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Market-based loss mitigation practices for troubled mortgages following the financial crisis

Author

Listed:
  • Sumit Agarwal
  • Eugene Amromin
  • Itzhak Ben-David
  • Souphala Chomsisengphet
  • Douglas D. Evanoff

Abstract

The meltdown in residential real-estate prices that commenced in 2006 resulted in unprecedented mortgage delinquency rates. Until mid-2009, lenders and servicers pursued their own individual loss mitigation practices without being significantly influenced by government intervention. Using a unique dataset that precisely identifies loss mitigation actions, we study these methods—liquidation, repayment plans, loan modification, and refinancing—and analyze their effectiveness. We show that the majority of delinquent mortgages do not enter any loss mitigation program or become a part of foreclosure proceedings within 6 months of becoming distressed. We also find that it takes longer to complete foreclosures over time, potentially due to congestion. We further document large heterogeneity in practices across servicers, which is not accounted for by differences in borrower population. ; Consistent with the idea that securitization induces agency conflicts, we confirm that the likelihood of modification of securitized loans is up to 70% lower relative to portfolio loans. Finally, we find evidence that affordability (as opposed to strategic default due to negative equity) is the prime reason for redefault following modifications. While modification terms are more favorable for weaker borrowers, greater reductions in mortgage payments and/or interest rates are associated with lower redefault rates. Our regression estimates suggest that a 1 percentage point decline in mortgage interest rate is associated with a nearly 4 percentage point decline in default probability. This finding is consistent with the Home Affordable Modification Program (HAMP) focus on improving mortgage affordability.

Suggested Citation

  • Sumit Agarwal & Eugene Amromin & Itzhak Ben-David & Souphala Chomsisengphet & Douglas D. Evanoff, 2011. "Market-based loss mitigation practices for troubled mortgages following the financial crisis," Working Paper Series WP-2011-03, Federal Reserve Bank of Chicago.
  • Handle: RePEc:fip:fedhwp:wp-2011-03
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    References listed on IDEAS

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    1. Adelino, Manuel & Gerardi, Kristopher & Willen, Paul S., 2013. "Why don't Lenders renegotiate more home mortgages? Redefaults, self-cures and securitization," Journal of Monetary Economics, Elsevier, vol. 60(7), pages 835-853.
    2. Christopher L. Foote & Jeffrey C. Fuhrer & Eileen Mauskopf & Paul S. Willen, 2009. "A proposal to help distressed homeowners: a government payment-sharing plan," Public Policy Brief, Federal Reserve Bank of Boston.
    3. Piskorski, Tomasz & Seru, Amit & Vig, Vikrant, 2010. "Securitization and distressed loan renegotiation: Evidence from the subprime mortgage crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 369-397, September.
    4. Foote, Christopher L. & Gerardi, Kristopher & Willen, Paul S., 2008. "Negative equity and foreclosure: Theory and evidence," Journal of Urban Economics, Elsevier, vol. 64(2), pages 234-245, September.
    5. John Y. Campbell & Stefano Giglio & Parag Pathak, 2011. "Forced Sales and House Prices," American Economic Review, American Economic Association, vol. 101(5), pages 2108-2131, August.
    6. Lawrence R. Cordell & Karen E. Dynan & Andreas Lehnert & J. Nellie Liang & Eileen Mauskopf, 2009. "Designing loan modifications to address the mortgage crisis and the making home affordable program," Finance and Economics Discussion Series 2009-43, Board of Governors of the Federal Reserve System (U.S.).
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    Citations

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    Cited by:

    1. Fang, Hanming & Kim, You Suk & Li, Wenli, 2016. "The dynamics of subprime adjustable-rate mortgage default: a structural estimation," Working Papers 16-2, Federal Reserve Bank of Philadelphia.
    2. Andreas Fuster & Paul S. Willen, 2017. "Payment Size, Negative Equity, and Mortgage Default," American Economic Journal: Economic Policy, American Economic Association, vol. 9(4), pages 167-191, November.
    3. Janice Eberly & Arvind Krishnamurthy, 2014. "Efficient Credit Policies in a Housing Debt Crisis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 49(2 (Fall)), pages 73-136.
    4. Maximilian D. Schmeiser & Matthew B. Gross, 2016. "The Determinants of Subprime Mortgage Performance Following a Loan Modification," The Journal of Real Estate Finance and Economics, Springer, vol. 52(1), pages 1-27, January.
    5. Tracy, Joseph & Wright, Joshua, 2016. "Payment changes and default risk: The impact of refinancing on expected credit losses," Journal of Urban Economics, Elsevier, vol. 93(C), pages 60-70.
    6. repec:eee:regeco:v:68:y:2018:i:c:p:73-83 is not listed on IDEAS
    7. Karikari, John A., 2013. "Why homeowners’ documentation went missing under the Home Affordable Mortgage Program (HAMP)?: An analysis of strategic behavior of homeowners and servicers," Journal of Housing Economics, Elsevier, vol. 22(2), pages 146-162.
    8. Agarwal, Sumit & Chang, Yan & Yavas, Abdullah, 2012. "Adverse selection in mortgage securitization," Journal of Financial Economics, Elsevier, vol. 105(3), pages 640-660.
    9. Benjamin J. Keys & Tomasz Piskorski & Amit Seru & Vincent Yao, 2014. "Mortgage Rates, Household Balance Sheets, and the Real Economy," NBER Working Papers 20561, National Bureau of Economic Research, Inc.
    10. Janice Eberly & Arvind Krishnamurthy, 2014. "Efficient Credit Policies in a Housing Debt Crisis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 45(2 (Fall)), pages 73-136.
    11. Henri Fraisse & Anne Muller, 2011. "Les commissions de surendettement des ménages : de l’objectif de négociation à la prévention de la rechute," Économie et Statistique, Programme National Persée, vol. 443(1), pages 3-27.

    More about this item

    Keywords

    Asset-backed financing ; Financial crises ; Securities ; Mortgages;

    JEL classification:

    • D10 - Microeconomics - - Household Behavior - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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