The New York Fed is out with a new paper (“Payment Changes and Default Risk: The Impact of Refinancing on Expected Credit Losses”) that shows that reducing monthly mortgage payments “significantly” reduces future default risks. (Abstract follows.) The details of the paper strike me as less interesting than the fact that this basilica of High Finance is arguing that some degree of debt reduction is prudent—bolder than anything that a mainstream politician would ever say. Remember, these are the folks who had David Graeber in recently to talk about debt (and debt forgiveness).
Payment Changes and Default Risk: The Impact of Refinancing on Expected Credit Losses
June 2012 Number 562
JEL classification: G21, G18, R51
Authors: Joseph Tracy and Joshua Wright
This paper analyzes the relationship between changes in borrowers’ monthly mortgage payments and future credit performance. This relationship is important for the design of an internal refinance program such as the Home Affordable Refinance Program (HARP). We use a competing risk model to estimate the sensitivity of default risk to downward adjustments of borrowers’ monthly mortgage payments for a large sample of prime adjustable-rate mortgages. Applying a 26 percent average monthly payment reduction that we estimate would result from refinancing under HARP, we find that the cumulative five-year default rate on prime conforming adjustable-rate mortgages with loan-to-value ratios above 80 percent declines by 3.8 percentage points. If we assume an average loss given default of 35.2 percent, this lower default risk implies reduced credit losses of 134 basis points per dollar of balance for mortgages that refinance under HARP