Immediate Relief Kept Homeowners Afloat; Long-Term Aid Helped Little

Policy makers had debated which would be more effective, and now data suggest that the former did considerably more to keep homeowners out of foreclosure and boost their overall consumption, according to research by University of Chicago Harris School of Public Policy’s Peter Ganong and Chicago Booth’s Pascal Noel.

HAMP provided payment reductions for the first five years to all participants, and it offered the principal reduction only to certain homeowners. This created a quasi-experimental design, with a control group that did not receive the principal reduction and an experimental group that did. Ganong and Noel focused on modifications performed between October 2010 and March 2015, before HAMP ended in 2016.

Principal reduction lowered default rates by less than 1 percentage point, they find. But that small effect came at significant cost to the government. On the assumption that the banks were unlikely to forgive debt on their own, the government paid them an average of 27 cents for every dollar of principal forgiven. That translated into $10,000 in government spending per principal reduction. The researchers find that the government essentially spent $800,000 on each avoided foreclosure.

“Our data show that mortgage principal reductions, which do not affect short-term payments but substantially reduce long-term obligations, have no significant impact on default or consumption for underwater borrowers,” the researchers write.

Ganong and Noel’s data come from monthly consumer-credit-bureau records that tracked credit-card expenditures and new auto-loan originations, as well as data (scrubbed of identifying information) that incorporated mortgage, credit-card, and checking-account figures for about 30,000 JPMorgan Chase borrowers who received a HAMP modification.

Their analysis suggests that when someone suddenly finds herself short of cash, it can have a significant impact on the likelihood she’ll default on her mortgage, and a sudden loss of income often coincides with missed monthly payments. Yet in terms of credit-card and auto spending, borrowers who received a principal reduction in addition to lowered mortgage payments behaved virtually the same as those who didn’t.

The researchers reason that the short-term payment reductions prompted mortgage holders to spend more, whereas the principal deduction didn’t because it didn’t provide any immediate liquidity.

Homeowners most often default during cases of “double trigger,” when their mortgages are underwater, and they face a negative income shock such as losing a job. The deeper their homes are underwater, the smaller the shock necessary to push them to default. In the wake of the financial crisis, “the borrowers ordinarily most responsive to wealth gains may have found themselves unable to translate increased housing wealth into disposable wealth,” write the researchers.