B Effect of Payment Reduction on Default

In this section we analyze the effect of payment reduction on borrower default. Using a regression discontinuity empirical strategy, we find that immediate payment reduction with no change in long-term obligations significantly reduces default. Our findings indicate that additional payment reduction is effective irrespective of a borrower’s payment-to-income ratio, which is contrary to the view of affordability that has defined government housing policy since 1937. Furthermore, our findings suggest that the arbitrary income-ratio target embodied in the government program crowded out private bilateral modifications that could have been more generous, and led to fewer defaults, for up to 40% of HAMP borrowers. Finally, we show that by extending mortgage maturities, modifications can be structured so as to reduce defaults in a way that is likely to leave borrowers, investors, and taxpayers better off.