Mortgage Modification and Strategic Behavior: Evidence from a Legal Settlement with Countrywide

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-indifference 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.2

Household Debt: Facts, Puzzles, Theories, and Policies

“…), and empirical evidence on whether, how, and how much asymmetric information actually affects market outcomes is finally catching up to theory and practice. Examples include Adams et al (2009) and Dobbie & Skiba (2013) on subprime auto and payday loans, several papers on mortgage securitization (e.g., Keys et al 2010, Bubb & Kaufman 2014, and a growing literature on strategic default by mortgagors (e.g., Mayer et al 2014).…”

Mandatory Mediation and the Renegotiation of Mortgage Contracts

“…We employ a difference‐in‐differences model along the lines of that used by Mayer et al . () in their analysis of the countrywide settlement. We use a linear probability model (LPM) with interaction terms.…”

“…Mayer et al . () show that in response to a court mandated change in mortgage contract terms, borrowers who otherwise would have been unlikely to default stopped making payments to be eligible for more attractive loan terms.…”

Too Little, Too Late, and Too Timid: The Federal Response to the Foreclosure Crisis at the Five-Year Mark

“…Yet, any evidence that delinquencies would increase substantially due to aggressive modifications was thin. In a paper that has been cited as evidence of mortgage modifications encouraging borrowers to become delinquent, Mayer, Morrison, Piskorski, and Gupta (2011) found that even after a major settlement was announced in which delinquent Countrywide borrowers would unilaterally be offered aggressive loan modifications, the proportion of borrowers going from being current to being 60 days delinquent rose only from 4.8% to 5.43%, an increase of 13%. This scale of moral hazard effect would seem to be one that might be easily compensated for by the benefits of reduced foreclosures.…”