WSJ: Lessons from the Last Housing Crisis and How to Avoid Another
By Maggie Wilson @ Real Estate Daily
December 28, 2017

When the housing market crashed almost a decade ago, many homeowners saw their home’s value fall below what they owed on their mortgage. The federal government reacted with a policy to help reduce amounts of principal owed on many of these mortgages, but the policy was largely unsuccessful and financially inefficient. A new study suggests that in the wake of another crash, the government should focus on temporarily lower homeowners’ mortgage payments.

Key Takeaways

  • About 24% of residential properties with mortgages were underwater by early 2010
  • Federal policy aimed at reducing principal owed was ineffective and financially inefficient
  • Each avoided foreclosure between 2010 and 2016 cost the federal government $800,000
  • Temporarily reducing homeowners’ mortgage payments would have been a better approach


Pascal Noel and Peter Ganong are co-authors of a new working paper at the University of Chicago. They claim that in the wake of another housing crash, the government needs to address federal policy much differently than it did in 2008. The following are excerpts from their interview with The Wall Street Journal:

WSJ: Explain the study?

DR. NOEL: It has always been difficult to tease apart the effect of principal and monthly payment reductions because prior research had studied them together. But we were able to exploit policy variation in the government’s Home Affordable Modification Program, which modified about 1.6 million mortgages between 2009 through 2016.

One group of borrowers, which became our control group, received a modification temporarily reducing their mortgage payments for five years. The second group received the exact same short-term payment reduction, but also received about $70,000 in mortgage principal reduction, writing down, on average, a third of their mortgage balance.

WSJ: What did you find?

DR. NOEL: The principal reduction had no statistically significant effects on borrowers’ short-term default rates. Reducing borrowers’ loan-to-value ratio by about 11 percentage points affected default rates by less than 1 percentage point. That is within the first three years of receiving the modification.

It also had very little effect on consumption. A $70,000 reduction in mortgage principal increased borrowers’ monthly credit-card expenditures by less than $1 and their auto spending by less than $5.

The main message is that underwater borrowers during the financial crisis were much less sensitive to changes in their housing wealth than the average borrower during normal times, and that was very surprising.

WSJ: Why was it so surprising?

DR. NOEL: The link between housing wealth and consumption is very well documented empirically. But we find that relationship completely broke down. In most cases, the mortgage-principal reduction wasn’t enough to bring homeowners above water.

We calculate that if the government spent $4.6 billion—the amount of money it used to subsidize principal reductions during the financial crisis—and used it instead to reduce short-term mortgage payments, the spending response would have been 10 times greater. It would have increased consumer spending by about $1.4 billion.

WSJ: What lessons does the paper suggest in hindsight?

DR. NOEL: The main lesson looking back is that the government would have been better off if it had used the same amount of money to finance deeper reductions in mortgage payments or reduce more borrowers’ monthly payments. Still, writing down mortgage debt before borrowers are underwater might be an effective policy and is worth further investigation.