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Before the global financial crisis, the proportion of households defaulting on the mortgage while remaining current on the unsecured loan was almost the same as the proportion of households current on the mortgage but defaulting on the unsecured loan. After the crisis, the former ratio became higher than the latter. By using a heterogeneous agent model with the mortgage and the unsecured loan, I examine how the order of defaults changed before and after the crisis. I then analyze the impacts of unsecured credit policies on households' mortgage and unsecured loan defaults. My quantitative exercise shows that both default rates can decrease as the cost for unsecured loan defaults increases.

We examine how the structure of mortgage modification affects the likelihood that the mortgage redefaults over the next year. We focus on pre-HAMP (Home Affordable Modification Program) subprime modifications where the borrower was seriously delinquent and the monthly payment was reduced. The average redefault rate over the year following the modification is 56%. Redefault rates decline with the magnitude of reduction in monthly payments, and redefault rates decline more when the payment reduction is achieved through principal forgiveness as compared to lower interest rates.

This paper analyzes the roles of corporate governance in bank defaults during the recent financial crisis of 2007-2010. Using a data sample of 249 default and 4,021 no default US commercial banks, we investigate the impact of bank ownership and management structures on the probability of default. The results show that defaults are strongly influenced by a bank’s ownership structure: high shareholdings of outside directors and chief officers (managers with a “chief officer” position, such as the CEO, CFO, etc.) imply a substantially lower probability of failure. In contrast, high shareholdings of lower-level management, such as vice presidents, increase default risk significantly. These findings suggest that high stakes in the bank induce outside directors and upper-level management to control and reduce risk, while greater stakes for lower-level management seem to induce it to take high risks which may eventually result in bank default. Some accounting variables, such as capital, earnings, and non-performing loans, also help predict bank default. However, other potential stability indicators, such as the management structure of the bank, indicators of market competition, subprime mortgage risks, state economic conditions, and regulatory influences, do not appear to be decisive factors in predicting bank default.

The mortgage default decision is part of a complex household credit management problem. We examine how factors affecting mortgage default spill over to other credit markets. As home equity turns negative, homeowners default on mortgages and home equity lines of credit at higher rates, whereas they prioritize repaying credit cards and auto loans. Larger unused credit card limits intensify the preservation of credit cards over housing debt. Although mortgage nonrecourse statutes increase default on all types of housing debt, they reduce credit card defaults. Foreclosure delays increase default rates for housing and nonhousing debts. Our analysis highlights the interconnectedness of debt repayment decisions.

Rapid house-price depreciation and rising unemployment were the main drivers of the huge increase in mortgage default during the downturn years of 2007 to 2010. However, mortgage default was also partly driven by an increased reliance on alternative mortgage products such as pay-option ARMs and interest-only mortgages, which allow the borrower to defer principal amortization. The goal of this paper is to better understand the forces that spurred use of alternative mortgages during the housing boom and the resulting impact on default patterns, relying on a unifying conceptual framework to guide the empirical work. The conceptual framework allows borrowers to choose the extent of mortgage “backloading,” the postponement of loan repayment through various mechanisms that constitutes a main feature of alternative mortgages. The model shows that, when future house-price expectations become more favorable, reducing default concerns, mortgage choices shift toward alternative contracts. This prediction is confirmed by empirical evidence showing that an increase in past house-price appreciation, which captures more favorable expectations for the future, raises the market share of alternative mortgages. In addition, using a proportional-hazard default model, the paper tests the fundamental presumption that backloaded mortgages are more likely to default, finding support for this view. † The views expressed in this paper are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. This paper is available free of charge at http://www.philadelphiafed.org/research-anddata/publications/working-papers.

Using a proprietary database from a large Chinese state-owned bank, we examine whether information evolved from banking relationships predicts commercial loan default by industrial firms. We find that the bank's relationship information is significantly linked to the incidence of default, and that its contribution to prediction accuracy is larger than any hard information. Furthermore, the effect of relationship information is stronger among firms that have a more sustained banking relationship. Our findings indicate that, at least in the emerging markets, a bank's relationship information still matters for large firms, despite the fact that hard information for such firms is abundant.

Sovereign defaults are associated with declines in foreign and domes- tic credit to the domestic private sector. This paper analyzes theoreti- cally whether sovereign defaults can lead to this decline, even if domestic agents do not hold sovereign debt. It also studies whether the quality of domestic …nancial institutions aect the magnitude of this eect. In order to address these issues the paper embeds the traditional sovereign borrower/foreign creditors relationship of the sovereign debt literature in a macro model where widespread individual …nancial constraints limit a country's ability to reallocate resources. The paper …nds that sovereign defaults can indeed generate a decline in foreign and domestic credit even if domestic agents do not hold sovereign debt, and that stronger domestic …nancial institutions can amplify this eect. These …ndings constitute a new step towards understanding the costs of sovereign defaults.

We empirically analyse the appropriateness of indexing emerging market sovereign debt to US real interest rates. We find that policy-induced exogenous increases in US rates raise default risk in emerging market economies, as hypothesised in the theoretical literature. However, we also find evidence that omitted variables which simultaneously increase US real interest rates and reduce the risk of default dominate the hypothesised relationship. We can only conclude that it’s not a good idea to index emerging market bonds to US real interest rates.

A model is developed where firms belonging to a group are obliged to make payments to one another by using a liquid asset. The paper studies the exogenous endowments of this asset that are necessary to assure that all obligations are met. Conditions are presented under which the degree to which firms are interconnected (so that each creditor has more debtors and each debtor has more creditors) increases the number of firms that must be endowed with the liquid asset. Interconnectedness then makes payment defaults more likely. By acquiring too many payment obligations, firms may also become too interconnected.

This paper examines the price reaction of loans relative to bonds prior to and surrounding information intensive events, such as corporate (loan and bond) defaults, and bankruptcies using a unique dataset of daily secondary market prices of loans. Specifically, we find that risk-adjusted loan prices fall more than risk-adjusted bond prices prior to an event, and less than risk-adjusted bond prices of the same borrower during a short time period surrounding an event. This evidence is consistent with a monitoring advantage of loans over bonds. Our results are robust to a different empirical methodology (Vector Auto Regression based Granger causality), and to alternative explanations which control for security-specific characteristics, such as seniority, collateral, recovery rates, liquidity, covenants, and for multiple measures of cumulative abnormal returns.

We examine the role of non-economic partnerships in promoting international economic exchange. Since far-sighted countries are more willing to join costly international partnerships such as environmental treaties, environmental engagement tends to encourage international lending. Countries with such non-economic partnerships also find it easier to engage in economic exchanges since they face the possibility that debt default might also spill over to hinder their non-economic relationships. We present a theoretical model of these ideas, and then verify their empirical importance using a bilateral cross-section of data on international crossholdings of assets and environmental treaties. Our results support the notion that international environmental cooperation facilitates economic exchange.

This paper solves an empirically parameterized model of life cycle consumption, which allows for uncollaterized borrowing and the possibility of default. The simulation results show that: (i) “social stigma” and credit limit have a very large impact on default rates; (ii) education level also has a significant effect on the probability of default, namely, through differences in the shape of lifetime labor income profiles; and (iii) the response of simulated default rates to labor income shocks is determined by the nature of labor income uncertainty (temporary versus permanent). Additionally, the model generates simultaneous consumer holdings of credit card debt and liquid assets.

This paper extends current mortgage pricing models to recognize the impact that delays between default and foreclosure have on the value of default to the borrower and the resulting value of the mortgage to investors. The model explicitly captures potential costs (through postforeclosure deficiency judgments) and benefits (in the elimination of negative equity and 'free' rent) that must be weighed at the time of default in determining whether the ultimate put option (via allowing foreclosure) is in-the-money. The results provide policy implications concerning the operation of the FHA insurance program. Copyright 1997 by Ohio State University Press.

This paper uses option pricing techniques to rationally price mortgage instruments subject to both default and prepayment risk. Attention is given to terminations due to purely financial consideration of the mortgage contract itself, as well as to personally induced terminations. Explicit inclusion of default in the mortgage valuation procedure also permits the valuation of insurance against such default. Qualitatively, it is found that default differs significantly in the behavior from either prepayment or nonfinancial termination. Quantitatively, however, there is significant substitution between prepayment and default, so that the addition of a default feature to the contract has only a modest impact on mortgage values, unless there is substantial price volatility in the housing market or a high loan-to-value ratio. Copyright 1992 by Ohio State University Press.

AN ISSUE OF CONSIDERABLE CONTROVERSY in recent years is whether segmentation exists in the municipal bond market. The presence of market segmentation suggests that securities can be subdivided into distinct groups according to some characteristic and there exists a lack of substitution between these groups on the part of borrowers and/or investors [ 1, 4, 8] . Hendershott and Kidwell [4], for example, found evidence that market segmentation affected yields between regionally and nationally marketed municipal bond issues. Others contend that the municipal bond market is relatively efficient and no permanent segmentation effects can exist [2, 9]. Most recently, Campbell [2] examined possible segmentation resulting from the large acquisitions of municipal securities by commercial banks and found that bank demand for municipal securities had no significant influence on the yield spreads between municipal bonds which differed in default risk, term to maturity, and tax treatment. This is consistent with the argument that the combination of progressive personal income tax rates and fixed corporate income tax rates induces corporations to issue an amount of debt such that the marginal investor in taxable and tax-exempt securities pays taxes at the full corporate rate [9]. If segmentation does not exist, two peculiar features of the term structure of municipal yields cannot be fully explained. For one, municipal yields have almost always increased monotonically with maturity. This is true both for market averages of similarly rated municipal securities and for reoffering yields on individual serial

In Fumio Hayashi's 1987 model of consumption under imperfect capital markets, the Ricardian equivalence theorem holds. This paper shows that Hayashi's result depends on the creditor receiving a positive partial payment when the debtor chooses to default. The specification of a positive partial payment to the creditor when the debtor defaults is inconsistent with evidence on personal bankruptcies. Under the more empirically plausible specification that the creditor may receive nothing if the debtor defaults, the analysis shows the Ricardian equivalence theorem does not hold. Copyright 1989 by Ohio State University Press.

It is the purpose of this note to consider the determinants of contract provisions, in particular those that stipulate possible actions in the event of the breach of the terms in a credit contract. This category of provisions is generally called "creditors' remedies" when used in credit contracts. The use of creditors' remedies, collateral in particular, to reduce the likelihood of loan default has been examined in earlier papers [1,2]. Robert Barro's paper [1, p. 455] in concluding, suggested that "Useful extensions to the model would include generalizations to the form of the loan contract, introduction to other types of transactions, costs, and analysis of the loan period." Although we do not extend Barro's model, we do extend some of his concepts in the direction suggested. In particular we will show that a theory based on nonzero information costs is capable of explaining the observed variation in the form or structure of credit contracts and their use of explicit remedies.

In a recent article, Yair E. Orgler observes that while analytical models have long been developed to screen new loan applications, much less attention has been devoted to the loan review function [1] . While it is of primary importance for a loan officer to ascertain credit quality prior to granting a loan, nonetheless, many apparently qualified borrowers become poor loan risks for reasons that develop subsequent to the granting of the loan. In such cases it is important to identify weak loans as early as possible so that appropriate corrective action can be taken to avoid or minimize losses. In this regard, it is Orgler's stated objective, "to develop a general credit-scoring model for evaluating existing commercial loans," [1, p. 437] . As is customary in statistical studies of credit quality, Orgler defines the dependent variable in qualitative terms and then tests several sets of independent variables to find the set which best discriminates between the groups defined by the dependent variable. While Orgler's statistical methodology appears sound, the definition and justification of his dependent variable is less satisfactory. The dependent variable measures loan quality as being either good or bad based on the judgment of bank examiners. Orgler defends his choice of dependent variable by stating that, "this definition was selected because of data availability and because of the fact that many loans which are eventually paid off are either not profitable or incur a partial loss," [1, p. 438]. He further claims that, "loan classification by examiners is . . . a better indicator of poor quality than actual default," [1, p. 438]. To support this claim Orgler relies on work by Wu, who argues that, "ex post measures of quality such as defaults, losses, and changes in contract terms are the actual credit performance and can only be determined after the event. Ex ante measures, in contrast, are expectations, conditions, or characteristics that would indicate the later actual credit performance," [2, p. 697] . Thus, Wu feels that ex ante measures such as loan examiner ratings of loan quality are superior because they are made prior to loss or default and so give bank management the opportunity to take corrective action. Wu's statement that loan defaults, losses, and changes in contract terms are ex post measures of credit quality is correct. However, the implication that such ex post information is useless to the objective of Orgler's study is incorrect. Loan defaults, losses, and changes in contract terms can become ex ante measures if information which existed at the time the loan was originally granted can be used