Intervention and Mitigation in the US Mortgage Market: (Re) Negotiation as a Real Option?

UoM administered thesis: Phd

  • Authors:
  • Michael Flanagan

Abstract

Within the context of the 2007/2008 subprime crisis, we examine the impact and relevance of previous ex ante residential mortgage research to prevent and mitigate mortgage default and develop a general taxonomy of (ex-ante) government intervention. We continue by investigating the various forms of (ex-post) default mitigation options prevalent in the United States and innovatively categorise them into one of three categories based on whether the mortgage contract has been renegotiated. We examine the strategic renegotiation option, alongside the more traditional ruthless or strategic default option, for a US owner-occupier residential mortgage holder and non-owner occupier residential mortgage holder uniquely deriving closed form solutions to calculate the optimal ex-ante LTV (Loan to Value) and ex-post exercise moment where a heterogeneous borrower exercises a renegotiation option. We finally relax the perpetual ability to pay assumption underlying strategic default and negotiation to investigate default and negotiation triggered by both an inability to pay and unwillingness to pay. We simulate the overall effect of (institutionalised) renegotiation under these two assumptions, comparing the effect of a stylised HAMP program on the overall default, foreclosure and prepayment probabilities of owner occupied residential homeowners in the absence of a HAMP program. We conclude that the traditional option theoretic assumption that homeowners "can always pay" is a very strong assumption the consequence of which could induce relevant policy makers to incorrectly interpret and act on conclusions and recommendations flowing from historical option theoretic mortgage research.

Details

Original languageEnglish
Awarding Institution
Supervisors/Advisors
Award date31 Dec 2013