Perverse Incentives from Mortgage Modification

Posted by David Henderson at "EconLog."

"Christopher J. Mayer, Edward Morrison, Tomasz Pikorski, and Arpit Gupta of Columbia University (variously Business School and Law School) find that a mortgage modification program that Countrywide Financial agreed to implement as part of a settlement with U.S. state attorneys general caused more people to become delinquent. Give people an incentive not to pay their mortgage and some of them will decide--not to pay their mortgage.

In a difference-in-difference framework, we estimate the percentage increase in defaults among Countrywide borrowers during the months immediately following the Settlement announcement relative to the percentage increase during the same period among comparable borrowers who were unaffected by the Settlement because their loans were not serviced by Countrywide (the "Control Group"). In regressions controlling for many borrower attributes, including current credit scores and indebtedness, we find a thirteen percent increase in the overall probability that Countrywide 2/28 ARMs loans roll straight from current to sixty days delinquent during the three months immediately after the Settlement announcement (relative to a control group of loans with non-Countrywide servicers). The effect of the Settlement rises to over twenty percent when we subset on borrowers with (i) greater access to liquidity through credit cards and (ii) lower current combined loan-to-value (CLTV) ratios. These borrowers were arguably less likely to default in the near term because they had significant untapped liquidity through their credit cards or some positive equity in their homes.

We also find no effect of the Settlement on default rates among subprime Countrywide borrowers with respect to debts (credit cards, second mortgages) that were not targeted by the Settlement. In fact, Countrywide borrowers exhibit a very large increase in the likelihood of being delinquent on their first mortgage while remaining current on other debts relative to the control group.

The full study is at Christopher J. Mayer, Edward Morrison, Tomasz Piskorski, and Arpit Gupta, "Mortgage Modification and Strategic Behavior: Evidence from a Legal Settlement with Countrywide," NBER Working Paper No. 17065, May 2011.