Mortgage Loss Severities: What Keeps Them so High?

Abstract

Mortgage loss-given-default (LGD) increased significantly when house prices plummeted during the financial crisis, but it has remained over 40 percent in recent years, despite a strong housing recovery. Our results indicate that the sustained high LGDs post-crisis is due to a combination of an overhang of crisis-era foreclosures and prolonged liquidation timelines, which have offset higher sales recoveries. Simulations show that cutting foreclosure timelines by one year would cause LGD to decrease by 5 to 8 percentage points, depending on the tradeoff between lower liquidation expenses and lower sales recoveries. Using difference-in-differences tests, we also find that recent consumer protection programs have extended foreclosure timelines and increased loss severities despite their potential benefits of increasing loan modifications and enhancing consumer protections.

Keywords: loss-given default (LGD), foreclosure timelines, regulatory changes, Heckman two-stage model, accelerated failure time model

JEL Classification: G21, G18, C41, C24, G01