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The Dynamics of Subprime Adjustable-Rate Mortgage Default: A Structural Estimation

Author

Listed:
  • You Suk Kim

    (Federal Reserve Board)

  • Wenli Li

    (Federal Reserve Bank of Philadelphia)

  • Hanming Fang

    (University of Pennsylvania)

Abstract

We present a dynamic model of subprime adjustable-rate mortgage (ARM) borrowers making payment decisions, taking into account delinquency consequences from lenders. We implement the model using data that contain information on borrowers' payment history, broad balance sheets, and lender responses. Our investigation reveals that subprime ARMs are not all alike. For loans originated in 2004 and 2005, neither interest rate resets nor the housing or labor market conditions were as important in borrowers' delinquency decisions as in their payoff decisions. For loans originated in 2006, interest rate resets, housing price declines, and worsening labor market conditions all contributed importantly to high delinquency rates. Counterfactual policy simulations reveal that even if the benchmark interest rate could be lowered to zero, it would have a limited effect on reducing the delinquency rates. We find that automatic modification mortgages with cushions, under which payment reductions are triggered only when housing price declines exceed a threshold, may result in a Pareto improvement, in that borrowers and lenders are better offthan under the baseline. Our counterfactual analysis also suggests that lenders' limited commitment power regarding loan modification policies may be an important reason for the relatively low rate of modifications observed during the housing crisis.

Suggested Citation

  • You Suk Kim & Wenli Li & Hanming Fang, 2016. "The Dynamics of Subprime Adjustable-Rate Mortgage Default: A Structural Estimation," 2016 Meeting Papers 400, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:400
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    Cited by:

    1. Reed, Robert R. & LaRue, Amanda & Ume, Ejindu S., 2018. "Mortgage recourse provisions and housing prices," Regional Science and Urban Economics, Elsevier, vol. 73(C), pages 99-111.
    2. Jason R. Blevins & Wei Shi & Donald R. Haurin & Stephanie Moulton, 2020. "A Dynamic Discrete Choice Model Of Reverse Mortgage Borrower Behavior," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 61(4), pages 1437-1477, November.
    3. Xudong An & Lawrence R. Cordell, 2017. "Regime Shift And The Post-Crisis World Of Mortgage Loss Severities," Working Papers 17-8, Federal Reserve Bank of Philadelphia.

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    More about this item

    JEL classification:

    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • G2 - Financial Economics - - Financial Institutions and Services
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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