Punishment or Forgiveness? Loan Modifications in Private Label Residential Mortgage Backed Securities from 2008-2014

Thomas Herndon estimates the extent to which modifications of privately securitized mortgages increased or forgave debt during the Great Recession and aftermath, from 2008-2014. He finds that loan modifications weakened household balance sheets by adding $20 billion to household debt, with the net amount of debt added per modification doubling from 2010-2014. Using a decomposition analysis, he also finds that the increase in debt is consistent with capitalization of fees. Capitalization of fees is significant, because it has been associated with a principal-agent problem between investors and mortgage servicers which prevented efficient loss mitigation, as well as consumer financial protection abuses.

Abstract

I estimate the extent to which modifications of privately securitized mortgages increased or forgave debt during the Great Recession and aftermath, from 2008-2014. I find that loan modifications weakened household balance sheets by adding $20 billion to household debt, with the net amount of debt added per modification doubling from 2010-2014. Using a decomposition analysis, I also find that the increase in debt is consistent with capitalization of fees. Capitalization of fees is significant because it has been associated with a principal-agent problem between investors and mortgage servicers which prevented efficient loss mitigation, as well as consumer financial protection abuses.

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