.
Abstract: Using individual-level data on homeowner debt and defaults from 1997 to 2008, we show that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the rise in U.S. household leverage from 2002 to 2006 and the increase in defaults from 2006 to 2008. Employing land topology-based housing supply elasticity as an instrument for house price growth, we estimate that the average homeowner extracts 25 cents for every dollar increase in home equity. Home equity-based borrowing is stronger for younger households, households with low credit scores, and households with high initial credit card utilization rates. Money extracted from increased home equity is not used to purchase new real estate or pay down high credit card balances, which suggests that borrowed funds may be used for real outlays. Lower credit quality households living in high house price appreciation areas experience a relative decline in default rates from 2002 to 2006 as they borrow heavily against their home equity, but experience very high default rates from 2006 to 2008. Our conservative estimates suggest that home equity-based borrowing added $1.25 trillion in household debt, and accounts for at least 39% of new defaults from 2006 to 2008.
997 citations
Posted Content•
TL;DR: In this paper, the authors used data on house transactions in the state of Massachusetts over the last 20 years to show that houses sold after foreclosure, or close in time to the death or bankruptcy of at least one seller, are sold at lower prices than other houses.
Abstract: This paper uses data on house transactions in the state of Massachusetts over the last 20 years to show that houses sold after foreclosure, or close in time to the death or bankruptcy of at least one seller, are sold at lower prices than other houses. Foreclosure discounts are particularly large on average at 28% of the value of a house. The pattern of death-related discounts suggests that they may result from poor home maintenance by older sellers, while foreclosure discounts appear to be related to the threat of vandalism in low-priced neighborhoods. After aggregating to the zipcode level and controlling for regional price trends, the prices of forced sales are mean-reverting, while the prices of unforced sales are close to a random walk. At the zipcode level, this suggests that unforced sales take place at approximately efficient prices, while forced-sales prices reflect time-varying illiquidity in neighborhood housing markets. At a more local level, however, we find that foreclosures that take place within a quarter of a mile, and particularly within a tenth of a mile, of a house lower the price at which it is sold. Our preferred estimate of this effect is that a foreclosure at a distance of 0.05 miles lowers the price of a house by about 1%.
700 citations
TL;DR: In this article, the authors study how two forces, regulatory differences and technological advantages, contributed to the growth of shadow banks in residential mortgage origination, concluding that traditional banks contracted in markets where they faced more regulatory constraints; shadow banks partially filled these gaps.
584 citations
TL;DR: This article found that people who consider it immoral to default are 77% less likely to declare their intention to do so, while people who know someone who defaulted are 82% more likely to decide to default.
Abstract: We use survey data to study American households’ propensity to default when the value of their mortgage exceeds the value of their house even if they can afford to pay their mortgage (strategic default). We find that 26% of the existing defaults are strategic. We also find that no household would default if the equity shortfall is less than 10% of the value of the house. Yet, 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. Besides relocation costs, the most important variables in predicting strategic default are moral and social considerations. Ceteris paribus, people who consider it immoral to default are 77% less likely to declare their intention to do so, while people who know someone who defaulted are 82% more likely to declare their intention to do so. The willingness to default increases nonlinearly with the proportion of foreclosures in the same ZIP code. That moral attitudes toward default do not change with the percentage of foreclosures in the area suggests that the correlation between willingness to default and percentage of foreclosures is likely to derive from a contagion effect that reduces the social stigma associated with default as defaults become more common.
387 citations
Additional excerpts
...For more details see Mayer et al. (2011)....
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TL;DR: The authors assesses the relative importance of two key drivers of mortgage default: negative equity and illiquidity, with comparably sized marginal effects, and find that negative equity is significantly associated with mortgage default.
Abstract: This paper assesses the relative importance of two key drivers of mortgage default: negative equity and illiquidity. To do so, the authors combine loan-level mortgage data with detailed credit bureau information about the borrower's broader balance sheet. This gives them a direct way to measure illiquid borrowers: those with high credit card utilization rates. The authors find that both negative equity and illiquidity are significantly associated with mortgage default, with comparably sized marginal effects. Moreover, these two factors interact with each other: The effect of illiquidity on default generally increases with high combined loan-to-value ratios (CLTV), though it is significant even for low CLTV. County-level unemployment shocks are also associated with higher default risk (though less so than high utilization) and strongly interact with CLTV. In addition, having a second mortgage implies significantly higher default risk, particularly for borrowers who have a first-mortgage LTV approaching 100 percent.
283 citations
References
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TL;DR: In this article, the authors present the correct way to estimate the magnitude and standard errors of the interaction effect in nonlinear models, which is the same way as in this paper.
5,500 citations
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TL;DR: In this paper, the effects of the level and length of unemployment insurance (UI) benefits on unemployment durations were investigated and individual behavior during the weeks just prior to when benefits lapse.
Abstract: This paper tests the effects of the level and length of unemployment insurance (UI) benefits on unemployment durations. The paper particularly studies individual behavior during the weeks just prior to when benefits lapse. Higher UI benefits are found to have a strong negative effect on the probability of leaving unemployment. However, the probability of leaving unemployment rises dramatically just prior to when benefits lapse. When the length of benefits is extended, the probability of a spell ending is also very high in the week benefits were previously expected to lapse. Individual data are used with accurate information on spell durations, and the level and length of benefits. Semiparametric estimation techniques are used and compared to alternative approaches. The semiparametric approach yields more plausible estimates and provides useful diagnostics.
1,493 citations
"Mortgage Modification and Strategic..." refers background in this paper
...8 See, for example, Meyer (1990) and Krueger and Meyer (2002)....
[...]
TL;DR: In this article, the authors characterize the optimal regulation, which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets, and establish the robustness of their insights when the set of optimal regulations is set.
Abstract: The paper elicits a mechanism by which private leverage choices exhibit strategic complementarities through the reaction of monetary policy. When everyone engages in maturity transformation, authorities haver little choice but facilitating refinancing. In turn, refusing to adopt a risky balance sheet lowers the return on equity. The key ingredient is that monetary policy is non-targeted. The ex post benefits from a monetary bailout accrue in proportion to the number amount of leverage, while the distortion costs are to a large extent fixed. This insight has important consequences. First, banks choose to correlate their risk exposures. Second, private borrowers may deliberately choose to increase their interest-rate sensitivity following bad news about future needs for liquidity. Third, optimal monetary policy is time inconsistent. Fourth, macro-prudential supervision is called for. We characterize the optimal regulation, which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets. We establish the robustness of our insights when the set of
1,124 citations
Additional excerpts
...19 See Tables A.3 and A.4 in the online Appendix....
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...See Countrywide Financial Corporation (2008)....
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...We present our results in Section IV and discuss their implications for mortgage modification policies in Section V. 4 See Farhi and Tirole (2012) and Poole (2009), for example, for the analysis of bailouts....
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...8 See, for example, Meyer (1990) and Krueger and Meyer (2002)....
[...]
...See Agarwal et al. (2012)....
[...]
TL;DR: This article showed that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the rise in U.S. household leverage from 2002 to 2006 and increase in defaults from 2006 to 2008.
Abstract: Using individual-level data on homeowner debt and defaults from 1997 to 2008, we show that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the rise in U.S. household leverage from 2002 to 2006 and the increase in defaults from 2006 to 2008. Employing land topology-based housing supply elasticity as an instrument for house price growth, we estimate that the average homeowner extracts 25 cents for every dollar increase in home equity. Home equity-based borrowing is stronger for younger households, households with low credit scores, and households with high initial credit card utilization rates. Money extracted from increased home equity is not used to purchase new real estate or pay down high credit card balances, which suggests that borrowed funds may be used for real outlays. Lower credit quality households living in high house price appreciation areas experience a relative decline in default rates from 2002 to 2006 as they borrow heavily against their home equity, but experience very high default rates from 2006 to 2008. Our conservative estimates suggest that home equity-based borrowing added $1.25 trillion in household debt, and accounts for at least 39% of new defaults from 2006 to 2008.
997 citations
"Mortgage Modification and Strategic..." refers background or methods in this paper
...See also Mian and Sufi (2011) who examine the role of the home equity-based borrowing channel in the recent crisis using a dataset consisting of individual credit files....
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...Most of our analysis focuses on 2/28 ARMs, a type of loan primarily targeted by the settlement and very common among subprime borrowers (see Mayer, Pence, and Sherlund 2009)....
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Posted Content•
TL;DR: In this paper, the authors used data on house transactions in the state of Massachusetts over the last 20 years to show that houses sold after foreclosure, or close in time to the death or bankruptcy of at least one seller, are sold at lower prices than other houses.
Abstract: This paper uses data on house transactions in the state of Massachusetts over the last 20 years to show that houses sold after foreclosure, or close in time to the death or bankruptcy of at least one seller, are sold at lower prices than other houses. Foreclosure discounts are particularly large on average at 28% of the value of a house. The pattern of death-related discounts suggests that they may result from poor home maintenance by older sellers, while foreclosure discounts appear to be related to the threat of vandalism in low-priced neighborhoods. After aggregating to the zipcode level and controlling for regional price trends, the prices of forced sales are mean-reverting, while the prices of unforced sales are close to a random walk. At the zipcode level, this suggests that unforced sales take place at approximately efficient prices, while forced-sales prices reflect time-varying illiquidity in neighborhood housing markets. At a more local level, however, we find that foreclosures that take place within a quarter of a mile, and particularly within a tenth of a mile, of a house lower the price at which it is sold. Our preferred estimate of this effect is that a foreclosure at a distance of 0.05 miles lowers the price of a house by about 1%.
700 citations
"Mortgage Modification and Strategic..." refers background in this paper
...Because foreclosures may exert significant negative externalities (see, for example, Campbell, Giglio, and Pathak 2011 and Mian, Sufi, and Trebbi 2011), it may be socially optimal to modify mortgage contracts to a greater extent than lenders would select independently....
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...Such foreclosures, however, can yield negative externalities for surrounding communities, as illustrated by Campbell, Giglio, and Pathak (2011) and Mian, Sufi, and Trebbi (2011)....
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