Effects of Government Bailouts on Mortgage Modification

Abstract

This paper shows, for the first time, how liquidity infusions from government bailouts affect loan modification in the mortgage market. The design of the Pooling and Service Agreement leads mortgage servicers to prefer foreclosure to modification when the servicers are liquidity constrained. Therefore, a liquidity infusion is expected to boost modification rates. Using a residential mortgage dataset, including loan-level information, we find that liquidity infusions from the Troubled Asset Relief Program significantly increased the modification rate. Our findings help us better understand the economic consequences of government intervention and have important policy implications for the renegotiation of distressed mortgages.

Keywords: loan modification, financial crisis, mortgage, TARP, government intervention, liquidity

JEL Classification: E60, E65, G18, G21, H3