Foreclosures, Enforcement, and Collections under the Federal Mortgage Modification Guidelines

Casey B. Mulligan

NBER Working Paper No. 15777
Issued in February 2010
NBER Program(s):   EFG   ME   PE

Federal mortgage modification initiatives, targeting millions of borrowers, are intended to prevent foreclosures of underwater home mortgages. Those initiatives discourage principal reductions in favor of interest reductions, despite the possibility that the former would be a more durable foreclosure prevention tool. The programs also impose marginal income tax rates substantially in excess of 100 percent. Using the framework of optimal income taxation, this paper shows how alternative means-tested modification rules would simultaneously improve collections, efficiency, the number of foreclosures, and their total cost. As a result, lenders have an incentive to foreclose on borrowers deemed modification eligible by the federal programs.

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