Mortgage Modification Activity—Recent Developments
This very detailed article focuses on recent trends in modification activity in the non-agency securitization market. The authors focus primarily on two trends: the increased share of principal reduction modifications and the increased share of second and subsequent modifications. They show that principal reductions result in higher modification success rates than other modification types, even controlling for pay relief. They also show that second and subsequent modifications have higher re-default rates than first modifications. Finally, the authors focus on the variations in modification activity and modification success rates among subprime servicers.
Household Debt Overhang and Labor Supply
For households with homes worth less than the mortgage I test the effect of “household debt overhang” on their labor supply decisions. I utilize a new transaction-level dataset with comprehensive information on assets, liabilities, and deposits for all customers of a major U.S. financial institution from 2010-2014. I then exploit plausibly exogenous variation in the timing of home purchases among households in the same region and time as an instrument for the probability of negative home equity and find that negative equity causes a 2%-6% reduction in household labor supply. These results are robust to the inclusion of time-varying national cohort fixed effects as well as using a life-event driven proxy for the timing of home purchase based on the date of college attendance. Income-contingent loss mitigation creates implicit marginal tax rates that provide a plausible channel by which household debt overhang acts. Consistent with this explanation I find that the labor supply decline is larger in regions where mortgage modifications are more prevalent, even if foreclosures occur less frequently. Taken together these results provide evidence that the moral hazard problem caused by mortgage debt overhang can exacerbate employment declines and highlights the potential unintended consequences of mortgage assistance programs.
Dimensioning the Housing Crisis
The author argues that more than one borrower in every five could face foreclosure absent stronger policy measures. The solution is to (1) reduce the housing supply through a modification program that explicitly addresses negative equity and (2) increase housing demand by expanding the availability of credit to investors. With the apparent stabilization of home prices and the increase in existing-home sales, many investors believe that the housing market has bottomed and is beginning to recover. I believe that such optimism is premature. To be sure, there are many positives in the housing market: Prices have fallen significantly, housing is more affordable now than at any time in the past two decades, and the tax credit for first-time homebuyers has helped spur purchasing. Investors, however, are overlooking two critical factors: (1) the size of the “housing overhang” (i.e., the number of loans in delinquency or foreclosure) and (2) the borrowers with negative equity who are likely to default. I argue that the solution to the current housing crisis is to (1) reduce the housing supply through a modification program that explicitly addresses negative equity and (2) increase housing demand by expanding the availability of credit to investors.